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SFC streamlined requirements for master-feeder ETFs

The Securities and Futures Commission (SFC) published a circular on 16 December 2019 which introduces a streamlined approach in respect of the authorization of index tracking exchange traded funds (ETF) adopting a master-feeder structure. In essence, the SFC is prepared to allow an SFC-authorized feeder ETF to invest its assets in an overseas-listed master ETF without the latter obtaining the SFC authorization on a case-by-case basis, so long as certain conditions are met.

Before this relaxation, index-tracking ETFs adopting a master-feeder structure were permitted only if both the feeder ETF and the master ETF were authorized by the SFC.

To rely on the streamlined approach, the feeder ETF must be a Hong Kong-domiciled ETF authorized by the SFC and managed by a management company which is licensed or registered for type 9 regulated activity and has a good compliance record.

In addition, the master ETF should, at a minimum, meet the following key eligibility requirements:

(a) the master ETF must be a scheme regulated in a recognised jurisdiction managed by a management company in an acceptable inspection regime or a scheme eligible under a mutual recognition of funds arrangement;
(b) the master ETF, together with its management company and trustee/custodian, must have a good compliance record with the rules and regulations of its home jurisdiction and (in the case of master ETF) the listing venue;
(c) the master ETF must have a fund size of not less than USD 1 billion and a track record of more than five years at the time of the feeder ETF’s listing on the Stock Exchange of Hong Kong;
(d) the master ETF must adopt physical replication of the underlying index through either a full replication or a representative sampling strategy; and
(e) the master ETF’s engagement in securities financing transactions should not exceed 50% of its total net asset value unless there are comparable safeguards and disclosures.

The SFC commented that the streamlined approach is adopted in response to requests from the industry for greater flexibility in the master-feeder ETF structure, with an aim to facilitate the development of ETF product offerings in a more cost-effective manner, thereby providing more investment choices to investors.

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