On September 2, 2020, the Securities and Futures Commission (SFC) released the conclusions of its two-month industry consultation (Consultation Conclusions) on proposed enhancements to the Open-Ended Fund Company (OFC) regime. The Consultation Conclusions outline several key enhancements to the OFC regime (Reforms), which are expected to increase its competitiveness and rate of adoption, including:
- removing all investment restrictions applicable to private OFCs
- expanding the scope of persons permitted to act as custodians for private OFCs
- introducing a statutory mechanism for the re-domiciliation of overseas corporate funds to Hong Kong
The Reforms include other changes applicable to key operators of OFCs, such as additional requirements for the safekeeping of private OFC scheme property.
The Reforms are widely welcomed by the industry, as the market has generally considered the OFC regime to be overly restrictive, lacking flexibility, and simply not competitive with comparable structures in other developed fund centers. As of the date of issuance of the Consultation Conclusions, only five OFCs had been established in Hong Kong since its introduction on July 30, 2018.
The Reforms are expected to significantly increase the rate of adoption of the OFC structure and help to further cement Hong Kong’s position as Asia’s premier investment funds hub.
Whom does this affect?
The Reforms are relevant to fund managers and to custodians.
How does it affect you?
|
|
Investment Scope The investment scope of private OFCs is being broadened significantly. Private OFCs will no longer be subject to any statutory investment restrictions and will be able to invest in all asset classes (subject to investment restrictions (if any) set out in the OFC’s offering documents). Disclosure Disclosure of the specific risks relevant to the type and nature of assets to be invested in by the OFC must be included in the OFC’s offering documents, particularly if the OFC intends to invest 10% or more of its gross asset value in non-financial or other less common asset classes. Records Investment managers will be required to keep records sufficient to explain and reflect the financial position and operation of the OFC’s activities in premises approved by the SFC for not less than seven years, in such manner that will enable an audit to be conveniently and properly carried out. Re-domiciliation In future, it will be possible for corporate funds established in overseas jurisdictions to be re-domiciled in Hong Kong as a private OFC. |
|
Custodians |
Eligibility Intermediaries who are licensed or registered to carry on Type 1 (dealing in securities) regulated activities in Hong Kong will be eligible to act as custodians of private OFCs, subject to further licensing, financial, regulatory, and independence requirements. Safekeeping Obligations Additional obligations are being introduced in Chapter 7 and the new Appendix A of the Code on Open-Ended Fund Companies (OFC Code). These will require the custodian to:
Existing private OFC custodians will have a six month transition period to comply with the new safekeeping requirements. |
Overview of the key enhancements
The table below summarizes the key enhancements to the OFC regime announced by the SFC in the Consultation Conclusions.
| Existing Requirements | Key Enhancements | Comment | |
|
Removal of all investment restrictions applicable to private OFCs |
A private OFC must invest at least 90% of its gross asset value (GAV) in securities and futures contracts, as defined under the Securities and Futures Ordinance, and/or cash, bank deposits, certificates of deposit, foreign currencies and foreign exchange contracts. A private OFC may also invest in other asset classes, but only up to 10% of its gross asset value (GAV). |
All investment restrictions applicable to private OFCs will be removed. New requirements will be introduced requiring (i) that investment managers and custodians have sufficient expertise and experience in managing and safekeeping the asset classes in which an OFC invests, (ii) enhanced risk disclosure in the offering documents, and (iii) maintenance of proper records. |
This Reform became effective on September 11, 2020. This Reform significantly increases the investment scope for private OFCs, which will now be able to invest in Hong Kong private company shares and debentures, non-financial assets (e.g., real estate projects), or other less common asset classes (e.g. virtual assets) without restriction, subject to compliance with risk disclosure and other applicable regulatory requirements. |
|
Expansion of custodian eligibility requirements for private OFCs |
The custodian of an OFC (public or private) must meet the same eligibility requirements for custodians of SFC-authorized funds as set out in the Code on Unit Trusts and Mutual Funds (UT Code). These eligibility requirements essentially mean that a custodian must be a Hong Kong or overseas bank, or a trustee of a registered scheme under the Mandatory Provident Fund Schemes Ordinance. |
Intermediaries licensed or registered to carry on Type 1 (dealing in securities) regulated activities in Hong Kong are also eligible to act as custodians of private OFCs, subject to further licensing, financial, regulatory and independence requirements. The SFC has clarified that the current requirements do not preclude the appointment of multiple custodians and/or sub-custodians by an OFC. |
This Reform became effective on September 11, 2020. The Reform is only applicable to private OFCs – it does not apply to public OFCs. Overseas regulated/licensed intermediaries must still meet the eligibility requirements under the UT Code. Trust companies in Hong Kong remain ineligible to act as custodians for OFCs. |
|
Re-domiciliation of overseas corporate funds |
No mechanism is currently provided for re-domiciliation. In practice, funds that are established in other jurisdictions may transfer the assets and the investors to a new vehicle in Hong Kong through a restructure, which may be effected by various means including an asset transfer or share swap. |
A statutory re-domiciliation regime will be introduced in Hong Kong. A corporate fund established overseas will be able to re-domicile to Hong Kong as an OFC, provided that it satisfies the requirements currently applicable to the registration of a newly established OFC. |
The SFC is working on the legislative amendments to introduce the re-domiciliation mechanism. This will involve the introduction of a bill to the Legislative Council. |
The SFC has also issued a further consultation on the customer due diligence requirements that OFCs are subject to, which will end on October 5, 2020. The SFC proposes requiring OFCs to appoint a “responsible person” to carry out anti-money-laundering and counter-terrorist financing functions as required under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615). This change would align the OFC requirements with the requirements of Hong Kong limited partnership funds. Any changes to be implemented from this consultation will need to be effected by way of legislative amendments.
What happens next?
The Reforms that lift investment restrictions on private OFCs and expand the category of persons eligible to act as custodian of a private OFC became effective on September 11, 2020 and the revised OFC Code is available on the SFC website. The Reforms introducing a statutory re-domiciliation mechanism will become effective following completion of the legislative process.
The Reforms are expected to significantly enhance the utility and the competitiveness of the OFC regime, making it an attractive alternative to comparable structures available in other developed fund centers.
Given the continuing evolution of international tax law and practice, especially in connection with the Organisation for Economic Co-operation and Development’s forthcoming Base Erosion and Profit Shifting (BEPS) 2.0 package, we expect that funds structured in offshore jurisdictions (such as the Cayman Islands) and their related tax arrangements will continue to be subject to scrutiny and increasing uncertainty where the fund’s form and substance are not aligned. This presents an enormous opportunity for Hong Kong to solidify its position as the asset management hub in the region and also to develop a robust domestic private fund industry.
If you would like to hear more about these developments and explore how you can capitalize on these changes, please contact us.
Sidley Austin LLP provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.
Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300; One South Dearborn, Chicago, IL 60603, 312.853.7000; and 1501 K Street, N.W., Washington, D.C. 20005, 202.736.8000.
