On 1 July 2015, two significant developments in the Asian funds space will come into effect. Hong Kong’s Mutual Recognition of Funds Scheme (MRF) with the PRC will – for the first time – allow international managers to distribute their funds to domestic Mainland Chinese retail investors, after such funds have been registered by the local Chinese Securities Regulatory Commission (CSRC). Also, the existing (low profile) Hong Kong-Australia Mutual Recognition Scheme (MRS) will receive a shot in the arm.
Hong Kong – PRC MRF
The regulators’ broad framework for MRF, applicable to retail funds domiciled in either jurisdiction that wish to take advantage of the MRF, stipulates that each fund must:
- be domiciled, registered and operated in Hong Kong or the PRC, as the case may be (home jurisdiction);
- have a manager that is appropriately licensed to operate in the home jurisdiction, without a major disciplinary record in the home jurisdiction for the preceding three years;
- have a track record of at least one year;
- have a minimum AUM of RMB 200 million (approximately USD 32.3 million);
- be a “plain vanilla” equities or bond fund;
- not be more than 20% invested in the other (host) jurisdiction; and
not have more than 49% of its issued shares held by local residents in the host jurisdiction.
These requirements are set out in the CSRC’s “Provisional Rules for Recognised Hong Kong Funds” and the Hong Kong Securities and Futures Commission’s (SFC) “Circular on Mutual Recognition of Funds between the Mainland and Hong Kong”. The regulators have indicated that more than 800 Mainland China-domiciled funds are ready to become registered in Hong Kong for distribution to retail investors. Conversely, about 100 Hong Kong-domiciled and authorised funds are appropriately eligible to apply to be registered in Mainland China under the MRF.
However, before the applications can be submitted, the regulators must provide greater clarity and detail on eligibility requirements and operational issues to overcome potential stumbling blocks (including the current prohibition against delegation of the investment management function outside Hong Kong, and the potential exposure to PRC tax for Hong Kong-based retail investors investing into eligible PRC funds).
Hong Kong – Australia MRS
Currently, Australian investors in offshore funds face fairly stiff tax disadvantages – a burden shared by international investors investing into Australia. As a consequence, the existing mutual recognition of funds agreement entered into by Hong Kong and Australia in 2007 has never taken off in either jurisdiction. However, after a number of unsuccessful attempts, Australia’s prohibitive tax laws will be relaxed as of 1 July 2015, with the introduction of a safe harbour for “widely held” offshore funds that are distributed in Australia that will create an exemption from Australian profits tax. This will go a long way to make it more attractive for Australian investors to invest in such offshore funds, and for international investors to invest in Australia.
The MRS’ eligibility requirements for Hong Kong-authorised funds wishing to be distributed in Australia, and, conversely, for registered Australian-based funds to be distributed in Hong Kong, are very similar to the applicable requirements under the HK-PRC MRF, except for some adjustment to the applicable value thresholds and limits.
It is anticipated that the significant improvement to Australia’s federal tax laws with effect from 1 July should encourage the flow (in both directions) of mutually recognised funds under the HK-Australia MRS.
Potential Challenges to the Successful Implementation of a Mutual Recognition of Funds Scheme
The most significant challenges to the successful implementation of a mutual recognition scheme, as identified by industry players in Hong Kong, relate to distribution, tax issues and delegation.
Without a successful local distribution network and a strong local partner in the host jurisdiction, it will be difficult to achieve the commercial success that the scheme could bring. Home jurisdiction fund issuers and managers obviously also need to ensure that their product can stand out from the pack sufficiently to merit (i) shelf space with the local distributor and (ii) appeal to the targeted prospective investors.
As has been evidenced by the example of the Australian tax regime, the entire scheme can be scuttled by prohibitive tax restrictions, notwithstanding what may otherwise be a good framework for mutually recognising foreign funds. With respect to other jurisdictions, Thai withholding tax issues are currently a hurdle to the smooth implementation of the ASEAN CIS Framework; and South Korea must ensure that its domestic tax restrictions are eased in time to not hinder the introduction of the Asia Region Funds Passport (in which South Korea will participate), targeted for late 2016.
Prohibition against Delegation
The HK-PRC MRF currently prohibits any delegation of investment discretion away from the HK-domiciled and licensed manager of the HK-domiciled and authorised fund – a source of concern for a number of the “eligible HK-domiciled unit trusts” whose de facto portfolio managers do not sit in Hong Kong. This is but one issue where clarity is being sought from the regulators. Pragmatic industry players are taking the approach that the regulations do not prohibit the delegation of non-discretionary investment advisory services to an entity that is based outside Hong Kong.
Both the SFC and the CSRC will accept applications for MRF (in their respective jurisdictions) from 1 July 2015. The regulators’ processing of each application is expected to take anywhere from three to six months. Notwithstanding the further guidance needed from the regulators on certain aspects of MRF, the race is definitely now on – by fund houses on both sides of the border in Hong Kong and Mainland China – to be among the first movers to have a fund registered under MRF.
MRS is expected to have a more subdued welcome on 1 July 2015, but is no less a move in the right direction to increase the flow of funds and investments between Hong Kong and Australia.