Hong Kong

Author: | Published: 3 Oct 1999
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The attention of fund managers in Hong Kong has been diverted in recent times by the financial crisis in Asia and, more positively, by the preparations being made for the introduction in Hong Kong of the Mandatory Provident Funds Schemes Ordinance. This will create a system of compulsory retirement savings schemes, with contributions received by these schemes being invested in funds.

Impact of the Mandatory Provident Fund

It is expected that contributions into mandatory provident fund (MPF) schemes will start from December 2000. MPF schemes will be private sector schemes which must comply with the MPF legislation, which is designed to establish a system of monitoring and controls to protect the monies contributed. The first list of approved trustees for MPF schemes should be announced by the Mandatory Provident Fund Schemes Authority (MPFA) later this year with the first batch of master trust schemes being approved early in 2000.

MPF schemes will be able to establish feeder funds and funds of funds to invest in new approved pooled investment funds authorized by the Securities and Futures Commission (SFC) and the MPFA. These funds have to be established as unit trusts in Hong Kong. Investment will also be permitted, to a limited extent, in unit trusts and mutual funds (including overseas funds) authorized by the SFC. Fund managers of MPF schemes and the underlying approved pooled investment funds must meet specific requirements. A fund manager must be a Hong Kong incorporated company with paid-up share capital of not less than HK$10 million ($1.3 million) and net assets of at least the same amount. The manager must also be registered as an investment adviser under the Hong Kong Securities Ordinance. As the MPF system offers member choice and prices of the MPF funds will be published in the press, it is to be hoped its introduction will bring funds to the attention of the Hong Kong public who have traditionally favoured direct stock market investment over investment in funds.

Hong Kong Index Trust

In addition to the introduction of MPF the Hong Kong government has recently announced it will establish a unit trust to dispose of a significant portion of the government's share portfolio. This comprises the constituent stocks of the Hang Seng Index and is estimated to be worth in excess of HK$200 billion. It seems the new fund will be similar in structure to the Standard & Poor's Depositary Receipts (SPDRs, known as Spiders) but will track the Hang Seng Index. The units in the proposed fund will be listed on the Hong Kong Stock Exchange. The proposed index fund, coupled with the introduction of MPF, should raise levels of awareness of funds in Hong Kong.

Authorizing open-ended funds for public sale in Hong Kong

Hong Kong maintains a system permitting access to overseas collective investment schemes to be authorized for public sale and the majority funds authorized (over 90% of the 1,500 plus funds authorized) are overseas funds. As at the end of 1998, over 90 fund management groups were authorized to market their funds in Hong Kong. The SFC has issued a Code on Unit Trusts and Mutual Funds (Code) which sets out details of the qualifications of service providers, the procedures and minimum standards for authorization, and the post-authorization requirements for open-ended funds.

Regulation of fund managers of authorized funds

The Code sets out requirements for managers of funds which are authorized for sale to the public. A manager must:

  • have sufficient financial resources to enable it to conduct a business effectively and meet its liabilities; in particular, it must have a minimum issued and paid-up capital and capital reserves of HK$1 million or its equivalent in foreign currency;
  • be primarily engaged in the business of fund management;
  • not lend to a material extent;
  • maintain at all times a positive net asset position; and
  • have directors and key staff of good repute and (in the opinion of the SFC) with suitable experience.

It is important to note that if the fund manager appoints an investment manager/adviser or sub-adviser, the SFC will require evidence that the investment adviser is qualified to perform its functions.

A fund manager group profile is available in the Code and has to be completed by a new fund manager (or adviser) seeking approval from the SFC as manager of a fund to be authorized. Details of in-house procedures of the manager on compliance matters such as personal account dealing rules and transactions with connected parties are required to be completed in the profile, in addition to setting out background information on the experience of the company and its key personnel. The SFC has also indicated which jurisdictions it regards as imposing an acceptable level of regulation on overseas investment managers — these are Luxembourg, the UK, the US, Ireland and France (as well as Hong Kong). The list is not intended to be exhaustive and other jurisdictions may be added from time to time.

Applications for authorization can be made for a variety of vehicles (single class and umbrella funds, feeder funds and funds of funds) and more specialized investment vehicles such as money market funds, futures and option funds as well as guaranteed and leveraged funds. The Code requires a trustee or custodian of an authorized fund to be subject to regulatory supervision; if not, provision is made for an independent audit to review its internal controls and systems. This review is to be on terms of reference agreed with the SFC.

Trustees/custodians: audit review guidelines issued

The SFC has recently issued guidelines for Review of Internal Controls and Systems of Trustees/Custodians. The guidelines relate to provisions of the Code and the SFC Code on Pooled Retirement Funds which state that trustees/custodians should either be subject to continuing regulatory supervision or should appoint an independent auditor to review their internal controls and systems annually, on terms of reference agreed with the SFC. The review should relate to period of at least 12 months and should normally coincide with the financial year of the trustee/custodian.

The guidelines deal with the scope of review to be conducted by the auditor and set out minimum content requirements for the engagement letter to be entered into with the auditor. The auditor's report should include an opinion from the auditor as to whether the report, prepared by the management of the trustee/custodian, fairly describes the control procedures in place and whether the specific control procedures operated as described when tested by the auditor.

The report of the auditor (together with the management report on internal control objectives) should be submitted to the SFC within four months from the end of the financial year.

It is likely that the SFC will clarify which jurisdictions it considers already subject trustees/custodians to sufficient regulatory supervision, to confirm when review by an independent auditor will be necessary.

Year 2000 disclosure requirements

The SFC has required fund managers of funds authorized for sale in Hong Kong to make disclosure of Y2K readiness and risks in the funds' offering documents and in financial statements. The areas which the SFC has required to be covered include:

  • the state of readiness of the management company to meet Y2K challenges including the contingency plans prepared;
  • the risks posed by the Y2K issue for the management company and how the funds under management may be affected; and
  • whether and how the Y2K readiness of third party service providers may affect the funds.

The SFC is also seeking assurances from managers of funds authorized in Hong Kong that they have Y2K contingency plans in place and they are ensuring that other service providers are prepared for any Y2K disruption to reduce the risk to authorized funds.

Post-authorization requirements for authorized funds

The continuing obligations in relation to authorized funds require fund managers to seek approval from the SFC to all proposed alterations or additions to the offering documents and to the constitutive documents of a fund. The constitutive documents are all the principal documents — so for corporate funds, these would include the articles of incorporation, the investment management agreement, the custodian agreement and all material contracts.

Authorized funds must issue their offering documents in Hong Kong in both English and Chinese, (unless a waiver has been granted) although it is not necessary to translate other documents such as accounts and annual reports. However, notices sent to Hong Kong investors should be published in both languages. For example, notices of extraordinary general meetings or letters to shareholders in Hong Kong should be sent in both English and Chinese.

Regulation of Internet Activities

Internet scams involving bogus investment schemes have hit the headlines around the world in recent months. There have been concerns regarding the application of existing securities laws, designed for traditional securities-related activities, to activities conducted over the internet. For Hong Kong, the SFC's recent Guidance Note on Internet Regulation clarifies the regulator's position on various internet activities, including internet advisory services and advertising of investment products.

The SFC's Guidance Note covers a broad range of issues including:

  • securities, futures and foreign exchange dealing;
  • conducting advisory services over the internet; and
  • internet advertisements for dealing and investment advisory services.

The SFC states that, in its view, the provisions in existing legislation, relating to transactions involving securities and investment arrangements, apply to their analogous transactions over the internet. However, the borderless nature of the internet presents difficulties to regulators as it challenges the traditional basis of jurisdiction — the geographical location of the provider. The SFC states that although it only intends to regulate activities in Hong Kong and does not seek to stop Hong Kong residents from using legitimate services offered by foreign providers over the internet, it will not hesitate in exercising its supervisory jurisdiction over activities that are detrimental to the interests of the investing public in Hong Kong.

The Guidance Note confirms that the registration and licensing process the SFC administers is applicable to all businesses which provide advisory services in Hong Kong irrespective of the communication or delivery medium used in the conduct of such business.

The issue becomes whether business is carried on in Hong Kong. Relevant factors in establishing whether this test is met are:

  • actual physical location or presence of the business;
  • manner in which activities are carried on in Hong Kong;
  • nature of the activities that are carried on in Hong Kong; and
  • the motives and circumstances surrounding the conduct of such activities.

Persons using internet technology will be required to register as investment advisers with the SFC if they carry on or hold themselves out as carrying on investment advisory activities in Hong Kong.

In relation to advertisements, existing approval requirements under various laws and regulations, including the Protection of Investors Ordinance are also applicable to cyber-ads.

The SFC states that it is primarily concerned with advertisements targeted at Hong Kong residents. Relevant factors to determine if an advertisement is targeted at people residing in Hong Kong include:

  • whether the information is targeted at people residing in Hong Kong via push technology, meaning any technology which broadcasts or directs information to a particular person or group of persons by direct methods such as e-mail;
  • whether the information is presented or provided in a manner which gives the appearance that people residing in Hong Kong are targeted;
  • use of local distribution agents, references to HK dollars and use of Chinese language; and
  • publication in Hong Kong newspapers or magazines of internet addresses.

In relation to funds authorized for sale in Hong Kong, the SFC has published advertising guidelines (contained in the Code) which also apply to internet marketing. All marketing materials must be approved by the SFC before they are used in Hong Kong.

Fund managers in Hong Kong

Fund managers wishing to operate in Hong Kong need to obtain the appropriate registration with the SFC to enable them to carry on business. The Hong Kong Securities Ordinance requires persons carrying on a business dealing in securities or acting as an investment adviser in Hong Kong must be registered with the SFC. The Ordinance also allows certain companies to be exempt dealers or advisers in which case many of the provisions of the Securities Ordinance do not apply. However, the SFC is reluctant to grant exemption at present and it is proposed that the category of exempt status will be removed in future.

Once registered a number of compliance obligations arise as the SFC has issued various codes on the conduct of business of registered persons in Hong Kong, in particular:

  • Code of Conduct for Registered Persons;
  • Management, Supervision and Internal Control Guidelines for Persons Registered with the SFC;
  • Fund Manager Code of Conduct; and
  • Money Laundering Guidelines.

The Fund Manager Code of Conduct came into force last year and is intended to be a helpful resource for fund managers in highlighting some of the provisions of the other codes by reference. It also imposes the requirement for a fund management company to have a designated compliance officer.

Future reforms to Hong Kong securities legislation

The Hong Kong government and the SFC are proposing a wholesale reform of the legislation affecting the Hong Kong securities and futures markets. A new consolidated Securities and Futures Bill is scheduled to be tabled before the Legislative Council late in 1999 (and is intended to be passed in 2000). Various consultation papers describing the proposed reforms have been issued but draft legislation is not expected to be available until the end of 1999. The proposals are likely to make the licensing regime for fund managers tougher, removing some of the exemptions which have been available and requiring registered investment advisers to pass examinations and ensure continuing training is provided to staff.

The reforms are considered necessary to update relatively old pieces of legislation and ensure that the regulatory objectives adopted by the International Organization of Securities Commissions (IOSCO) are reflected.

The reforms are also intended to assist Hong Kong in maintaining its position (in the face of increasing regional competition) as a premier fund management centre in Asia.


Contact Details:

Susan Gordon

Tel: (852) 2825 9788

Email: susan.gordon@dgj.com.hk