Our previous article in the November 2013 edition of the Chronicle introduced the genesis of the Asia Region Funds Passport project, being a framework to allow collective investment schemes (CIS) established and regulated in a passport member economy (the home economy) to be offered to investors in other passport member economies (the host economy)1. The working group members2 have since released a consultation paper3 setting out proposals relating to the application process and supervision / enforcement regime for the ARFP, as well as substantive criteria relating to the eligibility of passport funds, licensing of the passport fund operator, operation of the passport fund and investor interactions.
This article does not purport to comprehensively summarise the consultation paper but to highlight features of certain key proposals.
The passport arrangements have been proposed with the following principles and objectives in mind:
- To deliver the benefits of competition without compromising on investor protection - investors are expected to benefit from lower fees and greater access to a diversified array of CIS in their home jurisdictions. The interplay of home/host economy rules with the passport rules will ensure a level-playing, acceptable ‘base’ standard is applied insofar as the registration, operation and offer of passport funds are concerned.
- To strengthen the capacity and competitiveness of Asia’s fund management industry - through economies of scale, CIS operators are expected to enhance their competitive edge and to create, in the long-term, ‘brand value’ for Asia-Pacific based CIS.
- Keeping capital flows within Asia will help strengthen the region’s financial markets against external shocks and volatility - passport economies will enjoy improved liquidity and access to finance as investors will have an additional route to investing in Asia’s debt and equity markets.
REGULATORY MESH OF RULES
A partial approach to mutual recognition has been proposed to create a regulatory mesh made up of home economy rules, host economy rules and passport rules. A table illustration of this application is set out at the end of this article4.
From a bird’s eye perspective, it is worth highlighting that:
- the eligibility of a passport fund will be governed by the passport rules; and
- where home economy rules apply, these could in certain instances be supplemented with passport rules to ensure a common base standard applies across the various passport member economies. Where, however, a home economy regime is more stringent than the passport rules, compliance with that home economy regime will still be required.
Eligibility of passport funds
Each passport economy member will propose the types of CIS that are authorised for offer to the public in its jurisdiction for agreement by member economies for inclusion in the passport.5 The CIS must be constituted and authorised in a member economy in compliance with that home economy’s rules.
Only eligible CIS investing mainly in transferable securities and certain other liquid assets are likely to qualify as passport funds. The CIS must have AUM in investment schemes of at least US$500 million6 when it applies to be authorised as a passport fund.
Licensing of the passport fund operator
The operator must be authorised by the home regulator and have its principal place of business in the home economy of the passport fund.
Passport rules will require an audit of an operator’s compliance with its home economy rules in compliance-related areas such as disclosure, risk monitoring and management and resolution of conflicts of interests.
The operator should have a minimum equity of US$1 million and if its assets under management (AUM) exceeds US$500 million, an additional capital buffer equal to 0.1% of the excess AUM (up to US$20 million of additional capital) should be maintained.
The operator, its directors, senior managers and key personnel must be in good standing. Minimum qualifications will be prescribed for key officers :
- CEO with at least 10 years experience;
- at least 2 executive directors with at least 5 years experience; and
- fund managers with at least 3 years (in preceding 5 years)7 experience, in a business dealing with the financial or capital markets.
Operation of the passport fund
A passport fund must appoint an independent custodian to hold its assets. Passport fund assets should be held separately from non-passport fund assets (for example, assets of the operator) although co-mingling may be permitted if certain prescribed safeguards are implemented.
Passport funds will be subject to an annual audit for compliance with passport rules and operational requirements.
Passport funds must provide for reasonable redemption rights, pay the redemption price generally no later than 15 days from the time the request for redemption is received and set out clearly when redemption rights may, under the passport rules, be suspended.
The operator is to be subject to oversight by a separate and independent entity such as a board of directors of compliance committee. The operator may delegate any of its functions (as permitted under home economy rules) but remains responsible for any delegated function and must supervise its delegate. Where the portfolio management function is delegated, the delegate must be a regulated entity and be ‘equivalently’ qualified in respect of the passport requirements relating to capital, experience, AUM and good standing.
Passport funds will only be permitted to invest in prescribed liquid investments that are readily priceable such as investments in regulated CIS, deposits, currency, derivatives, transferable securities, money market instruments and depository receipts over gold.
To promote investor confidence, a passport fund should be well- diversified between issuers and fungible assets, and invested primarily in liquid assets. As such, portfolio allocation limits based on the UCITs model have been proposed.8
A passport fund will be required to limit its exposure to derivatives and securities lending transactions to less than 20% of its gross assets value. If a derivative is not centrally-cleared, the counterparty must be subject to prudential supervision by a financial supervisory authority in its home jurisdiction and be authorised by an IOSCO member to deal in derivatives.
While passport funds will be permitted to engage in securities lending, this must not be to generate leverage, must not exceed 50% of the value of the passport fund’s assets and will be subject to conditions pertaining to collateral and minimum counterparty conditions.
To minimise risk-taking activities, passport funds cannot engage in money-lending, provide guarantees, underwrite or engage in short-selling activities.
A passport fund may borrow up to 10% of its net asset value subject to prescribed criteria including the borrowing being for prescribed purposes, the passport fund otherwise not having sufficient funding to meet redemption requests or pay expenses and the borrowing being repayable in full within 31 days from internal funding resources.
Investor dealings / interactions
The host economy rules will apply in investor relations matters including areas of distribution and intermediaries, disclosure requirements, marketing of passport funds as well as investor compliant-handling procedures. While a host economy may impose additional rules that apply to passport funds only, these must not be unduly burdensome and must be reasonable to promote confident retail investment in passport funds.
GETTING YOUR CIS A PASSPORT
Make an application to your home regulator who will ascertain if your fund satisfies the home economy’s registration requirements for a CIS and the passport’s eligibility and registration requirements. Note that information provided to your home regulator may be disclosed to other passport economy regulators.
Once the home regulator accepts your CIS as a passport fund, it will publish general information required by the passport rules relating to your CIS and you (the operator). You may then apply for entry into a host economy either by way of :
- authorisation by the host regulator pursuant to a streamlined process which should take no more than 21 days to process; or
- by way of notification whereby you can offer interests in your CIS in the host economy if the host regulator has not, within 21 days from your notification date, informed you otherwise.
Your application will be rejected only if, after due process, the host regulator is not satisfied that your CIS complies with or is likely to comply with the rules of the host economy, home economy or passport rules, as the case may be. That said, the host regulator will not typically reassess your CIS’s compliance home economy or passport rules which should have been undertaken by the home economy.
Home and host regulators will be empowered, on an ongoing basis, to require an operator to cease offering interests in a passport fund, either indefinitely or for a period of time, if the regulators are not satisfied that the passport fund is complying (or likely to comply) with relevant rules of the home economy, host economy or passport rules, as the case may be.
Home and host regulators will also be empowered (with mutual agreement) to exempt passport funds from adhering to any passport rule or modify any passport rule.
The consultation is slated to close on 11 July 2014. Economies looking to be passport member economies are expected to finalise the passport arrangements by early 2015 with a view to domestic implementation of the passport rules by 2016.