On 22 May 2015, the Hong Kong Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) entered into a Memorandum of Regulatory Cooperation on Mainland-Hong Kong Mutual Recognition of Funds, and the SFC issued the Circular on Mutual Recognition of Funds between the Mainland and Hong Kong (“Circular on Mutual Recognition of Funds”) which formally permits eligible Mainland retail funds to be publicly distributed in Hong Kong upon authorisation by the SFC and opens the “South-bound” path for Mainland retail funds (“Recognised Mainland Funds”).
Correspondingly, the CSRC issued the Interim Provisions on the Administration of Recognised HK Funds (“Provisions on Recognised HK Funds”) permitting eligible Hong Kong retail funds to be “North-bound” after registering with the CSRC, to be distributed in the Mainland. Under the Circular on Mutual Recognition of Funds implemented from 1 July 2015, North-bound funds and South-bound funds are respectively subject to a total initial investment quota amount of RMB 300 billion for fund-flows each way. The SFC pointed out in the Circular on Mutual Recognition of Funds that applicants are encouraged to consult or seek relevant clarification or guidance from their Investment Products Division as early as possible in order to understand the relevant requirements applicable to specific circumstances.
From our review of the stipulations of the Circular on Mutual Recognition of Funds and the Provisions on Recognised HK Funds, we note that the conditions, procedures and laws and regulations applicable on the mutual recognition in both jurisdictions are highly similar, but also with some differences. This article mainly provides a brief analysis on the Circular on Mutual Recognition of Funds.
1. Eligibility Requirements for Recognised Mainland Funds
1.1 Conditions for recognition
According to the Circular on Mutual Recognition of Funds, Mainland funds need to fulfil the following conditions for mutual recognition in order to be authorized and distributed in Hong Kong (in accordance with CSRC’s official statistics, as at the end of 2014, there were 850 Mainland funds which fulfilled the conditions for recognition. The figure should be significantly increased up to the date of this article):
(1) Basic requirements: A Recognised Mainland Fund shall be established, managed and operated in accordance with Mainland laws and regulations and its constitutive documents (mainly referring to the fund contract), and has for custodian a fund custodian who meets the requirements of Mainland laws and regulations. Recognised Mainland Funds shall remain registered with the CSRC for offering to the Mainland public, and be subject to on-going regulation and supervision of the CSRC.
(2) Manager Eligibility: The fund management firm shall be registered and operated in accordance with Mainland laws and regulations and approved by the CSRC for undertaking retail securities investment fund management businesses. In the Mainland, other than fund management companies, there are also a number of securities companies (or their subsidiaries) and insurance asset management companies that possess retail fund management qualifications, and such companies may also participate in the mutual recognition of funds. Meanwhile, the Circular on Mutual Recognition of Funds requires that the management firm shall not have delegated the investment management function to entities in other countries or areas. Therefore, where some QDII funds in China have engaged an offshore investment advisor and delegated part or whole of their investment management functions to the investment advisor, for such QDII funds, even though they do not mainly invest in Hong Kong, the eligibility for recognition is not met, due to the said arrangement of delegation of investment management function.
(3) Manager Compliance: The fund management firm must not have been subject to major regulatory action over the past three years or since its establishment. It should be noted that this condition does not indirectly require the fund management firm to have been in establishment for 3 years and specifically states that fund management firms which have not been established for 3 years or longer shall only need to fulfil the requirement not to have been subject to major regulatory action “since establishment”. However, what amounts to ‘major regulatory action’ is an important issue. If ‘major regulatory action’ includes relatively more serious administrative regulatory measures such as temporary suspension of business (although such measures do not amount to administrative penalties in China), it will render a certain number of Mainland fund management firms unable to fulfil the requirements for recognition. This question will need to be determined by the SFC according to its regulatory requirements and practice, and fully taking into account the unique features in the administration and regulations of the CSRC, so as to differentiate the types and seriousness of regulatory actions.
(4) Fund Type: Recognised Mainland Funds shall be general equity funds, bond funds, mixed funds, unlisted index funds and physical index-tracking exchange traded funds, and must not be primarily investing in the Hong Kong market. According to such requirement, both money market funds and tiered funds (分级基金) do not qualify for mutual recognition at this stage. Moreover, it is yet to be officially explained by SFC as to how the following questions shall be interpreted taking into consideration the different regulations and fund characteristics of the two jurisdictions:
- Definition of “general” funds: According to the “Provisions on Issues Relevant to the Measures for the Administration of the Operation of Publicly Offered Securities Investment Funds”, CSRC streamlined procedure applies to products that include general equity funds, mixed funds, bond funds, index funds, money market funds, seed funds, QDII funds, wealth management funds and exchange traded funds (including single market, cross-market/border ETFs) and their feeder funds. Streamlined procedures is so far not implemented on tiered funds and other special products as determined by the CSRC. The SFC may refer to CSRC’s interpretation for the definition of ‘general fund products’.
- Grasping the idea of ‘not primarily invest in Hong Kong market’: For some of the QDII funds and Mainland retail funds investing in Hong Kong through the Shanghai-Hong Kong Stock Connect, it is not clear how ‘primarily invest in Hong Kong’ and ‘not primarily invest in Hong Kong’ shall be differentiated, which is to be seen how it would be applied in practice.
(5) Fund Size: Established for more than 1 year with minimum fund size of not less than RMB 200 million (or its equivalent in a different currency). Considering that the net assets of Mainland funds are assessed by the custodian, we understand that the question whether a fund meets the RMB 200 million asset size requirement should be ascertained from the latest net asset value of the fund as assessed by the custodian.
(6) Target investors: not more than 50% of the value of the fund’s total assets may be from distribution in Hong Kong.
Overall, SFC’s eligibility requirements on mutual recognition are not difficult to fulfil, but it is worth noting that the above eligibility requirements are continuing requirements. If an eligible Mainland fund shall have commenced distribution in Hong Kong but subsequently any situation arises that it does not fulfil the conditions, the fund management firm shall immediately notify the SFC, suspend the marketing activities to the Hong Kong public, and shall not accept new subscription applications.
1.2 Changes to Recognised Mainland Funds and recognition withdrawal
According to the Circular on Mutual Recognition of Funds, changes to Recognised Mainland Funds shall be carried out in accordance with applicable Mainland laws and regulations and the constitutive documents such as the relevant fund contract. According to the Law of the Peoples’ Republic of China on Securities Investment Funds and Measures for the Administration of the Operation of Publicly Offered Securities Investment Funds (CSRC Order No.104), Recognised Mainland Funds may have changes for the purpose of amending registration matters, or for adjustment to fees, change to investment percentages or other changes that do not trigger amendments to their registration.
Changes to Recognised Mainland Funds shall be subject to the approval of the CSRC or by carrying out appropriate procedures, and thereafter shall be filed with the SFC and notify Hong Kong investors of such changes. Further, changes to Recognised Mainland Funds shall not be in conflict with applicable Mainland laws and regulations and the Circular on Mutual Recognition of Funds. Accordingly, when considering proposed fund changes going forward, Mainland fund management firms shall not only consider Mainland laws but shall also consider Hong Kong laws and regulations, especially the mutual recognition requirements under the Circular on Mutual Recognition of Funds.
Moreover, according to the Circular on Mutual Recognition of Funds, after a Recognised Mainland Fund is approved, if the manager intends not to maintain the relevant qualifications, it may apply to the SFC for withdrawal of authorisation in accordance with the relevant Hong Kong laws and regulations such as the Code on Unit Trusts and Mutual Funds (the “UT Code”).
2. Authorisation of Recognised Mainland Funds by the SFC
2.1 Recognised Mainland Funds shall be authorised by the SFC before they may be distributed in Hong Kong.
According to the Circular on Mutual Recognition of Funds and other relevant laws and regulations, Mainland funds shall be authorised by the SFC before public distribution in Hong Kong. Information on the application procedures for authorisation of Mainland Recognised Funds may be obtained from the SFC website (http://www.sfc.hk/web/EN/forms/products/forms.html). According to the said SFC requirements, application materials required to be submitted to the SFC includes1 (but not limited to):
- Confirmation letters: in respect of the confirmation that the application documents comply and the documents are the latest version registered with the CSRC; in respect of the confirmation that traditional Chinese and English versions of the documents being true and accurate translation; and other matters to be confirmed as required by the SFC.
- Forms: properly completed forms, which include information on the management firm, the fund, Hong Kong representative and Hong Kong offering documents.
- Fund constitutive documents: Simplified Chinese version of the fund contract; Offering documents in Chinese and English (Chinese version needs to be in traditional Chinese), with covering document containing supplementary information in accordance with Hong Kong laws and regulations; Product key facts statement (“KFS”) in Chinese and English versions (Chinese version needs to be in traditional Chinese).
- Financial report and regular reports: The latest audited financial report of the fund and its latest quarterly or semi-annual report (if more recent than the latest audited financial report), and such materials may be submitted in simplified Chinese version.
- Status of the Hong Kong Representative: The status of the Hong Kong Representative with relevant confirmation letter and undertaking.
- Status of the approved person: the manager of the Recognised Mainland Funds shall nominate an approved person in accordance with paragraph 1.3(g) of the UT Code, with submit the nomination letter together with such information required to be submitted by such approved person. According to paragraphs 1.5 and 1.6 of the UT Code, the approved person shall have his or her ordinary residence in Hong Kong, be responsible for the issue of any advertisement, invitation or document for the fund, to act as the contact person for service of relevant documents for the fund, and as the designated contact person for the SFC. We suggest that the approved person should be an employee of the HK Representative.
Except for specific documents which may be filed in simplified Chinese as outlined above, the above application documents to be submitted to the SFC shall be prepared in English. Moreover, the Circular on Mutual Recognition of Funds requires that Chinese documents to be issued to the Hong Kong public (including offering documents, KFS, notices and announcements) shall be in traditional Chinese. Where such documents are originally in simplified Chinese, the traditional Chinese text shall be a true and accurate reflection of the original text, as well as taking into account the market practice and customary use of traditional Chinese in the Hong Kong. In all circumstances, there shall be no substantive difference between the traditional Chinese text and the simplified Chinese text registered or filed with the CSRC.
In light of the above, whether an application for authorisation adopts a longer form prospectus in English, or in future ongoing information disclosure, the need to fulfil customary practice of the Hong Kong fund industry and investors’ reading habits in traditional Chinese, the preparation and translation of such documents are not easy tasks for Mainland fund managers.
3. SFC Review Process
Application for mutual recognition of funds shall be made to the SFC in accordance with the requirements set out above and enclosing the required SFC fee for authorisation. Unless otherwise specified by the SFC in respect of applications for authorisation of Recognised Mainland Funds, the application fee for each fund shall be HK$20,000. The SFC will issue a Take-up Letter within two business days after all necessary documents are submitted, the application fee is paid and the SFC accepts the application; if the SFC is of the view that the application materials are incomplete or inadequate, the application materials will be returned to the applicant and the application will not be taken up.
After an application is taken up, the SFC shall issue their initial comments within 7-14 business days; during the review process, the SFC may from time to time raise queries or make requests for information to the applicant and the applicant shall be required to respond within 1 month. According to the relevant SFC circular issued in November 2013, review of an application shall be completed within 6 months after it has been taken up. If authorisation is not obtained from SFC after 6 months, the application will lapse. A new application will need to be made and new application fee paid if an application has lapsed.
According to clause 3 of the Circular on Mutual Recognition of Funds, in respect of funds that are eligible for mutual recognition, the SFC will use a streamlined process which should greatly reduce the time from the usual 6-month review period.
4. Hong Kong Representative System
4.1 The Hong Kong Representative System and the qualification requirements
According to paragraph 9 of the UT Code, a fund to be distributed in Hong Kong is required to appoint a representative in Hong Kong if its fund management company is not incorporated and does not have a place of business in Hong Kong. Accordingly, each fund management firm of a Recognised Mainland Fund shall appoint a representative on behalf of the fund as its representative in Hong Kong.
The Hong Kong Representative shall be incorporated in Hong Kong and should be licensed for Type 1 regulated activity (Dealing in Securities) under the SFC licensing regime or a trust company that has satisfied the relevant requirements. If the Mainland fund management firm has already set up a subsidiary which holds a license for Type 1 regulated activity, that subsidiary is suitable to act as the Hong Kong Representative of the Recognised Mainland Fund. Currently, there are not many Hong Kong subsidiaries that possess a license for Type 1 regulated activity. However, it is not too difficult to apply for a Type 1 license subject to the SFC requirements.
4.2 The functions of the Hong Kong Representative
According to the UT Code, the Hong Kong Representative’s functions include the following:
- receive applications and subscription money for the fund
- issue receipts/contract notes in respect of the applications received
- receive redemption notices, transfer instructions and conversion notices from holders for immediate transmission to the fund management company
- accept and transfer any notices or correspondence from holders (including litigation related documents);
- notify the SFC immediately if redemption ceases, or is suspended;
- make available for public inspection the fund constitutive documents, offering documents and financial information of the fund
- deliver to the SFC, if it requests, all relevant accounts and records
- represent the fund management company in relation to matters in which any Hong Kong holder has a pecuniary interest
- Deal with other relevant fund distribution matters in Hong Kong
In respect of the Mainland fund management firm, it shall enter into an appointment agreement with the Hong Kong Representative to agree on the specific terms with respect to the above matters, in accordance with the requirements to distribute the fund in Hong Kong, and taking into account the characteristics of the Recognised Mainland Fund.
5. Operation and Distribution of Recognised Mainland Funds
5.1 The legal principles which shall apply:
According to the Circular on Mutual Recognition of Funds, the operation, marketing and information disclosure of Recognised Mainland Funds shall follow the principles below:
- Investment operations shall comply with Mainland laws and regulations and the fund constitutive documents;
- Distribution of the fund in Hong Kong shall comply with Hong Kong laws and regulations;
- Information disclosure shall mainly be based on Mainland laws and regulations and the provisions under the fund contracts and prospectus. However, they shall be supplemented in accordance with Hong Kong laws.
5.2 Dispute resolution:
In relation to dispute resolution of fund contracts, the Circular on Mutual Recognition of Funds requires that if the fund contract of a Recognised Mainland Fund provides for litigation for dispute resolution, then the jurisdiction of Hong Kong courts shall not be excluded from any disputes in relation to the Recognised Mainland Funds. Up to now, the vast majority of fund contracts provide for dispute resolution through arbitration, but a minority of funds have chosen litigation, and these funds must amend their dispute resolution clauses through appropriate procedures before applying for mutual recognition. In the meantime, such fund managers shall also consider whether amendments to dispute resolution clause requires the convening of a meeting of fund holders. For Hong Kong courts, it will be a new legal issue as to the application of China law in disputes related to mutual recognition of funds.
5.3 Distribution of recognised funds:
According to the Circular on Mutual Recognition of Funds, distribution of Recognised Mainland Funds must be conducted by SFC licensed intermediaries and the sale and distribution activities must comply with applicable requirements of Hong Kong laws and regulations.
According to Hong Kong law, only intermediaries with Type 1 licence (i.e. licensed for ‘dealing in securities’) may carry out sales and distribution of funds. Accordingly, where a Recognised Mainland Fund appoints a Hong Kong Representative which holds a Type 1 license, the Hong Kong Representative may also act as the main distributor or sales agent for the Recognised Mainland Fund. In the Hong Kong market, holders of Type 1 license that may conduct the activities of sale and distribution of funds include banks, securities brokers, independent financial advisors and online fund platform operators.
6. Information Disclosure of Recognised Mainland Funds
6.1 Content of information disclosure
According to the basic legal principles mentioned above, Recognised Mainland Funds may utilize the offering documents registered with the CSRC for information disclosure. The type of documents, content, format, frequency of update and the update procedures shall comply with the applicable Mainland laws and regulations and the provisions of the constitutive documents. However, CSRC-registered offering documents of a Recognised Mainland Fund must be supplemented by a Hong Kong covering document to comply with the following disclosure requirements under the Circular on Mutual Recognition of Funds:
- Bilingual offering documents (mainly referring to prospectuses) shall be prepared as per paragraph 5.6 of the Overarching Principles Section of the SFC Handbook. (In respect of advertisements, it is acceptable to select only one language necessary for promoting to the target audience.)
- The KFS shall be prepared in accordance with paragraph 6.2A of the UT Code. There is no requirement in the Mainland for Mainland funds to prepare a document such as the KFS and this is a special requirement of the SFC. KFS shall be part of the offering documents containing information to help investors understand the main features and risks of the fund.
- The offering documents shall contain information on enquiries and complaints handling as required under paragraph 7.4 of the Overarching Principles Section of the SFC Handbook.
- Enquiries and complaints handling as per paragraph 7.4 of the Overarching Principles Section of the SFC Handbook.
- Information or data as required under appendix C of the UT Code which mainly includes the name and registered address of the Hong Kong Representative engaged by the Mainland fund manager, tax arrangements of the fund, the types, language and mode of delivery of reports that are sent to holders, the address where fund constitutive documents are kept, warnings to investors to seek independent professional financial advice when subscribing in the fund, disclaimer statement of the SFC and securities lending arrangement of the fund.
In addition, the Circular on Mutual Recognition of Funds contains several requirements regarding ongoing information disclosure and information disclosure on the fund financial reports, which are required to be complied with by Recognised Mainland Funds. These requirements are not elaborated here but managers of Mainland funds should note that for satisfying SFC requirements and to comply with the Circular on Mutual Recognition of Funds which provides for fair treatment of investors in both jurisdictions in respect of information disclosure, the required efforts of the fund manager in ongoing information will be significantly increased to meet the regulatory requirements of both jurisdictions.
6.2 Mode of information disclosure
According to paragraph 11.7 of the UT Code, it is provided that “The scheme’s latest available offer and redemption prices or net asset value must be made public on every dealing day in an appropriate manner. (Note: Means of dissemination may include newspapers, telephone hotlines and websites)”. Paragraph 11.7A further provides that “A scheme should, as a matter of best practice, maintain a website for publication of its offering document, circulars, notices, announcements, financial reports and the latest available offer and redemption prices or net asset value of the scheme.”
According to the above provisions of the UT Code, the fund manager may use a designated website to disclose information such as offering documents, regular reports, financial reports, ad hoc reports and net asset value of the Recognised Mainland Fund. In practice, the net asset value of funds are usually simultaneously disclosed in the Chinese language and English language newspapers in Hong Kong. For major ad hoc information requiring investors’ attention, fund managers commonly deliver notices to investors by post to ensure investors receive the relevant information.
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The mutual recognition of funds is a milestone for establishing new market frontiers for retail funds in both Mainland and Hong Kong, and will no doubt be a key new business for the fund management industry in both Mainland and Hong Kong, where managers of Mainland funds will face several procedural and specific issues in their ‘south-bound’ endeavours. Our firm has been dedicated to in-depth participation in the work of mutual fund recognition in various respects, and with a focus on best market practices, provide assistance to institutions in both Mainland and Hong Kong on relevant issues to be addressed and to offer solutions.
(This article is for general information only and does not constitute legal advice. For further information, details or enquiries, please contact us.)