On 15 January 2016, Hong Kong's government gazetted proposed amendments to the Securities and Futures Ordinance to allow for the establishment of open-ended fund companies (OFCs) for both public and private funds. The Securities and Futures (Amendment) Bill 2016 (the Bill) follows from the public consultation conducted in 2014.
Outline of the OFC structure
The Bill largely follows the proposals in the original consultation, with some welcome additional flexibilities. The Bill provides for:
- a company with variable capital
- established under the Securities and Futures Ordinance (SFO)
- regulated and supervised by the Securities and Futures Commission (SFC), and
- registered with, but not licensed by, the SFC
An OFC will be required to:
- delegate all investment management functions to an asset manager holding an SFC type 9 licence
- entrust all assets to a qualifying custodian
- limit its primary investments to those types of investments regulated by the SFO, namely securities and futures, and OTC derivatives once the new OTC regime is in force – a 10% de minimis limit has been included for other types of investments
- comply with an OFC Code, to be the subject of a future consultation, whether the OFC is publicly or privately offered
- have at least two directors
Changes from the original consultation
The Bill includes several changes from the original proposals that add flexibility to the OFC structure:
- as noted above, a 10% de minimis limit has been included to permit an OFC to invest in investments that are not regulated by the SFO
- the requirement to appoint a Hong Kong custodian has been removed; it will now be possible to appoint a custodian either in Hong Kong or overseas, so long as various eligibility criteria are met
- the requirement that an OFC have at least one Hong Kong-resident director has been removed
Publicly offered OFCs, which are required to be authorised by the SFC in the ordinary course, will enjoy a level playing field with existing authorised funds in terms of tax concessions: the existing profits tax exemption for public funds will apply to publicly offered OFCs.
For privately offered OFCs, the government recognises the importance of tax considerations in deciding where a fund is to be domiciled. Initially, the profits tax exemption will be available under the existing regime for offshore funds provided the OFC's central management and control is located outside Hong Kong. However, the government has also indicated that it will further review the existing profits tax exemption with a view to placing onshore privately offered OFCs on a level playing field with offshore privately offered OFCs.
As currently envisaged, a transfer of shares in an OFC will be subject to stamp duty.
We anticipate the OFC structure is likely to be more attractive to retail fund managers initially, given retail funds are already subject to SFC regulation and the existing profits tax exemption for public funds will apply to publicly offered OFCs. Retail fund managers will be keen to understand how the OFC Code will work with the existing Code on Unit Trusts and Mutual Funds.
For the private funds industry, much depends on the nature of the registration process, the supervisory approach adopted by the SFC and the detail of the OFC Code, to be the subject of a separate consultation. At least initially, the restrictions on investment scope, the tax uncertainty and the higher regulatory burden as compared to various offshore jurisdictions that are typically used by Hong Kong fund managers for private funds mean take-up of the OFC structure for private funds is likely to be subdued.