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 overseeing 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).
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.
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. Non-retail funds 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 or provide services to clients in Hong Kong without being properly licensed by the SFC for the conduct of relevant regulated activities.
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 regulatory 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. Any changes to a licensed entity’s substantial shareholders would require the prior approval of the SFC.
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?
No. However, 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.
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 applicable 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 subsidiary can act as the sponsor to support the overseas manager’s application for a temporary licence.
What restrictions are there on intermediaries earning commission payments in relation to their marketing activities in your jurisdiction?
From August 2018, under the revised Code of Conduct, intermediaries earning commission payments in the marketing of fund products will be restricted in 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).
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 will soon be possible to establish a Hong Kong domiciled open-ended fund in the form of an open-ended fund company structure with variable capital. This is subject to further detailed rules to be issued by the SFC, which shall be the proposed Open-ended Fund Companies Rules (as subsidiary legislation of the SFO) (the OFC Rules) and the proposed Code on Open-ended Fund Companies (the OFC Code), which are expected later in 2018.
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.
Hong Kong has also entered into respective MRF arrangements with France and Switzerland.
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); 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.
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.
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 may be considered derivatives products would require specific assessment of suitability including derivatives knowledge of the investor.
Managers and operators
Are there any special requirements that apply to managers or operators of retail funds?
Managers of retail funds have to 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, a minimum issued and paid-up capital and capital reserves of HK$1 million, or equivalent in foreign currency (note that the capital requirement will likely be increased to HK$10 million as proposed in the revised UT Code, which will take effect in 2018); and
- not lend to a material extent and maintain at all times a positive net asset position.
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 that is a subsidiary of such a bank;
- a trust company registered under Part VIII of the Trustee Ordinance; or
- a banking institution or trust company incorporated outside Hong Kong, which is acceptable to the SFC.
The trustee or custodian must have minimum issued and paid-up capital and non-distributable capital reserves of HK$10 million, or equivalent in foreign currency.
Further, the trustee or custodian should be subject to regulatory supervision on an ongoing basis; or appoint an independent auditor to periodically review its internal controls and systems on terms of reference agreed with the SFC, and should file such report with the SFC.
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 (eg, 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, funds investing in other funds, index funds, hedge funds or structured funds.
What is the tax treatment of retail funds? Are exemptions available?
SFC-authorised retail funds are exempt from Hong Kong profits tax.
In respect of a fund’s investment, Hong Kong stamp duty is payable on transfers of Hong Kong registered stock.
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.
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.
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.
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);
- changes in investment objectives, policies and restrictions of the fund (including the purpose or extent of use of derivatives), fee structure and dealing and pricing arrangements;
- any other changes that may materially prejudice holders’ rights or interests; and
- merger or termination of a fund.
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.
The maximum interval between the receipt of a properly documented request for redemption of units 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.
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
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 will soon be possible to establish Hong Kong domiciled open-ended funds in the form of an open-ended fund company structure with variable capital. This is subject to further detailed rules to be issued by the SFC, being the OFC Rules and the OFC Code, which are expected later 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.
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.
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).
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.
However, from November 2018, when the revised FMCC comes into force, Hong Kong-licensed managers of non-retail funds will be 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;
- use and disclosure of leverage;
- liquidity management;
- risk management;
- use of side pockets; and
- managing conflicts of interest.
What is the tax treatment of non-retail funds? Are any exemptions available?
Non-retail funds with Hong Kong-sourced profits derived from carrying on business in Hong Kong would be subject to Hong Kong profits tax.
However, non-retail funds that are not Hong Kong resident and meet other qualifying conditions may be exempted from tax according to the offshore funds profits tax exemption. Under the Hong Kong Inland Revenue Ordinance (IRO), an offshore fund must satisfy the following conditions in order to qualify for the offshore funds profits tax exemption:
- the fund is a non-resident of Hong Kong;
- the fund’s profits are derived from ‘specified transactions’ or incidental transactions and the fund does not carry out any trade, profession or business in Hong Kong involving transactions other than the specified transactions and incidental transactions; and
- the specified transactions have been carried out through, or arranged by, a ‘specified person’ or the fund is a ‘qualifying fund’.
Specified transactions, as defined in Part 1 of Schedule 16 of the IRO, are transactions:
- in securities;
- in futures contracts;
- in foreign exchange contracts;
- consisting of the making of a deposit other than by way of a money-lending business;
- in foreign currencies; and
- in exchange-traded commodities.
In 2015, the profits tax exemption for offshore funds was extended to offshore private equity funds, with the definition of ‘securities’ amended such that, for the purposes of the profits tax exemption, transactions in shares, stocks, debentures, etc, of a private company that is a special purpose vehicle or an exempted private company are covered as specified transactions.
A specified person means a licensed corporation or an authorised financial institution registered under the SFO, and this includes Hong Kong-licensed managers.
A qualifying fund is defined in the IRO to mean a fund that falls within the following descriptions:
- at all times after the final closing of sale of interests:
- the number of investors exceeds four; and
- the capital commitments made by investors exceed 90 per cent of the aggregate capital commitments; and
- the portion of the net proceeds arising out of the transactions of the fund to be received by the originator and the originator’s associates, after deducting the portion attributable to their capital contributions (which is proportionate to that attributable to the investors’ capital contributions), is agreed under an agreement governing the operation of the fund to be an amount not exceeding 30 per cent of the net proceeds.
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 offer of securities or through the regulation of Hong Kong managers of non-retail funds.
From November 2018, when the revised FMCC comes into force, Hong Kong-licensed managers of non-retail funds will be subject to additional specific requirements under the revised FMCC 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.
What are the main governance requirements for a non-retail fund formed in your jurisdiction?
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, 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, 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 to meet certain requirements. This is subject to further detailed rules to be issued by the SFC, being the OFC Rules and the OFC Code, which are expected later in 2018.
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 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, from November 2018, when the revised FMCC comes into force, where a Hong Kong-licensed manager is responsible for the overall operation of a non-retail fund, there will be additional specific requirements on fund valuation and calculation of net asset value, and on appropriate policies and procedures for valuation of fund assets. There will also be a requirement 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
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 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 will introduce 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 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.
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.
Are there proposals for further regulation of funds, fund managers or marketers of funds in your jurisdiction?
The SFC has issued consultation drafts of proposed amendments to the UT Code. Key proposals include:
- strengthening requirements for the key operators (management companies, trustees and custodians);
- providing greater flexibility and enhanced safeguards for funds’ investment activities (particularly in relation to derivatives, securities lending and repo and reverse repo transactions); and
- introducing new fund types (including active ETFs).
The public consultation phase ended in March 2018.
The FMCC will be modified and enhanced, with key areas covering:
- additional requirements in respect of securities lending and repurchase agreements;
- custody of fund assets;
- liquidity risk management; and
- disclosure of leverage by fund managers.
The revised FMCC will take effect in mid-November 2018.
There are also enhancements to the Code of Conduct aimed to address conflicts of interest in the sale of investment products and enhance disclosure at the point of sale by:
- restricting an intermediary from representing itself as ‘independent’ or using any terms with a similar inference when distributing an investment product if the intermediary receives commission or other monetary benefits in relation to distributing such investment product, or it receives any non-monetary benefits from any party or has close links or other legal or economic relationships with product issuers that are likely to impair its independence; and
- requiring an intermediary to disclose the maximum percentage of any monetary benefits received or receivable that are not quantifiable prior to or at the point of sale.
The enhancements to the Code of Conduct will take effect in mid-August 2018.
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.
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.
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.
Update and trends
Update and trends
Are there any other current developments or emerging trends in your jurisdiction that should be noted? Please include reference to world-wide regulatory concerns, such as high-frequency trading, commodity position limits, capital adequacy for investment firms and ‘shadow banking’.
The availability of the new Hong Kong open-ended fund company structure, details of which are anticipated in 2018, will be an important development in the Hong Kong funds market. The additional aforementioned requirements under the revised FMCC that will take effect in November 2018, as well as the updates to the Code of Conduct that will take effect in August 2018, will also be changes with significant implications for the industry. Many of the changes have been introduced by the SFC in view of the financial policy reforms published by the International Organization of Securities Commissions, the Financial Stability Board and other international regulatory bodies, to address issues and areas such as systemic risk, shadow banking, liquidity and risk management, enhanced custody requirements, securities lending and repos, and to reduce conflicts of interest. Proposals to amend the UT Code include increasing the minimum capital requirement for managers of retail funds.
In March 2018, the SFC further released its conclusions on earlier consultation with respect to the proposed ‘Guidelines on Online Distribution and Advisory Platforms’, and issued tailored guidance to the asset management industry on the design and operation of online platforms, including specific guidance on the provision of automated or robo-advice.