In recent authorisation applications to the Hong Kong Securities and Futures Commission (SFC) in respect of funds which allow payments of dividends to be made out of capital, the SFC has requested the following additional disclosures to be covered in the offering documents:
In addition to the above, the SFC has requested the management company submit an undertaking that all future marketing materials for the fund will adhere to these disclosure requirements.
Similar requests have also been made by the SFC in relation to applications for funds which allow other payments (e.g. management fees) out of capital.
The SFC has not issued any policy updates or other publications on why the above requests are currently being sought. However, we understand that under the SFC's Handbook for Unit Trusts and Mutual Funds, the SFC has the power to request for disclosure of such information as it considers necessary for investors to be able to make an informed decision of the investment.
The concept of payments of dividends out of capital was in the past prohibited by some regulators in overseas jurisdictions. The Central Bank of Ireland (Central Bank) lifted its prohibition in February 2012 – Irish authorised retail funds, including UCITS, may pay dividends out of capital provided that they comply with the various disclosure requirements.
By way of historical background, the Central Bank's prohibition on retail funds paying dividends out of capital was due to concerns for investor protection, in that retail investors may not be aware of the potential for capital erosion and the danger that returns which include distributions out of capital may mislead investors. However, due to the fact that many countries across the globe have aging populations, there is now increasing investor demand for investment products that can provide a consistent flow of income with a certain tolerance for a stable decline in the net asset value. In light of this, the Central Bank has recently determined that rather than an outright prohibition, its concerns for payments of dividends out of capital can be addressed by means of enhanced disclosures.
The SFC's approach is in line with that of the Central Bank and is a reflection of the SFC's efforts in seeking to strike a balance between investor demands and investor protection.