Hong Kong: Offshore Investment
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.
Participants in the Hong Kong market benefit from a stable, transparent operating environment, as evidenced in a thriving asset management sector which, according to Securities and Futures Commission CEO Martin Wheatley, saw a 45.4% year-on-year growth in assets under management to just over US$1 trillion in 2009.
The Securities and Futures Commission is responsible for regulating the marketing to the public of unit trusts, mutual funds and other collective investment schemes.
The Investment Products Department has regulatory responsibility for unit trusts, mutual funds, investment-linked assurance schemes, pooled retirement funds and immigration-linked investment schemes as well as other forms of investment arrangements. These products require authorisation by the SFC before they can be marketed to the public in Hong Kong. The Department vets applications for such authorisation and monitors ongoing compliance with regulatory requirements. The SFC has issued numerous sets of Rules and Codes of Practice for the guidance of the investment management sector.
On August 10, 2010, the SFC announced the authorisation of the first fund denominated in renminbi (RMB) for sale to retail investors in Hong Kong.
The SFC has been working closely with industry participants to enable the introduction of RMB-denominated investment products to support the initiative to develop Hong Kong into an offshore RMB centre.
“Hong Kong has a unique role in China’s internationalisation of its currency. As the RMB becomes more popular and widely held outside the Mainland, demand for RMB-denominated investment and financial products will grow. Hong Kong’s role is to make these products available and manage their risks,” said Mrs Alexa Lam, the SFC’s Deputy Chief Executive Officer and Executive Director of Policy, China and Investment Products.
The first retail RMB-denominated fund was authorized under the enhanced product authorization regime.
In May, 2001, the SFC published guidelines governing the sale of hedge funds to retail investors, which divide 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.
In November 2001, the SFC gave approval to the first three retail market hedge funds.
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.
The hedge funds are invested mainly in the Asia Pacific, using equities long/short strategy and multi-strategy. As at end-September, 66.1% of the total assets under management was invested in the Asia Pacific markets. Overseas investors continued to dominate, with over 92% of the investors being from overseas.
“Closer scrutiny of the hedge fund industry is a global trend,” said Martin Wheatley, the SFC’s Chief Executive Officer. “We will continue to maintain a balanced approach to regulation with a view to allowing room for industry development and growth without compromising investor protection.”
Speaking in December 2007 at the 5th Annual Hedge Funds Conference, Secretary for Financial Services & the Treasury, Professor KC Chan suggested that Hong Kong was fast becoming the hedge fund hub of Asia.
To back up this assertion, he quoted figures which showed that the number of hedge funds in Asia had increased substantially from 160 in 2001 to about 1,240 in the first half of 2007. Total assets under management had also increased by nine times, from US$16 billion to about US$167 billion during the same period, Professor Chan revealed.
"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."
2005 Hedge Fund Guidelines
In September, 2005, the SFC announced new hedge fund guidelines with immediate effect.
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 has 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.”
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.
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.
HKEx announced that it had 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.
"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. The Housing Authority is said to want to use reits to dispose of $20 billion worth of car parks and shopping centres, while Sun Hung Kai Properties, Cheung Kong (Holdings) and Hutchison Whampoa have all expressed interest.
In July, 2005, the Court of Final Appeal finally rejected an application by an elderly resident of the territory for a permanent ban on the government's US$3 billion real estate investment trust (REIT) plan.
The launch of the massive REIT offering - which includes 180 car parks and almost 1 million square metres of retail space - was set to take place in December, 2004, but Lo Siu-lan, an elderly resident of government-owned accommodation submitted a last minute application for a judicial review, in which she argued that the deal undervalued the assets, and could lead to higher costs for tenants.
However, in an unanimous judgment, Hong Kong's highest court held that the Housing Authority "plainly has the power to sell the... retail and car park facilities to the Link REIT."
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.
On June 25, 2010, the SFC announced the application of the Codes on Takeovers and Mergers and Share Repurchases (Codes) to SFC-authorised real estate investment trusts (REITs) with immediate effect following a public consultation on the proposals earlier in the year.
The majority of the proposals published in January 2010 have been adopted, with some modifications and amendments to take into account responses received during the two-month consultation process.
"We believe that the implementation of the proposals represent a significant step forward in establishing a regulatory framework that better protects the investors’ interests and assists the further development of the REIT market in Hong Kong," said Martin Wheatley, the SFC's Chief Executive Officer.
The proposed amendments to the Code on REITs (REIT Code) and the Codes include aligning the control structure of REITs with that of listed companies and introducing a set of REIT Guidance Notes. Unitholders who increase their holding to 30% or more will be subject to the trigger provisions under the Codes. Likewise, unitholders holding between 30% and 50% who increase their holding by more than 2% from the relevant lowest percentage in the 12-month period preceding the relevant increase in holding will also be subject to the creeper provisions of the Codes.
Consistent with the objective of ensuring as far as possible that all unitholders are neither advantaged nor disadvantaged, no transitional arrangement will apply.
In June 2010, Alexa Lam, the Deputy Chief Executive Officer and Executive Director of Policy, China and Investment Products of the SFC, said that exchange-traded and index funds are “one of the fast-developing segments of our markets.
Speaking at The Art of Indexing Summit Asia in Singapore, Mrs Lam noted that Hong Kong had seen significant changes in the last few years in the number and types of these funds on offer in Hong Kong.
Mrs Lam indicated that some of the forthcoming revisions to Hong Kong’s Code on Unit Trusts and Mutual Funds had been made to take account of market developments in certain areas, including index funds. She pointed to the increasingly broad range of asset classes tracked by index funds and the number of index funds using representative sampling or synthetic replication to track indices or benchmarks.
The Code on Unit Trusts and Mutual Funds applies to funds offered to the public in Hong Kong. During her address, Mrs Lam drew attention to the requirement for sufficient information to be provided to investors to enable them to make informed judgments about the products and, in the case of index funds, for indices to be “acceptable”, rules-based and impartial. The revised Code, she said, also included detailed provisions applicable to authorized funds seeking to use swaps and other derivatives to achieve their investment objectives, as this strategy could affect the risk characteristics of the funds and limit transparency.
Speaking about developments in exchange-traded funds (ETFs), Mrs Lam said, “Certainly the demand for ETFs is there. ETFs are not just the domain of the retail investor, of course. I’d note that we’re seeing increasing use of ETFs by institutional investors as well. This has implications at the design stage, with product providers catering to a broader range of investors with increasingly diverse investment needs, and it also has implications for the way in which ETF units trade in the secondary market.”