Hong Kong proposes new corporate fund structure which would be recognised overseas

18 June 2018 | Asia | Articles

The SFC has taken a significant step in promoting Hong Kong as a global asset management hub by proposing new rules for a Hong Kong domiciled corporate fund structure. Currently the only fund structure possible in Hong Kong is a unit trust.

The proposed changes are set out in the SFC consultation conclusion on Securities and Futures (Open-ended Fund Companies) Rules (OFC Rules) and Code on Open-ended Fund Companies (OFC Code) which was issued on 18 May 2018.

For fund managers in Hong Kong, this would be a good time to consider setting up local funds to be eligible for participating in the mutual recognition of funds arrangements between Hong Kong and PRC (introduced in July 2015), Switzerland (introduced in December 2016), and France (introduced in July 2017). This is expected to help local fund managers to broaden their overseas client base.

The key changes to the SFC’s proposals are:

• Regulatory requirement for changes in the instrument of incorporation: Changes in the instrument of incorporation only need post-change filing with the SFC now (SFC’s approval was required in the previous SFC’s proposal). Material changes to the instrument of incorporation would only require shareholders’ approval.
• Scheme changes: To meet the demand of private investors from time to time, private OFCs might need to customize their investment policy and operations. the SFC is allowing scheme changes to be made in accordance with the offering documents and/or the instrument of incorporation. For an immaterial scheme change, the board of directors will need to certify that the change is immaterial and the custodian’s confirmation should be obtained to confirm it has no objection. Material scheme changes will need reasonable prior notice to the shareholders.
• Ultra vires provision: The SFC has removed the ultra vires provision as it would be difficult for a third party to determine whether a transaction falls within the OFC’s operation as a collective investment scheme
• Sub-delegation of investment managers: There is no separate SFC approval for sub-delegation arrangements by the investment managers. The SFC states that the key operators need to exercise due care in the selection, appointment, and ongoing monitoring of the performance of the delegate and remain fully liable for complying with the applicable regulatory requirement.
• Investment manager requirement: All investment management functions of a OFC must be delegated to an investment manager licensed by or registered with the SFC for Type 9 (asset management) regulated activity. Investment manager’s investment management functions should include valuation and pricing.
• Responsibilities of directors of OFC: Directors of a OFCsremain ultimately legally responsible in overseeing the investment manager’s activities, and the directors’ general duty of oversight over the investment manager (and the custodian) has been reflected in the revised OFC Code
• Custodian requirement: Regarding custodians, that custodians’ eligibility requirements are essential baseline requirements for the protection of the scheme property. Accordingly, prime brokers acting as custodians will be expected to meet the eligibility requirements as set out in the OFC Code.
• Public OFC: The custodians of public OFCs must observe the UT Code’s requirements. The requirements under the proposed OFC Code are comparable to the custodian’s duties in the proposed revised UT Code, consistent with the compliance obligations of the custodians of other SFC-authorized funds.
• Process agent: The SFC clarifies that the appointment of the process agent is imposed on the custodian and not on the sub-custodian. The SFC also states that the primary duty to safeguard the OFC’s assets remains with the custodian.
• Winding-up of OFCs: Regarding disqualification and winding-up, OFCs will be subject to the disqualification and court winding-up process as an “unregistered company” under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (“C(WUMP)O”) in the first stage. A separate legislative exercise will be launched to amend the Securities and Futures Ordinance and/or the C(WUMP)O as well as the OFC Rules to enable the winding-up of OFCs as conventional companies in second stage.
• Business scope of OFC: Since an OFC is not designed to operate as a corporate entity for the purposes of general commercial business or trade, the SFC is retaining its 10% de minimis limit in other asset classes. The OFC code has also been revised to explicitly states that an OFC should not be a business undertaking for general commercial or industrial purpose.
• Disclosure requirement: The OFC regime has the segregation liability feature for sub-funds for an OFC with an umbrella and sub-funds structure. The OFC Code has been revised to include a new disclosure requirement for cross sub-fund investments in the OFCs’ annual reports. OFCs will need to disclose whether a particular sub-fund is a public or private fund.

The OFC Rules and OFC Code will be submitted to the Legislative Council for negative vetting and are targeted to come into effect on 30 July 2018 (together with other subsidiary legislations). The OFC regime is expected to be operational in 2018.

As the authorization requirement and fees would be the same as the SFC-authorized funds (i.e. retail funds), the public OFCs are likely to attract retail fund managers to set up OFCs targeting retail public in Hong Kong since most of them would already be familiar with the SFC’s regulation on retail funds.

For the private OFCs, the set up and ongoing obligations are more burdensome than funds domiciled in other offshore locations, e.g. Cayman Islands. For example, the custodian of a private OFC will need to comply with the requirements as set out in the OFC Code. This might lower the interest of private fund managers to set up a private OFC instead of an offshore fund vehicle.

There are similar developments in other jurisdictions in the Asia-Pacific region now. For example, the Monetary Authority of Singapore is proposing a framework for Singapore variable capital companies. The Australian government is also going to introduce a framework for corporate collective investment vehicles. Both jurisdictions are aiming at finalizing the frameworks in 2018, which would direct competing with the OFC framework in Hong Kong.

How we can help

Bovill can help you understand the OFCsregime and requirement, and obtain the Type 9 SFC license for investment managers, as well as drafting policies and procedures to exercise due care in the selection, appointment, and ongoing monitoring of the performance of the delegate.