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With the launch of Hong Kong’s open-ended fund company (OFC) vehicle tipped for 2018, the Government aims to deliver on one facet of its long-stated policy initiative of bolstering Hong Kong as a full-service asset management hub.
For Hong Kong based managers, the preferred hedge fund structure has tended to be an offshore limited liability company, typically domiciled in the Cayman Islands. In the retail space, managers looking to establish a Hong Kong platform have opted to seek local authorisation for either an offshore vehicle or, more recently, a Hong Kong unit trust. The policy aim of the OFC is to offer an alternative local legal structure for funds and to boost Hong Kong as a fund domicile.
In this article, we examine the key advantages and perceived disadvantages for a Hong Kong manager in using the OFC, based on current proposals, when compared to the most common type of Cayman Islands’ investment vehicle, the exempted company (Cayman fund). In its Fund Management Activities Survey published in July 2017, the Securities and Futures Commission (SFC) valued Hong Kong’s combined fund management business at $18,293 billion as of 31 December 2016. Will the OFC entice more managers and sponsors to set up their funds in Hong Kong?
Regulatory framework
The legal framework for the establishment of OFCs is set out in the Securities and Futures (Amendment) Ordinance 2016, which was enacted in 2016 and amends the Securities and Futures Ordinance (SFO). It is expected to come into force in 2018. Detailed rules (OFC Rules,subsidiary legislation to the SFO) and a non-statutory OFC code (OFC Code) are the subject of an SFC consultation which closes on 28 August 2017. Proposals for a profits tax exemption for certain privately offered OFCs are set out in the Inland Revenue (Amendment)(No.4) Bill 2017 (Tax Bill).
The OFC structure is designed to be used by both retail and private funds. Retail funds in Hong Kong must be authorised by the SFC for public sale under the SFO. The conditions for authorisation are set out in the SFC’s Code on Unit Trusts and Mutual Funds (the UT Code). As OFCs are collective investment schemes, the OFC regime will be established under the SFO and supervised by the SFC rather than the Companies Ordinance and Registrar of Companies (CR) framework.
Single jurisdiction
The advantages for a Hong Kong manager in setting up an OFC over a Cayman fund largely centre around the savings in management time and money, and the simplicity, in dealing with one jurisdiction instead of two.
Use of a Hong Kong domiciled vehicle by a Hong Kong manager avoids the Cayman layer of service providers – auditors, lawyers, corporate services – and allows for a single regulator, the SFC, for both the manager and the fund. Instead of dealing with both the Cayman Islands Monetary Authority (CIMA) and the SFC, the manager may focus on dealing with one regulator and complying with one regulatory regime and may enjoy relatively lower regulatory fees.
As an adjunct to the single regulator approach, the SFC is proposing a streamlined application process. The OFC establishment and registration process involves dealing with one authority (the SFC) who in turn will deal with the CR for the incorporation certificate and the Inland Revenue Department for the business registration certificate. Similarly, post-establishment, the SFC has proposed a streamlined process for ongoing filings, with filings requiring SFC approval being submitted only to the SFC and filings not requiring SFC approval being submitted only to the CR.
The OFC also allows for a simpler fund operating structure, with a Hong Kong manager serving a Hong Kong fund and no requirement for an offshore manager – one less entity to establish and maintain – and no requirement for the fund’s directors to be CIMA registered or licensed.
Additional requirements
Drawbacks to adopting the OFC structure largely impact private funds and their managers. The level of prescription and oversight which is contemplated by the OFC regime, whilst familiar to operators of Hong Kong authorised funds, will be new to managers of private Cayman funds. Here we set out some of the key additional obligations and requirements:
Hong Kong fund industry participants have welcome the Government’s commitment to the introduction of an alternative vehicle for Hong Kong domiciled funds. The level of SFC oversight and prescription in the proposed OFC Rules and OFC Code will be largely familiar to managers and custodians of SFC-authorised funds. However, the OFC regime as currently drafted (together with the complexities of the proposed profits tax exemption in the Tax Bill) faces a significant challenge to tempt private fund managers away from the flexible, simply-established and more lightly regulated Cayman structure. Appetite for the OFC is therefore likely at the outset to be weighted more to the retail sector.
The SFC consultation on the draft OFC Rules and OFC Code is open for comment until 28 August 2017.
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