Hong Kong deciphers its OFC code

The Hong Kong Securities and Futures Commission (SFC) is developing rules for a new open-ended fund company (OFC) structure that will allow funds to be established in corporate form, similar to other jurisdictions. Along with proposed tax breaks, the new structure is intended to position Hong Kong as an attractive domicile for asset managers.

A new legal and regulatory framework

The proposed OFCs are open-ended collective investment vehicles set up in corporate form, with the ability to vary share capital t0 meet shareholder redemption and subscription requests. OFCs may be publicly or privately offered, and as they are not subject to capital reduction restrictions, they can create and redeem shares in response to the investment demands of the market.¹ OFCs are governed by a board that is subject to the same statutory and fiduciary duties as a conventional company, and shareholder liability is limited to the shares they hold in OFCs.²

Currently, Hong Kong's open-ended investment funds are established in unit trust form rather than in corporate form due to restrictions on capital reductions and distribution out of capital under the Hong Kong Companies Ordinance.³ However, the SFC has worked closely with the Hong Kong government to set up the framework for OFCs to further develop the Asian trade hub into a preferred fund domicile. The legal framework for Hong Kong's OFC regime was established with legislation in June 2016 and the SFC launched a two-month consultation in June 2017. The new regime is expected to be implemented in 2018.⁴

One-stop process

As collective investment vehicles, OFCs are to be established by amendments to the Hong Kong Securities and Futures Ordinance and primarily regulated by the SFC, as opposed to the Registrar of Companies.⁵ Accordingly, applicants will only need to deal with a single authority for registration purposes, a “one-stop process" that is welcomed by analysts.⁶ The proposed OFC structure contains a set of seven general principles for their management and operation, including diligence and competency, proper protection of assets, disclosure and regulatory compliance.⁷

The proposed OFC structure contains a set of seven general principles for their management and operation

OFCs’ investment scope will be aligned with the types of investment activities subject to licensing and regulation by the SFC: securities, futures and, eventually, over-the-counter derivatives.⁸ OFCs may also be set up as umbrella funds; however, a “protected cell structure” is contemplated, such that the assets of each sub-fund cannot be used to discharge the liabilities of the umbrella fund or other sub-funds. This structure is aimed at reducing contagion risk by providing for a legally enforceable segregation of the assets and liabilities of each sub-fund.⁹

Privately offered OFCs may enjoy tax breaks

Authorities have also proposed separate legislation to offer onshore privately offered OFCs a profits tax exemption. The tax break acts as an additional incentive to fund managers to consider Hong Kong as a jurisdiction for investment funds, without compromising investor protection.¹⁰ 

The tax break acts as an additional incentive to fund managers to consider Hong Kong

“Hong Kong is in competition to position itself as the asset management and fund domicile centre of the region,” said Andrew Gordon, managing director, RBC Investor & Treasury Services in Asia. “The launch of an OFC regime is certainly an important step in this, expanding the choice of structures available to managers of both retail and private funds.”

While other jurisdictions may be further ahead in setting up OFC structures, the new regime in Hong Kong is expected to foster a more flexible business environment to meet market demand, which in turn could attract more mutual and private funds to domicile in the Asian financial hub.

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Sources

1. Securities and Futures Commission, Frequently asked questions: Open-ended Fund Companies (“OFCs")
2. Ibid.
3. Securities and Futures Commission (June 28, 2017) SFC consults on new OFC Rules and OFC Code
4. Securities and Futures Commission (June 2017) Consultation Paper on the Securities and Futures Rules and Code on Open-ended Fund Companies.
5. Ibid.
6. Deacons (August 10, 2017) Comparison of two fund vehicles: the Hong Kong OFC and the Cayman exempted company.
7. Ibid. Securities and Futures Commission (June 2017)
8. Ibid. Securities and Futures Commission, Frequently asked questions: Open-ended Fund Companies (“OFCs")
9. Ibid.
10. Ibid.