Hong Kong: Offshore Business Sectors
Investment Fund Management
Hong Kong is widely recognised as the leading fund management centre in Asia with the largest concentration of fund managers. The industry is characterised by its international and offshore nature.
In July 2011, the Securities and Futures Commission's annual survey of fund management activities confirmed that such business in Hong Kong reached over HKD10 trillion (US$1.3 trillion) last year, up 18.6% compared to 2009.
The increase outperformed the previous annual record of US$9.6bn achieved in 2007, and suggested a return of investor confidence in global financial markets and continuing inflows of investment capital into the Asia Pacific region. It also found that Hong Kong continued to be a preferred location for international investments.
Overseas investors contributed HKD6.6 trillion (or 66%) of Hong Kong’s total fund management business, excluding real estate investment trusts (REITs). The number of intermediaries engaging in asset management business also grew in 2010 by about 10% from 2009.
Licensed asset management and fund advisory houses continued to contribute the largest proportion of total asset management business in Hong Kong. Their aggregate business amounted to HKD7.3bn in 2010, recording a year-on-year increase of 13.3% from 2009.
Some other highlights of the survey include that, for non-REIT asset management business, almost HKD4.2bn of assets were managed in Hong Kong and 79.7% of these assets were invested in Asia; other private banking business grew more than 32% to HKD2.2bn; and the market capitalisation of SFC-authorized REITs recorded a growth of approximately 39% to HKD103bn, in 2010.
The report also highlighted the three key aspects that the SFC has been focusing on to enhance the status of Hong Kong as a leading asset management centre - strengthening the regulatory framework for public offers of investment products; contributing to the process of renminbi internationalisation and fostering closer ties with the Mainland market; and developing exchange-traded-fund (ETF) market and implementing new measures to enhance transparency of synthetic ETFs.
The SFC’s Acting Chief Executive Officer Alexa Lam said: "Hong Kong will strive to fortify its position as an international asset-management centre and an offshore renminbi centre. The SFC will continue to work with all to capitalise on our robust regulatory framework and local asset-management expertise to attract international investors to select Hong Kong as an investment platform.”
According to a 2007 review of the retail fund business in Hong Kong since the establishment of the SFC in 1989, the number of retail funds offered to the public grew from 783 at the end of 1989 to 1,980 in 2007. In value terms, the size of retail funds grew 22 times, from HKD283 billion to HKD6,154 billion over the same period.
There has also been substantial increase in the nature and types of funds available to the retail investing public. Retail funds in 1989 essentially consisted of four fund types, namely equity funds, bond funds, money market funds and bond/equity or diversified funds. Today, retail investors may also invest in exchange-traded funds, index funds, guaranteed funds and hedge funds. The SFC has been working alongside the industry to enable these new fund types to come to the market.
Over the medium to long-term, Hong Kong's fund industry will be boosted by the implementation of the MPF scheme (which began collecting contributions in December 2000). The MPF scheme is expected to bring about an increase of US$ 2-3 billion per year into the industry and will continue doing so for the next 30 years.
Linkages With the Chinese Fund Market
In April 2007, the SFC entered into a Memorandum of Understanding (“MOU”) with the CBRC for co-operation and information sharing with respect to Hong Kong licensed intermediaries who provide services to Mainland commercial banks conducting overseas wealth management business on behalf of their clients. In May, 2007, the CBRC announced a widening of the scope of investments allowed under the overseas wealth management business provided by the Mainland commercial banks for their clients. At the time, the SFC was the only securities regulator with whom the CBRC had signed an MOU and Hong Kong was therefore the only non-Mainland equity market in which Mainland commercial banks may invest on behalf of their clients. These measures were expected to contribute to the demand for fund management services in Hong Kong and to generate increased investment via the Hong Kong platform.
In June 2007, the China Securities Regulatory Commission (CSRC) announced that QDII fund management companies and securities firms would be allowed to invest in overseas stocks and other specified securities that are listed in markets regulated by a supervisory authority that has signed an MOU on regulatory cooperation with the CSRC. Although the SFC is only one of the 33 regulators who have signed MOUs with the CSRC, making Hong Kong only one of the markets that QDII fund management companies and securities firms can invest in, Hong Kong is well positioned to capture business opportunities based on:
- close economic ties with the Mainland
- a well-established, deep and liquid market
- a world class regulatory regime
- a broad range of investment products
a critical mass of financial talent with international exposure and Mainland
Amongst other provisions, the fourth round of liberalization measures under the Closer Economic Partnership Arrangement between Hong Kong and China (CEPA IV), signed in 2007, allowed qualified Mainland fund management companies to set up subsidiaries in Hong Kong. Together with prior commitments under CEPA, Mainland securities and futures companies and fund-management companies can now participate in the Hong Kong market through their subsidiaries. CEPA IV complements the QDII scheme announced by the CSRC and promotes increased participation of Mainland intermediaries in Hong Kong, broadening Hong Kong’s intermediary base.
The mainland will have to open up its fund management industry now it has entered the World Trade Organisation (WTO). The full potential of Hong Kong's fund management industry will be realised through the Chinese mainland market. China's fund management industry is emerging, and is still relatively small in size. China has a growing demand for fund management expertise to manage its massive savings pool and rapidly expanding retirement funds. Hong Kong is expected to play a key role in sharing its management skills and reservoir of experience in fostering the development of the mainland's fund management industry.
Hong Kong's retail investors also have access to China's vast A-share market through such vehicle's as HSBC Asset Management's China Dragon Fund, the first actively managed, authorised Chinese equity fund listed and traded on the Hong Kong Stock Exchange. The A-shares market, which accounts for the majority of Chinese offerings, comprises around 1,250 listed companies. The market was previously only available to domestic investors, but has been opened to investment by qualified foreign institutional investors.
As China continues its reforms and opening up policies, Hong Kong is the ideal testing ground for renminbi (RMB) products. At the end of August 2011, total outstanding RMB deposits in Hong Kong amounted to some RMB610bn (US$96bn), almost a tenfold increase since 2009. In addition, by September 2011, there had been 95 RMB bond issues, totalling around RMB160bn, while, in the first eight months of this year, more than RMB1 trillion worth of Mainland trade was settled in Hong Kong (more than 80% of the total trade settled in RMB).
According to a speech by Hong Kong’s Financial Secretary, John C Tsang, at the Annual Conference of the Hong Kong Investment Funds Association in October 2011, China's National 12th Five-Year Plan, adopted in March 2011, explicitly supports the development of Hong Kong as an offshore RMB business centre and, for the first time, it affirms the function and role to be played by Hong Kong's asset management industry.
Tsang pointed out that, during his recent visit to Hong Kong, China’s Vice-Premier Li Keqiang had announced new initiatives, such as allowing investments in the Mainland equity market through the RMB Qualified Foreign Institutional Investor scheme, and the launch of an exchange-traded fund with underlying Hong Kong stocks on the Mainland.
He was sure that these measures would not only facilitate the development of Hong Kong as an offshore RMB centre, but also help promote the growth of the SAR's asset management industry. Hong Kong’s government will continue to foster a favourable environment for that growth he said.
Profit Tax Exemption
In March, 2006, Hong Kong's Legislative Council finally passed the Revenue (Profits Tax Exemption for Offshore Funds) Bill 2005.
Under the provisions in the Bill, offshore funds, i.e. non-resident entities (which can be individuals, partnerships, trustees of trust estates or corporations) administering a fund, are exempt from tax in respect of profits derived from dealings in securities, dealings in futures contracts and leveraged foreign exchange trading [as defined in the Securities and Futures Ordinance (Cap. 571) (SFO)] in Hong Kong carried out by specified persons such as corporations and authorized financial institutions licensed or registered under the SFO to carry out such transactions.
To prevent abuse or round-tripping by local funds disguised as offshore funds seeking to take advantage of the exemption, the Government has introduced as a deterrent measure specific anti-avoidance provisions to deem a resident holding a beneficial interest in a tax-exempt offshore fund to have derived assessable profits in respect of profits earned by such offshore fund in Hong Kong.
These deeming provisions will not apply if the offshore fund is bona fide widely held. Considering that a resident may have difficulty in obtaining information from an offshore fund in which he only holds a small percentage of beneficial interest, the deeming provisions would also not apply if the resident (alone or with his associates) holds less than 30% of the offshore fund unless such offshore fund is his associate.
"Profits derived by offshore funds from securities trading transactions in Hong Kong were previously liable to profits tax. The effect of the deeming provisions is merely to recoup the tax amount in the hands of residents holding substantial interests in the offshore funds which became tax-exempt under the proposal. There are other deeming provisions in the IRO for tax collection and anti-avoidance purposes," a spokesman explained.
The exemption provisions apply with retrospective effect to the year of assessment commencing on April 1, 1996, in order to provide legal certainty on the tax liability of offshore funds in respect of past years, which was much called for by the industry as otherwise there would be huge problems for offshore funds to finalise their tax liabilities for past years.
Secretary for Financial Services & the Treasury Frederick Ma told lawmakers that exempting offshore funds from profits tax is vital for Hong Kong to reinforce its status as an international financial centre and enhance its competitiveness.
"The proposed exemption will strengthen Hong Kong's competitiveness in attracting new offshore funds and encourage existing funds to continue their investment," he stated.
"It will lead to an increase in market liquidity and employment opportunities in the financial services and related sectors. Downstream service sectors such as brokers, accountants, bankers, lawyers, will also benefit from the proposal," Mr Ma added.
Under the bill, individuals', partnerships', corporations' and trust estate trustees' offshore funds will enjoy tax exemption by satisfying two conditions - the entity that owns the fund is non-resident, and does not carry on any business in Hong Kong other than the fund-related qualifying transactions.
Mr Ma said the well-established common law rule of 'central management and control' many other places adopt will be used to determine whether a non-individual entity is resident in Hong Kong or not.
He said the proposed scope of the qualifying transactions includes those in securities, futures contracts, foreign-exchange contracts, deposits other than by way of a money-lending business, foreign currencies and exchange-traded commodities.
Subscriptions to and redemptions of units in unit trust funds domiciled in Hong Kong are also exempt from the $5 fixed stamp duty under a bill passed in November 2003 by the Hong Kong Legislative Council.
Licensing Process Streamlined
Early in 2007, the SFC decided to prioritise the streamlining of its licensing processes for all types of intermediaries, and to implement these changes gradually by means of a phased approach. Given the overall complexity and impact of this exercise, the SFC decided to confine the first initiatives to the licensing of fund managers. A circular to intermediaries was issued on June 11 - principally directed at overseas hedge fund managers - because there appears to be insufficient understanding amongst this group as to the SFC’s licensing requirements.
The SFC intends to apply similar principles to the licensing of fund managers more generally, where they will only be serving professional investors and where the particular circumstances of a case warrant this.
The SFC said the initiatives described in the circular reflect a pragmatic and flexible approach:
- Firms that are already licensed or registered in the US or UK as investment managers or advisers, and which only serve professional investors and have good compliance records, will benefit from an expedited licensing process.
- Persons nominated to be the Responsible Officers (ROs) of hedge fund managers, who fulfil the necessary criteria, can be exempted from the local regulatory examination.
- A broader range of relevant past industry experience will be recognised as satisfying the competence requirements for ROs.
The Hong Kong Securities and Futures Commission authorised the first Islamic fund for sale to retail investors in the territory in November 2007.
The Commission's Intermediaries & Investment Products Executive Director, Alexa Lam explained that facilitating the development of the Islamic investment market is a high priority. "The introduction of Islamic retail funds gives added variety to our retail fund market and underscores the versatility of our asset management industry".
In support of the government's initiative to develop Hong Kong's Islamic finance capabilities, the Commission has been working with industry participants to enable the introduction of Islamic financial products to the Hong Kong market. It has also uploaded related educational materials to its website.
Islamic funds comply with the investment principles under the Islamic religious law of Sharia. The Sharia Principles preclude investments in businesses such as conventional financial services, alcohol, pork-related products, gambling, leisure and entertainment. Sharia principles also preclude interest bearing investments and investments in companies with unacceptable levels of debt.
However, as interest is not allowed by Sharia law, earnings on Islamic bonds are taken as profit, which is subject to being taxed. The government is therefore looking to introduce a bill to offer the same withholding tax exemption as is given to normal bonds on interest paid.
“Hong Kong is well-suited to become a vibrant Islamic financial platform and market for Sharia-compliant bonds," Financial Secretary, John C Tsang, at the Annual Conference of the Hong Kong Investment Funds Association in October 2011. "This is an opportunity we will continue to pursue. We are working on a bill to provide a level playing field for sukuk vis-à-vis their conventional counterparts in terms of tax liabilities.”
Tsang confirmed that the government aims “to conduct a second round of consultation with major market players on the relevant details of our legislative (Islamic) proposal in the first quarter of 2012.”
In May, 2002, the SFC published guidelines governing the sale of hedge funds to retail investors, making Hong Kong one of the first jurisdictions to enable retail hedge funds. The guidelines divided hedge funds into three categories - single hedge funds, fund of hedge funds and hedge funds with a capital guarantee.
For single hedge funds, a retail investor must subscribe at least US$50,000, while funds of hedge funds, seen to be less risky, will require a minimum investment of US$10,000. No minimum investment has been set for guaranteed capital funds.
However, the SFC has imposed strict rules on managers of single hedge funds and funds of hedge funds, requiring them to have five years' hedge fund management experience, and limiting access for retail investors to fund managers with at least US$100 million worth of hedge funds under management.
According to a survey report released by the Securities and Futures Commission (SFC) in March 2011, Hong Kong’s hedge fund industry has continued to register a strong growth rate, both in the number of such funds and in their assets under management.
The “Report of the Survey on Hedge Fund Activities of SFC-licensed Managers/Advisers” shows that assets under management or advisory in Hong Kong increased 14% from the time of the last survey in March 2009 to US$63.2bn as at September 30, 2010.
In addition, the number of hedge funds managed by SFC-licensed hedge fund managers in Hong Kong stood at 538 as at September 30, 2010, similar to that in 2009 and nearly five times the level in 2004, the earliest year covered in similar SFC surveys.
2005 Hedge Fund Guidelines
In September, 2005, the SFC announced new hedge fund guidelines, effective immediately.
The SFC published its conclusions on the Consultation Paper on the Review of the Hedge Fund Guidelines (HF Guidelines) contained in Chapter 8.7 of the Code on Unit Trusts and Mutual Funds, which were generally supportive of its main proposals:
- to adopt a holistic approach in the assessment of a management company, and providing greater flexibility in recognising the experience of fund manager's key personnel;
- to increase the transparency of the management company's operations through additional disclosures in the offering documents of its risk monitoring and due diligence process; and
- to consolidate and codify existing SFC regulatory practices in the application of HF Guidelines by way of additional notes.
However, taking into consideration the responses of the Consultation Paper, recent international regulatory developments, and the need to ensure investor protection, the SFC decided that: the minimum subscription threshold for SFC-authorised single hedge funds is maintained at US$50,000; and there will not be a relaxation of the current restriction imposed on the level of collateralisation to prime brokers for SFC-authorised hedge funds.
The SFC says it will keep monitoring the overseas regulatory and market developments regarding these two issues, and may revisit them in the future.
Respondents also provided comments relating to other provisions of the HF Guidelines. In view of these comments, the SFC has made revisions to clarify its regulatory intent on certain provisions, such as the requirements on valuation. The HF Guidelines requires SFC-authorised hedge funds to value their assets in a fair and independent manner. A principles-based approach has been adopted in the revised HF Guidelines to set out the general principles in respect of fair and independent valuation, including the need to ensure proper segregation of the functions of investment management from those of valuation and the need to maintain proper checks and balances in the way valuation is carried out.
Mrs Alexa Lam, SFC's Executive Director of Intermediaries and Investment Products, said: "The Commission is fully aware of the changing international regulatory landscape for hedge funds. Extensive discussions about the risks associated with hedge funds and how to handle these risks are taking place among industry and market practitioners as well as regulators in major overseas jurisdictions. As one of the first jurisdictions to allow the sale of hedge funds to the investing public, the Commission will continue to monitor the international regulatory developments in the hedge fund arena, and make further changes to the HF Guidelines when necessary."
Speaking in December 2007 at the 5th Annual Hedge Funds Conference, Secretary for Financial Services & the Treasury, Professor KC Chan suggested that Hong Kong is fast becoming the hedge fund hub of Asia.
"Hong Kong got the largest number of new Asia Pacific hedge funds launched in 2006 as well as in the first half of 2007, ahead of Singapore, Japan and Australia."
"We have adopted various tax measures to promote the growth of the industry. Since 2006, offshore funds have been exempted from profits tax. This brings us in line with other major financial centres such as New York and London. More importantly, the measure helps attract new offshore funds to come to Hong Kong and encourages existing offshore funds to continue to invest in Hong Kong."
"We have also abolished estate duty since last year to encourage local and overseas investors to invest in Hong Kong. To further enhance our competitiveness, the Chief Executive announced in his Policy Address in October this year that our profits tax will be reduced from 17.5% to 16.5% in 2008-09. Given our already low and simple tax regime, these measures will further enhance our attractiveness to overseas fund managers."
By 2010, assets managed by the hedge fund industry in Hong Kong had reached US$55.3bn. But in a speech to the HFR Industry Summit Asia in September 2010, Chang said that more stringent regulation of the hedge fund industry in the US and the EU would "inevitably" have an effect on Hong Kong's hedge fund sector.
"Regulations, particularly in the financial sector cannot be expected to have a local effect only. Developments in the EU and the US relating to regulation of hedge funds will inevitably have a huge impact on the international asset management industry," he said.
"We believe any regulations coming out of the EU should not discriminate against non-EU managers. We are supportive of co-operative arrangements between the authorities but they should be in line with international standards. Regulations should also be predictable and consistent," he added.
Of the total hedge fund assets managed in Hong Kong, about 40% are funded by European investors. Therefore, it is "critical," Chang noted, that Hong Kong's hedge funds can continue to service their European clients.
"We are committed to designing regulations that are suitable for our needs and our markets. We need to strike a balance between the goal of having a quality market and maintaining a forward-looking market friendly approach," he said.
Hong Kong's Securities and Futures Commission (SFC) announced in February 2011 that it was proceeding with proposals to refine the requirements for evidencing whether a person qualifies as a high-net-worth professional investor.
The purpose of the proposals is to create more flexibility by adopting a principles-based approach whereby firms may use methods that are appropriate in the circumstances to satisfy themselves that an investor meets the relevant assets or portfolio threshold to qualify as a professional investor under the Securities and Futures (Professional Investor) Rules.
The SFC takes the view that it would not be desirable to seek to prescribe all the possible ways that an investor could demonstrate that they have the relevant assets so as to qualify as a professional investor under the Professional Investor Rules (PIR). The SFC will rely on the firms’ professional judgement to decide the methods by which they can satisfy themselves that their clients have the required assets or portfolio levels at the relevant date.
The SFC therefore expects firms to keep proper records of their assessment process so as to demonstrate that they have exercised professional judgement and have reached a reasonable conclusion that their clients meet the relevant thresholds, for example, keeping copies of the documents they have relied on to assess clients’ means.
In addition, however, to enable firms that so wish to continue with existing practices, the current methods for proving that investors qualify as professional investors will be preserved.
Under the previous PIR, there are four types of high-net-worth professional investors - a trust corporation with total assets of not less than HKD40m (US$5.1m), or its equivalent; an individual with a portfolio of not less than HKD8m; a corporation or partnership with either a portfolio of not less than HKD8m or total assets of not less than HKD40m; or a corporation the sole business of which is to hold investments and which is wholly owned by an individual who has a portfolio of not less than HKD8m.
Collective Investment Funds
In Hong Kong, approved Collective Investment Funds are exempt from profits tax. In August, 2003, the Securities and Futures Commission decided to allow Reits (Real Estate Investment Trusts) to take the form of Collective Investment Funds, leading the stock market regulator HKEx (Hong Kong Exchanges and Clearing) to simplify the listings process for all Collective Investment Funds, including Reits.
'The Stock Exchange of Hong Kong Limited (the Exchange) has amended Chapter 20 and its ancillary sections of the Main Board Listing Rules for the purposes of:
- Creating a listing and trading platform for all collective investment schemes that are authorised by the Securities and Futures Commission (the “SFC”);
- Clarifying the respective regulatory roles of the SFC and the Exchange in the initial listing of, and the on-going regulatory monitoring of, collective investment schemes; and
- >Streamlining the listing process for authorised collective investment schemes.
The rule change came into effect on 1 September 2003.
HKEX announced at the time that:
"Since the offer structure and offer document of a collective investment scheme would have been vetted by the SFC during its authorisation process, the Exchange’s role at the time of listing will be confined to ensuring compliance with procedural aspects of the listing process. Therefore, the function to grant listing approvals will now be discharged by the Listing Unit, instead of the Listing Committee, of the Exchange."
"An authorised collective investment scheme listing applicant will no longer require a 'sponsor.' Given the involvement of the SFC in all aspects of the approval of a CIS, the SFC is in a position to impose requirements as to the qualification and behaviour of persons involved in arranging the offering of interests in a CIS. The new rules simply codify the current practice of the Exchange in accepting the administrative nature of the listing related work of the “sponsor”, which can be carried out by an experienced agent of the CIS."
Initially, many Hong Kong institutions expressed major doubts about the usefulness of Reits in the SAR, but recently property companies and agencies have warmed to the idea.
Hong Kong's nascent market for real estate investment trusts (REITs) has "huge potential" for growth, with potent sources of growth located in mainland China and the other parts of Asia, according to Martin Wheatley, Chief Executive Officer of the Securities and Futures Commission.
Wheatley said in September, 2006, that the REIT market was relatively new in Hong Kong, but the capitalisation of the four REITs launched up to that point had reached US$6.5 billion, with average daily turnover of US$38 million in the first seven months of the year.
Giving the keynote address at the Asia Pacific Real Estate Securitisation Summit 2006, Mr Wheatley said the opportunities presented by the sheer size of the Mainland and its rapidly growing economy were a major driving force of the Hong Kong REIT market.
"The size of Hong Kong is limited and Hong Kong has already got a substantial universe of listed real estate assets in the form of listed property companies," Wheatley observed.
"A significant part of the growth of our market will be through the process of overseas investments by REITs in Hong Kong. In the process, it is only natural that issuers of REITs will look to the Mainland for assets. It is physically close to Hong Kong; market practitioners and Hong Kong investors are familiar with the languages, culture, business practices and systems in the Mainland," he added.
Wheatley also noted the geographical advantage of Hong Kong as being in the heart of Asia; home to half the world's population and where real estate per capita is among the lowest globally.
"As Asian real estate markets are opened up in the coming years due to rapid urbanisation, strong economic growth and the increasing presence of foreign institutional investors, the Asian market will constitute a potent force in the development of REITs in Hong Kong. In the process, large scale funding has to be obtained and REITs offer an attractive means to property owners to liquidate their holdings to fund further development projects," he noted.
The SFC is committed to facilitating the development of REITs with Asian real estate exposure, said Wheatley.
"While we are encouraged to see the development of local expertise in REIT management, we very much like to see and welcome international professional asset managers to package their real estate investments into REITs for listing in Hong Kong. Our aspiration is for the Hong Kong REIT market to attract not just assets already listed in the portfolio of Hong Kong listed companies, but a new universe of quality listing grade real estate assets in the region, managed by internationally renowned houses, as in the case of the more developed REIT markets of Australia and the US," he stated.
According to the regulatory chief, the SFC's role was to maintain a regulatory framework of international standards and market integrity. This would attract investors and quality issuers, and preserve an environment conducive to product development and market growth.
"In this regard, the Commission has to uphold a fine balance between market facilitation on the one hand, and investor protection and reputation of Hong Kong as an international financial centre on the other," he concluded.