Launched in 2018, Hong Kong’s open-ended fund company (OFC) regime is a variable structure for fund management firms, as opposed to current structures, such as the unit trust, which have a fixed capital structure.
Variable capital structures allow investors to come in and out of a fund more easily than fixed capital structures.
While the OFC is new in Hong Kong, other developed markets, including Europe, already have a similar model in place, according to Scott Peterman, Hong Kong-based partner at global law firm Orrick.
“This is one of Hong Kong’s attempts to catch up and enter new legislation that has already been in existence around the world,” he told FSA.
“From what I can see, the OFC structure has been largely modelled on an Irish fund structure called the ICAV (Irish collective asset-management vehicle), which is a corporate variable capital form.”
Three firms in Hong Kong have adopted the OFC structure for five funds. They include Cedar Asset Management and Pacific Hawk, with each having one private fund, and three ETFs managed by Mirae Asset Global Investments, according to records from Hong Kong’s Securities and Futures Commission (SFC).
Singapore also launched in January a variable structure for asset managers, the variable capital company (VCC) framework, according to a statement from the Monetary Authority of Singapore and the Accounting and Corporate Regulatory Authority.
At the time, the regulators said that it initially rolled out a VCC pilot programme in September, in which 18 fund managers participated.
As of January, all 18 managers have incorporated or re-domiciled 20 investment funds as VCCs, which include venture capital, private equity, hedge fund and ESG strategies. Mindful Wealth is among them, FSA reported earlier.
Offshore distribution
While Mirae Asset already has several Hong Kong-listed products that follow the old Hong Kong unit trust structure, the firm decided to adopt to the new OFC regime for its three ETFs that were launched last month.
Stephen Chung, Hong Kong-based vice president for ETF sales, explained that one of the reasons for using the OFC regime is the ease of understanding the structure. Global institutions and distributors are familiar with variable structures.
“Professional investors usually conduct due diligence before buying a fund. From a legal perspective, a unit trust is sometimes vague, whereas the OFC structure is more standardised and clear-cut,” he told FSA.
“So there is that time element that is beneficial for them and for us as the issuer of the product.”
Given that the structure is a global standard, distributing OFC ETFs in other markets should also be easier.
“If we need something to be recognised in a different market, then OFC is a better way to do it. For example, it will be easier to cross-list the ETFs if any potential opportunities arise in the future,” he said, adding that a majority of the ETFs listed in the US and Europe follow a variable structure rather than a unit trust structure.
“I definitely expect that other ETF managers in Hong Kong will probably adopt the OFC structure for that benefit,” he said.
Cost-saving benefits
Managing an OFC fund is also operationally easier and cheaper, according to Orrick’s Peterman.
Unlike the unit trust structure, OFCs do not need to appoint a trustee.
“For unit trusts, the trustee is a very active counterpart. By law, a trustee has a lot of responsibilities because it is the fiduciary to all the beneficiaries of the trust.
“And in most of these cases, the trustee is a big bank, and there are fund managers who would rather not have someone like that to deal with. So it offers a cost-savings and time-savings for people and provides less frustration of having a counterparty who is well-represented by a team of lawyers,” he said.
While Peterman was not able to provide an exact figure of how much fund managers can save with the OFC structure, he estimates that it makes a “20-30% significance”.
Setting up a unit trust in Hong Kong could be expensive. Without naming the firm, Peterman said that an asset management group launched seven publicly authorised funds in Hong Kong using the unit trust structure, with the cost of putting up each fund at $400,000 (HK$3.1m).
“So that’s not bad if you’re a bank or an established fund business. But for a start-up manager, that is very high,” he said.
But adoption will not be quick
Despite the advantages of having an OFC, Peterman expects that adoption will be slow.
“Fund houses and trustees have been looking at the unit trust document for years, so they all know the touchpoints. People will often resist change, especially with a lot of legal documents. So I think a lot of the fund houses will probably stick with the unit trust structure for quite a while.”
In December, the SFC launched a consultation that will examine proposed changes to the OFC.
The changes to the regime would allow licensed or registered securities brokers to act as custodians for private OFCs, and expand the investment scope for private OFCs to include loans as well as shares and debentures of Hong Kong private companies, according to the consultation.
Allowing brokers to act as custodians to private funds would meet complaints that both fees charged by traditional custodians and their minimum size requirements are too high for many private banks, the consultation added.
