Hong Kong's Securities and Futures Commission has five priorities for improving the funds industry, topped by growing the hedge funds market, says Alexa Lam, executive director of intermediaries and investment products.

The authorized (retail) hedge funds industry in Hong Kong is small, but this belies the true size of the industry here, Lam says.

Although the SFC authorized only five hedge funds in 2004, for a total of 13 funds managing $1.13 billion, Hong Kong also captured the largest share of start ups - more than Japan or the United States, she claims, and five times more than Singapore. The total Asia-Pacific hedge fund industry topped $47 billion midway last year. "This is where Europe was in 2001," she says.

Lam cites a number of reasons for Hong Kong's success, including its legal and market structure, its deepening talent pool, its transparent regulation and its proximity to Japan and China, the markets where hedge fund managers invest.

As a result of this growth beneath the otherwise lacklustre retail segment, the SFC is reviewing its guidelines. In particular, Lam believes the scope of a hedge fund manager's required experience can be made more flexible, while the regime for discloser can be "tightened", to enable more hedge funds to register. She would not comment, however, on what such measures could entail, and emphasized the rules must continue to provide transparency and information to investors.

Secondly, the SFC is looking at market-timing practices. Last year, in the wake of the market-timing fund scandals in America, the SFC reviewed market participants. It was relieved to find that market timing is not common in Hong Kong, mainly because the time zone differentials in the Asia-Pacific are too small to make it a worthwhile arbitrage for funds that invest primarily in the region.

Moreover the majority of fund assets are now in MPF structures where market timing is not in demand. "But we can't ignore the issue," she says, vowing the regulator will monitor those fund companies that do try to short during times when Asian market windows vary, and introduce penalties to deal with any malfeasance. "We'll continue to engage the industry for a more cohesive strategy," she says.

Third, as it has already said in public, the SFC is reviewing regulations for real estate investment trusts. Despite the setback of the Housing Authority's inaugural Reit listing, Lam says this product will still develop in Hong Kong, and she realizes the market wants Reits to be able to invest in overseas properties, which is now forbidden. The SFC will release a consultation paper by the end of the first quarter.

Fourth, the SFC is aware of the potential impact of Ucits-3, the new set of fund regulatory norms from Europe that will affect every fund listed in Dublin and Luxembourg. The SFC is working with the mutual funds industry to facilitate a migration to Ucits-3 standards.

"We want an interim approach," Lam says, noting the Securities and Futures Ordinance gives the regulator leeway, to tide things over while more long-term measures can be introduced.

Lastly, the SFC wants to help the Hong Kong funds industry take advantage of mainland Chinese opportunities. In 2004 it authorized 12 mutual funds with a retail exposure to A shares, including an ETF and guaranteed funds linked to A-share performance.

The dream, Lam says, is a platform for a Greater China fund passport. But this will mean resolving two issues.

First is China's exchange controls - a subject much bigger than the mutual funds industry. Second is the need to harmonize regulatory systems, so ultimately funds recognized either in Hong Kong or the mainland can be sold across the border.

This is going to take time, but is doable, and the SFC maintains contact with the China Securities Regulatory Commission, Lam says.

The SFC is also tidying up a matter left over from 2003: in December it released a consultation paper on its taxation of offshore funds, a matter that has particularly vexed hedge fund managers. "We need to deal with this issue and eliminate uncertainties," Lam concludes.