Non-Hong Kong Investment Funds: Relaxation of SFC Authorization Practices
November 13, 2007
By Timothy Loh and Howard Burchfield
This article looks at recent developments which suggest a relaxation of SFC authorization requirements for collective investment schemes based outside of Hong Kong. First, the SFC has expanded the ability of managers of authorized schemes to delegate their investment management functions to sub-managers in jurisdictions previously considered to be generally unacceptable. Secondly, the SFC appears to have softened its policy of insisting that investment management agreements and custodian agreements preserve the jurisdiction of the Hong Kong courts.
TIMOTHY LOH | Financial Services & Law Review
Vol. 1 (2007) at p. 29
Hong Kong is an important market for global
asset managers. Whilst the Securities and Futures Commission ("SFC") is open to authorizing collective investment schemes ("CIS")
based abroad, experience shows that difficulties can arise in the complying with SFC requirements. This is particularly so where the scheme has already been commercialized outside of Hong
Kong.
JURISDICTION OF SUB-INVESTMENT MANAGER
One area that has sometimes proven difficult is the
SFC's requirement that, with certain exceptions, both the manager of a
collective investment scheme and every sub-manager to whom the manager
delegates investment discretion be either licensed by the SFC or otherwise
subject to regulatory supervision in specified jurisdictions which are regarded
as subject to an acceptable inspection regime ("AIR").
AIR Jurisdictions
AIR jurisdictions are recognized by the SFC as
providing regulatory protection for investors comparable to that in Hong
Kong. The Code on Unit Trusts and Mutual Funds ("Mutual Fund
Code") lists 8 specific AIR jurisdictions, namely Australia, France,
Germany, Ireland, Hong Kong, Luxembourg, the United Kingdom, and the United
States.
Approval of these locations as AIR jurisdictions is
based upon the fact that the regulatory authority of the AIR jurisdiction
carries out inspections of the scheme managers within its jurisdiction in a
manner generally consistent with the requirements of the SFC and the regulatory
authority of the AIR jurisdiction has a satisfactory procedure in place
(usually in the form of a formal Memorandum of Understanding) for exchanging
information about the scheme managers with the SFC.
The Challenges Posed By Globalization
Potential scheme managers or sub-managers located
in non-AIR jurisdictions have in the past been approved on a case-by-case basis
under the Mutual Fund Code. However, the SFC has been understandably cautious
about granting such approvals and the delays in securing such approvals can be
significant.
The small number of jurisdictions officially
recognized by the Mutual Fund Code, combined with the SFC's conservative
approach to ad hoc approvals, has proven problematic for some scheme sponsors.
For example, a scheme sponsor may be based in a
non-AIR jurisdiction and thus, may be unable to arrange for investment
discretion to be exercised by the core manufacturing center for the sponsor
group.
Equally, for example, a scheme sponsor may wish to
arrange for investment discretion to be exercised by sub-managers in non-AIR
jurisdictions which have markets in which the scheme invests.
New Practice
To address these developments, the SFC recently
announced its intention to facilitate the delegation of investment management
functions to sub-managers based in non-AIR jurisdictions. It has formulated the
following criteria for acceptance of a non-AIR sub-manager:
- the delegating manager must itself be licensed by or
registered with the SFC for Type 9 regulated activity, or be subject to
supervision in an AIR jurisdiction;
- the sub-manager must be licensed or registered for
management of investment funds by its home regulator, and have a good
regulatory record;
- the sub-manager should be an affiliate of the
delegating manager subject to the same system of internal controls and
compliance procedures, and it should comply with various prescribed requirements
of the Mutual Fund Code;
- the sub-manager should remain under the supervision
of the delegating manager, which will be responsible for the sub-manager's
activities in respect to the delegated management functions;
- all transaction records relating to the delegated
activities should be available for inspection by the SFC, and all enquiries
from the SFC should be properly addressed;
- the delegating manager must report any material
breach, infringement or non-compliance by the sub-fund manager or itself with
the laws and regulations of its home regulator to the SFC;
- the jurisdiction where
the sub-manager is based should have a developed fund market (demonstrated by
the presence therein of international firms) or its regulator should be a
signatory to international cooperation arrangements; and
- the delegating manager must retain primary
responsibility for the proper management of the scheme in question.
Illustrative Case
Shortly before the release of the SFC's
announcement of the change in practice on non-AIR jurisdictions, we obtained
SFC authorization of a Luxembourg-based scheme whose Luxembourg-based manager
delegated investment discretion to a Belgian sub-manager. Belgium is not an AIR
jurisdiction. In our submission to the SFC we emphasized that:
- the manager is regulated in Luxembourg, an AIR
jurisdiction, and is required by the regulatory authority there, the Commission
de Surveillance du Secteur Financier ("CSSF"),
to closely monitor and supervise the Belgian sub-manager;
- the Belgian sub-manager is subject to indirect
supervision by the CSSF as the CSSF and the Belgian regulator, the Commission
Bancaire, Financiere et des Assurances ("CBFA"),
have a supervision agreement in place pursuant to which the CSSF can request
the CBFA to provide information regarding the Belgian sub-manager or to take
corrective action;
- the Belgian sub-manager and the Luxembourg manager
are both members of the same corporate group and thus subject to the same
system of internal controls and compliance procedures; and
- the Belgian sub-manager was willing to provide a
voluntary undertaking to submit to the jurisdiction of the SFC by providing
information on request to the SFC to demonstrate that it was carrying out its
investment management functions satisfactorily.
The process confirmed the SFC's commitment to
enhanced flexibility in the delegation of investment management functions.
EXCLUSIVE JURISDICTION CLAUSES
Another area that has sometimes proven difficult is
the SFC's historical objection to any clause ("non-Hong Kong exclusive jurisdiction clause") in the investment management
agreement or custodian agreement providing for exclusive jurisdiction of non-Hong Kong courts.
Constitutive documents of collective investment
schemes structured outside of Hong Kong often provide for the courts of the
jurisdiction in which the scheme is domiciled or the manager is based to assume
exclusive jurisdiction in the event of a dispute. For example, the constitutive documents of a Luxembourg
based scheme may provide for the courts of Luxembourg to exercise exclusive
jurisdiction.
In the past, the SFC has required non-Hong Kong exclusive jurisdiction
clauses to be amended to allow for Hong Kong courts to assume
jurisdiction. For existing schemes,
such a requirement is often undesirable for the scheme sponsors as amendments
to such agreements may require, in addition to consent of scheme holders,
approval from regulators in other jurisdictions in which the scheme is
marketed.
Authority
Ostensibly, the SFC's objection to non-Hong Kong
exclusive jurisdiction clauses arises as a result of the Mutual Fund Code. The Mutual Fund Code provides that the
constitutive documents of a CIS may not exclude the jurisdiction of the Hong
Kong courts to entertain actions concerning the CIS. In this regard, "constitutive documents" means "the
principal documents governing the formation of the scheme, and includes the
trust deed in the case of a unit trust and the Articles of Association of a
mutual fund corporation and all material agreements".
These provisions are designed to ensure that Hong
Kong investors may enforce their rights under an SFC authorized scheme in Hong
Kong courts and thus, are not deprived of a forum in which to pursue available
remedies.
Non-Hong Kong Jurisdiction Clauses Now Acceptable?
Whilst the SFC has yet to publish formal guidance,
in a recent application to the SFC in which the investment management agreement
provided for the exclusive jurisdiction of Luxembourg courts, we argued, and
the SFC apparently accepted, the following:
- no Hong Kong investors are parties to the investment
management agreement, and thus the agreement creates no contractual rights
which may be enforced by Hong Kong scheme holders;
- the agreement creates no third-party rights in
favour of Hong Kong scheme holders; and
- the agreement does not affect, either positively or
negatively, the ability of Hong Kong scheme holders to enforce, in the courts
of Hong Kong, any rights (whether in contract or tort) they may otherwise possess.
As a result, the SFC has intimated that it will no
longer object to non-Hong Kong exclusive jurisdiction clauses in investment
management agreements or custodian agreements. However, based on the Mutual Fund Code, the SFC will
continue to object to non-Hong Kong exclusive jurisdiction clauses in articles
of association or trust deeds.
If in fact the SFC has changed its practice,
foreign collective investment schemes seeking admission to the Hong Kong market
may no longer need to undertake the difficult task of amending investment management
agreements or custodian agreements to remove non-Hong Kong exclusive
jurisdiction clauses.
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