On 16 May 2024, Hong Kong’s Securities and Futures Commission (SFC) updated the circular on streamlined requirements for eligible exchange traded funds (ETFs) adopting a master-feeder structure (Circular) to expand the scope of eligible ETFs to cover both passive ETFs and active ETFs and relax certain requirements on the eligible ETFs (including requirements on home jurisdiction, fund size and track record).
By way of background, the streamlined requirements for eligible ETFs adopting a master-feeder structure were first introduced by the SFC in December 2019 (as discussed in our earlier article) and were updated on 25 February 2022 with the fund size and track record requirements relaxed (see our earlier article). In essence, provided that certain conditions are met, the SFC will allow an SFC-authorised feeder ETF to invest its assets in an overseas-listed master ETF without the latter obtaining the SFC authorisation.
Before the Circular of 16 May 2024, in order for a master ETF to be eligible under the streamlined master-feeder structure, it must meet the following conditions:
1. the master ETF be a passive ETF which adopts physical replication of the underlying index through either a full replication or a representative sampling strategy;
2. the master ETF must be a scheme regulated in a recognised jurisdiction managed by a management company in an acceptable inspection regime or a scheme eligible under a mutual recognition of funds arrangement;
3. the master ETF must have a fund size of not less than USD 400 million and a track record of more than one year at the time of the feeder ETF’s listing on the Stock Exchange of Hong Kong;
4. the master ETF’s engagement in securities financing transactions should not exceed 50% of its total net asset value unless there are comparable safeguards and disclosure.
The Circular of 16 May 2024 replaced the above conditions with the following:
1. the master ETF must be a scheme with satisfactory safeguards and measures in place to provide substantially comparable investor protection as an ETF authorised under the Code on Unit Trusts and Mutual Funds, taking into account its underlying assets, investment strategy, applicable rules and regulations in the home jurisdiction; and
2. the master ETF must have sizeable assets under management with a good track record.
The new conditions in the Circular expand the scope of the eligible ETFs to cover both passive ETFs and active ETFs and no longer restrict eligible ETFs to schemes regulated in a recognised jurisdiction managed by a management company in an acceptable inspection regime or a scheme eligible under a mutual recognition of funds arrangement.
In addition, the Circular no longer specifies the minimum fund size and track record of the eligible ETFs and replaces it with a generic requirement of “sizeable assets under management with a good track record”. The restrictions related to securities financing transactions have also been removed.
Notwithstanding the above relaxation, the Circular continues to require that the master ETF, its management company and trustee/custodian, must have a good compliance record with the rules and regulations of its home jurisdiction and (in the case of master ETF) the listing venue.
The relaxations in the Circular shows that the SFC welcomes applications for authorisation of feeder ETFs that invest in overseas-listed ETFs through the streamlined master-feeder structure, with an aim to facilitate the development of ETF products in Hong Kong. As the Circular replaced some specific requirements (such as minimum fund size and track record) with generic requirements, it shows that the SFC will adopt a case-by-case approach and ETF issuers are advised to contact the Investment Products Division of the SFC to assess the eligibility of specific overseas-listed ETFs under the Circular.
