The Mainland-Hong Kong Mutual Recognition of Funds (MRF) scheme was launched in May 2015, and since the first funds were approved late 2015, to-date, more than 20 Mainland funds have been approved and authorized by the Hong Kong Securities and Futures Commission (SFC) to be offered in Hong Kong. At the same time, 3 Hong Kong-domiciled funds have so far gained approval in the Mainland for cross-border distribution. On both fronts, the number of funds to be approved are expected to continue to increase.
The MRF arrangement has made the establishment of Hong Kong-domiciled funds attractive and enhanced Hong Kong’s position as an asset management centre. The next step forward for Hong Kong to further develop into a global cross-border fund hub is, as most industry participants believe, to enhance its attractiveness as a fund domicile by introducing an open-ended fund company (OFC) structure.
We may soon see the adoption of the OFC regime in Hong Kong towards meeting its long-standing aspiration of becoming a global cross-border fund centre.
Securities and Futures (Amendment) Bill 2016
On 15 January 2016, the proposed Securities and Futures (Amendment) Bill 2016 was gazetted to be put before the Hong Kong Legislative Council, with the intention to introduce the legal, regulatory and tax framework for Hong Kong’s OFC regime.
The proposals put forward are the result of more than two years of design and industry consultations on the framework. The Hong Kong Financial Services and Treasury Bureau (FSTB), the SFC and other relevant authorities have coordinated and developed the details of the proposed framework which was first announced in early 2014. A consultation paper was published in March 2014, and the consultation conclusions were published earlier this month by FSTB. The consultation conclusions culminated in the release of the detailed proposed legal and regulatory frameworks in respect of the OFC regime.
In particular, the proposed Bill shall introduce a new Part IVA to the Securities and Futures Ordinance (Cap. 571) (SFO) on OFC, containing provisions on the incorporation, registration, capacity and specific requirements on the establishment and operations of OFC (including on the directors, investment manager, custodian, sub-custodian and auditor of an OFC).
The Bill also outlines the powers of the SFC who shall be the primary regulator of OFCs, including for the SFC to make further rules on the regulation of OFCs. It is expected that the SFC will also issue a new OFC Code detailing the operational requirements to supplement the legislation.
The Companies Registry (CR) shall be responsible for the incorporation and administration of statutory corporate filings of OFCs, alongside such role of the CR with respect to Hong Kong companies in general.
Fund market landscape in Hong Kong
As at the end of September 2015, among the 2,090 SFC authorized unit trusts and mutual funds in Hong Kong, there were only 628 domiciled in Hong Kong, with the rest mainly in Luxembourg (1,010), Ireland (281) and the Cayman Islands (92), according to the latest available data of Securities and Futures Commission (SFC). The current fund market in Hong Kong is overwhelmingly dominated by Luxembourg or Irish Undertakings for Collective Investment in Transferable Securities (UCITS).
While the number of Hong Kong-domiciled funds increased by around 54% from 386 in March 2012 to 594 in March 2015, according to FSTB, creating the OFC structure will provide asset managers with an additional option and flexibility for Hong Kong to be more attractive as a fund domicile.
Corporate structure a more popular form of investment fund
The OFC is seen as an increasingly popular fund vehicle in the industry globally, in particular for cross-border funds, and is available in most major fund centers such as Luxembourg, Ireland, Cayman Islands and United States.
At the moment, an open-ended investment fund established in Hong Kong can only take the form of a unit trust. Due to various restrictions on capital reduction under the Hong Kong Companies Ordinance, and lack of flexibility to vary its capital in order to meet investors’ subscriptions and redemptions, open-ended funds cannot be established as a Hong Kong company.
The unit trust structure has been described as “inflexible” once it is established and “not particularly suitable” for some investment strategies currently used by both public and private funds. Onerous trustee provisions in trust deeds may deter asset managers from structuring their funds as a unit trust or render some trustees unwilling to accept appointment for funds of certain investment strategies.
Further, unit trust is not a familiar structure to asset managers in jurisdictions which do not have well-established trust law, such as in the Mainland. From this perspective, there may indeed be attractiveness in a Hong Kong OFC structure for funds that may seek to be authorized by the SFC for public offer and eventually to apply for approval by the Mainland securities regulator for distribution in the Mainland.
Read our legal update for an outline of the proposed legal, regulatory and tax provisions for the Hong Kong OFC structure: Hong Kong Proposed OFC Framework
