On 25 June 2021, Fiona Fong, one of our financial services partners, interviewed Elizabeth Wong, an Associate Director of Investment Products at Hong Kong’s Securities and Futures Commission (SFC). The interview provided pointers gleaned from Fiona’s first-hand experience in advising clients on establishing open-ended fund companies (OFCs) and covered the practical aspects of setting up a private OFC and applying for Hong Kong’s newly-announced OFC grant scheme administered by the SFC.

There are many benefits of using the Hong Kong OFC structure to establish private funds, said Fiona. For one, it is a very cost-effective solution due to the low incorporation and maintenance fees. It is also more efficient for Hong Kong-based fund managers in terms of compliance. Furthermore, from a tax perspective, Hong Kong funds can enjoy an exemption from profits tax under the Unified Fund Exemption regime. Private Equity fund managers may also be eligible for the new carried interest tax concession.

Flexibility and popularity of OFCs

An OFC can be structured as a standalone fund or an umbrella fund and is able to accommodate both closed-ended and open-ended structures.

There are no rules or restrictions on the number of investors who can participate in an OFC sub-fund, and Elizabeth observed that there are currently over 50 OFCs and sub-funds in Hong Kong. Around half are private OFCs employing a range of investment strategies (including in popular sectors such as environmental, social and governance (ESG) and artificial intelligence). An increasing number of authorised funds such as exchange-traded funds (ETFs) are using the OFC structure. Fiona added that her team is seeing keen interest from private fund managers who are looking to establish their first OFC. Elizabeth also noted that the OFC structure may be used for family offices.

Applications for OFCs started to pick up near the end of 2020 following the release of the revised SFC Code on OFCs (OFC Code) which came into effect last September. The SFC has received a greater number of enquiries since the launch of the OFC grant scheme in May 2021.

“One-stop shop” approach to OFC applications

Fiona noted that, from her experience, applying for an OFC is a straightforward, quick and efficient process. Elizabeth explained that the SFC adopts a “one-stop shop” approach whereby applicants submit all application documents and associated fees to the SFC, which forwards them to the Companies Registry to register and incorporate the OFC. Currently, private OFCs are typically registered by the SFC within 7 to 14 business days.

Responding to a question from the audience regarding the circumstances under which the SFC would reject an OFC application, Elizabeth noted that the SFC has not rejected any to date, and would do so only if the application were not compliant with the requirements, such as where the required documents, confirmations or other information had not been provided despite the regulator’s repeated requests.

Key operators of an OFC

Requirements for the key operators of an OFC are fairly standard and in line with industry norms.

Directors

An OFC must have at least two directors who are natural persons, aged 18 or above and not an undischarged bankrupt (unless with leave of the court). At least one of the directors must be an independent director. Elizabeth explained that the concept of “independence” in this context means that the relevant person must not be a director or employee of the custodian. The proposed appointee must also have appropriate experience and expertise and be of good repute. The SFC will take into consideration such matters as breaches of any company or financial markets laws and regulations, convictions for fraud or other misconduct as well as disciplinary actions by or disqualification from professional bodies.

Custodians

The SFC recently relaxed the requirements for OFC custodians after feedback from industry participants. In addition to banks and trustee companies, Type 1 licensed corporations or registered institutions meeting the eligibility criteria under the OFC Code may now act as custodians for private OFCs. Elizabeth added that the eligibility criteria under the OFC Code are relatively straightforward. Overseas prime brokers are also eligible to act as custodians for private OFCs so long as they meet certain requirements under the Code on Unit Trusts and Mutual Funds. Multiple custodians and sub-custodians are also permitted.

Managers

Fiona noted that her clients have a common misconception that it is more onerous for investment managers to operate private OFCs than offshore funds. She clarified that the flexibility of the OFC structure is comparable to that of offshore fund structures. Elizabeth added that in general there would not be additional compliance obligations for OFCs. She explained that the SFC seeks to regulate private funds including private OFCs through the conduct of the investment managers who are required to meet the relevant “fit and proper” requirements and comply with the Fund Manager Code of Conduct and other conduct requirements.

Ongoing compliance

The SFC adopts a streamlined approach when dealing with private OFCs. Elizabeth explained that there are four situations where approval from the SFC will have to be sought for a change to the fund, namely: (a) the change of the name of an OFC or its sub-funds; (b) the appointment of key operators; (c) the establishment of new sub-funds; and (d) the termination of the OFC or a sub-fund.

Investors’ identities

Information about an OFC’s shareholders is not required to be provided to the Companies Registry as it is for Hong Kong private companies. An OFC’s shareholders’ register is not public information and is maintained by the OFC itself. Nevertheless, Elizabeth noted that the SFC and other government bodies can inspect the register and the SFC has the power to request shareholder information from the investment manager, as is the case in respect of offshore funds managed by an SFC-licensed investment manager.

OFC grant scheme

Hong Kong-based asset managers can now apply for a grant which will cover up to 70% of the incorporation costs for new OFCs or the expenses incurred by overseas corporate funds in moving to Hong Kong and registering as OFCs, subject to a cap of HK$1 million per OFC. Under the grant scheme, each manager can establish up to three OFCs (i.e. each OFC and its sub-funds created at the time of incorporation would count as one use of the grant). Managers need to apply to the SFC within three months after the date of incorporation of the OFC. The SFC will process grant scheme applications on a first-come-first-served basis.

Elizabeth noted that eligible expenses under the OFC grant scheme must be expenses paid to Hong Kong-based service providers relating to the incorporation of an OFC or the re-domiciliation of a non-Hong Kong fund. Examples include fees relating to legal services, audit, tax and accounting services, corporate services and regulatory compliance services.

In response to a question from the audience about whether a fund has to be set up and launched within a certain timeframe in order to be eligible for the grant, Elizabeth observed that there is no specific requirement, but noted that the Government reserves the right to claw back the grant if the OFC commences winding-up or applies for termination of registration within two years from the date of its incorporation or re-domiciliation.

Looking forward: re-domiciliation

As the interview wrapped up, Fiona and Elizabeth discussed the future development of the OFC regime. Under the upcoming re-domiciliation framework, an overseas-domiciled fund can move to Hong Kong and retain its legal personality after registering to become a Hong Kong OFC. No new entity is created in the process, and the fund would remain the same legal entity before and after moving to Hong Kong.

Elizabeth noted that re-domiciliation may appeal to fund managers due to the tax incentives offered under the Unified Fund Exemption regime and carried interest exemptions; lower compliance costs by eliminating the need to maintain a fund domiciled in another jurisdiction; and the cost effectiveness of the OFC structure. Fund managers may also wish to leverage the growing business opportunities arising from Hong Kong’s close proximity to mainland China