Last Friday, 22 April 2016, the Hong Kong Securities & Futures Commission (SFC) announced that the revamped fund application and authorization process (“Revamped Process”) shall be formally adopted and become SFC policy effective from 9 May 2016.  The Revamped Process will now also be extended to the applications from Mainland funds seeking authorization under the Mainland-Hong Kong mutual recognition of funds arrangement (“MRF Applications”).

The Revamped Process was implemented under a 6-month review from 9 November 2015 to 8 May 2016 (“Pilot Period”).  The Pilot Period has been considered a success, as the SFC notes that the quality of new fund applications has improved, responses from applicants are generally observed to be timelier, and the overall processing time for new fund applications shortened in line with the SFC’s targeted processing timelines under the Revamped Process.

With the formal roll-out of the Revamped Process, the SFC has also revised and certain documents which is intended to further guide applicants when submitting new fund applications:

• updated Information Checklist for Application for Authorization of Unit Trusts and Mutual Funds under the Revamped Process (“Updated New Information Checklist”);
• updated Guide on Practices and Procedures for Application for Authorization of Units Trusts and Mutual Funds (“Updated Guide”); and
• updated Frequently Asked Questions on Application Procedures for Authorization of Unit Trusts and Mutual Funds under the Revamped Process (“Updated FAQs on UT Code”).

The Updated New Information Checklist is available for new fund applications received by SFC on or after 22 April 2016 (i.e. with immediate effect).  However, applicants have a choice to submit the immediate preceding version of the Updated New Information Checklist, if their applications are received by SFC on or before 6 May 2016.  From 9 May 2016 onwards, all applications submitted to the SFC must use the Updated New Information Checklist.

MRF Applications

MRF Applications received by the SFC on or after 9 May 2016 shall come under enhanced processing arrangements under the Revamped Process as “Non-standard Applications” until further notice from the SFC.  In terms of target processing times for “Non-standard Applications”, the SFC aims to shorten the authorization time to about 2-3 months from submission of an application.  Currently, MRF Applications generally take up to 6 months processing time.

The SFC has also introduced a new Information Checklist for Application for Authorization of Mainland Funds under the Mutual Recognition of Funds Arrangement and the Revamped Process (“New MRF Information Checklist”), including new standardized templates for confirmations on compliance which are included in the New MRF Information Checklist.  For new MRF Applications received by the SFC on or before 6 May 2016, the existing Information Checklist for Application for Authorization of Mainland Funds seeking SFC’s Authorization under the Mutual Recognition of Funds Arrangement (“Existing MRF Information Checklist”) may still be used.

A new Section H of the Frequently Asked Questions on Mainland-Hong Kong Mutual Recognition of Funds (“Updated FAQs on MRF”) provides that, under the Revamped Process, the SFC will issue the “Take-up Letter” within 5 business days upon the receipt of the application documents, compared to the current 2 business days for “take-up” of an MRF application.   According to the Revamped Process for non-standard applications, which shall from 9 May 2016 be relevant to MRF Applications, the expected timeframe for replies to SFC requisitions would be shortened, to 14 business days or 10 business days as applicable.

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.)

The CSRC has issued a Q&A on 22 May 2015 in connection with the Mutual Recognition of Funds initiative, explaining the scheme and mentions the requirements for Hong Kong funds to be eligible for approval by CSRC for retail distribution in Mainland China.

Besides a basic premise that the funds are established and operating under Hong Kong law, approved by the Hong Kong SFC for public offer in Hong Kong and regulated by the SFC, the manager should be established and operating in Hong Kong, licensed by the SFC to conduct asset management activities in Hong Kong and it shall not delegate its investment management function outside of Hong Kong.

Eligible funds must have been established for at least one year, with assets-under-management of not less than RMB200 million (or the equivalent in foreign currency).  The fund must not be primarily investing in the Mainland, and its distribution in the Mainland shall not exceed 50% of the fund’s total assets.  Plain vanilla funds, balanced funds, fixed income funds and index funds (including exchange-traded funds) are permitted.

According to the CSRC Q&A, there are currently approximately 100 Hong Kong funds (as at end of 2014) that fulfil the afore-said requirements.  Besides the said eligibility requirements, funds are also required to appoint a CSRC-approved manager or custodian of retail funds, as the Mainland representative for handling fund distribution and administration matters including sales and settlement, information disclosure, customer services, compliance and regulatory reporting.

Appointed representatives may organise registration of the eligible funds with the CSRC and thereafter the funds may be distributed and available to retail investors in the same manner as domestic retail funds.

An observation as we review and compare the requirements for mutual recognition of funds in Hong Kong and China – whilst the eligibility requirements and key criteria for recognition seem largely aligned for both jurisdictions respectively, eligible funds may be registered with CSRC for retail distribution in China, whereas Mainland China funds are required to undergo review and approval by the Hong Kong SFC, due to the different regulatory process as it now stands in the two jurisdictions.

Mainland funds shall prepare a Hong Kong covering document that meet SFC requirements, and shall seek SFC authorisation under what the regulators announced would be a stream-lined process. (For details, please refer to our earlier article on the initiative and requirements for Mainland funds.)  For Hong Kong funds to prepare for registration in China to distribute to retail investors, the most important step may be the detailed arrangement to be agreed with the proposed China representative.

However, it may be a necessary and sensible difference in the regulatory process between the two,  considering that some 850 Mainland funds (as at end of first quarter 2015) are said to meet the eligible requirements for recognition in Hong Kong. Having said that, we will still need to wait to tell the actual application and approval process, and the relative ease of registration.

It’s been brewing for a while, but it may still come as a surprise to some that today the securities and funds regulators in China and Hong Kong have jointly announced the implementation of a mutual recognition initiative for funds regulated in the respective jurisdictions.

Referred to as the “Mainland-Hong Kong Mutual Recognition of Funds” (MRF) initiative, the initiative has now been formally agreed between the China Securities Regulatory Commission (CSRC) and the Hong Kong Securities and Futures Commission, under a memorandum of regulatory cooperation signed today, 22 May 2015.   Not only does the signing of memorandum confirm the much awaited scheme is now going ahead, the regulators have set an effective roll-out date of 1 July 2015, just over a month away.

As stated in the Joint Announcement of China Securities Regulatory Commission and Securities and Futures Commission, under the MRF, the CSRC and SFC will allow Mainland and Hong Kong funds that meet the relevant eligibility requirements to follow stream-lined procedures to obtain authorisation or approval for offering to retail investors in each other’s market.   There will be an initial investment quota of RMB300 billion as a cap on total fund-flows each way.

According to the SFC announcement, Mainland funds applying for SFC authorization must meet the following eligibility requirements:

• • • • • the fund is established and managed and operates in accordance with Mainland laws and regulations and its constitutive documents;

• the fund is a publicly offered securities investment fund registered with the CSRC under the Securities Investment Fund Law of the People’s Republic of China;

• the fund must be established for more than 1 year;

• the fund must have a minimum fund size of not less than RMB200 million or its equivalent in a different currency;

• the fund must not primarily invest in the Hong Kong market; and

• the value of shares/units in the fund sold to investors in Hong Kong shall not be more than 50% of the value of the fund’s total assets.

• At the initial stage, only general equity funds, bond funds, mixed funds, unlisted index funds and physical index-tracking exchange traded funds would be eligible under the scheme.

Detailed requirements, application procedures and regulatory arrangements are set out in the SFC “Circular on Mutual Recognition of Funds between the Mainland and Hong Kong”.  The corresponding requirements for Hong Kong SFC authorised funds to be recognised for retail distribution in Mainland China, the requirements and application procedures to the CSRC are in the “Provisional Rules for Recognised Hong Kong Funds” issued by the CSRC.

According to the Joint Announcement, the CSRC and SFC have established cooperation mechanism for cross-border regulation and enforcement, to ensure that Mainland and Hong Kong investors will receive equal protection.  One of the general principles for recognition requires that the management firm of a fund to be recognised shall ensure that holders of both the home jurisdiction and the host jurisdiction receive fair and the same treatment, including in respect of investor protection, exercise of rights, compensation and disclosure of information.

Each Mainland fund to be recognised by the SFC (“Recognised Mainland Fund”) must appoint a firm in Hong Kong to be its representative, and comply with Chapter 9 of the SFC Code on Unit Trusts and Mutual Funds.  The SFC Circular also stipulates that the management firm of the Mainland fund shall make effective and proper arrangement to ensure that, where constitutive documents provide for effective resolution by way of litigation, the courts of Hong Kong shall not be excluded from entertaining an action concerning the fund.  This is an area we believe management firms seeking recognition should pay particular attention in addressing and consider whether specific amendments to the fund constitutive documents are required.

A Recognised Mainland Fund may use the offering documents registered with the CSRC, but in addition, there must be a Hong Kong covering document which complies with the SFC requirements for bilingual offering document, product key facts statement (KFS) and other disclosure requirements of the SFC.  Further to the bilingual offering document requirement, the Hong Kong supplement covering offering document and other documents, notices and announcements made to Hong Kong investors will need to be in English and Chinese (traditional Chinese).

The MRF initiative is an important milestone towards the further opening up of the Mainland market, and an additional enhancement to the close cross-border cooperation between Mainland and Hong Kong especially in the areas of investments and asset management.  The Stock Connect scheme introduced quite recently has been another strong example of that.

The Joint Announcement also states that the MRF will lay the foundation for the CSRC and SFC to jointly develop a fund regulatory standard, introduce diverse fund investment products to Mainland and Hong Kong investors and enhance the international competitiveness of Mainland and Hong Kong fund management firms.   Further, it goes beyond China and Hong Kong, as its stated aims extend to also promote the integration and development of the Asian asset management industry, and encourage the transformation of Asian savings into cross-border investments.

Mainland firms who wish to seek authorisation of Mainland funds under the MRF initiatve are encouraged to consult the SFC Investment Products Division for any clarification or guidance.  Firms should be preparing for making application to the SFC and organising the application materials to be among the firsts to have their funds authorised by the SFC come 1 July 2015.