The long anticipated Open-Ended Fund Company (OFC) took effect in Hong Kong last week and is widely expected to play a key role in the future growth of Hong Kong as a fund domicile. But there is still work to do.
As of July 30, asset managers in Hong Kong can now establish investment funds in corporate form as Open-ended Fund Companies (OFCs), in addition to the already available unit trust regime. The introduction of the OFC, whether set up under a private or public umbrella, is widely expected to bring growth opportunities to Hong Kong as a fund domicile, and make Hong Kong funds more marketable across the globe. Hong Kong looks set to benefit from its long-established fund management industry and its privileged access to Mainland China. Hong Kong OFCs can be set up as private or public funds and they may be structured as umbrella funds, with multiple sub-funds that have statutory segregated liability – similar to UCITS funds.
Time to Gain Traction
Whilst the OFC regime is now up and running, we expect a trickle rather than a flood of launches as policymakers, asset managers, and industry bodies continue to provide feedback to the Securities and Futures Commission (SFC) in framing practical and operational best practices to supplement the existing legal text. The SFC plans to streamline the application process, estimating the process for public OFCs will take one to three months, whilst private OFCs will take less than a month to launch. Nonetheless, reaching the effective date is a critical step in the maturation of Hong Kong as an international fund domicile and provides more choices to asset managers establishing Hong Kong fund vehicles. Corporate fund vehicles are the generally accepted and recognized form for collective investment vehicles across the globe and are crucial for cross border fund passporting for the public OFC.
Here are five areas global asset managers looking to operate in Greater China should focus on, based on the introduction of the Hong Kong OFC:
- Unit Trust Conversions
Existing Hong Kong domiciled funds are currently set up as unit trust structures. There is a lot of current debate about whether these unit trusts will choose to convert to corporate form or whether OFCs will be new funds brought to market. The latter is more likely. Whilst the SFC proposed a regime to facilitate conversions of existing unit trusts to OFCs there are downsides to such an approach. Since an OFC is a new company it is likely that switching of investments and investors from the unit trust may be deemed a taxable event. As such, a detailed cost benefit analysis inclusive of independent Hong Kong tax and legal advice would be critical in making that decision. A newly minted OFC may be simpler and more efficient for asset managers. Whilst an OFC makes passporting easier, no one will want to disrupt existing unit trust investors. The industry is keeping a close eye on how this area will shake out.
- Complementary to UCITS Distribution Strategy
For global asset managers in the process of building out or enhancing their Greater China strategies, Hong Kong domiciled funds represent complementary fund structures to facilitate access to Hong Kong and Mainland China investors and potentially other jurisdictions in the future. They should complement any existing UCITS vehicles that already exist in the region. Other than the distribution to retail investors in Hong Kong, Hong Kong OFC is not in direct competition with UCITS funds which will continue to be passported and listed in Hong Kong for wider distribution in the region.
- Mutual Recognition Opportunity
Although not yet eligible for immediate use, the mutual recognition of funds (MRF) scheme between Hong Kong and China may represent the greatest future growth opportunity to asset managers. It is widely expected that OFC will be added to the MRF program in time. The MRF program launched over two years ago but has not taken off as expected. Some asset managers feel the regime is too restrictive, particularly in relation to the “50/50 rule.” (The 50/50 rule says if a fund has $100 sourced from Hong Kong, it cannot raise more than $100 from the mainland market.) Since Hong Kong is a much smaller market than China, the rule makes it difficult to scale up a fund. However, policymakers and industry bodies are engaged in constructive dialogue to make the appropriate revisions.
- Hong Kong Links to Europe
Hong Kong has already entered into mutual recognition agreements with Switzerland and France. Now that the OFC is part of the Hong Kong toolkit, this will be a future avenue of growth for those agreements. There are also rumblings in the industry about a future bilateral agreement with a post-Brexit UK market. Should it ever come to pass, it’s likely the proposed AIFMD Third Country passport would extend to Hong Kong allowing Hong Kong funds to be passported to EU investors under AIFMD third country rules.
- ETF Connect
Exchange Traded Funds (ETFs) in OFC form is not explicitly contemplated within the OFC rules, however, ETFs structured as OFCs will likely be feasible in the future. Global asset managers are already interested in the opportunities within an ETF Connect scheme and Hong Kong public OFCs are likely to rank high on the list of product structuring priorities for ETF Connect.
According to a BBH survey of professional ETF investors, almost 90 percent of Mainland China respondents said they plan to invest in Hong Kong ETFs when ETF Connect launches. Asia Pacific equity ETFs were the top asset class Mainland investors are looking to access through the program. We expect regulators will announce ETF Connect before the end of 2018.
This article was written with contribution from BBH Head of Trust Services, Hong Kong, Gabriel Cheung.