This article was written by Minny Siu, Hayden Flinn and Cindy Shek.
The regulatory framework and application details for mutual recognition of publicly offered funds (MRF) between the Chinese Mainland and Hong Kong have finally been released after almost 2 years of market expectation. The Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) signed a Memorandum of Regulatory Cooperation concerning Mutual Recognition of Funds between the Mainland and Hong Kong (Memorandum) on 22 May 2015, confirming the launch of MRF on 1 July 2015.
This could be a game changer for all global fund management groups which want retail fund distribution in Asia. It will give Hong Kong public funds an advantage over the European standard UCITS funds in accessing the Mainland China market. Although UCITS funds can be distributed in over 80 countries, including Hong Kong, they cannot be distributed directly to retail investors in Mainland China under the mutual recognition rules.
Under the MRF, public funds operating from Hong Kong and the Mainland that meet certain eligibility requirements prescribed by CSRC and SFC respectively for MRF will generally be deemed to have complied in substance with the other market’s registration requirements under a streamlined process for distribution in such market.
The initial investment quota for the MRF will be set at RMB300 billion for funds flow between Hong Kong and the Mainland each way. This link between funds operating in the two markets is conceptually similar to mutual access of equity trading under the Stock Connect. This alert will focus primarily on the northbound (i.e. from Hong Kong to the Mainland) requirements prescribed by the CSRC.
SFC authorised funds seeking CSRC registration – the “Northbound” eligibility requirements
The CSRC issued the Provisional Rules for Recognised Hong Kong Funds (Provisional Rules) , alongside the signing of the Memorandum, to set out the eligibility requirements, application procedures and operational requirements for a SFC authorised fund (HK Fund) seeking CSRC registration under MRF.
The adoption of the rules and principles of the home jurisdiction is a key and fundamental principle under MRF. The Provisional Rules expressly recognise that the investment activities, custody of fund assets, fund valuations, fees arrangements, taxation, fund investor meetings, and any modification to the relevant fund constitution documents of, and general disclosure by, a HK Fund registered with CSRC under MRF (Recognised HK Fund) will continue to be regulated by the applicable Hong Kong regulations, and its constitutive documents. The sale and distribution of Recognised HK Funds in the Mainland will be required to comply with the applicable Mainland laws and regulations.
What types of SFC authorised funds will be considered under the MRF?
Standardised funds including equity funds, bond funds, mixed funds and index funds (including exchange traded funds) will all be eligible under the MRF according to the Provisional Rules.
What are the eligibility requirements for SFC authorised funds seeking CSRC registration?
HK Funds seeking CSRC registration must:
- be established, operated and publicly distributed in accordance with Hong Kong laws and regulations;
- be authorised by the SFC;
- have a trustee/custodian that meets the SFC’s regulatory requirements;
- have at least 1 year track record, with not less than RMB200 million asset under management (or its equivalent in other currency); and
- not primarily invest in the Mainland market.
The value of the shares/units sold to Mainland investors must not be more than 50% of the Recognised HK Fund’s total assets under management.
What are the requirements on the management company?
Under the Provisional Rules, the management company of a Recognised HK Fund must:
- be licensed by the SFC to conduct Type 9 (Asset Management) regulated activities;
- not delegate its investment management activities to entities in any other jurisdiction; and
- not have been the subject of any major regulatory action by the SFC in the past 3 years or, if it has been established for less than 3 years, since the date of its establishment.
The management company of a Recognised HK Fund must ensure that investors in both Hong Kong and the Mainland receive fair and the same treatment, including in respect of investor protection, exercise of rights, compensation and disclosure of information.
What are the requirements for the Mainland China agent?
Each Recognised HK Fund must be represented by an appropriately qualified agent in the Mainland with respect to its Mainland operations. The management company of a Recognised HK Fund must exercise diligence in its selection and continuous supervision of the Mainland agent, and conduct periodic assessment of the performance of such agent. A Mainland agent must:
- be approved by the CSRC to perform public fund management or custodial activities; and
- be responsible for the Recognised HK Fund’s:
- registration with the CSRC;
- disclosure of information to the Mainland public;
- distribution arrangements in the Mainland (via distribution agents – see below);
- exchange of information between Hong Kong and the Mainland;
- regulatory reporting to the CSRC; and
- client servicing and point of contact in the Mainland for notices and enquiries to the HK Fund.
Fund distribution in the Mainland must be conducted through a qualified distribution agent, who may be appointed by either the management company of the relevant Recognised HK Fund or its Mainland agent.
The management company should ensure that its distribution agency agreement clearly sets out the responsibilities and obligations of each of the management company, the Mainland agent and the Mainland distribution agent, including AML/KYC requirements for client onboarding for Mainland investors and other continuing obligations.
Commercial banks are a primary fund distribution channel in the Mainland. We understand the Mainland bank regulator (CBRC) will separately issue administrative rules for regulation of fund distribution by commercial banks in the Mainland under MRF. Recognised HK Funds should assess the implications of these measures on their master distribution agreement.
What do I need to submit for the CSRC application?
An eligible HK Fund may apply to the CSRC for registration under the MRF starting on 1 July 2015, with the following submission materials:
- an application report;
- its constitutive documents;
- its offering document and product disclosure statement;
- its latest audited annual report;
- an agency agreement between the management company of the HK Fund and the Mainland agent;
- documents of the management company, trustee/custodian and agent evidencing their compliance with the CSRC requirements for MRF;
- legal opinion regarding the authorisation status of the HK Fund, and its management company; and
- such other documents as may be requested by the CSRC.
Fund offering documents for distribution in the Mainland
The fund offering documents issued by a Recognised HK Fund to the Mainland investors must be based on its fund offer documents approved by the SFC, with the necessary modifications and supplements to address:
- risk factors and information specific to the mutual recognition of such fund under MRF;
- the types, timing and means of fund disclosures for the Mainland investors, including the location of document inspection;
- the rights and obligations of fund investors, including the procedures and requirements of fund investor meetings, the grounds on which fund documents may be terminated, and dispute resolution mechanism;
- any other material difference between the Mainland investors’ rights in respect of the fund in comparison with their Hong Kong counterparts, and material information relevant to the Mainland investors.
Next steps – Get prepared!
The MRF opportunities for fund managers in Hong Kong are unprecedented. In February this year, the SFC was reported to have identified approximately 100 Hong Kong domiciled funds that are eligible for participation in the MRF allowing cross-border fund sales. If based in Hong Kong you should conduct a preliminary assessment on your eligibility under MRF, and get prepared for this MRF initiative! If based outside Hong Kong you should consider whether to establish Hong Kong operations and funds in order to access the Mainland Chinese investor base.
The Provisional Rules (香港互认基金管理暂行规定) will take effect on 1 July 2015
The CSRC Rules concerning the Relevant Issues in Implementing the Administrative Measures for Operating Publicly Offered Securities Investment Funds (关于实施<公开募集证券投资基金运作管理办法〉有关问题的规定) for further information on CSRC’s categorisation of standardised funds.