Earlier this month, Hong Kong’s Securities and Futures Commission (SFC) and the UK’s FCA signed an agreement to allow Hong Kong-domiciled mutual funds and UK funds to be distributed in each other’s markets.
The new programme, the UK-Hong Kong Mutual Recognition of Funds (MRF) scheme, opens opportunities for 250 funds Hong Kong-domiciled funds to be sold in the UK’s retail market, according to a report issued by Citi. However, a number of them are not eligible to join as they do not comply with UK regulations.
“Many of the largest funds domiciled in Hong Kong are ineligible to participate,” Stewart Aldcroft,” Cititrust’s chairman, told FSA. “The reason is that they have a custodian or fiduciary that is part of the financial group as the fund manager, which is not allowed under UK regulation.”
Aldcroft did not name any non-compliant firms or products, but said that those who do not comply with the regulation and wish to joint the scheme would have to change their custodian, fiduciary or depositary if they are part of the same financial group.
Aldcroft added that the European Union also applies the same regulation and so do other markets in Asia, including Singapore.
“Hong Kong is one of the very few places in the world that doesn’t have that as a mandate or regulatory requirement,” he said.
OFC structure?
BEA Union Investment, which is a participant in both the Hong Kong-Switzerland and China-Hong Kong MRF programmes, is aware of the UK requirement of having an independent trustee or custodian, according to Eleanor Wan, the firm’s CEO.
But she said it is too early to say whether her firm will participate in the UK-Hong Kong MRF.
“It would be a good opportunity for us to [promote our Asian investment capabilities], but we need to study registration a bit more,” she said.
The firm’s Hong Kong-domiciled funds do not yet comply with UK regulations. BEA Union Investment’s products, which are structured as Hong Kong unit trusts, have Bank of East Asia as their trustee.
“Unfortunately, under the unit trust structure, the trustee, which holds most of the fiduciary [duties of the fund], is our group company,” she said.
However, the firm’s custodian or fund depositary, which is appointed by the trustee, is independent from the BEA Group, she said.
To get around the UK requirement, one option is to transfer the unit trusts to Hong Kong’s open-ended fund companies (OFC) structure, which is a variable capital structure for fund management firms that was implemented at the end of July.
“If we move the unit trust structure to the OFC, then we wouldn’t need to appoint a trustee. You just appoint a custodian, and our custodian is already independent,” she said.
Other firms that manage Hong Kong-domiciled funds, such as HSBC Global Asset Management and Hang Seng Investment Management, which is part of the HSBC Group, have HSBC Institutional Trust Services (Asia) as their trustee, according to the key fact statement.
Commission-free
Citi’s Aldcroft added that Hong Kong-based fund managers interested in the scheme are also required to create share classes that do not include commissions, which are banned in the UK.
“Very few domestic Hong Kong unit trusts have already got a [commission-free] share class,” he said.
Aldcroft added that share classes should also be denominated in sterling. Although this is not a regulatory requirement, he said that UK investors are not used to investing in foreign currencies, even in US dollars.
He expects Hong Kong-based fund managers to face the same difficulties in the new scheme as with any other mutual fund recognition or passporting programmes. “Again, they will have to set up distribution agreements and representative businesses.”
He also believes that the take-up will be slow.
“The problem for all these passporting schemes is that many people sit on the sidelines and then wait for someone else to get success before doing something.
“If you look the way the MRF in China has worked, only after JP Morgan Asset Management was quite successful did you start to see a lot more interest from the other managers. My guess is the same would be needed for the UK-Hong Kong scheme.”
For UK-based managers, he believes that the MRF programme presents opportunities for smaller firms that do not have a Ucits platform. If a firm manages a Ucits platform, they don’t need the MRF because Ucits is allowed in Hong Kong.
Given that Hong Kong’s fund industry is already concentrated, UK managers are advised to look at offering specialist or sector-focused funds, which are not yet widely available under the Ucits product platform.
