Hong Kong: A Guide To Selling Regulated Investment Funds In Asia June 2012 - Hong Kong

Overview

Irish investment funds may be sold in Hong Kong by way of either public offering or by private placement. Public offerings require Securities and Futures Commission's ("SFC") authorisation, involving a two step process - the approval of both the manager of the Irish fund and its offering and constitutive documents.

For private placements there is no requirement to seek authorisation from the SFC but there are restrictions in terms of the types of funds that can be offered, how they can be offered and who may offer them.

The SFC is very familiar with Irish funds, and with Irish UCITS in particular. Irish UCITS are regularly sold in Hong Kong.

As detailed below, the prospectus of any Irish domiciled fund being sold in Hong Kong may be required to comply with certain Hong Kong requirements. It should be noted that if a Hong Kong Covering Document or a specific Hong Kong offering document is prepared, such document will need to be submitted to the Central Bank of Ireland in advance to ensure that there are no inconsistencies with the Irish prospectus.

Public Offering

The SFC authorisation process is a two step process involving the approval of both the manager of the fund and its offering and constitutive documents. In order to obtain authorisation, the fund must demonstrate compliance with the SFC's Code on Unit Trusts and Mutual Funds (the "Code") and the Overarching Principles Section (the "Overarching Principles"), which form part of the SFC's Handbook for Unit Trusts and Mutual Funds, Investment Linked Assurance Schemes and Unlisted Structured Investment Products (the "Products Handbook"). Where compliance with a specific provision of the Code is not possible, an application for a waiver from compliance may be made to the SFC. However, as a general rule, it is becoming increasingly difficult for any foreign fund to obtain SFC waivers from the Code.

The SFC will review an Irish UCITS fund on the basis that its structural and operational requirements and core investment restrictions already comply in substance with the Code. However, in the event of any deviation from the Code, compliance may still be required.

Notwithstanding the above, certain UCITS funds (e.g. money market funds, index tracking funds, hedge funds and structured funds) described in Chapter 8 of the Code, are classified as "specialised schemes" and are required to demonstrate full compliance with the applicable provisions and structural and operational requirements and core investment restrictions of the Code. This also applies to "hybrid" products which share one or more of the above characteristics.

The following general requirements will also apply:

1. The fund must appoint a management company and a custodian/trustee acceptable to the SFC. Where the management company delegates the investment management function to an investment manager or adviser (i.e. where the investment manager and / or adviser undertakes the day to day investment management and exercises control over the investment portfolio) the investment manager and / or adviser will also require SFC approval. The investment manager and / or adviser should be based in one of the acceptable inspection regimes as set out on the SFC's website (http://www.sfc.hk/sfc/html/EN/intermediaries/products/products.html ). The SFC will consider other jurisdictions, and any sub-delegation to an intra-group sub-investment manager and / or sub-adviser which is not based in an acceptable inspection regime, on their merits.

Where a management company has not previously been approved by the SFC to manage SFC authorised funds, the fund's application for authorisation will be referred to the SFC's Products Advisory Committee (the "Committee"). The Committee will review the fund's application and the acceptability of the new management company. A referral to the Committee extends the process for obtaining the SFC's approval and delays should be factored into any timeline.

In the case of each new management company, the following information will need to be submitted to the SFC:

  • the most recent audited financial report and the semi-annual reports. The audited reports must evidence, in particular, that the management company has at least HK$1 million (or its foreign currency equivalent) in issued and paid up capital and capital reserves;
  • details of the corporate ownership and management structure;
  • details of the number of fund managers and the investment approach;
  • CVs of all directors and key operating individuals of the management company;
  • a summary of the internal compliance rules and regulations; and
  • a certified copy of the licence issued by the home regulator.
  • It is worth noting that the acceptability of each management company will be assessed on certain criteria including:
  • the key personnel of the management company or those of the investment manager / adviser (where the latter has been delegated the investment management function by the management company) are expected to possess at least 5 years investment experience managing unit trusts or other public funds with reputable institutions. In practice, at least two such key personnel must be nominated whose expertise is in the same type of investments as those proposed for funds seeking SFC authorisation; and
  • sufficient human and technical resources must be at the disposal of the management company, which should not rely on a single individual's expertise.

As mentioned above, it will be necessary to submit detailed CVs of the directors of each management company to the SFC detailing their education, professional experience and employment history, including sufficient evidence that at least two of them possess the requisite 5 years experience in managing retail authorised funds.

2. The SFC will also need to approve the custodian / trustee of the fund if it has not previously been approved to provide such services to authorised funds in Hong Kong. Most of the custodians/trustees operating in Ireland have been previously approved by the SFC.

3. Funds or their management companies will be required to appoint a Hong Kong Representative whose responsibilities include receiving applications for the issue, conversion and redemption of shares in the fund from Hong Kong investors, liaising with investors and undertaking certain other operational responsibilities required by the Code. The entity to be appointed as a Hong Kong Representative must be duly licensed for Type 1 Regulated Activity ("Dealing in Securities") under the Hong Kong Securities and Futures Ordinance (the "SFO") or exempted from such licensing.

4. It will also be necessary to prepare Hong Kong specific documentation for the fund, as more fully described under "Documentation" below.

Once the fund is authorised in Hong Kong, it will be subject to a number of ongoing reporting and other requirements in relation to its Hong Kong activities. These are detailed in Chapters 10 and 11 of the Code. SFC authorised funds must also keep abreast of SFC circulars and investment products related "FAQs", which are issued by the SFC to the industry from time to time, as guidance.

Documentation

As mentioned above, the fund's offering and constitutive documentation are required to comply with the Code. In addition, in the case of a UCITS fund, the SFC require a confirmation from the management company that such constitutive documents comply with all applicable Irish laws, regulations and requirements of the Central Bank of Ireland, that they are the latest versions that have been filed with the Central Bank of Ireland and that they do not exclude the jurisdiction of the courts of Hong Kong and contain provisions on connected party transaction provisions meeting the requirements of the Code. Depending on the structure of the fund, the constitutive documents may include the memorandum and articles of association or the trust deed and the relevant service agreements (such as management agreement, investment management agreement, investment advisory agreement, administration agreement, custodian agreement, etc). For a fund investing in financial derivative instruments, a confirmation by the management company to the SFC that there are suitable risk management and control processes in place, which are commensurate with the risk profile of the fund, will be required. A summary of such risk management and control processes will also need to be disclosed in the fund's Hong Kong offering document.

It should be noted that the Code prohibits the charging of marketing expenses to an SFC authorised fund. This issue is non-negotiable with the SFC and all existing SFC authorised funds are required to adhere to this provision.

A Hong Kong Representative selected and which meets the requirements of Chapter 9 of the Code, will also need to be appointed pursuant to a Hong Kong Representative Agreement.

The fund's Hong Kong offering document will be required to comply with the Code and it will also be necessary to prepare a Chinese translation of the offering document. There are a number of options available in satisfying this requirement. (i) The existing Irish prospectus can be supplemented by a Hong Kong Covering Document (for use solely in Hong Kong), which would contain specific additional information required in order to comply with the Code. Thereafter both the Irish prospectus and the Hong Kong Covering Document can be translated into Chinese. (ii) A Hong Kong specific bilingual offering document can be prepared for distribution solely in Hong Kong. Such document would be drafted on the basis of the existing Irish prospectus but with appropriate amendments required in order to comply with the Code. If this second option is utilised, the Irish prospectus would not need to be approved by the SFC (and therefore would not be available for distribution in Hong Kong). In this case, the only offering document in Hong Kong would be the Hong Kong specific bilingual offering document.

The Products Handbook also introduced the concept of the products key fact statement (the "KFS") which SFC authorised funds are required to issue and which contains information that enables investors to comprehend the key features and risks of funds. Standard templates setting out the format of the KFS are available on the SFC website.

Use of Financial Derivative Instruments for Investment Purposes and / or extensively for "Efficient Portfolio Management" purposes ("EPM")

The SFC distinguishes between UCITS funds which make use of the expanded powers to use financial derivative instruments for investment purposes and those which limit their use of financial derivative instruments to hedging. The SFC also distinguishes between funds which use financial derivative instruments extensively for EPM and those which do not. The Code also introduces a new Chapter 8.9 dealing with the investment and operational requirements of non-UCITS funds in this regard.

Time Frame for Authorisation

The timetable for obtaining SFC authorisation will, to a large extent, depend on whether the management company has previously been approved by the SFC to manage SFC authorised funds, whether the custodian / trustee has previously been approved for SFC authorised funds and the nature of the fund for which authorisation is being sought. Under the terms of the SFC application procedures, if SFC authorisation of the fund is not granted within 12 months from the date an application is taken up by the SFC, such application will automatically lapse.

Where new management companies are involved, the timetable for completing all issues in connection with the authorisation of the fund can take at least 20 weeks from submission of a complete application which is taken up by the SFC. The time involved in gathering the relevant information varies greatly depending on the response times of the managers and / or relevant service providers.

Typically a fund will take approximately 16 weeks after acceptance of the application documents by the SFC before it can be authorised by the SFC.

Fees and Expenses

The SFC's fees for an umbrella fund comprise of the following:

Please note that the SFC's application fee is not refundable in the event that the fund fails to obtain authorisation or where an application lapses for want of authorisation being granted within the requisite 12 months, as noted above. The authorisation and the first annual fees are payable upon, and a pre-requisite to, SFC authorisation being granted.

Upon authorisation, the fund will have to apply for a one-off authorisation for the issue of an advertisement for the fund. After such authorisation is obtained, the fund will not have to apply for authorisation for any advertisement issued thereafter provided that (i) the issuer of any such advertisement has obtained the relevant licence to do so, (ii) the content of any such advertisement is in compliance with the advertising guidelines of the SFC and (ii) each advertisement of the fund will be kept for record for a three-year period.

Local legal fees and costs associated with translations can be obtained as required.

Private Placement

The criteria for an Irish fund to be sold / marketed in Hong Kong on a private placement basis, without having to be authorised by the SFC, are set out below.

General Principle

Different rules apply to the marketing of "Corporate Funds" and "Non-Corporate Funds".

Corporate Funds

Regulatory approval, registration or filing of a fund's offering documents is not required when a Corporate Fund is offered:

  • to an unlimited number of "professional investors" ;
  • to no more than 50 people; or
  • with a minimum investment of not less than HKD500,000 (approximately USD65,000).

"Professional investors", as defined in the Securities and Futures Ordinance, include various institutional investors; trust corporations with at least HKD40 million in assets; and individuals, corporations and partnerships with investment portfolios of at least HKD8 million.

It is possible to combine the offerings at the first two bullet points above (that is, to offer the fund to an unlimited number of professional investors as well as to no more than 50 nonprofessional investors).

Non-Corporate Funds

Regulatory approval and registration or filing of a fund's offering documents is not required when a Non-Corporate Fund is offered:

  • to an unlimited number of "professional investors"; or
  • to no more than 50 people.

It is possible to combine the above.

For the purposes of this section, a "Corporate Fund" means a fund that is constituted as a company and includes a special purpose corporate vehicle that issues shares or debentures. A "Non-Corporate Fund" means a fund that is structured as a limited partnership, a limited liability partnership, a unit trust, or a contractual joint venture.

The principal securities requirements that apply to the offer of interests in Non-Corporate Funds are contained in the Securities and Futures Ordinance ("SFO"). For Corporate Funds, they are contained in the SFO and the Companies Ordinance ("CO").

Prohibitions

Prohibition on Offering Unauthorised Funds

Section 103(1) of the SFO provides that it is an offence to issue, or have in one's possession for the purposes of issue, whether in Hong Kong or elsewhere, an advertisement, invitation or document which one knows contains an invitation to the public:

  • to enter into or offer to enter into:
  • an agreement to acquire, dispose of, subscribe for or underwrite securities; or
  • a regulated investment agreement or an agreement to acquire, dispose of, subscribe for or underwrite a structured product; or
  • to acquire an interest in or participate in, or offer to acquire an interest in or participate in, a collective investment scheme, unless the issue is authorised by the SFC.

Subject to the exemptions set out in the SFO or ancillary regulation, it is also a criminal offence for a person to offer to the public an investment that is not authorised by the SFC. The maximum penalty is HK$500,000 and 3 years' imprisonment.

"Advertisement" is defined very widely and could include, for example, oral communications and websites.

"Issue" includes publishing, circulating, distributing or otherwise disseminating the material or the contents thereof whether by any visit in person, in a newspaper, magazine, journal or other publication or by the display of posters or notices, by means of circulars, brochures, pamphlets or handbills, by an exhibition of photographs or film, by way of sound or television broadcasting, by any information system or other electronic device, or by any other means. "Public" is defined as "the public of Hong Kong" and includes any class of that public.

Prohibition on Cold Calling

Section 174 of the SFO prohibits cold calling. In other words, a licensee (otherwise known as an "intermediary") or its representatives may not make an offer to a person to enter into an agreement to provide financial products or services, nor induce or attempt to induce a person to enter into such an agreement, during or as a consequence of an unsolicited call. As described below under "Exemptions", this provision does not apply to calls on professional investors.

A person who contravenes the prohibition on cold calling commits an offence and is liable on conviction to a fine of up to HK$50,000. A person who enters into an agreement as a result of a cold call may, subject to the rights of a subsequent purchaser in good faith for value, rescind the agreement within 28 days after the day it is entered into or 7 days after the day on which the person becomes aware of the contravention, whichever is earlier.

Prohibition on Promotion by Unlicensed Intermediaries

Under the SFO, "dealing in securities" is defined widely to include "the making or offering to make an agreement with another person, or inducing or attempting to induce another person to enter into or offer to enter into an agreement for or with a view to acquiring, disposing of, subscribing for or underwriting securities". Accordingly, a person who visits Hong Kong for the purpose of promoting a fund to prospective investors would normally be considered to be "dealing in securities". Section 114 of the SFO prohibits a person from carrying on a business of dealing in securities or holding himself as carrying on such a business unless such person is appropriately licensed to undertake such regulated activity.

Section 115 of the SFO provides that if a person actively markets to the public any services that he provides, and if such services would constitute a regulated activity if provided in Hong Kong, then the person would be regarded as carrying on a business in that regulated activity. Accordingly, a person needs to be appropriately licensed before actively marketing his or her services in Hong Kong, even if the person is based outside Hong Kong.

It is a criminal offence for a person to carry on a regulated activity while unlicensed by the SFC. Commission of such offence may attract a fine of up to HK$5 million and 7 years' imprisonment.

Exemptions

Exemption from Prohibition on Offering Unauthorised Investments

There are a limited number of situations in which an information memorandum or other document which contains an invitation to subscribe for interests in a fund which will be made available to potential investors in Hong Kong is not required to comply with the prospectus requirements of the CO or be authorised by the SFC before issue.

The first situation is known as the "professional investor" exception. "Professional investors", as defined in the SFO, include various institutional investors; trust corporations with at least HKD40 million in assets; and individuals, corporations and partnerships with investment portfolios of at least HKD8 million. Until 15 December 2011, documentary proof of the financial holdings was required, such as audited financial statements (or in the case of high net worth individuals, financial statements verified by an accountant), to verify status. On 16 December 2011, the SFC introduced a more flexible approach to the requirements for evidencing whether a person qualifies as a professional investor, allowing intermediaries to use any method to establish whether different types of high net worth investor meet the relevant assets or portfolio threshold at the relevant date, although the SFC does expect proper records of the assessment process to be maintained.

The second situation arises where information is distributed in such a manner that it does not constitute an offer to the public and therefore does not fall within the prohibition contained in the SFO or within the definition of "prospectus" in the CO. This is known as the "private placement" exception. Schedule 17 to the CO sets out some situations where a document used in a private offer by a corporate issuer (e.g. a Corporate Fund) will not constitute a "prospectus", including an offer:

  • to not more than 50 persons (the "limited offerees" exception);
  • in respect of which the total consideration does not exceed HKD5 million or its equivalent in another currency (the "small offer" exception); and
  • in respect of which the minimum subscription per investor is not less than HKD500,000 or its equivalent in another currency (the "minimum subscription" exception).

In each case, the offer document must include a prescribed warning statement in the following form or a form to the like effect:

In relation to a Non-Corporate Fund, steps must be taken to ensure that an offer intended as a private offer is not treated as an offer to the public in Hong Kong. An offer to an unlimited number of professional investors, plus not more than 50 offerees (not actual subscribers) who do not qualify as professionals, is exempt. The following are normally understood to be the requirements for a private placement of securities issued by a Non-Corporate Fund:

  • each information memorandum issued should be numbered in series and contain on the cover a statement that it is not an offer to the public.
  • each information memorandum issued should be individually addressed to each offeree, the subscriptions for interests in the fund should only be accepted from that offeree and the offeree should be requested not to pass on the information memorandum to any other person.
  • the offeree should only be able to purchase interests in the fund as principal or on behalf of clients pursuant to a discretionary mandate.
  • the minimum subscription per investor should be stated and should be a sizeable amount.
  • the transfer of the interests in the fund by the offeree to any person in Hong Kong should preferably be restricted for a minimum period of 6 months following allotment.
  • there should be no public advertising at all in Hong Kong in relation to the information memorandum. The issue of promotional material relating to the acquisition of interests in the fund should also be strictly limited to offerees.

Exemption from Prohibition on Cold Calling

Exemptions to this prohibition include calls made to solicitors, professional accountants, licensed persons, money lenders, professional investors or existing clients. In addition, the prohibition does not apply to an agreement to sell or purchase securities of a corporation to or from a person who is already the holder of securities of that corporation.

"Existing client" means a person who has entered into a client contract with the intermediary at any time during the period of 3 years immediately preceding the day on which the call is made, and remains a party to the client contract when the call is made; or for whom the intermediary has provided a service, the provision of which constitutes a regulated activity, at any time during the period of 3 years immediately preceding the day on which the call is made.

"Call" means a visit in person or a communication made by any means. "Unsolicited call" means a call made otherwise than at the express invitation of the person called upon. A call does not include a "permissible communication", which is a communication that is not a visit in person, a telephone conversation or any other interactive dialogue where immediate exchange of statements can be made. Therefore, faxes, postal mail and email are permissible, although the latter may be subject to the Unsolicited Electronic Messages Ordinance.

Exemption from Prohibition by Unlicensed Intermediaries and application for Temporary Licences

There is no exemption to the prohibition of carrying on a business of dealing in securities without an appropriate licence. However, an overseas corporation or individual carrying on a business outside Hong Kong, which in Hong Kong constitutes a regulated activity, may apply for a temporary licence to carry on the same business in Hong Kong. This provision may be useful for fund managers intending to make intermittent visits to Hong Kong to undertake marketing activities.

Temporary licences are not available for type 9 regulated activities (asset management), and licence holders are prohibited from holding any client assets in the course of conducting the regulated activities. The approved period of each temporary licence will not exceed 3 months. If an applicant has obtained a temporary licence in the past, the total approved period of the licences cannot exceed 6 months in any period of 24 months.

An applicant for a temporary licence must establish that it has a valid authorisation from an overseas regulator to carry on in the jurisdiction of the overseas regulator any business which it intends to carry on in Hong Kong. A corporate applicant must also establish that the overseas regulator can investigate and take disciplinary action against the applicant in respect of its business activity in Hong Kong. It is required to nominate at least one individual for the approval of the SFC who will supervise its regulated activities in Hong Kong. An individual applicant must be the representative of a licensed principal. If the principal is a corporation, it must belong to the same group of companies as the corporation for which the applicant is authorised to act outside Hong Kong.

In practice it is very difficult for a corporation to obtain a temporary licence. One of the application requirements is that the applicant corporation must have a business registration in Hong Kong, which means that the applicant corporation would need to establish and register either a branch or a subsidiary company in Hong Kong. Business registration would also trigger Hong Kong profits tax liability for the subsidiary company or branch for any profits it generates in Hong Kong. There is also a requirement for an audit to be conducted by a Hong Kong auditor in respect of the period for which the corporation was licensed.

Accordingly, temporary licensing is only practical where the overseas manager has an associated entity licensed in Hong Kong. Individual representatives can then apply for individual temporary licences as representatives of the associated licensed entity. Such applications are processed relatively quickly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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