Hoping to attract traditional mutual and hedge funds, Hong Kong is considering legislative amendments to introduce the open-ended investment company. Chee Seng Lok at Multifonds discusses the move.
One of the proposals set out in Hong Kong’s 2013 budget is the creation of a more flexible business environment, to help it further develop its financial services industry.
Hong Kong is now considering legislative amendments to introduce the open-ended investment company (Oeic) in an attempt to attract more traditional mutual funds and hedge funds to domicile there.
The relevant legal and regulatory frameworks are being discussed by regulators and the public will be consulted once a fuller proposal is drawn up.
Singapore and Hong Kong are predominantly fund management and administration centres, rather than an obvious domicile choice for funds.
The traditional fund business in both jurisdictions is made up of mainly offshore funds.
The number of authorised collective investment schemes in Hong Kong was 1,842 in December 2012, of which 65% were cross-border funds distributed in Hong Kong. The remaining were locally domiciled unit trusts.
More than 70% of the cross-border funds distributed in Hong Kong were domiciled in Luxembourg and about 17% in Ireland, according to the Global Fund Distribution report published by PwC in 2013.
This is largely as a result of the established Ucits framework, which is more popular among Asian investors and provides an international standard for funds.
Another reason for the popularity of offshore funds is the tax incentives/exemption granted to offshore funds. Foreign-sourced income, capital gains, are generally tax exempted.
For alternative funds, most in Hong Kong are domiciled in tax neutral jurisdictions, such as the Cayman Islands, the British Virgin Islands and Bermuda.
Some view Hong Kong’s Oeic proposal as a direct response to Singapore’s efforts as both jurisdictions compete to be the fund domicile of choice.
Both have established bilateral tax treaties with other jurisdictions and have a conducive business environment for investment funds.
However, while they are fast becoming the domicile of choice in Asia, they are still not on a par with the more established European investment fund centres, such as Luxembourg and Dublin.
Hong Kong and Singapore’s regulatory frameworks cater only for unit trusts, hence the need to offer a greater variety of investment fund platforms beyond this, such as open-ended companies or segregated portfolio companies.
Typically, an investment fund should offer the ability to invest in and out of the structure by way of subscriptions and redemptions, and, therefore, the need to have an open-ended nature.
The Companies Act in Singapore requires a company to declare dividends from profits and not capital. This deviates from the operation of a typical investment fund structure where redemptions would be funded at the net asset value, which incorporates accumulated profits and capital.
There are limited options available in Singapore and Hong Kong at present for frequent subscribing-redeeming structures, such as an Oeic, apart from the collective investment scheme, which again is set up for primarily trust purposes.
This is one of the reasons most of the alternative investment funds today are set up as private limited companies, with feeder funds in Cayman.
It remains to be seen if Oeics will appeal to the fund manufacturers as a fund vehicle amid the competition of offshore funds and unit trusts as well as the renminbi qualified foreign institutional investor scheme.
One point to be considered is the cost to set up Oeics versus unit trusts. There may be requirements for the mutual fund company to maintain proper risk control and compliance, and speed of approval process. Although this is not the case for the trustee.
Retail investors may be more familiar with a unit trust and may perceive it as a safer structure given the presence of a trustee.
Potentially, some fund sponsors may prefer to opt for a unit trust structure and an international known trustee for their product distribution.
Another consideration is the need for the corporate to adopt International Financial Reporting Standards. This may not be conducive to the investment fund industry, potentially leading to financial instruments being classified as debt instead of equity, creating serious implications on the solvency test.
Most investment centres that have specific investment fund laws have a financial reporting framework tailored for the investment fund industry, which rids itself of the anomalies of the international framework that is not built to be industry specific.
With ongoing discussions around an Asian cross-border investment fund recognition regime, both Hong Kong and Singapore need to consider alternative investment structures that suit regulator and investor preferences if they want to stand a good chance of becoming the preferred centre to domicile and launch funds for Asian distribution.
Chee Seng Lok is business development manager for Asia at Multifonds
©2013 funds global asia