On 18 December 2017, the Securities and Futures Commission (SFC) published a consultation paper on proposed amendments to the Code on Unit Trusts and Mutual Funds (UT Code) for a three-month public consultation.
The key areas of change include proposals to provide flexibility and strengthen requirements for a) management companies and trustees/custodians, b) investments, in particular the investment restrictions applicable to plain vanilla products (i.e. Chapter 7 funds) and c) specialised schemes (i.e. Chapter 8 funds). There are also proposals to codify existing practices such as requirements for the general obligations of management companies, eligibility of trustees/custodians, operational matters and streamlined measures for processing scheme changes.
Certain enhanced requirements may have a significant impact on existing funds. For instance, the minimum capital requirement for the management companies of authorised funds will be increased from HK$1 million to HK$10 million. In respect of investments, the investment restrictions applicable to Chapter 7 funds will be strengthened in respect of diversification, illiquid assets, loans and borrowings, financial derivative instruments (FDIs), securities financing transactions (i.e. securities lending, sale and repurchase and reverse repurchase transactions) and collateral.
In order to ensure a level playing field between UCITS funds and all other SFC-authorised funds, the SFC proposes the following new Chapter 7 requirements in respect of FDIs:
a) A fund may acquire any type of FDI for investment purposes subject to an overall derivatives limit of 50% of net asset value (NAV) based on the commitment approach (which focuses on measuring the use of derivatives for investment purposes).
b) Funds which cannot comply with this limit may fall under Chapter 8.9 of the UT Code (which covers funds that invest extensively in FDIs but are subject to a derivatives limit of 100% of NAV based on the commitment approach). Such funds will likely be regarded as “derivative products” under the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) and so subject to enhanced distribution requirements.
c) Funds which cannot comply with the requirements in Chapter 8.9 of the UT Code will be reviewed under Chapter 8.7, which deals with hedge funds.
d) Whilst the SFC intends to maintain the current streamlined measures for processing UCITS fund applications, UCITS funds with FDI investments over 50% of NAV based on the commitment approach will also be regarded as funds investing extensively in derivatives and therefore likely be considered as “derivative products” for the purposes of the Code of Conduct. UCITS funds with FDI investments over 100% of NAV will be subject to a minimum initial subscription by investors of US$50,000.
In addition, all SFC-authorised funds will be required to disclose in their KFS the purpose of, and expected maximum leverage arising from, FDI investments. In light of this and the proposals above, issuers are advised to review their existing funds’ investments in FDIs and the expected maximum leverage, which may impact distribution models.
For specialised schemes, the SFC has proposed to enhance requirements in respect of money market funds, index funds and structured funds. Chapters 8.3 (warrant funds) and 8.4A (futures and options funds) will be removed from the UT Code. Existing futures and options funds, depending on their investment strategies, will be subject to the requirements under Chapter 8.9 or Chapter 8.7 of the UT Code.
Notwithstanding the enhanced requirements, the SFC has proposed amendments to the UT Code to provide flexibility or streamline its requirements. For instance, there is a proposal to provide flexibility to allow managers with a multi-national presence to leverage group resources in meeting the five-year public fund investment management experience requirement. The SFC will consider authorising listed open-ended funds (active ETFs) under a new Chapter 8.10. The SFC may also allow a fund to have both listed and unlisted share classes.
The SFC proposed a 12-month transitional period for compliance with the major amendments by existing SFC-authorised funds. The consultation paper may be accessed via this link. Comments on the proposals should be submitted to the SFC in writing no later than 19 March 2018.