Investment funds in Hong Kong: regulatory overview

A Q&A guide to investment funds law in Hong Kong.

This Q&A is part of the global guide to investment funds. It provides a high level overview of investment funds in Hong Kong, looking at both retail funds and hedge funds. Areas covered include a market overview, legislation and regulation, marketing, managers and operators, restrictions and requirements, tax and upcoming reform.

To compare answers across multiple jurisdictions, visit the Investment funds Country Q&A tool. For a full list of jurisdictional Q&As visit www.practicallaw.com/investmentfunds-guide.

Contents

Retail funds

1. What is the structure of the retail funds market? What have been the main trends over the last year?

Open-ended retail funds

Hong Kong remains the major asset management and funds industry hub in Asia. At the end of June 2016, over 2,100 open-ended funds were authorised for public sale in Hong Kong. Most Hong Kong regulation concerning retail funds does not differentiate between Hong Kong domiciled and offshore collective investment schemes. Indeed, a large proportion of authorised funds are managed from outside Hong Kong. However, with the introduction of the Mainland-Hong Kong Mutual Recognition of Funds (MRF) scheme for retail funds in July 2015, there has recently been a trend of re-domiciling retail funds from non-Hong Kong jurisdictions to Hong Kong. Therefore, the number of Hong Kong domiciled retail funds is expected to continue to increase (see Question 15).

The growing popularity of the renminbi as a more internationally accepted and widely used currency drives the demand for renminbi products. Hong Kong has continued to play an active role in broadening the scope of renminbi products available to the public (such as Renminbi Qualified Foreign Institutional Investor (RQFII) A-share exchange-traded funds (ETFs) and renminbi-denominated bond funds).

The Hong Kong Securities and Futures Commission (SFC) introduced a revamped fund authorisation process in November 2015, which was formally adopted on 9 May 2016 after a six-month pilot period. Under the revamped process, the overall processing time of retail fund applications was shortened.

In terms of product innovation, the SFC issued a circular in February 2016 setting out the requirements under which the SFC would consider authorising leveraged and inverse products structured as exchange traded funds (ETF). After authorising the first crude oil futures-based ETF in Hong Kong in April 2016, the SFC authorised the first batch of leveraged and inverse products in June 2016. The SFC is expected to continue expanding the range of retail fund product choices for Hong Kong investors.

Apart from product types, the Securities and Futures (Amendment) Ordinance 2016 (Amendment Ordinance) aims to provide a legal framework for a new open-ended fund company (OFC) structure in Hong Kong and was passed by the Hong Kong Legislative Council in June 2016. This will provide an extra option for open-ended investment funds to be structured in corporate form in addition to the unit trust form. This provides more flexibility in terms of choices of investment fund vehicles for fund managers. The main provisions of the Amendment Ordinance will come into effect on a date to be appointed by a notice in the gazette pending the relevant subsidiary legislation and rules to be made by the SFC.

Closed-ended retail funds

The principal market for closed-ended retail funds in Hong Kong is in real estate investment trusts (REITs) authorised by the SFC and listed on The Stock Exchange of Hong Kong Limited (SEHK). As of June 2016, there are 11 REITs listed on the SEHK. The REITs market is less active than the open-ended retail funds market.

Regulatory framework and bodies

2. What are the key statutes, regulations and rules that govern retail funds? Which regulatory bodies regulate retail funds?

Open-ended retail funds

Regulatory framework. Hong Kong's securities laws prohibit offers of collective investment schemes to the public of Hong Kong unless either the:

  • Offer is within an express exemption (for example, it is limited to professional investors).

  • The Hong Kong Securities and Futures Commission (SFC) approves the relevant advertisement containing the offer (which the SFC will only do for a collective investment scheme that it authorises).

The key statutes are the:

  • Securities and Futures Ordinance (SFO), which gives the SFC power to authorise collective investment schemes.

  • Companies (Winding Up and Miscellaneous Provisions) Ordinance, which governs offers of retail funds in the form of mutual fund corporations.

The rules of the SFC relating to the authorisation of collective investment schemes are incorporated in the non-statutory Code on Unit Trusts and Mutual Funds (Code), which forms part of the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products (Handbook), and the Overarching Principles Section in the Handbook. The most recent significant update to the Code took effect on 25 June 2010. However, in addition to the Code, the SFC now often publishes new requirements and updates on its website by way of frequently asked questions (FAQs) (www.sfc.hk/web/EN/faqs/).

Retail funds listed on The Stock Exchange of Hong Kong Limited (SEHK) are also subject to Chapter 20 of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (Listing Rules).

Regulatory bodies. The SFC regulates open-ended retail funds.

Closed-ended retail funds

Regulatory framework. As a general policy, closed-ended funds (which are not REITs) are permitted by the SFC under the Code, subject to the additional conditions and requirements set out in Question 16 of the FAQ on the Code (www.sfc.hk/web/EN/faqs/). The main condition is that a closed-ended fund will only be authorised where it seeks a listing on the SEHK. As such, the closed-ended funds will be subject to the Listing Rules.

REITs can also be authorised by the SFC but must be listed on the SEHK. REITs must comply with the SFC's Code on Real Estate Investment Trusts (but not the Code). A key point to note regarding REITs is that the SFC can only authorise Hong Kong unit trusts.

Regulatory bodies. The SFC regulates closed-ended retail funds.

 
3. Do retail funds themselves have to be authorised or licensed?

Open-ended retail funds

The Hong Kong Securities and Futures Commission (SFC) must in effect authorise both local and foreign retail funds before they can be offered to the public in Hong Kong. The authorisation procedure in Hong Kong involves the SFC:

  • Reviewing the key documentation.

  • Approving the prospectus and advertisements (unless an exemption is applicable) and other documents.

  • Authorising the fund.

The SFC must also approve certain service providers, in particular the manager and trustee or custodian of the fund. The authorisation procedure can be quicker in cases where the applicant manager and its trustee or custodian already operate existing authorised funds. It may also be quicker for overseas funds which are recognised jurisdiction schemes, provided these do not use financial derivative instruments (FDIs).

If SFC authorisation is not obtained within six months after the date of the issuance of the SFC's formal "take-up" letter, the application will automatically lapse.

For an open-ended retail fund seeking a listing on The Stock Exchange of Hong Kong Limited (SEHK), although the SFC performs the primary regulatory role, certain of the SEHK's formalities must nonetheless be complied with. In particular, the open-ended retail fund must appoint a listing agent under the Listing Rules.

Closed-ended retail funds

The application procedures for seeking the SFC's authorisation for closed-ended retail funds are the same as those applicable to open-ended retail funds (see above, Open-ended retail funds).

Marketing

4. Who can market retail funds?

Open-ended retail funds

Any person marketing local or foreign retail funds is dealing in securities (which is very widely defined in the Securities and Futures Ordinance (SFO)) and accordingly would require a licence for Type 1 regulated activity unless it acts through another person (securities dealer) who holds a Type 1 licence. There is a carve-out to the requirement to be licensed for dealing in securities where that dealing is done wholly incidentally to the business of a licensed asset manager. To qualify for the exemption, the fund manager must hold a Type 9 licence and must have a substantive role in managing the fund in question.

Closed-ended retail funds

See above, Open-ended retail funds.

 
5. To whom can retail funds be marketed?

Open-ended retail funds

A local or foreign retail fund authorised by the Securities and Futures Commission (SFC) can be marketed to the public in Hong Kong. However, the person marketing the fund must, when making a recommendation or solicitation, ensure the suitability of the recommendation or solicitation for that client is reasonable in all the circumstances under the SFC's Code of Conduct.

Closed-ended retail funds

See above, Open-ended retail funds.

Managers and operators

6. What are the key requirements that apply to managers or operators of retail funds?

Open-ended retail funds

The fund's manager must be acceptable to the Securities and Futures Commission (SFC). The SFC will consider the:

  • Share capital of the manager, which must be at least HK$1 million or its equivalent in foreign currency.

  • Business of the manager, which must primarily be fund management and cannot involve lending to a material extent.

  • Manager's net asset position, which must be at all times positive.

  • Suitability of the directors and main shareholders of the manager.

Usually, the investment management operations of a manager and those of the investment adviser (where the latter has been delegated the investment management function) must be based in a jurisdiction with an acceptable inspection regime (AIR jurisdiction). The list of AIR jurisdictions is set out on the SFC's website and presently includes Australia, France, Germany, Ireland, Hong Kong, Luxembourg, Malaysia (in respect of Islamic funds only), Taiwan (in respect of index tracking ETFs only), the United Kingdom and the United States.

The SFC has also introduced guidelines setting out the key criteria under which managers, who are SFC licensees or whose investment management functions are based in an AIR jurisdiction, can delegate discretionary investment management to affiliates in non-AIR jurisdictions.

If the fund has a manager based in Hong Kong then the manager should generally be licensed for at least Type 9 (asset management) regulated activity (see Question 4, Open-ended retail funds).

Closed-ended retail funds

To be an approved REIT manager, the manager must demonstrate that it has the requisite competence, experience and resources to:

  • Analyse the issues and risks involved in property investment.

  • Develop, implement and keep up-to-date a set of effective internal controls and risk management system to deal with existing and foreseeable risks involved in property investments.

The REIT manager must also ensure that it holds a licence for Type 9 (asset management) regulated activity (see Question 4, Open-ended retail funds).

Assets portfolio

7. Who holds the portfolio of assets? What regulations are in place for its protection?

Open-ended retail funds

The assets of a retail fund must be held by a trustee or custodian that is acceptable to the Securities and Futures Commission (SFC). The trustee or custodian must be:

  • A licensed bank or a trust company.

  • Independent from the manager.

  • In possession of paid-up share capital and non-distributable capital reserves of at least HK$10 million.

  • Subject to regulatory supervision or agree terms of reference with the SFC for an auditor's annual review of its internal control systems.

Closed-ended retail funds

See above, Open-ended retail funds.

Legal fund vehicles

8. What are the main legal vehicles used to set up a retail fund and what are the key advantages and disadvantages of using these structures?

Open-ended retail funds

Legal vehicles. Open-ended retail funds in Hong Kong generally take the form of either:

  • Unit trusts: these are trusts established for the benefit of investors (participants' interests are called units). A unit trust has no legal personality and investors' assets are entrusted to a trustee.

  • Mutual funds: these are corporations which are primarily engaged in the business of investing (participants' interests are called shares) incorporated outside Hong Kong. A mutual fund is established as a limited liability company where investors are like shareholders in a company but can redeem shares at will.

Given the restrictions on redemption of shares of a company incorporated in Hong Kong under the Companies Ordinance, none of the Hong Kong domiciled open-ended retail funds offered in Hong Kong is in the form of a Hong Kong incorporated company. All retail funds in the form of mutual fund companies, therefore, are incorporated outside Hong Kong, typically as Luxembourg société d'investissement à capital variable (SICAVs) or Cayman Islands mutual funds. In addition, there is no segregated portfolio or protected cell legislation available in Hong Kong. As a result a corporate fund's assets cannot be ring-fenced (other than contractually).

The Securities and Futures (Amendment) Ordinance 2016 (Amendment Ordinance) was passed by the Legislative Council in June 2016 and will amend the Securities and Futures Ordinance to introduce a new open-ended fund company (OFC) structure in Hong Kong as an additional choice of investment fund vehicle. An OFC is an open-ended collective investment scheme set up in corporate form with both the flexibility to create and cancel shares for investors' subscription and redemption in the fund, and without the restrictions on distribution out of share capital applicable to companies formed under the Companies Ordinance. The Amendment Ordinance has not yet come into operation, pending the SFC's detailed operational and procedural rules to be set out in a new piece of subsidiary legislation (see Question 15).

Advantages. Hong Kong investors are familiar with both unit trust and mutual fund structures.

Disadvantages. The role of a trustee of a unit trust differs from (and is more onerous concerning liability than) the role of a custodian of a mutual fund. This may affect costs.

Closed-ended retail funds

Legal vehicles. See above, Open-ended retail funds. REITs listed on the SEHK are in unit trust form.

Advantages. See above, Open-ended retail funds.

Disadvantages. See above, Open-ended retail funds.

Investment and borrowing restrictions

9. What are the investment and borrowing restrictions on retail funds?

Open-ended retail funds

The investment limitations and borrowing restrictions will depend on the nature of the fund. Chapter 7 of the Code sets out the restrictions on investment type and limit and borrowing restrictions for equity and bond funds. A retail fund under the Code can typically borrow up to 25% of its total net asset value. The Code imposes additional and/or alternative requirements for "specialised schemes", including:

  • Unit portfolio management funds.

  • Money market or cash management funds.

  • Warrant funds.

  • Futures and options funds.

  • Guaranteed funds.

  • Index funds.

  • Hedge funds.

  • Structured funds.

  • Funds that invest in financial derivative instruments (FDIs).

Closed-ended retail funds

A REIT listed on the SEHK can only invest in income-generating properties located in Hong Kong or abroad. Investments in uncompleted units in a building are limited to 10% of the net asset value and a REIT is prohibited from investing in vacant land or engaging or participating in property development activities. A REIT can borrow up to 45% of its total gross asset value.

 
10. Can the manager or operator place any restrictions on the issue and redemption of interests in retail funds?

Open-ended retail funds

An open-ended retail fund can impose the following restrictions, provided the fund's constitutional document contains the relevant provisions and the offering document contains sufficient disclosures:

  • Imposing fees and charges, notice period and deadline for subscription and redemption.

  • Imposing a redemption gate (that is, where redemption requests on any one dealing day exceed a certain percentage (usually 10%) of the total number of interests in issue, redemption requests in excess of that percentage can be deferred to the next dealing day).

  • Prohibiting the issue or transfer of interests to any person whose holding would be illegal or which may result in regulatory, pecuniary, legal, taxation or material administrative disadvantage for the fund or its holders (prohibited persons).

  • Compulsorily redeeming or transferring interests in the funds from prohibited persons.

  • Suspending the calculation of net asset value of the fund and issue and redemption of interests in retail funds upon the occurrence of certain specific events.

Closed-ended retail funds

For restrictions on issue of interests, see above, Open-ended retail funds. For REITs listed on the SEHK, an issue of units must first be offered to existing holders in proportion to their existing holdings. Units not taken up by existing holders can be allotted or issued to other persons, or to existing holders in proportions other than their existing holdings.

Investors of closed-ended funds are not allowed to redeem their interests at their option. However, REITs can purchase their own units on the SEHK subject to the Listing Rules requirements.

 
11. Are there any restrictions on the rights of participants in retail funds to transfer or assign their interests to third parties?

Open-ended retail funds

Although not a regulatory requirement, funds commonly impose restrictions on transfers to prohibited persons (see Question 10, Open-ended retail funds).

Closed-ended retail funds

See above, Open-ended retail funds.

Reporting requirements

12. What are the general periodic reporting requirements for retail funds?

Open-ended retail funds

Investors. The fund must prepare and submit financial reports to investors at least twice a year (quarterly for authorised hedge funds). The annual report must be published and made available to holders within four months of the end of the fund's financial year and interim reports must be published and made available to holders within two months of the end of the period they cover.

The fund's latest available offer and redemption prices or net asset value must be made public on every dealing day in an appropriate manner, such as via newspapers, telephone hotlines and websites.

The fund manager must inform holders as soon as reasonably practicable of any information concerning the fund which is necessary to enable holders to appraise the position of the fund.

Regulators. Annual reports must be filed with the Securities and Futures Commission (SFC) within four months of the end of the fund's financial year and interim reports must be filed within two months of the end of the period they cover.

The SFC must also be notified as soon as possible of any suspension of trading or change to the data originally provided in the fund's application for authorisation.

Closed-ended retail funds

Investors. See above, Open-ended retail funds.

Regulators. See above, Open-ended retail funds.

Tax treatment

13. What is the tax treatment for retail funds?

Open-ended retail funds

Funds. Retail funds are exempt from Hong Kong profits tax. Stamp duty of 0.2% (which is borne equally by the buyer and the seller) is payable on transfer of Hong Kong stock (that is, where a retail fund is domiciled in Hong Kong).

Resident investors. No tax is generally payable by holders of a retail fund in Hong Kong (whether by way of withholding or otherwise) in respect of income distributions from the fund or in respect of any capital gains arising on a sale, redemption or other disposal of units/shares. However, Hong Kong profits tax may arise where:

  • Such transactions form part of a trade, profession or business carried on in Hong Kong.

  • The profits that are not capital in nature, arising in or derived from that trade, profession or business, are being sourced in Hong Kong.

Non-resident investors. See above, Open-ended retail funds: Resident investors.

Closed-ended retail funds

Funds. See above, Open-ended retail funds. A REIT constituted as a collective investment scheme authorised by the Securities and Futures Commission (SFC) is exempted from Hong Kong profits tax. Where a REIT holds Hong Kong property directly, the trustee is subject to Hong Kong property tax, currently at the rate of 15%.

Resident investors. See above, Open-ended retail funds.

Non-resident investors. See above, Open-ended retail funds.

Quasi-retail funds

14. Is there a market for quasi-retail funds in your jurisdiction?

There is no market for quasi-retail funds in Hong Kong.

Reform

15. What proposals (if any) are there for the reform of retail fund regulation?

In June 2016, the Legislative Council passed the Securities and Futures (Amendment) Ordinance 2016 (Amendment Ordinance) which will amend the Securities and Futures Ordinance (SFO) to provide a legal framework for a new open-ended fund company (OFC) structure in Hong Kong. An OFC is an open-ended collective investment scheme set up in the form of a company. However, unlike conventional companies formed under the Companies Ordinance, it will have the flexibility to create and cancel shares for investors' subscription and redemption in the fund and may distribute out of share capital (subject to solvency and disclosure requirements) without being bound by restrictions on distribution out of share capital applicable to companies formed under the Companies Ordinance. The Securities and Futures Commission (SFC) will be the primary regulator responsible for the registration and regulation of OFCs under the SFO, while the Companies Registry will be responsible for the incorporation and statutory corporate filings of OFCs. The main provisions of the Amendment Ordinance will commence operation on a date to be fixed by the government while the detailed operational and procedural rules will be set out in a new piece of subsidiary legislation made by the SFC under the SFO.

 

Hedge funds

16. What is the structure of the hedge funds market? What have been the main trends over the last year?

As of 30 September 2014, the number of hedge funds managed by Securities and Futures Commission-licensed hedge fund managers in Hong Kong increased from 676 in 2012 to 778, and the total hedge fund assets under management (AUM) in Hong Kong expanded from US$87.1 billion to US$120.9 billion, representing an increase of 38.8%. Hong Kong hedge fund managers mainly adopted Asia Pacific-focused equity long/short and multi-strategy. Overseas institutional investors made up the majority of the investor base. US and EU investors represented 61.3% of the total AUM while Hong Kong-based investors accounted for 7.9%.

Regulatory framework and bodies

17. What are the key statutes and regulations that govern hedge funds in your jurisdiction? Which regulatory bodies regulate hedge funds?

Regulatory framework

Private (non-retail) hedge funds. The activities of private hedge funds that are structured in ways so that they do not need to be authorised by the Securities and Futures Commission (SFC) are primarily regulated through the regulation of their Hong Kong-based fund managers. These fund managers must generally be licensed under Part V of the Securities and Futures Ordinance (SFO) in order to engage in the relevant types of regulated activities, such as dealing in securities and asset management. The fund managers must comply with the approval criteria for licensing as well as on-going obligations imposed on licensed corporations that are set out under the SFO, its subsidiary legislation and the SFC's codes, guidelines and circulars.

Retail hedge funds. Retail hedge funds must be authorised by the SFC under the SFO and must comply with the subsidiary legislation and the relevant codes and guidelines issued by the SFC, including in particular Chapter 8.7 of the Code in relation to hedge funds. Where a retail hedge fund becomes listed, it will also be subject to the Listing Rules. However, as of March 2016, there were only 3 authorised hedge funds and no listed hedge funds in Hong Kong.

Regulatory bodies

The primary regulator of SFC authorised hedge funds (whether private or retail) is the SFC. For private hedge funds that do not need to be authorised, the SFC regulates their fund managers as licensed corporations. This means that they must comply with the licensing requirements and on-going obligations relating to, among others, their financial resources and the fitness and properness of itself and its substantial shareholders and officers, in order to be and remain licensed by the SFC.

 
18. How are hedge funds regulated (if at all) to ensure compliance with general international standards of good practice?

Risk

A hedge fund manager must be fit and proper to be and remain licensed, including having the ability to carry on the regulated activity competently. In assessing competence, the Securities and Futures Commission (SFC) will consider whether the manager has the proper business structure, good internal systems and qualified personnel to enable it to properly manage the risks it will encounter in carrying on its business as detailed in its business plan.

Valuation and pricing

The Fund Manager Code of Conduct (FMCC) requires a manager to value the portfolio regularly and on the valuation basis disclosed to clients, and sets out the default rules of valuation for securities. The manager must ensure that a valuation is carried out, in accordance with the fund's constitutional documents, to calculate accurately the net asset value of the fund.

Systems and controls

In addition to risk management systems and controls, hedge fund managers should comply with the SFC's recommendations set forth in its Management, Supervision and Internal Control Guidelines for Persons Registered with or Licensed by the Securities and Futures Commission (Guidelines), which cover a range of internal control matters such as segregation of duties, training and audit policies. A failure to substantially follow the Guidelines tends to reflect adversely on the manager's fitness and properness as a licensed corporation (see above, Risk).

Insider dealing and market abuse

Hedge funds or their managers will be liable if they engage in (or attempt to, assist, counsel or procure another person to engage in) any of the six forms of market misconduct prohibited under the Securities and Futures Ordinance (SFO):

  • Insider dealing.

  • False trading.

  • Price-rigging.

  • Disclosure of information about prohibited transactions.

  • Disclosure of false or misleading information, inducing transactions.

  • Stock market manipulation.

Civil sanctions include:

  • Disgorgement of profits.

  • Cease and desist orders.

  • Cold shoulder orders (banning a person or entity from operating on a securities market).

  • Disqualification from directorship or management of a company.

  • Suspension or revocation of an SFC licence.

Criminal penalties include up to ten years' imprisonment and fines of up to HK$10 million.

Transparency

See Question 23 for disclosure and filing requirements for hedge funds.

Money laundering

The Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO) applies to licensed corporations including hedge fund managers. The AMLO imposes customer due diligence and record keeping requirements. A fund manager will commit an offence if it knowingly fails to take all reasonable measures to ensure proper safeguards exist to prevent non-compliance or generally to mitigate money laundering and terrorist financing risks.

Managers must also:

  • Not engage in certain prohibited acts which may facilitate money laundering or terrorist financing activities under the Organised and Serious Crimes Ordinance, the Drug Trafficking (Recovery of Proceeds) Ordinance and the United Nations (Anti-Terrorism Measures) Ordinance.

  • Have systems in place to prevent a failure to report those activities and the tipping off of persons involved in those activities in accordance with these ordinances.

Short selling

The SFO prohibits "naked" short selling, which means that short sellers must arrange to borrow stocks before they execute short sales. "Covered" short selling is only allowed for more liquid stocks designated by the Stock Exchange of Hong Kong Limited (SEHK). The SEHK imposes the "uptick rule" under which short sales cannot take place at less than the best ask price, in order to prevent short sales having an abnormal effect on market prices.

Market participants must also report to the SFC, on a weekly basis, short positions in certain listed securities on the SEHK that reach the lower of (Securities and Futures (Short Position Reporting) Rules):

  • HK$30 million in value.

  • 0.02% of the issued share capital of the particular listed company.

Marketing

19. Who can market hedge funds?

There are no differences between the requirement for marketing of local hedge funds locally and the marketing of foreign hedge funds locally.

The marketing of hedge funds generally falls within the scope of Type 1 (dealing in securities) regulated activity. Any person carrying on a business in a regulated activity will need to be licensed by the Securities and Futures Commission (SFC) for the relevant regulated activity.

A hedge fund manager licensed for Type 9 (asset management) regulated activity is permitted to market the hedge fund(s) under its management as the SFO allows a Type 9 licensee to carry on Type 1 (dealing in securities) regulated activity solely for the purpose of carrying on its asset management business, and vice versa. This however also means that the manager will need to be licensed for Type 9 (asset management) regulated activity if it markets a fund that is not under its management.

 
20. To whom can hedge funds be marketed?

There are no differences between the requirement for marketing of local hedge funds locally and the marketing of foreign hedge funds locally.

Unauthorised hedge funds cannot be marketed to the Hong Kong public unless an exemption applies. Key exemptions include marketing by way of private placement (therefore not to the public) or only to professional investors, which include:

  • Securities and Future Commission (SFC) licensed corporations.

  • Banks and insurance companies.

  • High net worth individuals that each have a portfolio of at least HK$8 million.

  • Companies and partnerships that each have a portfolio of at least HK$8 million or total assets of at least HK$40 million.

  • Trust companies that have total assets of at least HK$40 million.

  • Collective investment schemes and their operators.

  • Governments.

For unauthorised corporate funds, the Seventeenth Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance provides additional safe harbours, including marketing to no more than 50 persons in a 12-month period or at a minimum subscription level of HK$500,000 per investor.

Investment restrictions

21. Are there any restrictions on local investors investing in a hedge fund?

There are no restrictions on local investors investing in a hedge fund, but restrictions are imposed on marketing to local investors (see Question 20).

Assets portfolio

22. Who holds the portfolio of assets? What regulations are in place for its protection?

The Fund Manager Code of Conduct (FMCC), which applies to managers of both authorised and unauthorised hedge funds, requires a fund manager to ensure that the assets entrusted to it are properly safeguarded. This means that it should either:

  • Retain the responsibility for safekeeping in a segregated trust account, if permitted by the terms of its licence.

  • Arrange for the appointment of a custodian, taking all reasonable steps to:

    • ensure that the custodian is properly qualified for the performance of its functions;

    • satisfy itself as to the continued suitability and financial standing of the appointed custodian on an on-going basis.

A custodian appointed by a fund manager should be a registered trust company or an authorised financial institution or the subsidiary of a licensed bank, or equivalents regulated overseas, or another appropriately qualified institution appointed with the client's prior written consent.

Requirements

23. What are the key disclosure or filing requirements (if any) that must be completed by the hedge fund?

There are no prescribed disclosure or filing requirements for an unauthorised hedge fund.

However, in relation to side letters which typically include preferential terms, the SFC expects hedge fund managers, as a matter of good practice, to disclose material terms to all existing and potential investors and highlight, where applicable, that side letters have been entered into only with investors with a significant shareholding or interest.

 
24. What are the key requirements that apply to managers or operators of hedge funds?

Managers managing a hedge fund (whether local or foreign) in or from Hong Kong will need to be licensed for Type 9 (asset management) regulated activity and must comply with the Fund Manager Code of Conduct (FMCC), which applies to managers of both authorised and unauthorised funds.

Legal fund vehicles and structures

25. What are the main legal vehicles used to set up a hedge fund and what are the key advantages and disadvantages of using these structures?

The vast majority of the hedge funds managed in Hong Kong are established offshore in tax neutral jurisdictions such as the Cayman Islands. The most common types of vehicles used are companies (including segregated portfolio companies) and limited partnerships.

Companies

Corporate hedge funds may exist as stand-alone funds or be organised into a master-feeder structure, under which multiple feeder funds catering for different investors feed their assets into a master fund which act as their single investment vehicle.

Advantages. It is a more familiar structure to target investors and easier to establish. When used for a master-feeder structure, the fund can comply with or benefit from the regulatory environment (especially the tax position) applicable to different target investors in the fund.

Disadvantages. The constitutional documents of the fund will not normally be negotiated by the investors.

Segregated portfolio company

A segregated portfolio company (SPC) is created under statute in the Cayman Islands and the most popular way of setting up an umbrella structure. Multiple segregated portfolios (SP) can be created under the SPC "umbrella", with each SP functioning like a subsidiary of the SPC and having a separate pool of assets and separate liabilities. Each sub-fund can have its own manager, pursue its own investment strategy and have its own pool of assets. Importantly, liabilities generated from the trading activities of each sub-fund can be ring-fenced and contained to the assets only of that sub-fund.

Advantages. This structure dispenses with the need to incorporate a new company for every new fund and makes the setting up process much cheaper and more efficient.

Disadvantages. The effectiveness in asset segregating among the SPs is untested in other jurisdictions. Even under Cayman Island bankruptcy laws, the risk of cross-contamination is not definitely alleviated.

Limited partnership

Investors hold interests as limited partners in proportion to their investment, and share in the profits or loss of the fund in that proportion. As limited partners, their exposure is limited to the amount they invest. The general partner has unlimited liability but would typically itself be a company incorporated with limited liability. See also Question 8.

Advantages. This structure is popular with US investors for reasons of tax efficiency. It also provides greater flexibility in negotiating terms.

Disadvantages. Investors cannot benefit from the profits tax exclusion available specifically to corporate funds (see Question 26). It may also be costly where the limited partnership agreement is heavily negotiated by the core investors.

Tax treatment

26. What is the tax treatment for hedge funds?

Funds

Profits tax (currently at a rate of 16.5%) may be payable by an unauthorised hedge fund if the fund is treated as carrying on a trade or business in Hong Kong, in respect of any trading profits which arise in or derive from Hong Kong. These amounts may include profits arising from:

  • The sale of securities (except those held as capital assets) listed on The Stock Exchange of Hong Kong Limited (SEHK).

  • Off-exchange transactions in the sale of unlisted securities where the contracts of sale and purchase are effected in Hong Kong.

Non-Hong Kong resident funds are exempt from profits tax in respect of specified types of transactions (and incidental transactions not exceeding a certain threshold) which are carried out through, or arranged by, a licensed corporation such as a Type 9 manager. Place of incorporation is not a decisive factor in determining residency and the fund's central management and control must not be exercised in Hong Kong. This generally means that most of the directors of a corporate fund should be resident outside of Hong Kong and its board meetings conducted offshore.

Resident investors

Profits tax is charged on a person carrying on a trade, profession or business in Hong Kong, in respect of income profits (and excluding capital gains profits) arising in or derived from Hong Kong from that trade, profession or business. However, profits tax will not normally be payable by investors in respect of profits or income derived from their investments in hedge funds for the following reasons:

  • Investors typically hold investments in hedge funds for investment purposes rather than as part of a trade, profession or business.

  • A gain from disposing of shares or units in a fund will normally be a capital gain.

  • Dividends received by an investor in corporate funds are specifically excluded from profits tax.

Notably, there are anti-avoidance deeming provisions whereby a Hong Kong resident investor who is deemed to derive taxable profits by reference to his interest in an exempt non-Hong Kong resident fund if, alone or jointly with his associates, he:

  • Holds a beneficial interest of 30% or more in that fund.

  • Holds any level of interest and is an associate of that offshore fund.

This does not apply if the Hong Kong Inland Revenue Department is satisfied that the underlying interests in the fund are bona fide widely held.

Non-resident investors

Exposure to Hong Kong profits tax is unlikely as non-resident investors are unlikely to be carrying on a trade, profession or business in Hong Kong (see above, Resident investors).

Restrictions

27. Can participants redeem their interest? Are there any restrictions on the right of participants to transfer their interests to third parties?

Redemption of interest

Hedge funds are typically open-ended and allow investors to redeem their interest subject to the terms of the fund. Hong Kong law and regulation does not restrict redemptions by unauthorised funds in any way.

Transfer to third parties

There are no regulatory restrictions on the right of participants to transfer their interests to third parties. Where the transferor is selling as principal it can do so without a licence. Marketing an interest to sell, however, will usually amount to dealing in securities. However, funds commonly impose restrictions on transfers to persons whose holding of interests in the fund would be illegal or which could result in regulatory, pecuniary, legal, taxation or material administrative disadvantage for the fund or its unitholders or shareholders generally.

Reform

28. What (if any) proposals are there for the reform of hedge fund regulation?

On 10 June 2016, the government published the Securities and Futures (Amendment) Ordinance 2016 (Amendment Ordinance) in the Hong Kong Gazette. The Amendment Ordinance enables the introduction of a new open-ended fund company (OFC) structure in Hong Kong. Currently, an open-ended investment fund can be established in the form of a unit trust, but not in corporate form due to various restrictions on capital reduction under the Companies Ordinance. An OFC is an open-ended collective investment scheme set up in the form of a company, but with the flexibility to create and cancel shares for investors' subscription and redemption in the funds, which is currently not enjoyed by conventional companies. The OFC could provide a familiar and more marketable vehicle and possibly turn Hong Kong into a more attractive domicile for private funds over other popular jurisdictions such as Cayman Islands, where the registration costs alone for a standard master-feeder fund structure have almost tripled since the global financial crisis.

The detailed operational and procedural matters will be set out in a new piece of subsidiary legislation (the OFC Rules), by the SFC under the SFO.

 

Online resources

Bilingual Laws Information System

W www.legislation.gov.hk

Description. The Bilingual Laws Information System, an up-to-date electronic database of the statute laws of Hong Kong, is maintained by the Department of Justice of the Hong Kong Government.

Securities and Futures Commission

W www.sfc.hk

Description. This is the official website of the Securities and Futures Commission (SFC), which provides up-to-date codes, guidelines, circulars and other information issued and/or published by the SFC.

Hong Kong Exchanges and Clearing Limited

W www.hkex.com.hk

Description. This is the official website of the Hong Kong Exchanges and Clearing Limited (HKEx), which provides, among others, up-to-date information on the listing of funds in Hong Kong.

Inland Revenue Department

W www.ird.gov.hk

Description. This is the official website of the Inland Revenue Department of the Hong Kong Government, which provides up-to-date information on tax in Hong Kong.



Contributor profiles

Rolfe Hayden, Partner

Simmons & Simmons

T +852 2583 8302
F +852 2810 5040
E rolfe.hayden@simmons-simmons.com
W www.simmons-simmons.com

Professional qualifications. England and Wales, Solicitor, 1993; Hong Kong, Solicitor, 1996

Areas of practice. Investment funds, including listed and unlisted retail funds; private funds (both private equity and hedge funds); REITs; asset management; licensing and regulatory; financial services in general.

Recent transactions

  • Advising on the launch of Ally Bridge LB Healthcare Fund Limited, Chiyuan Fund Limited, Chongyang China Alpha Feeder Fund, Goldstream Capital Master Fund I Limited and Wei Capital Pan-Asia Offshore Fund, Multiple Cayman Islands domiciled hedge funds.

  • Advising on the SFC authorisation of Capital International Funds and Capital International Portfolios (Luxembourg UCITS) in Hong Kong.

  • Advising on the launch of Trinity Venture Fund LP, a closed-end Cayman Islands exempt limited partnership investing in real estate in Vietnam and Cambodia.

  • Advising on numerous ETF listings in Hong Kong including CSOP Oil Futures ETF, CSOP Leveraged and Inverse Series and China AMC Leveraged and Inverse Series.

Publications

  • World Securities Law Report, Fund Forum.

  • Capital Asia.

  • Barclays Guide to Private Equity in Asia.

  • Euromoney Alternative Investments Handbook 2003/4.

  • ISI's Marketing Unit Trusts and Mutual Funds in Asia in 2005 and 2006.

  • Capital Guide to REITs in Asia 2007.

  • Asia Law (Regulation of Mutual Funds in Asia).

Gaven Cheong, Partner

Simmons & Simmons

T +852 2583 8323
F +852 2810 5040
E gaven.cheong@simmons-simmons.com
W www.simmons-simmons.com

Professional qualifications. England and Wales, Solicitor, 2006; Hong Kong, Solicitor, 2003; Australia, Solicitor, 2000

Areas of practice. Fund establishment; hedge funds; private equity funds; hybrid funds; funds regulatory; funds-related litigation; insolvency and restructuring; commercial litigation.

Recent transactions

  • Advising on the establishment of a number of significant hedge fund launches, including:

    • Modus Capital, Asia Lion Capital and Samsung Triple Alpha fund.

  • Regulatory advice for a number of clients including:

    • Hutchin Hill Capital; Brown Brothers Harriman & Co and Folger Hill Asset Management LLC.

  • Representing several large fund managers in contractual negotiations for final closing of private equity funds with potential limited partners, including:

    • Spring Capital Asia Fund LP and Rich Fields China Growth Fund I LP.

  • Advising a large number of investment managers, including on their licensing requirements across various investment funds platforms – with a focus on Types 1, 4 and 9 licences under the SFO.

Publications. Company Law in Hong Kong: Insolvency (Hong Kong, Sweet & Maxwell, 2012).

Eva Chan, Partner

Simmons & Simmons

T +852 2583 8216
F +852 2810 5040
E eva.chan@simmons-simmons.com
W www.simmons-simmons.com

Professional qualifications. England and Wales, Solicitor, 2004; Hong Kong, Solicitor, 2003

Areas of practice. Investment funds; exchange traded funds; futures and options funds; guaranteed funds; hedge funds; UCITS funds; fund restructurings; funds de-authorisation; funds-related compliance.

Recent transactions

  • Advising Samsung Asset Management on the SFC authorisation and SEHK listing of Samsung KOSPI 200 Daily (2x) Leveraged Product, Samsung KOSPI 200 Daily (-1x) Inverse Product, Samsung TOPIX Daily (2x) Leveraged Product and Samsung TOPIX Daily (-1x) Inverse Product, the first leveraged and inverse ETFs in Hong Kong.

  • Advising Commerzbank on the SFC authorisation and SEHK listing of ComStage 1, the first German fund authorised by the SFC and listed in Hong Kong.

  • Advising a number of PRC fund managers including ChinaAMC, Harvest and Bosera in respect of SFC authorisation of RQFII funds.

  • Advising HSBC in respect of the termination, deauthorisation and delisting of its ETF platform.

  • Advising Deutsche Bank AG in connection with the listing of db x-trackers ETFs, the first ETFs in the form of company structure listed in Hong Kong and employing second generation synthetic replication.

Publications. Exchange Traded Funds in Asia 2010/11.


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