Regulatory enhancement - Investment scope
Initially, substantial investments of a private OFC must consist of such assets the management of which constitutes Type 9 regulated activity. Private OFCs are subject to a 10% de minimis limit, which expressly provides that the total value of an OFC’s investment in other asset classes (other than those the management of which would constitutes a Type 9 regulated activity, cash, bank deposits, certificate deposit, foreign currencies and foreign exchange contracts) shall not exceed 10% of the gross asset value of that OFC. For an umbrella OFC, this limit applies to each sub-fund as well as to the umbrella OFC as a whole.
This limit has been lifted in September 2020 and the SFC has removed all investment restrictions on private OFCs under the OFC Code such that private OFCs are allowed to invest in all asset classes without having to confine substantial amount of its investment in regulated activity. This enhancement is driven by the intention of placing private OFCs on a level playing field with other overseas corporate fund structures. Without the investment restrictions, OFC can now be adopted for investments other than securities or futures, such as investments in private companies, real estate, credit or other assets not previously eligible.
New requirements will be introduced requiring (i) investment managers and custodians to have sufficient expertise and experience in managing and safekeeping the asset classes in which an OFC invests, (ii) enhanced risk disclosure in the offering documents, and (iii) maintenance of proper records.
In terms of enhanced risk disclosure, this includes ensuring offering documents contain clear disclosures on all material risks specific to the type and nature of assets in which the OFC invests, in particular where the OFC invests 10% or more of the gross asset value of the OFC in non-financial or other less common asset class(es).
Regulatory enhancement - Significant controller register
The SFC suggested to require private OFCs to keep a significant controller register similar to the requirement for companies under the CO so as to enhance the transparency of corporate beneficial ownership of OFCs in its public consultation on enhancing OFC regime in 2019. However, such proposal met with a lot of criticisms, for reason of impracticability of such requirement, having considered the open-ended nature of OFC. This is because investors in a private OFC are constantly changing due to the feature of frequent subscription and redemption of shares of the funds.
The SFC has therefore proposed and conducted further consultation in September 2020 to require the OFC to appoint a responsible person to perform AML/CFT functions as stipulated under Schedule 2 to the Anti-Money Laundering and Counter Terrorist Financing Ordinance (Cap. 615). This is similar to the requirements imposed on limited partnership funds in an effort to harmonise AML/CFT requirements across different investment vehicles.
Such responsible person must be (a) an authorised institution (i.e., a bank, a restricted license bank, or a deposit-taking company under the Banking Ordinance (Cap. 155)), (b) a licensed corporation (i.e. a corporation that is licensed to carry on regulated activities under the Securities Futures Ordinance (Cap. 571)), (c) an accounting professional or (d) a legal professional. The appointment of a responsible person should be made by the board of directors of an OFC, as the board is legally responsible for all of the OFC’s affairs.
Regulatory enhancement - Re-domiciliation
When the OFC regime was first introduced, there was no mechanism for re-domiciliation. Funds that were established in other jurisdictions may only transfer the assets and the investors to a new vehicle in Hong Kong through restructuring by way of, among others, asset transfer or share swap.
The re-domiciliation proposal has been introduced by the Financial Services and the Treasury Bureau (the “Bureau”) in February 2021. The core requirements under the proposal is that the migrating offshore fund must meet the same set of eligibility requirements of an OFC.
The application process requires a single submission of the application documents and application fee to the SFC to register a non-Hong Kong fund as an OFC and the SFC would process the application and notify the Companies Registry upon completion for issuance of the certificate of registration/re-domiciliation. In terms of the application, the application for re-domiciliation should include:
- confirmation that the proposed re-domiciliation and de-registration of the offshore fund are not prohibited by its constitutive documents, contracts and laws of its place of establishment;
- a certificate issued by the directors to confirm the solvency of the fund and each sub-fund, the absence of any petition of winding-up, liquidation, receivership or arrangement or compromise arrangement; and
- notice of the proposed re-domiciliation served to creditors.
Once registered, the offshore fund will then have to de-register in its original place of establishment within 60 days of issuance of the certificate of registration, failure of which would lead to its registration being cancelled.
Upon re-domiciliation, the fund’s identity will be preserved and remains as the same legal entity. Re-domiciliation to Hong Kong does not intend to prejudice or affect the identity of the fund as previously incorporated or registered. This translates into numerous benefits:
- any contract made or resolution passed will remain intact;
- all rights, functions, liabilities or obligations, and property of the fund before its registration in Hong Kong, will be preserved;
- previous legal proceedings by or against the fund will not be rendered defective; and
- the re-domiciliation does not amount to a transfer of assets or a change in beneficial ownership, hence no stamp duty implications.
The Bureau targets to introduce the bill to effect the re-domiciliation proposal into the Legislative Counsel for first and second reading in the second quarter of 2021.
The OFC regime and the reforms aim to enhance the competitiveness of both the OFC regime and Hong Kong’s fund industry, making it an attractive alternative to comparable structures available in other developed jurisdictions.
Government dedication in boosting the use of OFCs can also be seen in the 2021-22 Budget Speech, in which additional measures were announced to include an intention to provide subsidies to cover 70% of the expenses paid to local professional service providers for OFCs set up in or re-domiciled to HK in the coming three years, subject to a cap of HK$1 million per OFC.
However, while these measures and regulatory enhancements are expected to significantly enhance the utility and competitiveness of the OFC regime, it is yet to be seen whether OFCs will become a trend in Hong Kong in light of the introduction of the limited partnership funds which is subject to less scrutiny with more freedom in governing the funds.
Nevertheless, given the introduction of economic substance law in Cayman Islands, Cayman funds are now subject to more stringent regulatory scrutiny and these reforms pose uncertainties as to the fund formation environment within Cayman Islands. The absence of clarity and market consensus around the economic and practical impact of these changes presents opportunity for Hong Kong to become the next alternative jurisdiction for investment funds and solidify its position as the asset management hub in the region and also to develop a robust domestic private fund industry. Hong Kong has always been a logical choice for fund managers given its strong community of investors and professional service providers, the proximity to Mainland China and the active initial public offering market for conducting fundraising, deal sourcing and investment management activities. It is expected to witness a growing trend of funds domiciled in Hong Kong in the future.