Financial Services Quarterly Report - Third Quarter 2013: Recent Developments in the Hong Kong Funds Industry

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The Hong Kong Government has been keen to demonstrate its willingness to evolve and focus its efforts on the overall growth of the Hong Kong financial services industry. Recent proposals to make fund-friendly changes to Hong Kong’s trusts, corporate and tax rules, as well as the introduction of the mutual recognition of Hong Kong and Chinese funds, serve as examples of the push towards raising Hong Kong’s profile in the global asset management industry.

Trusts Law (Amendment) Ordinance

Hong Kong’s trusts law, which has not been reformed since its enactment in 1934, will finally get the facelift it deserves. The Trusts Law (Amendment) Ordinance 2013 (“Ordinance”) was published on 26 July 2013 and will come into effect on 1 December 2013. It is aimed at modernizing Hong Kong’s existing archaic trusts law and enhancing clarity and certainty.

Key proposed amendments include:

  • introduction of a statutory duty of care for trustees;
  • provision of general powers to trustees to appoint agents, nominees and custodians;
  • abolishment of the existing rules against perpetuities and excessive accumulation of income; and
  • grant of increased powers to trustees to insure trust assets against risk of loss.

This move is expected to afford Hong Kong’s financial services sector with additional business opportunities in both the retail unit trusts and private trusts sectors, as more wealth may be channeled into Hong Kong-domiciled trusts as a result of these amendments. Open-ended Hong Kong-domiciled funds are predominantly constituted as unit trusts due to structural impediments posed by Hong Kong’s Companies Ordinance (Cap. 32, Laws of Hong Kong) (there is as yet no bespoke mutual funds law, although please note the section below). It is hoped that the legislative changes will enhance Hong Kong’s status as an international financial services centre in the region.

Hong Kong-PRC Mutual Funds Recognition Scheme

The Hong Kong-PRC Mutual Fund Recognition Scheme (“Scheme”) has been gaining steady momentum since it was first introduced by the Hong Kong Securities and Futures Commission (“SFC”) in January 2013.

The Scheme will allow funds domiciled in Hong Kong that are managed by SFC-licensed fund managers to be sold in the PRC and vice versa. This development should certainly raise Hong Kong’s profile as a leading funds domicile (and not just a fund distribution centre). The Scheme will potentially provide international asset managers unprecedented access to China’s ever-expanding retail funds market. The flurry of recent press coverage has also hinted that the Hong Kong and Mainland securities regulators are close to making the Scheme a reality. However, neither the SFC nor the China Securities Regulatory Commission has shed any light on the detailed regulations needed to launch the Scheme. The criteria for the funds to be eligible for the Scheme and the timing for the Scheme’s introduction – two important details – still remain uncertain.

Profits Tax Exemption for Offshore Funds

The Hong Kong Government has proposed extending the application of the Hong Kong profits tax exemption for offshore funds. Currently, the Profits Tax Exemption for Offshore Funds Ordinance (“Profits Exemption Ordinance”) exempts an offshore fund from Hong Kong profits tax where such fund is a non-resident and derives its profits from certain specified transactions (which include any transactions in public securities). However, the shares, debentures and options of, and the related rights in, a private company are specifically excluded from the definition of “securities”.

The exemption, as it presently stands, is intended to prevent non-residents from dealing in the underlying assets (such as landed property) of a private company through a transaction in shares of such company. Venture capital and private equity funds that utilize private companies incorporated offshore for investment have, up to now, not been able to take advantage of the Profits Exemption Ordinance.

The Government’s proposal envisages extending the profits tax exemption to offshore funds that engage in transactions through foreign-incorporated or foreign-registered private companies if such companies do not possess any Hong Kong property or carry out any business in Hong Kong, potentially increasing Hong Kong’s attractiveness as a domicile for private funds.

Nevertheless, the status of the proposal in relation to the extension of the application of the Profits Exemption Ordinance is uncertain and the extent to which (if at all) this proposal will be adopted is unclear. Further, even if this proposal is given the green light, its effect on the fund industry is debatable. While the Cayman Islands and the British Virgin Islands continue to enjoy tax haven status, the rate of corporate tax in Hong Kong on profits arising in or derived from Hong Kong is presently at 16.5%. Therefore, the proposal may not be as attractive to the private fund industry as at first glance.

A Mutual Funds Law in Hong Kong?

The Hong Kong Government has also been considering legislative amendment to allow open-ended investment companies to be established in Hong Kong. Currently, investment funds domiciled in Hong Kong can only be established in the form of unit trusts. Such legislation would at least encourage international asset managers to consider Hong Kong as a funds domicile.

At present, approximately 85% of SFC-authorized funds in Hong Kong are Undertakings for Collective Investment in Transferable Securities (more commonly known as UCITS) domiciled in Ireland or Luxembourg, while Hong Kong-domiciled funds are almost exclusively local mandatory provident funds1. Although the exact numbers for private funds are not publicly available, based on our experience in Hong Kong, these are generally domiciled in the Cayman Islands or the British Virgin Islands. Whether these recent developments would have a significant effect on the number of Hong Kong-domiciled funds is still uncertain.

Professional Investor Consultation

The SFC has in recent years taken a more conservative approach to investor protection. On 15 May 2013, the SFC published a Consultation Paper on the Proposed Amendments to the Professional Investor Regime and the Client Agreements Requirements (“Consultation Paper”) and sought feedback from the industry in relation to its proposals. The consultation period concluded on 14 August 2013. The Consultation Paper proposes to amend the professional investor regime, in particular, in relation to the investor protection measures applicable to individual and corporate professional investors. The SFC also recommends that the suitability requirements of the Code of Conduct for Persons Licensed by or Registered with the SFC be incorporated as a contractual term in client agreements, so that intermediaries will be contractually bound to comply with the suitability requirements. These proposals, if implemented, are likely have a significant effect on the way intermediaries currently conduct their business, with potential implications on operations, compliance procedures and costs.

Footnotes

1 The mandatory provident fund system in Hong Kong is a privately managed, fully-funded compulsory contribution scheme established under the Mandatory Provident Fund Schemes Ordinance (Cap. 485, Laws of Hong Kong) to offer basic retirement protection to the working population through savings.

 

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