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Hong Kong aims to strengthen UT Code

An update to Hong Kong's Code on Unit Trusts and Mutual Funds promises greater investment flexibility for asset managers

Amendments to Hong Kong's Unit Trust (UT) Code are intended to align local regulation more closely with international standards and boost growth in the retail fund industry. The update is expected to offer locally domiciled funds more choice in their investment activities while putting greater responsibility on management companies to safeguard assets through auditing and independent oversight.

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Key insights

  • The revamped UT Code is aimed at bringing local regulation up to international standards and to better manage investment risk
  • The UT Code's proposals could shake out smaller management companies but relax investment experience requirements for key personnel
  • Amendments include enhanced safeguards for investment in derivatives and active exchange traded funds

Since 2012, Hong Kong's home-domiciled funds nearly doubled to 753 at the end of September 2017, with assets under management soaring 158 percent to USD 151 billion. In order for the regulatory environment to keep pace with the burgeoning funds market, Hong Kong's Securities and Futures Commission (SFC) launched a three-month consultation period on proposed amendments to the UT Code to update the regulatory regime. The changes are intended to address the risks posed by financial innovation and fast-moving market developments.1 “An important part of the SFC's strategy to strengthen Hong Kong as an international, full-service asset management centre is to ensure that the regulations governing public funds remain robust and aligned with international standards," said SFC CEO Ashley Alder.2

Following the March 19, 2018 deadline for public feedback, a consultation conclusions paper will be issued with the revised UT Code. The industry is
expected to be given a 12-month transition period to
comply with most of the amendments.3

Higher bar for small firms

The amendments include a mix of investment flexibility for funds, and more stringent safeguards over compliance and oversight. Among the proposed changes is an increase in the minimum capital required for a management company managing public funds from HKD 1 million to HKD 10 million to better reflect the expected financial standing and commitment of management companies for SFC-authorized funds."4

The changes are intended to address the risks posed by financial innovation and fast-moving market developments

The move is intended to boost efficiency by reducing competition from small firms while ensuring funds have sufficient financial resources to cover their investment risks.

Another key change will allow management companies with a multinational presence to leverage group resources to meet the five-year public fund investment management experience requirement for key personnel.5 The current regime demands that at least two key personnel are dedicated full-time staff with at least five years' investment experience in managing public funds with “reputable institutions". Under the revamped code, the requirement will be waived if the company belongs to a well-established fund management group and can “leverage ... expertise from different offices," the SFC said.6 The new regime will demand more of management companies to safeguard investment activities, however. It will involve enhanced obligations on trustees and custodians to provide independent oversight and strengthen ongoing monitoring through stricter annual audit reviews.

More choice on the investment front

The SFC has argued that the existing code's Core Investment Requirements, which sets out investment rules, is insufficient as it lacks specific provisions for different investment activities.7 The modernization of the code aims to provide greater investment flexibility with enhanced safeguards for derivatives, securities lending, repo and reverse repo transactions. It proposes removing the requirement that plain vanilla funds may only invest in futures, options and warrants for non-hedging purposes.However, it also proposes applying an overall limit of 50 percent of the fund's NAV in derivatives, based on the Commitment Approach which is in line with other majorjurisdictions.8

For specialized schemes, the code will introduce new chapters for listed open-ended funds (active exchange traded funds) and closed-ended funds to facilitate the development of new products, while tightening regulation over money market funds to be more closely aligned with the relevant standards of the International Organization of Securities Commissions.9

SFC looking to signal broad experience

The move is intended to boost efficiency by reducing competition from small firms while ensuring funds have sufficient financial resources to cover their investment risks

The UT Code amendments are the latest in a string of initiatives to boost regulation over Hong Kong's growing funds industry and support the financial hub's ambitions of becoming a full-service asset management centre. The Code consultation follows the October 2017 implementation of the “manager in charge" regulations that require the hire of SFC-licensed professionals for senior management roles at brokerages and fund managers.

While placing more responsibility on management companies for oversight and ongoing monitoring, the updated UT Code may be welcomed by asset managers seeking  greater clarity and flexibility over their investment activities.

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  1.  Securities and Futures Commission (December 2017) Consultation Paper on Proposed Amendments to the Code on Unit Trusts and Mutual Funds
  2.  Ibid
  3. Simmons & Simmons (January 2018) SFC Consultation on major changes to Code on Unit Trusts and Mutual Funds
  4. Securities and Futures Commission (December 2017)
  5. Ibid.
  6. Ibid.
  7. Ibid. 
  8. Simmons & Simmons (January 2018)
  9. Securities and Futures Commission (December 2017)