Hong Kong just signed its fourth mutual fund recognition agreement with one of its longest and closest trading partners – the UK. At the same time, Brexit is compelling UK asset managers to look beyond European borders for opportunity. For these reasons, the excitement around this arrangement may be justified.
The UK and Hong Kong have a long and storied relationship that includes legal systems, political relationships, and the asset management industry. More than 300 UK-based companies have regional headquarters or offices in Hong Kong. In early October, the Hong Kong Securities and Futures Commission (SFC) and the UK’s Financial Conduct Authority (FCA) signed a memorandum of understanding concerning the mutual recognition of funds (MRF). The agreement establishes a framework to allow approved funds to be sold in one another’s market under a streamlined regulatory procedure.
The agreement is yet another step in Hong Kong’s ambition to act as a fund and asset management hub for the Greater China region. An important policy decision to progress this goal was the introduction of a corporate fund structure in Hong Kong, known as the Open Ended Fund Company (OFC). Corporate fund vehicles tend to passport better on a cross border basis and OFC will aid any Hong Kong funds wishing to sell into the UK – a market used to such vehicles through UCITS and OEICs.
The SFC previously implemented similar MRF arrangements with China, Switzerland, and France. However, unlike the France and Switzerland MRF where demand has been minimal so far, many believe the UK arrangement has a higher chance for success because the UK and Hong Kong are already so interconnected.
This arrangement is also indicative of the UK’s desire to foster financial services partnerships beyond the EU as Brexit negotiations continue to play out. The loss of certain EU fund passports such as UCITS are inevitable post-Brexit, but potentially is no reason why the UK – as a non-EU third country – cannot strike a similar deal with Ireland and Luxembourg, for example. Remember, even as an EU country, France has already entered into a mutual recognition agreement with Hong Kong, which includes UCITS funds.
UK Fund Access to Hong Kong
Any UK-domiciled fund wishing to benefit from the MRF must be a UK UCITS scheme. This becomes an issue when all UK funds lose UCITS designation post-Brexit. However, UK funds will strive for UCITS equivalency post-Brexit to strike similar cross border deals. The FCA recently published a Consultation Paper which foresees the maintenance of UCITS rules for UK retail funds post Brexit. The industry hopes this will ensure UK funds are looked on favorably when assessed for equivalency in negotiating similar fund recognition deals. UK funds must also be managed by a UK management company authorized by the FCA and its delegates must be based in a jurisdiction with an acceptable inspection regime.
Other regulatory obligations include:
- Issuance of Hong Kong prospectus and key facts statements in both English and Chinese
- A Hong Kong representative
- Mandatory requirements on valuation, pricing, dealing, fees paid from the fund, and transactions with connected persons
- Post-authorisation SFC notification and disclosure requirements
- Additional requirements specific to fund types (i.e. funds of funds, ETFs, and feeder funds).
These conditions largely replicate the arrangements currently in place for registering UCITS for Hong Kong distribution and involve direct FCA to SFC interactions.
HK Fund Access to the UK
For a Hong Kong Fund to benefit from the streamlined FCA authorization process, the fund must be Hong Kong-domiciled, established and managed in accordance with Hong Kong law and regulations, and authorized by the SFC. It may not engage in leverage exceeding 100% of the fund’s net asset value. The type of funds eligible for inclusion in the mutual recognition framework are the same as for UK funds, namely equity and bond funds, ETFs, fund of funds, and feeder funds. The FCA approval process adopts an identical approach in terms of relying upon the SFC to provide directly to the FCA a certificate confirming that the FCA’s eligibility requirements are met in full.
Who May Benefit?
This new framework is likely to benefit asset managers who fall into three main categories:
- Any UK-based managers currently without UCITS structures
- Hong Kong-based asset managers with Hong Kong domiciled funds who may look to distribute into the UK market
- Any European managers without a UK or Hong Kong fund range. An opportunity now emerges to establish funds in either UK or Hong Kong that can sell into these two significant markets as a supplementary distribution strategy to UCITS.
Another benefit of Hong Kong funds is their eligibility to participate in the existing mutual recognition regime between Hong Kong and China. This allows eligible Hong Kong funds to sell into mainland China in much the same way the Hong Kong-UK plan prescribes.