Fund management regulation

Regulatory framework and authorities

How is fund management regulated in your jurisdiction? Which authorities have primary responsibility for regulating funds, fund managers and those marketing funds?

Fund management in Hong Kong is primarily regulated under the Securities and Futures Ordinance (SFO). The SFO empowers the Hong Kong Securities and Futures Commission (SFC) to regulate fund management activities, to authorise collective investment schemes (funds) and also regulate offers of securities (including collective investment schemes as widely defined). Specifically, the Companies (Winding Up and Miscellaneous Provisions) Ordinance (CWUMPO) governs the offer of shares in the Hong Kong corporate structure.

The SFC is the main regulator for authorising retail fund products, licensing fund managers and supervising the conduct of intermediaries in the offer and marketing of fund products. The SFC issues various handbooks, codes, guidelines and frequently asked questions (FAQs) containing requirements and expected standards of conduct that licensed fund managers or other intermediaries or market participants are subject to. The SFC Code on Unit Trusts and Mutual Funds (the UT Code) is the main code governing the authorisation and ongoing requirements applicable to retail funds, while licensed fund managers are further subject to the SFC Fund Managers Code of Conduct (FMCC), as well as the SFC Code of Conduct for Persons Licensed by or Registered with the SFC (the Code of Conduct).

Fund administration

Is fund administration regulated in your jurisdiction?

Fund administration providers do not require a specific licence and are not directly regulated. However, some of these support services are considered the responsibility of the fund manager, and as such, the fund manager should exercise due care in selecting providers or outsourcing, and would bear the ultimate responsibility.

Authorisation

What is the authorisation or licensing process for funds? What are the key requirements that apply to managers and operators of investment funds in your jurisdiction?

Retail funds need to be authorised by the SFC before they can be offered to the public in Hong Kong. Funds not offered to the public and only for private placement do not need to be authorised.

A Hong Kong fund manager would require an SFC licence for conducting the Type 9 regulated activity of asset management, whether as a manager of private funds or retail funds. However, additional requirements apply under the UT Code in order for managers to qualify as managers of retail funds, as outlined in question 16. The UT Code also contains specific requirements on the trustee or custodian of retail funds, as described in question 16.

Marketing and distribution of funds (whether retail or not) would require an SFC licence for conducting the Type 1 regulated activity of dealing in securities.

Territorial scope of regulation

What is the territorial scope of fund regulation? Can an overseas manager perform management activities or provide services to clients in your jurisdiction without authorisation?

The SFO governs fund products offered in Hong Kong, or targeted to the Hong Kong public, or the conduct of businesses relating to regulated activities in securities or futures that is carried out in Hong Kong.

An overseas manager cannot perform management activities in Hong Kong or actively market services to clients in Hong Kong without being properly licensed by the SFC for the conduct of relevant regulated activities.

Acquisitions

Is the acquisition of a controlling or non-controlling stake in a fund manager in your jurisdiction subject to prior authorisation by the regulator?

Yes. Fund management constitutes a Type 9 regulated activity of asset management, and, as such, fund managers need to hold such licence, approved by the SFC, before business can be conducted in Hong Kong. The prior approval of the SFC is required before one may become a substantial shareholder of a licensed entity.

A person is a ‘substantial shareholder’ in relation to a corporation if he or she:

  • either alone, or with any associates, has an interest in shares in the corporation:
    • of which, the aggregate number is equal to more than 10 per cent of the total number of the corporation’s issued shares; or
    • that entitles the person, either alone, or with any associates, and either directly or indirectly, to exercise or control the exercise of more than 10 per cent of the voting power at general meetings of the corporation; or
  • holds shares in any other corporation that entitles him or her, either alone, or with any associates, and either directly or indirectly, to exercise or control the exercise of 35 per cent or more of the voting power at general meetings of the other corporation, or of a further corporation, which is itself entitled, either alone or with any of its associates and either directly or indirectly, to exercise or control the exercise of more than 10 per cent of the voting power at general meetings of the corporation.
Restrictions on compensation and profit sharing

Are there any regulatory restrictions on the structuring of the fund manager’s compensation and profit-sharing arrangements?

The structuring of fund managers’ compensation and profit-sharing arrangements are not subject to specific regulatory restrictions, but consideration should be given to general principles, such as avoiding conflicts of interest and taking into account any relevant tax implications. If the fund manager’s compensation and profit-sharing arrangement is in relation to an SFC-authorised retail fund, then disclosure would need to be made in such retail fund’s offering documents.

Fund marketing

Authorisation

Does the marketing of investment funds in your jurisdiction require authorisation?

Yes. Marketing of investment funds constitutes a Type 1 regulated activity of dealing in securities, and a licence granted by the SFC to conduct such regulated activity is required. A holder of a licence to conduct Type 9 regulated activity in asset management may market the funds under its management as an incidental exemption or unless other exemptions apply subject to relevant conditions.

What marketing activities require authorisation?

Advertisements relating to the offer of SFC-authorised retail funds will need the SFC’s approval before being issued, although when such advertisements are issued by intermediaries licensed by the SFC to conduct the Type 1 regulated activity of dealing in securities, the Type 4 regulated activity of advising on securities or the Type 6 regulated activity of advising on corporate finance, they are exempt from prior authorisation by the SFC. However, if the advertisements relate to certain funds, such as mandatory provident fund schemes and their constituent funds, occupational retirement schemes or insurance contracts, then the SFC’s prior vetting is still required.

Territorial scope and restrictions

What is the territorial scope of your regulation? May an overseas entity perform fund marketing activities in your jurisdiction without authorisation?

The SFO applies to securities and futures business activities carried out in Hong Kong, or from a place outside Hong Kong, directed to persons in Hong Kong.

An overseas entity may not actively market, whether in Hong Kong or from a place outside Hong Kong, to the Hong Kong public, any fund products (as it constitutes a regulated activity), unless it is registered or licensed by the SFC.

In determining what activities constitute ‘active marketing’, the SFC will consider the nature of the business activities as a whole with regard to relevant factors, such as language and currency, and other factors that may be considered relevant - potentially internet activities, websites or online content that target Hong Kong investors.

If a local entity must be involved in the fund marketing process, how is this rule satisfied in practice?

If the overseas manager has a local affiliate or subsidiary in Hong Kong with the relevant licence, such local entity could act as the sponsor to support the overseas manager’s application for a temporary licence, or the local entity could be appointed as the distributor or agent to undertake the licensed fund offering and marketing activities in Hong Kong.

Commission payments

What restrictions are there on intermediaries earning commission payments in relation to their marketing activities in your jurisdiction?

Under the Code of Conduct, intermediaries earning commission payments in the marketing of fund products are restricted from using the term ‘independent’ to describe themselves and, while there is no specific maximum amount of commission that can be earned, at the point of sale, intermediaries must make disclosures regarding the monetary benefits as well as the ongoing commission (trailer fees).

Retail funds

Available vehicles

What are the main legal vehicles used to set up a retail fund? How are they formed?

A Hong Kong domiciled open-ended fund is set up by way of a trust deed governed by Hong Kong law and takes the form of a unit trust. The Securities and Futures (Amendment) Ordinance gazetted in 2016 provides the framework for open-ended investment funds structured in corporate form, and it is now possible to establish a Hong Kong domiciled open-ended fund in the form of an open-ended fund company structure with variable capital. Further detailed rules and requirements are contained in the Open-ended Fund Companies Rules (as a subsidiary legislation of the SFO) (the OFC Rules) and the Code on Open-ended Fund Companies (the OFC Code) issued by the SFC.

However, the UT Code does not restrict the authorisation of retail funds to Hong Kong domiciled funds. Other than Hong Kong domiciled funds, the SFC accepts applications for authorisation of non-Hong Kong domiciled funds or schemes. In addition, overseas-approved schemes may be authorised in Hong Kong, broadly speaking, under two available schemes: recognised jurisdiction schemes (RJS) and schemes to be authorised under mutual recognition of funds (MRF) arrangements.

The majority of RJS are undertakings for collective investment in transferable securities (UCITS) funds domiciled in Luxembourg, Ireland and the United Kingdom, although the current list of RJS also includes United States-registered investment companies, UCITS from France and Germany, Guernsey Class A schemes, certain funds from the Isle of Man and Jersey, Swiss collective investment schemes, and from the Asia-Pacific region, Malaysian Islamic collective investment schemes, Taiwanese exchange-trade index tracking funds and Australian managed investment schemes.

RJS are considered as already complying in substance with certain provisions of the UT Code by virtue of prior authorisation in a recognised jurisdiction, although schemes would still be subject to certain review by the SFC during the authorisation application process, for compliance with certain requirements under the UT Code, including regarding the management company and trustee or custodian of the RJS.

As for MRF, by virtue of Hong Kong entering into mutual recognition arrangements with specific countries or jurisdictions, publicly offered funds in such countries or jurisdictions may be recognised and authorised for offer to the Hong Kong public, subject to specific requirements and application processes. Likewise, Hong Kong funds authorised by the SFC may be registered for public offer in such other countries or jurisdictions. The ‘Mainland-Hong Kong Mutual Recognition of Funds’ initiative was launched in 2015, under which mainland and Hong Kong funds that meet the relevant eligibility requirements may apply for approval and authorisation for offering to retail investors in each other’s market. Under this initiative, more than 40 mainland funds have been authorised by the SFC for retail offer in the Hong Kong market, while more than 10 Hong Kong funds have been registered for retail distribution in the mainland domestic market.

To date, Hong Kong has also entered into respective MRF arrangements with France, Switzerland, the United Kingdom and Luxembourg.

While the above applies primarily to open-ended funds, other fund types, including exchange-traded funds (ETF), real estate investment trusts and closed-ended funds for retail offer, are also subject to authorisation by the SFC for offer to the public in Hong Kong, or to be listed on the Hong Kong stock exchange.

Laws and regulations

What are the key laws and other sets of rules that govern retail funds?

The key legislation governing retail funds include:

  • the SFO;
  • the CWUMPO;
  • the SFC Handbook on Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Products (including the UT Code) (whereas retail funds structured as Hong Kong open-ended fund companies are also subject to the OFC Code); and
  • in respect of funds listed on the Hong Kong stock exchange, the Rules governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (Listing Rules).

As noted in question 1, there are regulatory requirements contained in various handbooks, codes, guidelines and FAQs containing requirements and expected standards of conduct that licensed fund managers or other intermediaries or market participants are subject to. The UT Code is the main code governing the authorisation and ongoing requirements applicable to retail funds, while licensed fund managers are further subject to the FMCC, as well as the Code of Conduct.

Authorisation

Must retail funds be authorised or licensed to be established or marketed in your jurisdiction?

Retail fund products marketed and offered to the Hong Kong public must be authorised by the SFC in accordance with the UT Code, as described in question 3.

If such fund products seek to be listed on the Hong Kong stock exchange, they will be subject to Chapter 20 of the Listing Rules.

Marketing

Who can market retail funds? To whom can they be marketed?

The marketing of retail funds (both open-ended and closed-ended) constitutes a regulated activity, and therefore only persons licensed with the SFC to conduct the Type 1 regulated activity of dealing in securities can carry out such activities.

Retail funds can be marketed to the public in Hong Kong. However, in the offering of fund products, the licensed person should further satisfy suitability and other know-your-customer requirements as set out in the Code of Conduct. In particular, offering of funds that are considered derivatives products would require specific assessment of suitability, including derivatives knowledge of the investor and a more stringent suitability standard.

Managers and operators

Are there any special requirements that apply to managers or operators of retail funds?

Managers of retail funds must satisfy the requirements as set out in the UT Code, which specifies that they must:

  • be engaged primarily in the business of fund management;
  • have sufficient financial resources - in particular, under the revised UT Code effective 1 January 2019, the minimum capital requirement for the management company is increased to HK$10 million (from previously HK$1 million); and
  • not lend to a material extent and maintain at all times a positive net asset position.

The management company is also expected to have at least two key personnel each with at least five years of investment experience managing public funds, although under the revised UT Code, a management company of established fund management groups may use group resources and expertise to meet this requirement.

The managers can be based in Hong Kong or other jurisdictions. If based in Hong Kong, the manager should be licensed for a Type 9 regulated activity of asset management. However, fund managers are not limited to Hong Kong licensed managers, as those regulated in jurisdictions within a list of acceptable inspection regimes (AIR) may be approved by the SFC to act as managers of retail funds, or as delegates to conduct discretionary management of SFC-authorised retail funds. The current AIR list includes, among others, Australia, France, Ireland, Luxembourg, the United Kingdom and the United States. Discretionary investment management functions can be delegated to non-AIR entities only upon the SFC’s prior approval.

The trustee or custodian of a retail fund needs to be acceptable to the SFC and must be one of the following categories of institutions:

  • a bank licensed under the Banking Ordinance of Hong Kong;
  • a trust company registered under Part VIII of the Trustee Ordinance that is a subsidiary of such a bank;
  • a trust company that is a trustee of Hong Kong pension schemes (a registered scheme defined under the Mandatory Provident Fund Schemes Ordinance); or
  • a banking institution or trust company incorporated outside Hong Kong, which is acceptable to the SFC.

Under the revised UT Code, trustees and custodians are subject to enhanced obligations to align with the standards imposed by the International Organization of Securities Commissions, particularly in relation to the appointment of sub-custodians. Further, trustees and custodians are required to appoint an independent auditor to periodically review its internal control and system. Such scope and level of review are expanded and extended.

The manager and the trustee or custodian must be persons independent of each other. If they are within the same group, they will be deemed as being independent of each other if they satisfy certain conditions (neither is the subsidiary of the other, no person is a director of both entities and they must sign an independency undertaking, etc).

Investment and borrowing restrictions

What are the investment and borrowing restrictions on retail funds?

Certain investment and borrowing restrictions apply under the UT Code, depending on the type of retail fund. Core requirements primarily apply to ‘plain vanilla’ (equity or bond) funds, covering spread of investments and diversification limits, restrictions on certain types of instruments or assets and limits on short selling and borrowing. Other requirements apply to specialised schemes, such as money market or cash management funds, unlisted index funds, hedge funds, structured funds, closed-ended funds or funds that invest extensively in derivative instruments.

Tax treatment

What is the tax treatment of retail funds? Are exemptions available?

SFC-authorised retail funds are generally exempt from Hong Kong profits tax.

At the investor level, generally, investors are not subject to Hong Kong tax in respect of distributions or dividends (if the fund is of corporate form) received, or in respect of any capital gains arising from a sale, redemption or disposal of the shares or units of an SFC-authorised retail fund, unless such receipt forms part of a trade, profession or business carried on in Hong Kong and fall to be regarded as profits sourced in Hong Kong.

Asset protection

Must the portfolio of assets of a retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?

The assets of a retail fund must be held by a trustee or custodian; however, there is no requirement to appoint a separate local custodian. As noted in question 16, the trustee or custodian may be a banking institution or trust company outside Hong Kong that meets the requirements of, and is acceptable to, the SFC.

Requirements applicable to the trustee or custodian of the assets of retail funds are described in question 16. Under the UT Code, the trustee or custodian of a retail fund must take into its custody or under its control all the property of the retail fund, register cash and registrable assets in the name of or to the order of the trustee or custodian, and be liable for the acts and omissions of its nominees or agents in relation to assets forming part of the property of the fund.

Governance

What are the main governance requirements for a retail fund formed in your jurisdiction?

Once a retail fund is authorised by the SFC, there are ongoing compliance and reporting requirements under the UT Code. There is also an annual fee payable to the SFC to maintain the authorisation status of a retail fund.

The key facts statement of the retail fund (a summary of key fund features and terms, similar to a key investor information document of a UCITS fund) will need to be updated at least once a year, and reflect changes in the retail fund’s ongoing charges and performance.

Certain scheme changes may require prior approval of the SFC, whereas scheme changes that are not subject to SFC prior approval or are not material in nature may be subject to post-filing requirements.

For example, changes to a retail fund (eg, the addition of share class, change of fund manager or change of benchmark) do not require the SFC’s prior approval. Investors holding interest in such funds should be informed as soon as reasonably practicable of the changes as necessary to enable them to appraise the position of the scheme. The offering document of the fund may be updated and reissued without further authorisation provided the content and format of such document remains fundamentally the same as the version previously authorised, and the revised documents must be filed with the SFC within one week of the date of issuance.

Other changes that would require the SFC’s prior approval, and prior notification to investors before they can take effect, would be changes such as the following, which are of a material nature:

  • changes to constitutive documents;
  • changes to key operators (including trustee or custodian, management company and its delegates and Hong Kong representative of funds established outside Hong Kong) and their regulatory status;
  • changes in investment objectives, policies and restrictions of the fund (including the purpose or extent of use of derivatives), introduction of new fees and charges or increase in fees and charges outside of permitted levels, dealing and pricing arrangements or distribution policy;
  • any other changes that may materially prejudice holders’ rights or interests; and
  • deauthorisation merger or termination of a fund.
Reporting

What are the periodic reporting requirements for retail funds?

Authorised retail funds must publish at least two financial reports each financial year, which are the annual reports and accounts published and distributed to holders within four months of the end of the fund’s financial year, and the interim reports within two months of the period they cover. These reports will need to be filed with the SFC.

Issue, transfer and redemption of interests

Can the manager or operator place any restrictions on the issue, transfer and redemption of interests in retail funds?

There must be at least one regular dealing day per month for retail funds, except for closed-ended funds authorised under the UT Code.

The maximum interval between the receipt of a properly documented request for redemption of units or shares and payment of the redemption money may not exceed one calendar month, unless a substantial portion of the investments is in a market that is subject to foreign currency control. Certain specialised schemes may have a longer maximum interval. Suspended or deferred dealing is allowed only in certain circumstances, such as during massive redemption, and there should be full disclosure in the offering documents on permitted circumstances.

Non-retail pooled funds

Available vehicles

What are the main legal vehicles used to set up a non-retail fund? How are they formed?

A non-retail fund in Hong Kong may be formed as a Hong Kong domiciled unit trust constituted under a trust deed governed by Hong Kong law. The Securities and Futures (Amendment) Ordinance gazetted in 2016 provides the framework for open-ended investment funds structured in corporate form, and it is now possible to establish Hong Kong domiciled open-ended funds in the form of an open-ended fund company structure with variable capital. Further detailed rules and requirements are contained in the OFC Rules and the OFC Code promulgated and issued in 2018.

However, non-retail funds that may be offered in Hong Kong on a private placement basis, primarily to ‘professional investors’, as defined under the SFO, are not restricted to Hong Kong domiciled funds or specific forms. Hong Kong managers may adopt legal vehicles domiciled in other jurisdictions when establishing non-retail funds and quite commonly do, subject to:

  • considering ease and costs of establishment and operation;
  • applicable legal and regulatory requirements in the jurisdiction of the fund domicile;
  • familiarity to investors and other factors that may be relevant under the manager’s or the group’s management and operational structure; and
  • other potential factors, such as tax implications or any proposed registration or listing in any market.
Laws and regulations

What are the key laws and other sets of rules that govern non-retail funds?

Non-retail funds are primarily subject to the SFO regarding offers of securities (including forms of collective investment schemes widely defined) in Hong Kong or to the Hong Kong market, including applicable requirements relating to offers to professional investors. Persons engaged in the business of offering investment funds, including non-retail funds, are required to be licensed by the SFC to conduct the Type 1 regulated activity of dealing in securities, unless any relevant exemption applies.

A Hong Kong manager of non-retail funds is required to be licensed by the SFC to conduct the Type 9 regulated activity of asset management, and is thereby subject to regulation by the SFC in its business of managing the non-retail funds, including applicable requirements under the Code of Conduct and the FMCC.

Authorisation

Must non-retail funds be authorised or licensed to be established or marketed in your jurisdiction?

Non-retail funds are not subject to authorisation or registration requirements in order to be established or marketed in Hong Kong.

Marketing

Who can market non-retail funds? To whom can they be marketed?

As noted in question 24, persons engaged in the business of offering investment funds, including non-retail funds, are required to be licensed by the SFC to conduct the Type 1 regulated activity of dealing in securities, unless any relevant exemption applies.

Non-retail funds should not be offered to the public, and under Hong Kong securities offering laws, an offering is not a public offer where (among other circumstances that may qualify and apply to exclude the offer as a public offer) it can be offered to an unlimited number of professional investors, or to no more than 50 people (not limited to professional investors).

In brief, professional investors refer to institutional investors, such as financial institutions and specific bodies as prescribed in the legislation, or individuals or corporates that meet the relevant minimum net-worth or net assets requirements (broadly speaking, individuals with a portfolio of at least HK$8 million or a corporation or partnership with a portfolio of at least HK$8 million or net assets of HK$40 million).

Ownership restrictions

Do investor-protection rules restrict ownership in non-retail funds to certain classes of investor?

Non-retail funds are typically offered to professional investors only, although, as noted in question 26, it is permitted under Hong Kong law to offer a non-retail fund to no more than 50 people by way of private placement. For non-retail funds of a Hong Kong corporate form, other exemptions apply, such as an offer involving at least HK$500,000 or not exceeding a specific overall size.

Managers and operators

Are there any special requirements that apply to managers or operators of non-retail funds?

A Hong Kong manager of non-retail funds is required to be licensed by the SFC to conduct Type 9 regulated activity in asset management, and is thereby subject to regulation by the SFC in its business of managing the non-retail funds. Non-retail funds that are not managed in Hong Kong are not subject to specific requirements by the SFC, other than the securities offering restrictions and the requirement for persons engaged in the marketing of the non-retail funds to hold a licence by the SFC to conduct the Type 1 regulated activity of dealing in securities.

Effective from November 2018, under the revised FMCC, Hong Kong-licensed managers of non-retail funds are subject to additional specific requirements where the Hong Kong manager is responsible for the overall operation of the fund, specifically covering several areas that are considered risk areas and for managing systemic risks, such as in relation to:

  • general market conduct;
  • securities lending and repurchase agreements;
  • custody;
  • use and disclosure of leverage;
  • liquidity management;
  • risk management;
  • valuation;
  • use of side pockets; and
  • managing conflicts of interest.
Tax treatment

What is the tax treatment of non-retail funds? Are any exemptions available?

Hong Kong has a new profits tax exemption regime effective 1 April 2019, which essentially provides exemption from Hong Kong profits tax for any vehicle that meets the definition of ‘fund’ under the IRO (which mirrors the definition of ‘collective investment scheme’ in the SFO) in respect of ‘qualifying transactions’ and ‘qualifying assets’. Furthermore, the said profits tax exemption requires that the qualifying transactions for the tax exemption are carried out through or arranged by a ‘specified person’, meaning a corporation licensed or registered for carrying out specified regulated activity under the SFO and which would include Hong Kong licensed managers.

Asset protection

Must the portfolio of assets of a non-retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?

Non-retail funds are not subject to specific requirements in Hong Kong regarding custodian or custody of fund assets, as non-retail funds are not under specific regulations in Hong Kong other than as regards the offer of securities or through the regulation of Hong Kong managers of non-retail funds.

Under the revised FMCC effective from November 2018, Hong Kong-licensed managers of non-retail funds are subject to additional specific requirements where the Hong Kong manager is responsible for the overall operation of the fund. Specifically, the revised FMCC introduces specific requirements on the fund manager to exercise due skill, care and diligence in the selection and appointment of the custodian (or trustee, in the case of a unit trust structure) and ongoing monitoring of the performance of the functions of the custodian or trustee. The revised FMCC also sets out in detail the matters that should be taken into account in considering whether a custodian is properly qualified and the expected eligibility of a custodian, as well as containing requirements on the custody agreement and the disclosure of custody arrangements to fund investors.

Governance

What are the main governance requirements for a non-retail fund formed in your jurisdiction?

As non-retail funds are not under specific regulation in Hong Kong other than as regards the offer of securities or through the regulation of Hong Kong managers of non-retail funds, non-retail funds are not subject to specific governance requirements, such as registration, record-keeping or filings.

However, further to the Securities and Futures (Amendment) Ordinance gazetted in 2016 that provides the framework for open-ended investment funds structured in corporate form, and subject to the detailed rules and requirements in the OFC Rules and the OFC Code, non-retail funds to be established as Hong Kong open-ended fund companies are subject to prior approval by the SFC under a registration process and must meet certain key requirements with respect to the manager, the directors, the custodian and other governance requirements.

Reporting

What are the periodic reporting requirements for non-retail funds?

As non-retail funds are not subject to specific regulations in Hong Kong, other than regarding the offer of securities or through the regulation of Hong Kong managers of non-retail funds, they are not subject to specific governance requirements such as registration, record-keeping or filings.

However, under the revised FMCC effective from November 2018, where a Hong Kong-licensed manager is responsible for the overall operation of a non-retail fund, there are additional specific requirements on fund valuation and calculation of net asset value, and on appropriate policies and procedures for valuation of fund assets. The manager is also expected to ensure an independent auditor is appointed to perform an audit of the financial statements of the fund in order to provide audited reports at least annually, to be made available to fund investors.

Separately managed accounts

Structure

How are separately managed accounts typically structured in your jurisdiction?

Separately managed accounts in Hong Kong are structured by the client contractually appointing a Hong Kong-licensed manager to conduct discretionary investment management services and giving authority to direct and manage investments. The portfolio of investments is usually held within the client’s custodian account with a third-party financial institution. If the Hong Kong manager is permitted under its licence to hold client assets, the fund manager is subject to requirements to ensure that client assets are properly safeguarded and to comply with applicable rules under the SFO regarding client money and client assets.

On the other hand, intermediaries, such as securities brokerage, futures or investment firms that hold an SFC licence to conduct the Type 1 regulated activity of dealing in securities or Type 2 regulated activity of dealing in futures contracts, may, if not restricted under any licensing condition, be given specific authority by the client to exercise investment discretion within the terms of the given authority, with the conduct of portfolio management in such situations to be wholly incidental to the activity of providing the services of dealing in securities or dealing in futures contracts, as the case may be.

The appropriate structure or arrangement may depend on the applicable licence held by the manager or relevant intermediary, the custody of client assets and the proposed investment strategy.

Key legal issues

What are the key legal issues to be determined when structuring a separately managed account?

The duties and obligations of the investment manager with respect to a separately managed account would primarily be contained in an investment management agreement between the manager and the client. A Hong Kong-licensed manager would be subject to the applicable requirements and expected regulatory standards contained in the Code of Conduct and the FMCC.

From November 2018, the revised FMCC has introduced additional requirements on licensed or registered persons that are involved in the management of discretionary accounts. A Hong Kong manager of discretionary accounts should ensure that there is a written agreement entered into with the client containing the minimum content before any services are provided, except where exemptions apply (these minimum requirements do not apply to clients falling within the categories of ‘institutional professional investors’, defined under the SFO).

Further, except otherwise agreed in writing with the client, the manager should review the performance of each account against any previously agreed benchmark, at least twice a year, and provide valuation reports to the client on a monthly basis or such shorter intervals containing minimum information.

The minimum content of an investment management agreement should contain at least the following provisions:

  • the appointment of the licensed or registered person as the discretionary account manager;
  • a statement of the client’s investment policy and objectives, including asset classes, geographical spread, risk profile of the target portfolio, any limitations or prohibitions on asset classes, markets or instruments (eg, use of derivatives) and performance benchmark (if any). In the case where the client has selected a predefined model portfolio, the agreement should also specify the proportion of the asset classes, markets and corresponding risk profile of the selected predefined model portfolios;
  • the amount of all fees to be paid by the client, whether to the discretionary account manager or to a connected person with respect to the account, and a description of fees to be paid by the client to third parties, where applicable;
  • any consent from the client where the discretionary account manager intends to receive soft commission or retain cash rebates;
  • details of custody arrangements if the discretionary account manager provides custody arrangement by itself or through its associated entity; and
  • details of periodic reporting to be made to the client.

Such minimum content is in addition to the other requirements as applicable and risk disclosures as expected under the Code of Conduct.

Regulation

Is the management or marketing of separately managed accounts regulated in your jurisdiction?

The conduct of business involving the management of asset management, including securities and futures contract management, is a Type 9 regulated activity under the SFO, which requires a licence issued by the SFC. Active marketing to the public in Hong Kong of any services that would constitute regulated activity if provided in Hong Kong would also require a licence. Hong Kong-licensed fund managers of separately managed accounts are also subject to applicable requirements under the Code of Conduct and the FMCC.

General

Proposed reforms

Are there proposals for further regulation of funds, fund managers or marketers of funds in your jurisdiction?

The SFC has issued a Circular to management companies of SFC-authorised unit trusts and mutual funds to address green or environmental, social and governance (ESG) funds. As stated in the Circular of 11 April 2019, the aim is to enhance disclosure comparability between similar types of SFC-authorised Green or ESG funds and their transparency and visibility in order to facilitate investors making informed investment decisions in this evolving investment areas. Admitting that the Circular is an initial step in SFC’s efforts to enhance disclosure standards of green or ESG funds, the SFC will keep in view local and international market and regulatory developments, and may provide further guidance or impose additional requirements for green or ESG funds, where appropriate.

For SFC-authorised funds, the SFC has also issued its Guide on the Use of Financial Derivative Instruments for Unit Trusts and Mutual Funds (FDI Guide). The FDI Guide published in December 2018 provides guidance on the use of financial derivative instruments (FDIs) including the calculation of the net derivative exposure of an SFC-authorised fund. All SFC-authorised funds must in their KFS disclose the purpose of and the expected maximum net derivative exposure arising from FDIs. Fund managers are required to determine and categorise whether their SFC-authorised fund is or is not a derivative fund, based on the net exposure arising from the fund’s FDI investments, and they will have a 12-month transition period from 1 January 2019 to update disclosures. The SFC has also included in its public register of authorised funds a new column indicating whether an SFC-authorised fund is or is not a derivative fund. Intermediaries are likely then to rely on the categorisation or registration of a fund as published on the SFC’s register of authorised funds in determining whether a fund is a complex product that would attract stricter suitability standard or distribution requirements under the Code of Conduct with effect from July 2019.

Public listing

Outline any specific requirements for stock-exchange listing of retail and non-retail funds.

The listing requirements are set out under the Listing Rules. Chapter 20 of the Listing Rules is applicable to SFC-authorised collective investment schemes (including ETFs), while Chapter 21 is applicable to investment companies (ie, closed-ended funds not subject to authorisation by the SFC).

A listing agent will need to be appointed, and a listing agreement must be signed by the relevant parties to undertake that there will be ongoing compliance with the applicable regulatory requirements.

Overseas vehicles

Is it possible to redomicile an overseas vehicle in your jurisdiction?

While there is no specific regulation pertaining to the redomiciliation of an overseas vehicle into Hong Kong, an overseas vehicle may be redomiciled in Hong Kong as a legal matter, and the SFC requires the redomiciliation of an SFC-authorised fund to apply for its prior approval. There have been a number of cases of redomiciliation of overseas vehicles to Hong Kong, particularly, in recent years, the redomiciliation of Cayman Islands unit trusts to Hong Kong, pursuant to the provisions in the trust deeds. Where the fund is an SFC-authorised retail fund, the redomiciliation requires the SFC’s prior approval, as well as prior notification to the unitholders (or approval, depending on the provisions of the trust deed). A new Hong Kong trustee is appointed in place of the existing Cayman trustee, and necessary amendments are made to the trust deed to reflect Hong Kong law and regulations, including mandatory provisions required under the UT Code, such as (but not limited to) clauses relating to liability of the trustee or other differences in trust law or specific Hong Kong or SFC requirements.

Foreign investment

Are there any special rules relating to the ability of foreign investors to invest in funds established or managed in your jurisdiction or domestic investors to invest in funds established or managed abroad?

There are no special rules regarding foreign investors investing in funds established or managed in Hong Kong or domestic investors investing in funds established or managed abroad, as Hong Kong is an open market without foreign exchange restriction or foreign ownership restrictions. As described above, foreign funds established or managed abroad may be offered in Hong Kong subject to the applicable securities offering restrictions and relevant conduct and licensing requirements for offer of securities, whereas foreign funds that meet applicable requirements under the UT Code may seek authorisation by the SFC to be offered to the public in Hong Kong.

Funds investing in derivatives

Are there any special requirements in your jurisdiction relating to funds investing in derivatives?

In general, for a plain vanilla retail fund domiciled in Hong Kong, it can use FDIs for hedging purposes, whereas the use of FDIs for non-hedging (ie, investment) purposes is subject to a limit that the fund’s net exposure relating to these FDIs does not exceed 50 per cent of its net asset value. The calculation of such net derivative exposure is set out in the FDI Guide mentioned in question 36.

Hong Kong domiciled retail funds that use FDIs extensively for investment purposes would be considered as specialised funds, which would then be subject to a maximum net derivative exposure of 100 per cent of their net asset value, applicable investment restrictions and additional disclosure requirements.

For UCITS funds whose net derivative exposure exceeds 50 per cent of net asset value are deemed to have already complied with the relevant UCITS requirements and therefore are only subject to disclosure requirements in the fund’s offering documents and KFS.

As noted in question 36, the FDI Guide published in December 2018 provides guidance on the use of FDIs, including the calculation of the net derivative exposure of an SFC-authorised fund. All SFC-authorised funds must in their KFS disclose the purpose of and the expected maximum net derivative exposure arising from FDIs. Fund managers are required to determine and categorise whether their SFC-authorised fund is or is not a derivative fund, based on the net exposure arising from the fund’s FDI investments, and they will have a 12-month transition period from 1 January 2019 to update disclosures. A fund with net derivative exposure of more than 50 per cent of its net asset value would be a derivative fund. The SFC has included in its public register of authorised funds a new column indicating whether an SFC-authorised fund is or is not a derivative fund. Intermediaries are likely to rely on the categorisation or registration of a fund as published on the SFC’s register of authorised funds in determining whether a fund is a complex product.

Effective from July 2019, licensed intermediaries are required to determine whether a product being marketed is a complex product, which would in turn attract a more stringent suitability standard under the Code of Conduct.