Following rapid economic growth and wealth creation in Asia, the increase of portfolio allocation in regional markets, and continued financial liberalization on the mainland, Hong Kong has a unique opportunity to further develop its asset management industry.

To diversify the city's fund management platform and legal infrastructure, the government has launched a three-month public consultation on introducing a new open-ended fund company (OFC) structure. This is to help Hong Kong's legal system adapt to meet these changes.

An OFC is an open-ended collective investment scheme in corporate form. It has limited liability and variable share capital and can be set up as a public or private fund. The main purpose of an OFC is to serve as an investment fund and to manage investments on behalf of shareholders.

The OFC structure is a response to market needs for a more flexible choice of investment fund vehicles. Under current laws, an open-ended investment fund may be established only in the form of a unit trust - not in corporate form. This is due to restrictions on capital reduction under the Companies Ordinance. The OFC proposal will allow funds to be set up in an open-ended structure such as a company. But it will have a degree of flexibility not enjoyed by conventional companies. It will be able to create and cancel shares for investors to trade the funds. This corporate fund structure is gaining popularity internationally.

Given the nature of OFCs as purely legal investment-vehicles, OFC shareholders do not have day-to-day management rights or control over the underlying assets.

An OFC will be governed by a board of directors, subject to statutory and fiduciary duties. The OFC board will be legally responsible for all affairs of the OFC. The board will provide an additional layer of oversight for shareholders. The day-to-day management and investment functions of the OFC must at all times be delegated to an investment manager. The investment manager must be licensed by or registered with the Securities and Futures Commission (SFC). But individual directors on the OFC board will not be required to be licensed under the Securities and Futures Ordinance (SFO).

I, therefore, propose that the investment scope of OFCs be aligned with those types of investment activities subject to regulation by the SFC under the SFO. That is: securities, futures and over-the-counter derivatives - once the Securities and Futures (Amendment) Bill 2013 is operating - as defined under the SFO. The scope of securities and futures currently defined under the SFO is fairly broad.

To set up an OFC, the applicant would have to apply to the SFC for approval. Upon the Companies Registry's receipt of specified documents and SFCs issuance of an approval-in-principle for registration, the Companies Registry will incorporate and register the OFC. In addition to registration, OFCs which seek to offer their shares to the public must seek SFC authorization under the SFO.

Some investor protection measures will be established. This will include: mandatory delegation of day-to-day management and investment functions of OFCs to a investment manager licensed or registered with the SFC, subject to the oversight of the OFC board; basic eligibility criteria applicable to the OFC board, investment manager and custodian; segregating assets of the OFC from those of the investment manager and entrusted to a separate, independent custodian for safekeeping; alignment of investment scope with those types of investment activities subject to licensing and regulation by the SFC under the SFO; and publicly offered OFCs seeking SFC-authorization will also have to comply with applicable requirements.

Given that OFCs function as an investment fund vehicle, the new OFC vehicle will be established under the SFO and regulated and supervised by the SFC. The SFO and the OFC subsidiary legislation will set out the full scheme of the OFC. It will cover matters relating to creation and regulation of OFCs. More detailed requirements relating to OFCs and their operations will be outlined in a separate OFC Code. This will be issued under the SFO.

The new OFC legislation and the OFC Code will set out key duties of directors and other operators of OFCs. These must be complied with as long as the OFC remains registered with the SFC. The OFC investment managers will also need to comply with existing regulatory requirements. The OFC will be subject to post-registration monitoring and supervision under the new legislation and OFC Code. Publicly-offered OFCs will also be subject to ongoing post-authorization requirements.

I also propose that the existing tax exemption regime for publicly-offered Collective Investment Schemes (CIS) be equally applied to publicly-offered OFCs authorized under section 104 of the SFO.

The author is deputy secretary for Financial Services and the Treasury (Financial Services) at the Financial Services and the Treasury Bureau.

(HK Edition 06/03/2014 page9)