I OVERVIEW OF RECENT ACTIVITY
At the end of 2016 Hong Kong’s asset management industry registered an increase of 4.6 per cent in assets under management to HK$12.824 trillion, from HK$12.250 trillion as at the end of 2015.2 While institutional funds experienced a year-on-year increase of 4.2 per cent, retail funds authorised by the Securities and Futures Commission (SFC) reported a decrease of 4.5 per cent. The category of ‘other funds’ (comprising mainly overseas retail funds, hedge funds, private equity funds and insurance portfolios) recorded significant year-on-year growth of 8.5 per cent. Looking at the industry on a wider level, the combined fund management business3 of Hong Kong also experienced growth, recording a year-on-year increase of 5.2 per cent to HK$18.293 trillion as at the end of 2016.
While Hong Kong continues to play an important role in the process of yuan internationalisation through its partnership with mainland China (the mainland), total outstanding yuan customer deposits and certificates of deposit in Hong Kong fell from a record 1.1 trillion yuan at the end of 2014 to pre-2012 levels of 625 billion yuan at the end of 2016.
Despite the volatility in the mainland’s markets and the depreciation of the yuan in 2016, Hong Kong remained the pre-eminent offshore yuan centre. The number of SFC-authorised unlisted structured investment products with yuan features rose from 222 in 2016 to 262 as of 31 March 2017. The launch of Stock Connect expanded mutual stock market access between the mainland and Hong Kong, while the launch of Bond Connect further consolidated Hong Kong’s position as a major offshore yuan hub.
The number of corporations licensed for asset management in Hong Kong continued to grow from 1,035 in December 2015 to 1,348 in December 2016.4 The number of Hong Kong-domiciled funds has also increased by more than 12 per cent to 735 as of March 2017.5
Going forward, Hong Kong looks set to continue to develop as a leading centre for the asset management industry for a number of reasons, including its rigorous but flexible and accommodating regulatory regime, its proximity to the mainland markets, its flexible tax regime and its world-class financial infrastructure.
II GENERAL INTRODUCTION TO the REGULATORY FRAMEWORK
The principal source of regulation of the asset management industry in Hong Kong is the SFO and its subsidiary codes, guidelines and circulars, and the principal regulator is the SFC.
Retail funds in Hong Kong (the funds offered to the Hong Kong public) must be authorised by the SFC, whereas non-retail funds generally structure and conduct themselves in such a manner as to avoid the need to be authorised, and thereby regulated, by the SFC. Unauthorised funds, whose investors are predominantly institutions, have an aggregate net asset value thought to be in excess of the figure for authorised funds, although this is hard to quantify in the absence of any obligation to file accounts.
Even where non-retail funds are able to avoid the need to be authorised, the regulatory regime generally requires their Hong Kong-based fund managers to be licensed by the SFC, whether they manage retail funds or non-retail funds.
The principal source of regulation in respect of both authorisation and licensing is the SFO, and key codes are the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products, and the SFC’s Fund Manager Code of Conduct.
i Authorisation by the SFC
The asset management structures utilised in Hong Kong and discussed below are collective investment schemes for the purposes of the SFO.6 Under Section 103(1) of the SFO, it is an offence for a person to issue any advertisement, invitation or document that to his or her knowledge is or contains an invitation to the public to acquire an interest in or participate in any collective investment scheme unless the issue is authorised by the SFC under Section 105(1) of the SFO, or is exempted by any other relevant provision.
A common way to structure a fund so as to avoid the requirement to be authorised by the SFC is by ensuring that the offer and marketing is not regarded as being made to the public.7
The meaning to be given to the public in the context of Hong Kong securities law has been the subject of much debate. Following previous market practice, the general consensus is that 50 persons (or fewer) in Hong Kong would not constitute the public.
In 1991, an SFC working group also informally stipulated that, in order for a document or invitation not to be regarded as made to the public:
- a not more than 50 copies of the offering document or invitation should be issued;
- b each copy should be serially numbered;
- c each copy should be individually addressed to a named person; and
- d each copy should make clear that only the named addressee is entitled to take up the offer or invitation, and that he or she is not entitled to transfer his or her acceptance to any other person.8
Another common way to structure a fund so as to avoid the requirement to be authorised by the SFC is by offering and marketing the fund only to professional investors, for which Section 103(3)(k) of the SFO provides a specific exemption. The definition of professional investors includes:
- a intermediaries (i.e., licensed corporations and registered institutions);
- b authorised institutions or overseas banks;
- c authorised insurers;
- d governments;
- e trust corporations with total trust assets of not less than HK$40 million (or its equivalent in foreign currency);
- f corporations or partnerships with a portfolio of not less than HK$8 million (or its equivalent in foreign currency) or total assets of not less than HK$40 million (or its equivalent in foreign currency); and
- g high-net-worth individuals with a portfolio of not less than HK$8 million (or its equivalent in foreign currency).
ii Licensing by the SFC
- a Type 1 – dealing in securities;
- b Type 2 – dealing in futures contracts;
- c Type 3 – leveraged foreign exchange trading;
- d Type 4 – advising on securities;
- e Type 5 – advising on futures contracts;
- f Type 6 – advising on corporate finance;
- g Type 7 – providing automated trading services;
- h Type 8 – securities margin financing;
- i Type 9 – asset management;
- j Type 10 – providing credit rating services;
- k Type 11 – dealing in over-the-counter (OTC) derivative products or advising on OTC derivative products;11 and
- l Type 12 – providing client clearing services for OTC derivative transactions.12
The general position under Hong Kong law is that if the fund manager is not performing any activities in Hong Kong it will not need to be licensed. However, the licensing provisions of the SFO can have extraterritorial effect where a person actively markets, to the public of Hong Kong, services falling within one of the regulated activities listed above.13 Again, following previous market practice, the general consensus is that 50 persons (or fewer) in Hong Kong would not constitute the public for these purposes.
Given the diversity of activities that fund managers conduct, the type of licence required will vary from case to case and, for each regulated activity, there are exemptions from licensing that need to be looked at on a case-by-case basis. For example, a typical hedge fund manager will hold a licence only in respect of Type 9 (asset management) regulated activity.
In considering a licensing application, the SFC seeks, among other criteria, to ensure that managers are fit and proper, and have adequate resources. Licensed persons are subject to, inter alia, continuing reporting obligations, restrictions on unsolicited calls, and obligations to pay annual fees, to submit annual returns and to manage risks prudently. Substantial shareholders, officers and any other person who is or is to be employed by, or associated with, a licensed corporation for the purposes of the regulated activity for which the application is made must also satisfy the fit and proper test.14
iii Other regimes
In addition to the SFO regime, other statutes, subsidiary codes, guidelines and circulars apply to specific sectors of asset management. For example, investment-linked assurance schemes (ILAS), which are discussed below, are life insurance policies issued by an insurance company, and subject to both the SFO and the Insurance Ordinance.
A fund established in Hong Kong will also be subject to the rules and regulations applicable to its structure: for example, the Companies Ordinance, the Partnership Ordinance, the Limited Partnership Ordinance or the Trustee Ordinance.
Specific sectors of asset management also fall under the ambit of other regulators, in addition to being under the regulation of the SFC. For example, Mandatory Provident Fund Schemes (MPF schemes), which are discussed below, are regulated by both the Mandatory Provident Fund Schemes Authority (MPFA) and the SFC. Both regulators issue their own codes, and MPF schemes are expected to comply with both codes.
Funds listed on the Stock Exchange of Hong Kong Limited (SEHK) are also subject to the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (Hong Kong Listing Rules).
III COMMON ASSET MANAGEMENT STRUCTURES
Various legal structures are used for the different sectors of asset management in Hong Kong.
Hedge funds managed from Hong Kong are commonly structured as companies or limited partnerships domiciled offshore in a tax-neutral jurisdiction such as the Cayman Islands. Far less often, they are structured as unit trusts constituted under trust deeds governed by Hong Kong law.
Most private equity funds managed from Hong Kong are also established in offshore tax-neutral jurisdictions such as the Cayman Islands, commonly as limited partnerships.
The majority of pension funds available to Hong Kong residents are in the form of MPF schemes (which are generally master trust schemes consisting of multiple constituent funds that are themselves invested in either feeder funds or portfolio managed funds) or Occupational Retirement Schemes Ordinance (ORSO) schemes, each of which is discussed below.
ILASs, which are utilised in insurance fund management in Hong Kong, are life insurance policies whose premiums are invested in underlying funds that can be offshore or onshore and of varying legal structure.
REITs managed from Hong Kong are required to be structured in the form of a trust.
IV MAIN SOURCES OF INVESTMENT
Hong Kong continues to be a preferred location for international investors. Contributions from non-Hong Kong investors accounted for 66.3 per cent of the non-REIT fund management business15 in 2016.
Despite a significant fall from 2015 levels, yuan currency remains a major source of investment in Hong Kong’s asset management industry, with total outstanding yuan deposits of 625 billion yuan as at the end of 2016.16
V KEY TRENDS
The global financial crisis and subsequent market events have led to significant regulatory reform, with profound implications for the asset management industry in relation to issues such as systemic risks, liquidity and risk management, enhanced custody requirements, securities lending and repos, conflicts of interest and product design. The SFC is looking at some of these issues closely with a view to further enhancing the regulation of the Hong Kong asset management industry and, in particular, is now focusing on the conduct of asset managers and intermediaries in relation to commissions and independent advice, securities lending and repurchase agreements, safe custody of fund assets, liquidity management and disclosure of leverage by fund managers.17 The SFC has also announced that it will conduct a holistic review of the Code on Unit Trusts and Mutual Funds (UT Code) with the aim of launching a public consultation on proposed enhancements.
The market has seen the SFC taking a more robust approach in its inspection and enforcement actions. The SFC’s regulatory reach has been extended by the Tiger Asia case,18 which established that Hong Kong’s High Court may (for remedial or protective purposes) determine market misconduct and make orders against persons located outside Hong Kong, allowing for the swift sanction of asset managers engaged in market misconduct. This enforcement avenue is in addition to the other enforcement mechanics set out in Parts XIII and XIV of the SFO.
VI SECTORAL REGULATION
Formerly, any company wishing to carry on insurance business in or from Hong Kong had to apply to the Office of the Commissioner of Insurance (OCI) for authorisation to do so under the Insurance Companies Ordinance. With the coming into effect of parts of the Insurance Companies (Amendment) Ordinance 2015 on 26 June 2017 the Insurance Authority (IA) took over the statutory functions of the OCI. The policy objectives of the establishment of the IA were to modernise the insurance industry’s regulatory infrastructure to facilitate stable development of the industry, provide better protection for policyholders and comply with the requirement of the International Association of Insurance Supervisors that insurance regulators should be financially and operationally independent of government and industry. Under the new regime the requirements for authorisation include capital and solvency requirements, adequacy of reinsurance arrangements, as well as fit and proper requirements in relation to the directors and key persons (such as officers responsible for risk management, compliance, financial control, audit and actuarial functions) of the insurer. Once authorised, insurers remain subject to various requirements, including in relation to their investment in, and the holding of, assets.
The IA is expected to establish a new statutory licensing regime within the next two years after which it will take over the supervision of insurance intermediaries from the three self-regulatory organisations that currently exist in Hong Kong.19
One of the key products used by insurance companies in Hong Kong are ILASs, which fall within the definition of Class C of Long-Term Business under the Insurance Ordinance20 and are also classified as collective investment schemes under the SFO.
ILASs are life insurance policies whose premiums are invested in funds chosen by the policyholder, the benefits of the ILAS policy then being linked to the performance of those investment options. As of March 2017, there were 300 SFC-authorised ILASs.21
As noted in Section II, supra, a collective investment scheme, including an ILAS, must fall within a relevant exemption under Section 103 of the SFO if it is to avoid the requirement to be authorised by the SFC. As an ILAS will generally be marketed to the public in Hong Kong, it is unlikely that any of the exemptions will apply, and accordingly, insurers are generally required to seek authorisation for the marketing of an ILAS.
The requirements for SFC authorisation of ILAS include:
- a the requirement that the insurer has obtained authorisation to carry on Class C of Long-Term Business;22
- b detailed disclosure requirements for scheme documentation;23 and
- c requirements in relation to fees and charges.24
Ongoing requirements for authorised ILASs include reporting obligations and the requirement to seek prior authorisation from the SFC for any changes to the scheme materials, unless an exemption applies.25
The SFC has published guidance stating that insurers, corporate insurance brokers and insurance intermediaries engaging in promoting, offering or selling ILASs to the public, or who advise members of the public concerning ILASs, are not, by virtue of those particular activities, required to be licensed under the SFO for the purpose of advising on securities (i.e., Type 4 regulated activity) or dealing in securities (i.e., Type 1 regulated activity).26
Retirement schemes in Hong Kong are governed primarily by ORSO and the Mandatory Provident Fund Schemes Ordinance (MPFSO). The MPFA is the primary regulator.
ORSO, which became effective in 1993, does not impose a requirement on employers to provide a retirement scheme, but rather aims to ensure that occupational retirement schemes established voluntarily are properly regulated.
Schemes that are covered by ORSO are required to apply for either registration or exemption under ORSO. ORSO exemptions may be allowed for offshore schemes that are registered or approved by a recognised overseas authority, or for schemes with not more than either 10 per cent or 50 of their members, whichever is less, who are holders of a Hong Kong permanent identity card.
Whether registered or exempted under ORSO, such schemes are subject to certain ongoing requirements.
MPFSO, which became effective in 2000, imposes a requirement on employers to ensure that all relevant employees are members of a registered provident fund scheme, as well as ongoing requirements for such schemes.
When MPFSO was introduced, pre-existing ORSO schemes (whether registered or exempted under ORSO) were permitted to apply for an exemption from certain provisions of MPFSO.
Owing to the interaction of the ORSO and MPFSO regimes, retirement schemes in Hong Kong are usually:
- a ORSO schemes that are neither MPF-exempted nor MPF-registered (acting as a top-up or supplement to MPF);
- b ORSO schemes that are MPF-exempted; or
- c MPF-registered schemes.
In June 2016, the Mandatory Provident Fund Schemes (Amendment) Ordinance 2016 was gazetted to mandate each MPF trustee to provide a highly standardised and fee-controlled Default Investment Strategy (DIS) in each MPF scheme. From 1 April 2017, accrued benefits, contributions of new scheme members who have not made any investment choices and, unless such members opt out, contributions of existing scheme members who have not made any investment choices will be invested according to the DIS.
iii Real property
Real property funds in Hong Kong are commonly in the form of REITs, which are considered collective investment schemes for the purposes of the SFO. As noted in Section II, supra, a collective investment scheme, including a REIT, must fall within a relevant exemption under Section 103 of the SFO if it is to avoid the requirement to be authorised by the SFC. As REITs will generally be marketed to the public in Hong Kong, it is unlikely that any of the exemptions will apply.
The SFC has issued a Code on Real Estate Investment Trusts (REIT Code) establishing authorisation and ongoing requirements for REITs. The REIT Code provides that an authorised REIT must have a trustee, a management company and a principal valuer, to value the real estate held under the scheme, that are, in each case, acceptable to the SFC. It is also a condition for a REIT to be authorised that it will be listed on the SEHK within a period acceptable to the SFC. Once listed, a REIT is subject to the Hong Kong Listing Rules.
An SFC-authorised REIT may hold real estate located in Hong Kong or overseas, directly or indirectly, through special purpose vehicles that are legally and beneficially owned by the REIT.
The REIT Code imposes various ongoing requirements, including that at least 75 per cent of the gross asset value of the scheme must be invested in real estate generating recurrent rental income;27 and the REIT is obliged to distribute to unitholders as dividends each year an amount not less than 90 per cent of its audited annual net income after tax.28
iv Hedge funds
The Hong Kong regulatory regime does not provide a clear definition of a hedge fund, but the SFC takes the view that non-traditional funds that possess characteristics, and utilise investment strategies, that are different from traditional funds will generally be regarded as hedge funds.
As noted in Section II, supra, a collective investment scheme, including a hedge fund, must fall within a relevant exemption under Section 103 of the SFO if it is to avoid the requirement to be authorised by the SFC. Most non-retail hedge funds structure and conduct themselves in such a manner as to avoid the need to be authorised by relying on these exemptions.
Authorisation of hedge funds
The UT Code is the applicable SFC code for authorised hedge funds and contains a special section31 that deals with collective investment schemes that are hedge funds. As well as ongoing requirements, the UT Code sets out the factors the SFC will consider in determining whether to authorise a hedge fund.
SFC-authorised hedge funds (whether local or foreign) can be marketed to the public in Hong Kong subject to a minimum subscription of US$50,000, or for funds of hedge funds, US$10,000.32
Regulation of typical hedge fund activities
Certain activities typically carried out by hedge funds, whether authorised or not, are regulated, such as:
- a there is a prohibition on on-exchange naked short-selling unless exempted;33
- b subject to certain limited exemptions contained in the Hong Kong Listing Rules, on-exchange covered short sales may only be effected in certain securities designated by the SEHK, and all such short-selling activities must be executed at or through the SEHK;
- c the Securities and Futures (Contracts Limits and Reportable Positions) Rules prescribe limits and reporting positions applicable to futures contracts and stock options contracts traded on the SEHK or the Hong Kong Futures Exchange Limited;
- d if a hedge fund is interested in more than 5 per cent of voting shares in a corporation listed on the SEHK, it has an obligation to make a disclosure that arises upon the occurrence of certain relevant events, including the crossing of certain percentage threshold positions and a change in the nature of their interest in the shares. Short positions also need to be disclosed; and
- e the Securities and Futures (Short-Position Reporting) Rules set out additional short-position disclosure requirements. A short-seller will need to compute his or her short position in certain listed shares on the SEHK at the end of the last trading day of each week in order to determine whether it amounts to, or exceeds, 0.02 per cent of the issued share capital of that particular listed company, or the value of the short position amounts to or exceeds HK$30 million, whichever is lower. If the short position amounts to or exceeds such threshold, then the gross short position must be reported to the SFC.
Following a consultation on the scope of the short-position disclosure regime, the SFC extended disclosure requirements to all securities that can be short sold under the rules of the SEHK in March 2017.
It is possible for a hedge fund to be listed on the SEHK. An authorised hedge fund’s listing on the SEHK would follow Chapter 20 of the Hong Kong Listing Rules. An unauthorised hedge fund’s listing on the SEHK would follow Chapter 21 of the Hong Kong Listing Rules.
v Private equity
Private equity funds are generally not regulated as a specific class of investment. However, as noted in Section II, supra, the SFO regulates the authorisation and operation of collective investment schemes, which are broadly defined and can include private equity funds. However, private equity funds will generally structure and conduct themselves so as to avoid the need to be authorised, and so regulated, by the SFC, by relying on the exemption for offers made only to professional investors.
Under the SFO, a private equity fund’s promoter, principals and manager need to be licensed if they carry out a regulated activity in Hong Kong. The most relevant regulated activity for private equity fund managers is dealing in securities (Type 1), advising on securities (Type 4) and asset management (Type 9). In practice, the licensing requirements mainly concern the fund manager, who manages and carries out investment activities for the fund.
Acquisitions by private equity funds of companies listed on the SEHK or stakes in such companies are fairly common and are governed by various laws, regulations, or both, including the Companies Ordinance, the Hong Kong Codes on Takeovers and Mergers and Share Buy-backs, and the Hong Kong Listing Rules.
As described in Section VII.i, infra, the government has introduced extensions to the profits tax exemptions that are expected to attract more private equity funds to Hong Kong.
vi Other sectors
Retail unit trusts and mutual funds
A large part of the retail asset management market in Hong Kong is in the form of non-specialised unit trusts and mutual funds (both of which fall within the meaning of collective investment scheme under the SFO) authorised by the SFC. The majority of such retail funds (by both number and net asset value) are equity funds and bond funds (there being 1,018 and 430 respectively as at 31 March 2017).34
Retail funds that are mutual funds or unit trusts are subject to the general regulatory framework noted in Section II, supra, and the provisions of the UT Code.
Exchange Traded Funds
The Exchange Traded Fund (ETF) segment is one of the fastest-growing segments in the asset management industry in Asia, and Hong Kong is at the forefront of this trend, with 127 ETFs listed on the SEHK as of 31 March 2017.35
As noted in Section II, supra, a collective investment scheme (including index funds such as ETFs) that is offered to the Hong Kong public must be authorised by the SFC unless a relevant exemption under Section 103 of the SFO can be relied upon. To be authorised, ETFs are expected to comply with the relevant provisions of the UT Code,36 which also provides ongoing requirements for authorised schemes.
The SEHK provides a listing avenue for authorised ETFs under Chapter 20 of the Hong Kong Listing Rules and is responsible for overseeing their compliance with the Hong Kong Listing Rules.
Streamlined process for certain ETFs listed overseas and waiver of stamp duty
Overseas ETFs that meet the core structural and operational requirements set out in the UT Code, and that are regulated in an acceptable ETF regime that has comparable or similar regulatory principles as those set out in the UT Code, may seek SFC authorisation by way of a streamlined recognition process.37
Since February 2015, a stamp duty waiver has been in effect for trading in ETF shares or units that are listed or traded on the SEHK stock market, as a means to lower transaction costs and further promote the growth of the ETF market.
Leveraged and inverse products, crude oil futures ETFs
Adding to the diversity of the products in Hong Kong’s ETF market, in June 2016 the SFC authorised the first batch of leveraged and inverse products structured as ETFs. From 9 January 2017, the SFC accepts applications for the authorisation of leveraged and inverse products that track liquid and broadly based Hong Kong and non-mainland foreign equity indices. The SFC has also stated that it is willing to consider, on a case-by-case basis, the authorisation of funds tracking non-equity indices, provided that they meet the relevant requirements of the UT Code. As of March 2017, 30 leveraged and inverse products were listed on the SEHK. In 2016, the SFC also authorised the first crude oil futures ETF and the first ETFs with multiple trading counters.
VII TAX LAW
Hong Kong has three separate types of income tax – property tax, salaries tax and profits tax. Of the three income taxes, profits tax is the most relevant to asset management funds, their investment managers and their investors. Unlike many other jurisdictions, Hong Kong does not have a separate capital gains tax regime.
Hong Kong stamp duty is chargeable on certain transactions.
i Profits tax – funds
Hong Kong adopts a territorial source principle of taxation.
Under the Inland Revenue Ordinance, profits tax is charged on a person carrying on a trade, profession or business in Hong Kong; and in respect of income profits (and excluding capital gains profits) arising in or derived from Hong Kong from that trade, profession or business.
The rate of profits tax for corporations is 16.5 per cent for the year of assessment commencing 1 April 2017.
Carrying on a trade, profession or business in Hong Kong
A low threshold is required to fall within the scope of carrying on a trade, profession or business in Hong Kong.
In some cases a non-Hong Kong resident fund, by using a Hong Kong investment manager, may be regarded as falling within that scope. The non-Hong Kong resident funds exemption referred to below was introduced to alleviate this concern.
Note that the locality of a fund’s central management and control is not a determinative factor when considering whether it carries on a trade, profession or business in Hong Kong.
Income arising in or derived from Hong Kong
If the above test – of carrying on a trade, profession or business in Hong Kong – is satisfied, then profits tax will (subject to exemptions) be chargeable if the income arises in or is derived from Hong Kong.
This is a factual question, which is determined by looking to see what the taxpayer has done to earn the relevant profit. A test often applied in difficult cases is where the operations take place from which the profits in substance arise. Note that the place where a taxpayer’s profits arise is not necessarily the place where he or she carries on business.
Inland Revenue Department guidelines and case law assist in determining the locality where income arises or is derived from. Two principles relevant to funds are:
- a listed shares and other securities – profits from the sale of listed shares and other securities arise at the location of the stock exchange where those shares and other securities in question are traded; and
- b unlisted shares and other securities – profits from the sale of unlisted shares and securities arise at the place where the contracts of sale and purchase are effected (regardless of where the relevant issuer is incorporated or carries on business).
Exemptions to profits tax
The following types of fund are exempt from profits tax:
- a mutual funds, unit trusts or similar investment schemes that are SFC authorised (and thus available for general distribution to the Hong Kong public); and
- b other mutual funds, unit trusts or similar investment schemes where the Commissioner of Inland Revenue is satisfied that the relevant fund is (1) bona fide widely held and (2) complies with the requirements of an acceptable non-Hong Kong supervisory authority. Further details on how the Commissioner of Inland Revenue applies (1) and (2) are set out in the Inland Revenue Departmental Interpretation and Practice Notes.38
A non-Hong Kong resident fund, for which a central management and control test is adopted, may be exempt from profits tax in respect of transactions that:
- a are specified types of transactions (including incidental transactions from which trading receipts do not exceed 5 per cent of the total trading receipts from the specified transactions and incidental transactions taken together); and
- b either the non-Hong Kong resident fund is a ‘qualifying fund’,39 or the transactions are carried out through or arranged by a corporation or financial institution licensed by the SFC.40
The specified types of transactions are, broadly, transactions relating to:
- a securities (other than shares and debentures in Hong Kong incorporated private companies or other companies with a permanent establishment in Hong Kong);41
- b futures contracts;
- c foreign exchange contracts;
- d the making of a deposit (other than by way of money lending);
- e foreign currencies; and
- f exchange-traded commodities.
The Inland Revenue Ordinance contains an anti-avoidance deeming provision to prevent resident investors from round-tripping and disguising themselves as non-resident persons in order to benefit from the non-Hong Kong resident exemption. Broadly, unless the Inland Revenue Department is satisfied that the beneficial interests in the fund are widely held, the investor may still be liable to tax if the investor (together with associates) has an interest in 30 per cent or more in the non-resident fund, or has any percentage in an associated non-resident fund.42
The description above of the exemption for non-Hong Kong resident funds includes amendments made under the Inland Revenue (Amendment) (No. 2) Ordinance 2015, which came into effect on 17 July 2015 (with retrospective effect from the tax year commencing 1 April 2015). The purpose of the amendments is to extend the previous exemption for non-Hong Kong resident funds to also cover offshore private equity funds. This is achieved largely by amending the list of ‘specified types of transaction’ – and hence widening the exemption – to include certain non-Hong Kong incorporated private companies.
ii Profits tax – investors
The same general principles of profits tax discussed above in respect of funds also apply to the taxation of investors.
An investor, however, typically holds investments for investment purposes (rather than as part of a trade, profession or business). In such a case, profits or income derived from his or her investments fall outside the charge to profits tax. In addition to the above, specific exclusions may also apply, in particular:
- a an investor’s gain from disposing of shares or units in a fund will usually be a capital gain (and therefore fall outside the charge to profits tax); and
- b dividends received by an investor are not chargeable to profits tax.43
iii Profits tax – fund managers
The same general principles of profits tax discussed above in respect of funds and investors also apply to the taxation of fund managers.
iv Double taxation agreements
As of 21 July 2017, Hong Kong had comprehensive double taxation agreements with Austria, Belgium, Brunei, Canada, China, the Czech Republic, France, Guernsey, Hungary, Indonesia, Ireland, Italy, Japan, Jersey, South Korea, Kuwait, Liechtenstein, Luxembourg, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Portugal, Qatar, Romania, Russia, South Africa, Spain, Switzerland, Thailand, the United Arab Emirates, the United Kingdom and Vietnam.
Comprehensive double taxation agreements that are not yet in effect have been made with Belarus, Latvia and Pakistan.44
The terms set out in double taxation agreements take precedence over the other provisions of the Inland Revenue Ordinance.45
v Stamp duty
Stamp duty is chargeable on transfers of real property, the issue of certain bearer instruments and the transfer of Hong Kong stock. In practice, stamp duty on Hong Kong stock is usually chargeable with respect to shares in Hong Kong incorporated companies or companies listed on the SEHK.
Although stamp duty may be chargeable on unit trusts, bonds and bearer instruments, these are often structured so as to fall outside the charge of stamp duty. Stamp duty is not chargeable on redemptions of shares. Stamp duty is also not chargeable on trading in ETF shares or units that are listed or traded on the SEHK stock market.
The current rate of stamp duty chargeable on the transfer of shares in a Hong Kong incorporated or a SEHK-listed company is 0.2 per cent of the consideration for (or, in the case of gifts, the value of) the shares.
i Cooperation arrangements with the mainland and other jurisdictions
Hong Kong is expected to develop further its role as an offshore yuan business centre, with the SFC continuing to promote offshore yuan-denominated investment products in Hong Kong. There is widespread mainland governmental support for using Hong Kong as a platform to further the liberalisation of the yuan, evidenced by recent policy initiatives, including the formation of a working group with the SFC to study the implementation of mutual recognition and cross-border offering of funds between Hong Kong and the mainland aiming to bring about a wider investment platform for both jurisdictions in terms of more product offerings and a bigger investor base.
The Shanghai-Hong Kong Stock Connect was launched in 2014 as a two-way arrangement under which Hong Kong and international investors can directly access the mainland A-share market, and mainland investors can directly access Hong Kong’s stock market. The Shenzhen-Hong Kong Stock Connect was established in December 2016. Its structure and rules mirror that of the Shanghai-Hong Kong Stock Connect.
Under the Mainland-Hong Kong Mutual Recognition of Funds initiative (MRF) the China Securities Regulatory Commission (CSRC) and the SFC allow mainland and Hong Kong funds that meet the relevant eligibility requirements to follow streamlined procedures to obtain authorisation or approval for offering to retail investors in each other’s market. The CSRC and the SFC have respectively prepared the ‘Provisional Rules for Recognised Hong Kong Funds’ and ‘Circular on Mutual Recognition of Funds between the mainland and Hong Kong’, which set out the eligibility requirements, application procedures, operational requirements and regulatory arrangements of the MRF. It is envisaged that this initiative will further promote Hong Kong’s development as a fund management hub and fund domicile. As of 30 June 2017, the SFC authorised 49 mainland funds and the CRSC approved six Hong Kong funds under the MRF Scheme.46
Mainland-related licensed firms are expected to play an even more significant role in Hong Kong, and it is predicted that the range of yuan-denominated retail investment products managed by mainland-related licensed firms will grow significantly in future years. The SFC has also announced that, following the successful implementation of the MRF, it will further explore cooperation arrangements in asset management with other overseas authorities.
ii Regulation of OTC derivatives
In April 2014, the Securities and Futures (Amendment) Ordinance was enacted, introducing a new regulatory regime for OTC derivatives in Hong Kong. The regime provides a framework for mandatory reporting, clearing, trading and record keeping obligations in respect of OTC derivative transactions, and introduces the new regulated activities of dealing in and advising on OTC derivative products (Type 11 regulated activity); and providing client clearing services for OTC derivative transactions (Type 12 regulated activity).
The regime is being implemented in phases. In July 2015, the Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules (OTC Rules) brought into effect mandatory reporting and related record-keeping obligations for certain interest rate swaps and non-deliverable forwards. The first phase of mandatory clearing came into effect in September 2016. In July 2017, the second phase extended mandatory reporting obligations to all five key asset classes, namely interest rates, foreign exchange, equities, credit and commodities. It is not expected that the OTC Rules will impact on asset managers that only trade as a disclosed agent to an unaffiliated named principal (i.e., the fund that it manages).47
In July 2017, the SFC published consultations conclusions on capital and other prudential requirements for activities involving OTC derivatives engaged in by licensed corporations under the Securities and Futures (Financial Resources) Rules. To keep in line with international standards on the internal models approach for market risk and counterparty credit risk, the SFC has stated that it will update related guidelines and submit them for further consultation.
iii Open-ended fund companies
On 10 June 2016, the Securities and Futures (Amendment) Ordinance 2016 was gazetted and will introduce an open-ended fund company (OFC) framework in Hong Kong as an additional investment fund vehicle option. Currently, an open-ended investment fund may be established in the form of a unit trust, but not in corporate form owing to various restrictions on capital reduction under Hong Kong company law. The new regime for OFCs will be established under the SFO and supervised by the SFC, with detailed operation and procedural requirements to follow under subsidiary legislation and a new OFC Code.48 In June 2017, the SFC launched a consultation on the legal and regulatory requirements applicable to the OFC framework. Implementation of the OFC regime is planned to take place in 2018.
iv Professional investor regime and client agreement requirements
On 25 March 2016, amendments to the Code of Conduct for Persons Licensed By or Registered with the SFC (the Code of Conduct) came into effect, providing that specified categories of professional investors who previously were not covered by a number of the Code of Conduct’s protections will be covered from this date. The amendments provide that intermediaries are, among other obligations, bound by the Code of Conduct’s suitability requirement in relation to these clients and need to enter into a written client agreement and provide relevant risk disclosure treatments. In March 2017, the SFC launched a consultation paper on amendments to the Securities and Futures (Professional Investor) Rules. For the purpose of determining individuals’ qualification as professional investors, it is proposed to allow joint accounts and investments to be counted towards meeting the monetary threshold, and to accept alternative forms of evidence. It is also proposed to expand the categories of corporations that qualify as professional investors.
Separately, intermediaries must now comply with new Code of Conduct requirements governing the contents of all client agreements. All client agreements must be in compliance with the new client agreement requirements on or before 9 June 2017.49
v Online trading and diversification of fund distribution channels
Following announcements in 2016, the SFC has published a consultation paper on proposed guidelines on online distribution and advisory platforms. The proposed guidelines set out various core principles concerning governance and controls with which all platform operators should comply. They further aim to clarify how the suitability requirement set out in the Code of Conduct would operate in the context of online platforms.
In May 2017 the SFC has proposed measures aimed at mitigating hacking risks associated with internet trading. These include preventive and detective controls for the protection of client trading accounts, infrastructure security management and cybersecurity management and supervision. Publication of the consultation conclusions for both proposals is pending.
vi Enhancement of asset management regulation and point-of-sale transparency
In November 2016, the SFC published proposals to make certain enhancements to the Fund Manager Code of Conduct, in particular in relation to securities lending and repurchase agreements, safe custody of fund assets, liquidity risk management and disclosure of leverage. The proposals also envisage amendments to the Code of Conduct to enhance point-of-sale transparency and to better address potential conflicts of interests. Adopting a two-pronged approach, the consultation paper discusses: (1) the conduct of intermediaries when representing themselves as ‘independent’ or as providing ‘independent advice’, and (2) the disclosure of monetary benefits that are not quantifiable at the point of entering into a transaction. Publication of the consultation conclusions is pending.
vii Senior management accountability
In December 2016, the SFC issued a circular50 aimed at enhancing the obligations of licensed corporations in relation to their senior management. The circular identified eight core functions for which licensed corporations must identify a manager-in-charge (MIC). These are: overall management oversight, key business line, operational control and review, risk management, finance and accounting, information and technology, compliance, anti-money laundering and counterterrorist financing. Licensed corporations are required to submit up-to-date information regarding their management structure to the SFC and ensure that MICs are aware of their regulatory obligations. The new requirements came into effect on 18 April 2017.
viii Enhancements to the position limit regime
Following the publication of the SFC’s consultation conclusions on the position limit regime in March 2017, the Securities and Futures (Contracts Limits and Reportable Positions) Rules were amended on 1 June 2017. The amendments, among other things, expand the categories of persons who are authorised to hold and control futures and stock option contracts in excess of the prescribed limits.
ix Introduction of new board on the SEHK and proposed changes to the Gross Enterprise Market
In June 2017, the SEHK published a concept paper on the possible introduction of a new board to accommodate the needs of different issuers, in particular pre-profit companies, companies with non-standard governance features and mainland companies that wish to obtain a secondary listing in Hong Kong. The concept paper sets out proposals for a new board with two distinct segments: a ‘New Board PRO’, which would only be open to professional investors and target early stage companies that do not meet the financial or track record criteria for the Growth Enterprise Market (GEM) or the Main Board; and a ‘New Board PREMIUM’, which would specifically target companies with non-standard governance structures (such as weighted voting rights) and be open to professional and retail investors. Concurrently, the SEHK has also invited market comments on a proposed reform of GEM and changes to the GEM and Main Board Listing Rules that would see the standards applicable under the GEM regime becoming more stringent.
1 Jason Webber and Peter Lake are partners, and Ben Heron is an associate, at Slaughter and May. The authors would like to thank Laura Mai, a trainee at Slaughter and May, for her help in updating this chapter.
2 These figures are taken from the Fund Management Activities Survey 2016 issued by the Securities and Futures Commission in July 2017 (Fund Management Survey), where ‘asset management’ refers to the provision of services that constitute Type 9 regulated activity as defined in Schedule 5 to the Securities and Futures Ordinance (SFO) carried out by licensed corporations and registered institutions (excluding assets from clients who are also licensed by or registered with the SFC); and the management of financial assets arising from the provision of services that constitute classes of long-term business as defined in Part 2 of the First Schedule of the Insurance Ordinance (excluding assets subcontracted or delegated to other licensed corporations or registered institutions in Hong Kong for management), but excludes real estate investment trusts (REITs) management, fund advisory business and other private banking business. Figures given for assets managed are to be construed in the same manner.
3 These figures are taken from the Fund Management Survey, where ‘combined fund management business’ comprises asset management, fund advisory business, private banking business and SFC-authorised REIT management business.
4 All figures are taken from the Fund Management Survey.
5 Securities and Futures Commission, Annual Report 2016–17.
6 As defined in Part 1 of Schedule 1 to the SFO.
7 As noted in an SFC Working Group report on offers of securities and other investments issued in December 1991.
9 Section 114(1) of the SFO.
10 Part 1 of Schedule 5 to the SFO.
11 Type 11 was added by the Securities and Futures (Amendment Ordinance) 2014. Type 11 has not yet come into operation (see further Section VIII.ii, infra).
12 Type 12 was added by the Securities and Futures (Amendment) Ordinance 2014. It came into partial operation on 1 September 2016.
13 Section 115(1) of the SFO.
14 Section 129 of the SFO.
15 These figures are taken from the Fund Management Survey, where ‘fund management business’ comprises asset management, fund advisory business and other private banking business.
16 These figures are taken from the Fund Management Survey.
17 See the Fund Management Survey.
18 Securities and Futures Commission v. Tiger Asia Management LLC and others  3 HKC 600; FACV 10/2012.
19 The three existing self-regulatory organisations are the Hong Kong Confederation of Insurance Brokers, the Professional Insurance. Brokers Association and the Insurance Agents Registration Board established by the Hong Kong Federation of Insurers.
20 See Part 2 of the First Schedule of the Insurance Ordinance.
21 Securities and Futures Commission, Annual Report 2016–17.
22 Paragraph 1.8 of the Code on ILAS.
23 Paragraphs 5.1 to 5.11 of the Code on ILAS.
24 Paragraphs 5.14 to 5.17 of the Code on ILAS.
25 Chapter 7 of the Code on ILAS.
26 SFC Circular Clarifying the Licensing Requirements arising out of the Promotion, Offering or Sale of Investment-Linked Assurance Schemes to the Public, 13 August 2009.
27 Paragraph 7.1 of the REIT Code.
28 Paragraph 7.12 of the REIT Code.
29 These figures are taken from the Fund Management Survey.
30 These figures are taken from Table D1, SFC Market & industry statistics.
31 Section 8.7 of the UT Code.
33 Unless exempted under Section 170(3) of the SFO, naked short selling is prohibited under Section 170(1) of the SFO.
34 Securities and Futures Commission, Annual Report 2016–17.
35 These figures are taken from the Securities and Derivatives Markets Quarterly Report (first quarter 2017), issued by Hong Kong Exchanges and Clearing Ltd.
36 Being the Guidelines for regulating index tracking exchange traded funds at Appendix I, and the requirements set out in Chapter 8.6, of the UT Code.
37 Guidelines for regulating index tracking exchange traded funds at Appendix I to the UT Code.
38 Practice Note No. 20 (Revised) – Mutual Funds, Unit Trusts and Similar Investment Schemes.
39 A ‘qualifying fund’ is defined in Section 20AC(6) of the Inland Revenue Ordinance to mean a fund that falls within the following descriptions:
a at all times after the final closing of sale of interests:
• the number of investors exceeds four; and
• the capital commitments made by investors exceed 90 per cent of the aggregate capital commitments; and
b the portion of the net proceeds arising out of the transactions of the fund to be received by the originator and the originator’s associates, after deducting the portion attributable to their capital contributions (which is proportionate to that attributable to the investors’ capital contributions), is agreed under an agreement governing the operation of the fund to be an amount not exceeding 30 per cent of the net proceeds.
40 Practice Note No. 43 (Revised) – Profits Tax Exemption for Offshore Funds.
41 Anti-avoidance provisions mean that the exemption will not apply to non-Hong Kong companies that have within the past three years held certain share capital in Hong Kong companies or Hong Kong immoveable property. The exemption may, however, be available in respect of a Hong Kong incorporated ‘special purpose vehicle’ whose purpose is limited to holding (and administering) private company shares that would otherwise fall within the exemption.
42 The anti-avoidance provision also extends similarly to a Hong Kong resident who holds an interest in an exempt Hong Kong incorporated special purpose vehicle (as described in footnote 41).
43 Encyclopaedia of Hong Kong Taxation, Volume 3, II 5811–5850.
45 Section 49 of the Inland Revenue Ordinance.
46 Securities and Futures Commission, Annual Report 2016–17.
47 See FAQ, Q26.
48 Government Press Release dated 15 January 2016 and consultation conclusions on Open-ended Fund Companies published in January 2016.
49 SFC Press Release dated 21 March 2016, and SFC Consultation Conclusions on the Client Agreement Requirements dated 8 December 2015.
50 SFC Circular to Licensed Corporations Regarding Measures for Augmenting the Accountability of Senior Management 16 December 2016.