Nine questions you need to answer in assessing the revised OFC regime in Hong Kong


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What are the reforms that make the OFC a more attractive structure for open-ended funds?

In June 2018, the Hong Kong Securities and Futures Commission (SFC) introduced the legal and regulatory framework for the open-ended fund company (OFC) regime. Two years later, only five OFCs had been established in Hong Kong. In late 2020, based on market consultation, the SFC brought in some key enhancements to the OFC regime to increase its competitiveness and adoption. These include the removal of investment restrictions for private OFCs, adding SFC Type-1 intermediaries to act as custodian, introducing the possibility to set up a mechanism to re-domicile funds from overseas jurisdictions to Hong Kong and appointing a Responsible Person to carry out the AML/CFT functions.

In this blog, we outline the changes you should be aware of, and explore the opportunities this will provide.

What is the OFC?

The OFC regime allows investment funds to be established in Hong Kong in corporate form. The OFC works in a similar way as unit trust, to increase or decrease its capital or distribution of capital without approval of shareholder(s) of the company. Its key features are:

  • Has a corporate structure and legal personality
  • Governed by a board of natural-person directors (at least 2 natural persons) one of whom should be independent director not being a director or employee of the custodian. Directors must be of good repute, appropriately qualified, experienced and proper for the purpose of carrying out the business of the OFC
  • Allows investors to subscribe and redeem shares and make distribution from capital without the approval of the shareholders
  • Offers limited liability to its shareholders
  • Share certificate not required to be issued
  • May operate one or more sub-funds with segregated assets
  • Can be offered to public or on private basis

What changes have been made by the SFC?

The key enhancements made by the SFC include:

  1. Removing all investment restrictions applicable to private OFCs
  2. Expanding the scope of persons permitted to act as custodians for private OFCs
  3. Introducing a statutory mechanism for the re-domiciliation of overseas corporate funds to Hong Kong
  4. Changes applicable to key operators of OFCs, such as additional requirements for the safekeeping of private OFC scheme property
  5. Changes on customer due diligence requirements

What does the removal of investment restrictions mean in practice?

An OFC must be registered with SFC and incorporated by the Companies Registry. SFC has issued OFC Rules and OFC Code which shall be complied by an OFC. SFC’s prior approval is required for change of name of an OFC, and appointment of key operators.

An OFC must make certain filings to the SFC i.e. an audited annual report, offering documents, resolution to remove a director, cessation of investment manager or custodian, alteration to instrument of incorporation, statement of circumstances issued by auditor or custodian.

A key change is the removal of investment restrictions for a private OFC and such an OFC can invest in all asset classes. The only investment restrictions will be as per the investment objective of the OFC as mentioned in its offering document. Further, the investment scope and investment strategies adopted by the investment manager, specific risks associated with the type and nature of assets must be clearly disclosed in the offering document of the private OFC. In particular, disclosure shall be made when OFC intends to invests 10% or more of its gross asset value in non-financial or other less common asset classes.

However, the overriding restriction still applies that an OFC must not be a business undertaking for general commercial or industrial purposes will continue to apply.

The implications of this are that Private OFCs can now invest into shares and debentures of private companies, non-financial assets (i.e. real estate and infrastructure projects) and the more exotic asset classes (e.g. virtual assets)

Who is now eligible to be the custodian of private OFC and what are their obligations?

Added to the list of custodians set out in the Code on Unit Trusts and Mutual Code (UT Code), entities holding a Type 1 regulated activity licence can now act as custodian of an OFC, provided its licence condition does not prohibit them from holding client assets and the OFC shall be its client. In case the custodian is a licensed corporation then it has to at all times maintain paid-up share capital of not less than HK$ 10 million and liquid capital of not less than HK$3 million.

The custodian must be independent of the investment manager and has sufficient experience, expertise and competence in safekeeping the asset type in which the OFC invests and to maintain internal controls and systems commensurate with the custodial risks specific to the type and nature of assets in which the OFC invests. The custodian must have at least one responsible officer or executive officer responsible for the overall management and supervision of its custodial function.

All money of a private OFC shall be held by the custodian in the segregated bank account maintained by the custodian for the purpose and must be paid by the custodian on the written direction of the private OFC or in accordance with standing authority or to meet the private OFC’s settlement or margin  obligations. Similar requirements are to be complied with for holding securities of the private OFC.

Further, the custodian has obligation to keep such accounting and other records to account for all the scheme property and all movement of the scheme property to be traced through its account system and asset holding system.

Who are mandatory intermediaries and what is their role?

An OFC must be managed by an investment manager who has a Type 9 (asset management) regulated activity licence issued by SFC. The OFC should delegate to the investment manager at a minimum the function of the investment management, valuation and pricing of the scheme property. Such delegation should be reflected in the investment management agreement.

The OFC must also appoint a custodian which should be a licensed bank or a licensed bank’s trust company registered under Trustee Ordinance. However, a private OFC can also appoint a Type 1 (dealing in securities) regulated activity licensed entity as the custodian subject to compliance with certain provisions. A custodian of a private OFC can appoint a sub-custodian over which it shall have proper oversight. An OFC should appoint an auditor independent of the investment manager, the custodian and the directors of the OFC. OFC’s accounts should be compliant with Hong Kong Financial Reporting Standards or International Financial Reporting Standards.

As a result of these changes, the choice of custodians has increased dramatically as Type 1 licensed corporations become eligible

What does the proposed re-domiciliation mechanism of overseas corporate funds mean to managers?

The consultation received a favourable response from the industry which sees this mechanism a positive reform to further promote Hong Kong as an asset management hub in Asia.

We see a growing trend of offshore funds moving onshore as the international tax and law practice evolves continuously. With the requirements of economic substance, increasing need for transparency in connection with OECD’s BEPS 2.0 package, offshore jurisdictions are expected to come under scrutiny and to the managers the costs of staying compliant are potentially on the rise.

What does the proposed change of CDD requirements provide?

The SFC is conducting a further consultation on the client due diligence requirements (CDD) for OFCs. At present, there is no prescribed AML/CTF obligation imposed on OFCs, and the investment manager of each OFC is currently expected to carry out the relevant AML/CTF measures.

The consultation further proposes that all retail and private OFCs keep a register of significant controllers (SCR) similar to the requirement under the Companies Ordinance for all other conventional companies, to provide transparency of corporate beneficial ownership of OFCs. However, given the open-ended nature of the OFC, there would be significant challenges in keeping an SCR, as the investors in a public OFC are constantly changing due to the frequent subscription and redemption of shares of retail funds.

Therefore, it is proposed that an OFC will be required to appoint a responsible person to perform AML/CTF functions, in line with the requirements imposed on the Limited Partnership Funds.



What impact do these changes have on fund administration services?

The OFC Code requires that the valuation and pricing of the OFC’s property is within the investment manager’s remit. This is inconsistent with the typical hedge fund model, where valuation and pricing of the hedge fund property is the responsibility of the board of directors of the hedge fund and its execution is delegated to the fund administrator. However, this is unlikely to impact the fund administrator’s services since the valuation and prices will continue to be provided by the investment manager a delegate of the OFC.

A custodian of a private OFC must control the cash of the OFC and for this purpose open and operate the bank accounts and is required to keep records of the same as per the regulations applicable to it. Therefore the fund administrator will not be able to either control or jointly operate any of the bank accounts of an OFC or keep the records thereof unless the custodian agrees to make the administrator a joint signatory to the bank account or delegates the function to the administrator.

Will these reforms make the OFC a more attractive structure for open-ended funds?

These changes to the regulation create excellent opportunity for the OFC to become the fund structure of choice for Hong Kong fund managers.

Along with the benefit of being in scope of a single regulator, with lower government fees than many offshore jurisdictions and service providers. The reforms have been generally welcomed by the industry, as the market had expressed concerns that the OFC regime was restrictive, lacking flexibility, and did not offer a compelling alternative to the fund structures in other developed jurisdiction.

The SFC’s changes are expected to significantly increase the rate of adoption of the OFC structure and help to further cement Hong Kong’s position as Asia’s leading investment funds hub. The outlook is encouraging and in practice, we have already seen a substantial increase in inbound enquiries regarding the structure.

In the 2021 Hong Kong Budget speech, they have said that they will provide subsidies to cover 70 per cent of the expenses paid to local professional service providers for OFCs set up in or re-domiciled to Hong Kong in the coming three years, subject to a cap of $1 million per OFC.

How can we help?

Our local team of experts can provide assistance in the establishment and operation of an OFC, including:

Want to make a quick enquiry? Contact Us.

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