HK urged to introduce open-ended fund structure

Hong Kong should replace its unit trust fund-raising structure with an open-ended fund company structure if it wants to attract Chinese hedge funds to domicile in the city, says the CFA's Paul Smith.
HK urged to introduce open-ended fund structure

To entice more Chinese hedge fund managers to raise capital in Hong Kong, the city should press ahead with introducing a new open-ended fund company structure, say observers.

Paul Smith, the CFA Institute’s managing director for Asia Pacific, says such reform is “absolutely necessary”.

Hong Kong is losing out to jurisdictions such as the Cayman Islands, because fund formation under its existing unit trust structure is uncompetitive, argue managers. 

“Most asset managers do not like trust structures, as it is the trustee that controls the structure, not the managers themselves,” says one industry player.

Unless an open-ended fund company (OEFC) structure is put in place and the tax rules are amended, Chinese hedge fund managers will not find it worthwhile to domicile and manage funds in Hong Kong, said Smith.

“Whether we are able to sell Hong Kong-domiciled hedge funds into China [through the Hong Kong-China mutual recognition scheme] is a secondary point. What we need first is to set Hong Kong up as the place where Chinese managers wish to raise capital overseas.

“You would then have Hong Kong-domiciled products enabling managers to run most of their strategies and access international capital,” he added.

Last month, the government concluded a three-month consultation on introducing a new OEFC structure. It has not indicated when or if it will make a decision on the issue.

Major fund centres, including Ireland, Luxembourg and the US, operate a corporate fund structure.

In Hong Kong, open-ended funds are formed through a trust deed, not through companies, as the latter are subject to restrictions on share capital reduction. But funds need to be able to increase or reduce share capital because of investments and redemptions.

Hence the government has proposed implementing an open-ended fund company vehicle, which would allow variable share capital with limited liability.

An OEFC structure would make it easier for Chinese hedge funds to domicile in Hong Kong and trade A-shares through the planned Shanghai-Hong Kong Stock Connect scheme. “You don’t need the Hong Kong-China recognition scheme if Stock Connect is in place,” said Smith.

When Stock Connect is implemented, Chinese managers of onshore funds will be able to form parallel products in Hong Kong and trade A-shares and access international capital from the city, he added.

Onshore Chinese managers that want to raise money overseas typically launch a Cayman Islands-domiciled fund.

Stock Connect is expected to go live in October. It will allow non-China-based investors to trade all SSE 180 and SSE 380 stocks through the Hong Kong exchange without applying for a quota under the QFII or RQFII schemes. Likewise, mainland investors will be able to trade all 266 stocks of the Hang Seng Composite Large Cap and Hang Seng Composite MidCap indices directly through the Shanghai Stock Exchange.

But the pending Hong Kong-China mutual recognition scheme will more directly benefit the funds industry, say observers. The scheme, unveiled in January last year, will allow Hong Kong-domiciled funds to be sold directly to Chinese investors onshore, and vice versa for authorised Chinese funds.

However, it is not clear whether hedge or private equity funds will be included or when the programme will be implemented.

According to latest data from the Securities and Futures Commission, as at end-March 469 funds were domiciled in Hong Kong, or 24% of the total 1,935 authorised unit trusts and mutual funds. In March last year, there were 305 Hong Kong-domiciled funds, out of 1,847 authorized unit trusts and mutual funds.

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