For many years, it was common to see advertisements in Hong Kong newspapers for seminars and opportunities about investing in overseas real estate developments, to have the property managed for you and (in some cases) to receive a guaranteed rental return. No more.
In its recent update to its “Frequently Asked Questions on ‘Offers of Investments’ under the Securities and Futures Ordinance” (the FAQs), the Securities and Futures Commission (SFC) publicly clarified its view that many such arrangements are likely to be “collective investment schemes” for the purposes of the Securities and Futures Ordinance (the Ordinance). That means (i) the arrangements themselves will be subject to the restrictions in the Ordinance on offering interests in collective investment schemes to the Hong Kong public, and (ii) the persons who are marketing the arrangements will be subject to the licensing regime in the Ordinance. The SFC also stated that, in order to be authorised, such arrangements would need to comply with the Code on Real Estate Investment Trusts. Most, if not all, of these arrangements will not be able to comply and so will not be able to be offered to the Hong Kong public.
The definition of “collective investment scheme” was introduced in 2003, when the Ordinance came into effect. The definition is very broad. It has four elements:
- it must involve an arrangement in respect of property;
- participants do not have day-to-day control over the management of the property even if they have the right to be consulted or to give directions about the management of the property;
- the property is managed as a whole by or on behalf of the person operating the arrangements; and
- the purpose of the arrangement is for participants to participate in or receive profits, income or other returns from the acquisition or management of the property.
The SFC first invoked the definition of collective investment scheme (CIS) in relation to real estate promotions in 2013, in the Pearl Wisdom case. In that case, Pearl Wisdom Limited sold hotel room units at The Apex Horizon development; the units were available for use by the purchasers. The SFC contended that the offer to purchase hotel room units at The Apex Horizon was an invitation to acquire an interest in or to participate in a CIS, given that:
- it related to property (the hotel room units);
- day-to-day management of the hotel was to be in the hands of a separate operator appointed to operate the hotel on behalf of the purchasers;
- the hotel operator would control key functions necessary to manage and supervise the hotel including allocation of guests to rooms; and
- the purpose of the arrangements was for the purchasers to participate in or receive profits, income or other returns from the acquisition of the hotel room units.
Pearl Wisdom Limited and other relevant parties (all members of Cheung Kong group) disagreed with the SFC’s contention, instead expressing the view that the purchasers had effective day-to-day control of their rooms and that the purchasers were making an investment in real estate, but chose to unwind the sales rather than engage in potentially time-consuming and costly litigation.
Since the Pearl Wisdom case, the SFC has raised queries with promoters of various real estate arrangements on a case by case basis. More recently, the SFC brought an action against IPFUND and Ronald Sin (the IPFUND case - our write-up of the case is available here). In that case, whilst it was held that the arrangements were a CIS, the Magistrate’s Court found that IPFUND and Ronald Sin did not need to be licensed under the Ordinance in order to promote the arrangements. The SFC has subsequently appealed that decision.
By issuing the FAQs, the SFC has now publicly signalled that many real estate arrangements historically promoted in Hong Kong will be viewed as CISs, and so both the schemes themselves and the persons promoting such schemes will be subject to regulation under the Ordinance. In particular, the SFC stated:
- Generally, real estate projects involving interests in hotels/holiday resorts, serviced apartments, student accommodation and shopping malls are more likely to be a CIS because it is more likely that they need to be managed on behalf of investors. It is also more likely that real estate projects with “buy-to-let” or “buy and leaseback” features could be a CIS as they often involve a centralized letting and management service.
- “Day-to-day control” means routine, ordinary, everyday management or operational decisions. The phrase does not just mean the legal ability to decide what is to happen to the property. Rather, the test focuses on whether investors can really make management decisions about the property. Where the contracts appear to give the investors day-to-day control but they do not have that control in practice, the arrangements may still be a CIS even if the investors have the right to be consulted or give directions in respect of such management.
- Even if the investors have the right to be consulted or to give directions about the management of their units, that is not enough to stop a scheme from being a CIS. For example, if the operator makes all management decisions using generic mandates (such as a power of attorney) from the investors, even if the investors may have notional control over decision-making, the operator likely has effective day-to-day control over the management of the property, not the investors.
The FAQs are available here. The SFC’s detailed views in relation to real estate arrangements are set out in Appendix 1.