As Chinese New Year celebrations conclude and we enter the Year of the Dog, the Greater China remains a critical region of focus for global asset managers. As BBH Vice President Gabriel Cheung tells us, between mutual fund recognition and the Stock Connect and Bond Connect programs, Hong Kong is central to many global asset managers Greater China ambitions.
In 2018, Hong Kong is expected to enhance its reputation as a key Asian regional fund hub by launching a new corporate fund vehicle, Open-Ended Fund Companies (OFCs). It is also expected to expand its ETF capabilities to allow actively managed strategies. Both changes offer asset managers new growth opportunities.
Hong Kong as a Fund Hub
The current Securities and Futures Commission (SFC) rules only allow Hong Kong funds to be set up as trusts, creating challenges for Hong Kong in exporting its funds to become a cross-border fund hub of choice. This is expected to change in 2018 with the introduction of OFCs. OFCs are corporate fund vehicles, like the fund structures commonly used in global cross-border centers like Ireland and Luxembourg.
Historically, Hong Kong law has required corporate fund vehicles to be close-ended. Further, open-ended mutual funds could only be established as unit trusts, which are often seen as disadvantaged from a tax standpoint relative to corporate fund structures. Corporate fund structures avail of double taxation treaty benefits on their underlying investments and are exempt from profit tax, key selling points for global investors.
Subject to the conclusion of the industry’s open consultation on the SFC’s OFC Code in early 2018, the OFC is likely to become the investment vehicle of choice for Hong Kong asset managers who issue funds publicly or privately, and have cross-border aspirations. The SFC will exclusively conduct the approval and establishment of the OFCs, thereby aligning regulatory treatment with offshore funds, such as UCITS, in Hong Kong.
According to a 2016 Brown Brothers Harriman survey, more than 55% of respondents considered OFCs critical to the success of Hong Kong as a regional fund domicile.
Active ETFs as a Game Changer
In 2017, there was much industry debate and excitement that Hong Kong ETFs could become eligible under the Stock Connect program between Hong Kong and Mainland China. While this remains a work-in-progress, it is on track for eligibility in 2018.
Another key initiative for ETFs in Hong Kong is the expansion to include active ETFs. The SFC’s December 2017 consultation updating the Code on Unit Trusts and Mutual Funds (the UT Code) could be a game changer, as it could allow active ETFs to be listed and traded on the Stock Exchange of Hong Kong Limited without the need to track the performance of an index or benchmark. This initiative would bring active ETFs to the mass market and make Hong Kong just the second market in Asia to offer active ETFs, after South Korea. While the discussion of portfolio disclosure for active ETFs is still in progress, the requirement would likely not be a deal-breaker for most asset managers, if it means their active funds could be sold on the secondary market, thus expanding their distribution channels. Additionally, funds that are currently unlisted may offer a listed share class once appropriate disclosure is included in the fund prospectus.
The consultation of the UT Code is expected to close by March 2018, marking one of the most significant changes for Hong Kong funds in years.
Preparing for Change
While the final details are still being ironed out in the SFCs consultation process, asset managers can leverage this time for planning. For asset managers without Hong Kong funds, there has never been a better time to assess whether Hong Kong domiciled funds would make a valuable addition to their Greater China fund strategy. Managers who already have Hong Kong funds should plan to leverage the upcoming enhancements for future product design. While it will not be appropriate for every type of fund, it warrants close consideration for the potentially large benefit to clients in 2018 and beyond.
These new initiatives affirm Hong Kong as a leading international hub for Greater China and a highly attractive location for asset managers to drive their regional strategy.
This article was originally published in the 2018 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.