Luxembourg and Ireland have historically reigned as popular fund domiciles, but could the tide be turning towards Asia?
Luxembourg, Ireland, Jersey and Guernsey are some of the most popular fund domicile locations, while historically, Hong Kong and Singapore are less attractive to international players. One of the main reasons for this is lack of fund structure choice for asset managers, namely a corporate form vehicle that caters to specific needs of hedge funds, private equity funds, mutual funds or real estate funds.
But the open-ended fund company (OFC) regime in Hong Kong could turn the tide.
OFC is an investment fund in corporate form domiciled in Hong Kong that allows managers an easier way of distributing their funds outside of Hong Kong. Launched in 2018, Hong Kong’s OFC regime is a variable structure for fund management firms, as opposed to current structures, such as the unit trust, which have a fixed capital structure.
Similarly in Singapore, the Variable Capital Companies Act (VCC) could be a game-changer for Singapore’s asset and wealth management industry. These two structures in Asia may rock the status quo.
But it hasn’t been all plain sailing, in September 2020 the Hong Kong Securities and Futures Commission (SFC) proposed amendments to the open-ended fund companies (OFC) regime.
Proposals in the consultation papers included the removal of investment restrictions for private OFCs, to allow them to match the same investment opportunities explored by overseas corporate fund structures. The majority of these amendments are in effect now, and set to shake up the industry for 2021.
OFC: a closer look
OFC works in a similar way as a unit trust to increase or decrease its capital or distribution out of capital without the approval of shareholder(s) of the company. Its key features mean that it has a corporate structure and legal personality. It is governed by a board of natural-person (meaning an individual person — not a company) directors (at least two natural persons) one of whom should be an independent director not being a director or employee of the custodian.
Experts say the directors must be of good repute, appropriately qualified, experienced and proper for the purpose of carrying out the business of the OFC.
The OFC allows investors to subscribe and redeem shares and make distribution from capital without the approval of the shareholders, and it offers limited liability to its shareholders.
Other key aspects of it mean that share certificates are not required to be issued, and it can operate one or more sub-funds with segregated assets. In addition, it can be offered to the public or on a private basis.
The amendments made
The amendments made to the OFC following requests from the SFC have helped increase the attractiveness of the regime as an alternative to comparable structures available in other developed fund centres.
Proposals in the SFC’s consultation papers included the removal of investment restrictions for private OFCs, to allow them to match the same investment opportunities explored by overseas corporate fund structures. In addition, the SFC proposed to expand the scope of entities eligible to act as custodians of OFCs to cover intermediaries licensed or registered for type 1 regulated activity to deal in securities. The SFC also recognised that the current regulatory framework does not specifically prohibit the appointment of multiple custodians to a private OFC, allowing for separate cash custodians and prime brokers.
Prior to the change initiated by the Securities and Futures Commission (SFC), a private OFC was required to invest at least 90 per cent 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.
Experts say investments in other asset classes can only make up 10 per cent of the GAV. Per the amendments, which are now effective, all investment restrictions applicable to private OFCs have been removed.
The new requirements require:
Investment managers and custodians to have sufficient expertise and experience in managing and safekeeping the asset classes in which an OFC invests
Enhanced risk disclosure in the offering documents
Maintenance of proper records
“These amendments significantly increase the investment scope for private OFCs, which will now be able to invest in Hong Kong private company shares and debentures, non-financial assets (such as real estate projects), or other less common asset classes (including virtual assets) without restriction, subject to compliance with risk disclosure and other applicable regulatory requirements,” comments Ganesh Valakati, director, product development, asset managers sector and regulations, securities services, HSBC,
According to Valakati, along with the other reforms around custodians for private OFCs and the re-domiciliation regime, the changes are expected to enhance the utility and the competitiveness of the OFC regime.
“This, in turn, will make the OFC an attractive alternative to comparable structures available in other developed fund centres,” says Valakati.
Similarly, Wilber Chiu, managing director, Hong Kong at Apex Group, says the changes combined create an excellent opportunity for OFC to become the fund structure of choice for HK fund managers.
Chiu notes this is in addition to other obvious benefits like dealing with only one regulator, saving fees from the offshore layer of service providers and in general government fees in Hong Kong are lower than in offshore jurisdictions.
Additionally, it has been suggested that there will be the main driver for the increase in uptake by fund managers as it opens up a lot more candidates of service providers for fund managers to choose from.
In the past, banks/trusts acting as the custodian have had a competitive edge in selling their ancillary services. Chiu identifies that now, after the change, it will be easier for other service providers along the entire value chain such as accountants, consultants, fund administrators etc. to find a role to play in OFC.
“This creates competition further driving down the costs associated with the set-up and operation of an OFC,” says Chiu.
Talking tax
While publicly offered OFCs will continue to enjoy profit tax exemption as all SFC authorised collective investment schemes do, experts say there was initially murmurings in the industry that the Hong Kong OFC is unlikely to gain traction due to tax conditions.
Now, a privately offered OFC may also qualify for a profit tax exemption if it can fulfil certain qualifying requirements.
HSBC’s Valakati comments: “The general consensus in the industry was that the regime, as originally launched, would need to be relaxed to make it more flexible especially for private OFCs. Some of the concerns expressed included Hong Kong profits taxation for private OFCs, restrictions on permitted investments, eligibility criteria for the custodians of OFCs, the lack of any re-domiciliation mechanism to allow offshore funds to “onshore” themselves into OFCs etc.”
“We are happy to see that most of the industry concerns have been adequately addressed by the SFC as part of the amendments now and around taxation earlier in April 2019 (Unified profits tax exemption regime),” adds Valakati.
The world’s an oyster
With the new fund structures in place, experts believe this has the potential to be a game-changer and the world could be Hong Kong (and Singapore’s) oyster.
In terms of any other regulations in Hong Kong that pose challenges or opportunities to custodians, Valakati explains custodians of public funds in Hong Kong are currently not subject to any specific licensing regime or direct on-going regulatory supervision of their custodial function for public funds.
According to Valakati, as part of SFC’s strategy to strengthen Hong Kong as an international, full-service asset management centre and to enhance the regulation of public funds, the SFC has proposed to introduce a new regulated activity.
This falls under the Securities and Futures Ordinance (SFO) – Type 13 regulated activity (RA 13) – acting as a depositary (trustee/custodian) of an SFC-authorised CIS.
Valakati affirms: “The SFC expects this initiative to result in a specific, direct regulatory handle thereby strengthening its ability to ensure appropriate regulation and supervision of top-level custodian entities in their provision of custodial services to public funds. The proposed regime is designed to cover entities on the top of the custody chain.”
“This will require top-level custodians/trustees (depositary as termed by the SFC) of relevant CIS to carefully review the proposals of the SFC, consider their internal control policies and procedures and ensure they meet the standards for eligibility, governance, organisation and operational conduct under the proposed RA13 licensing regime,” adds Valakati.
