Internal Controls for Family Offices
As family offices, whether single-family or multi-family, handle vast amounts of wealth across a range of asset classes, having effective internal compliance, governance, and operating processes/designs is therefore crucial to operate properly.
The distinction between single-family office (“SFO”) and multi-family office (“MFO”) is that the former does not need any Securities & Futures Commission (“SFC”) regulated activity license (including a Type 9 Asset Management license) as it is not ‘carrying on’ any business of asset management in performing their roles and functions for the Family Group; as such, SFO entities are often wholly (or at least largely) owned by the Family Group which they serve, whereas MFOs may be wholly independent from their Family Group clients.
Typically, the relationship between the family-owned investment holding vehicle (‘FIHV’) and the SFO / MFO will be governed by the investment management agreement which sets out the following:
* investment mandate that includes strategy, objectives and restrictions
* scope of discretionary power
* duties of the family office
* limitation of liabilities
* conflict of interest
* fee structure
The investment mandate – strategy and objectives and restrictions, essentially governs investment and trading activities, family offices therefore need to be equipped with the appropriate structure and procedures to operate effectively and to make certain the investment mandate is executed. The structure and procedures include:
Complete due diligence should be conducted to assess the potential investment, particularly for private equity investment, where (i) initial due diligence prior to investing and (ii) continuous due diligence to be conducted on an annual basis. The exercise should cover areas such as:
- operational feasibility and resilience – to consider the effectiveness of the overall operation;
- legal, risk and compliance – to make sure policies and procedures in place are compliant with the relevant rules and mitigate risks of non-compliance; and
- financial and tax considerations – to monitor the performance of the investment and determine whether to divest or continue to hold the investment.
Effective robust risk management policies and procedures are needed to identify, assess, manage, monitor, and possibly mitigate risks, such as market risk, credit risk, liquidity and operational risks associated with investments, operations and compliance issues.
Regular monitoring of the investment portfolio is needed to ensure that investments do not deviate from the investment mandate. A dedicated investment team (if any) should report to the Family Office regularly on portfolio performance and risk metrics, and review and adjust the portfolio’s asset allocation and risk exposure accordingly.
In monitoring investment performance and returns, there is a need to establish valuation policies and procedures, which set out the valuation methodologies of the assets, the frequency of valuations and dealing frequency of the FIHV.
Such valuation policies should be reviewed routinely to ensure their continued appropriateness and effective implementation.
Where a Family Office arranges the appointment of a third party to perform valuation services, prudence needs to be exercised during selection of the third party, as well as making sure the third party’s activities are periodically reviewed.
Policies and procedures are required to be in place to comply with relevant anti-money laundering (‘AML’) and know-your-customer (‘KYC’) rules, including customer risk assessment, report of suspicious transactions, provision of training to staff, record keeping, and ongoing monitoring of accounts.
While it is possible to delegate AML function to a third party, the family office should monitor its activities routinely as outsourcing controls.
Recordkeeping and reporting
It is critical in maintaining accurate and complete records of all transactions, financial statements and investment information. Records are required for tax purposes as well as ensuring the intra-group exemption applies, where no license is required for a firm providing asset management services to its related entities. Accepting third-party money may disqualify the Family Office from being able to rely on the intra-group exemption, therefore issues arising from the books require appropriate remediation in a prompt manner.
Compliance framework and monitoring program are needed to govern family office operations. Those offices that are regulated by the SFC should operate in a more cautious approach, with the below issues and disclosures required under the SFC’s Fund Manager’s Code of Conduct:
- conflicts of Interests
- gift and entertainment monitoring
- handling of client money/assets
- professional investor assessment
- disclosure of Interests, Substantial Shareholding Reporting, Short Position Reporting
- staff members’ personal account dealing
- fit and proper assessment
- breach/compliant handling
The sustainability of family wealth is achieved with effective succession planning which minimizes disputes over management and ownership of family assets.
Governance structures that clearly define the roles and responsibilities of family members in management and supervision of wealth should be in place. The inclusion of a family council or board of directors in the governance structure helps to establish stability in the family office’s operations and succession planning process.
Moreover, there should be contingency plans to ensure continuity of operations in the event of unexpected events such as the death or incapacity of key family members.
These best practices provide all Family Offices with the ingredients to ensure wealth management is effective and compliance is achieved while winning the trust of clients and stakeholders. Family Offices can reach out to professional business services and auditing firms for prompt assistance.