23 June, 2015
On 22 May 2015, the Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) signed a "Memorandum of Regulatory Cooperation on Mainland-Hong Kong Mutual Recognition of Funds" (Memorandum).
The Memorandum provides that, from 1 July 2015, eligible Mainland and Hong Kong funds will be permitted to follow a streamlined process to obtain approval to offer their funds to the public in both markets. The funds which are covered by the Memorandum are equity funds, bond funds, mixed funds, unlisted index funds and physical index-tracking exchange traded funds.
The CSRC and the SFC have each prepared rules which set out the application procedures, eligibility requirements, operational requirements and regulatory requirements for mutual recognition (see below).
General Principles For Mutual Recognition
Broadly, a fund from one jurisdiction (the "Home" jurisdiction) which is seeking recognition in the other jurisdiction (the "Host" jurisdiction) should be authorised by or registered with the "Home" regulator and should be operated and managed in accordance with the laws of the "Home" jurisdiction.
In addition, the fund should meet the eligibility requirements of the "Host" regulator, it should be sold and distributed in accordance with the laws of the "Host" jurisdiction and it should comply with any additional rules released by the "Host" regulator.
Further, the management firm of the fund should ensure that investors in both the "Home" jurisdiction and "Host" jurisdiction receive fair and equal treatment, including in respect of investor protection, exercise of rights, compensation and disclosure of information.
The SFC issued a circular on 22 May 2015 to provide guidance to Mainland funds seeking authorisation from the SFC under the mutual recognition arrangement (Circular). The SFC has also encouraged applicants to consult its Investment Products Division early for any clarification or guidance and, in order to assist, the SFC has produced an Information Checklist and FAQs. The SFC has also recently provided an overview of the procedures for Mainland funds in seeking its authorisation. The relevant presentation materials (in simplified Chinese) can be accessed here.
The Circular provides that if a Mainland fund complies with the relevant Mainland laws and regulations, it is generally deemed to have complied in substance with the relevant SFC requirements (i.e. the SFC's Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Scheme and Unlisted Structured Investment Products (UT Code)). However, due to the differences between the Hong Kong and Mainland regimes, the Circular sets out the additional requirements a Mainland fund has to: (i) comply with in order to get approval; and (ii) observe after it has been approved.
A Mainland fund is only eligible for mutual recognition if:
- it has been established for more than one year;
- it has a minimum fund size of not less than RMB 200m (or equivalent);
- it does not primarily invest in the Hong Kong market (this means that no more than 20% of its assets should be invested in the Hong Kong market); and
- the value of shares / units in the fund sold to investors in Hong Kong is not more than 50% of the value of the fund's total assets (this should be actively managed).
Management Firms And Custodians
The management firm of a Mainland fund:
- must not have been the subject of any major regulatory actions by the CSRC in the past three years or, if it has been established for less than three years, since the date of its establishment; and
- cannot delegate its investment management functions to a party operating outside the Mainland (although its investment advisor(s) may be located within or outside the Mainland).
The Mainland fund must also have a custodian that is qualified to act as a custodian for the fund pursuant to Mainland laws and regulations.
Hong Kong Representative
Each Mainland fund must appoint a firm in Hong Kong to be its representative and that representative should comply with section 9 of the UT Code.
Operational And On-Going Requirements
There are a number of operational and on-going requirements set out in the Circular. These operational requirements include that:
- the Mainland fund must remain registered with the CSRC and be subject to ongoing regulation and supervision;
- where the constitutive documents of the Mainland fund provide for dispute resolution by way of litigation, the courts of Hong Kong should not be excluded from entertaining an action concerning the fund;
- any changes to the fund must be filed with the SFC after approval by the CSRC or compliance with the appropriate procedures;
- in the event that the fund breaches Mainland laws and regulations or the requirements of the Circular, its management firm should notify the CSRC and the SFC at the same time and rectify the breach promptly; and
- if the Mainland fund ceases to meet the SFC's requirements after it has been authorised, it should notify the SFC immediately. It should not continue to be marketed in Hong Kong and should not accept new subscriptions.
Sales, Distribution And Ongoing Disclosure
There are also a number of sales, distribution and other ongoing requirements. In this regard, a Mainland fund:
- can only be sold and distributed by intermediaries properly licensed by or registered with the SFC and the sale and distribution of the fund must comply with all applicable Hong Kong laws and regulations relating to the distribution of funds;
- may utilise the offering documents which are registered with the CSRC but they must be supplemented by a Hong Kong covering document in order to comply with certain disclosure requirements including but not limited to:
- must provide information relating to the fund (i.e. ongoing disclosure) to investors in the Mainland and Hong Kong and file this with the CSRC and the SFC at the same time. In addition to the ongoing disclosure required by Mainland laws and regulations, the fund will have to comply with certain additional requirements including providing any other information which may have a significant impact on investors in Hong Kong.
CSRC's MRF Provisions
The Interim Provisions on the Mutual Recognition of Funds in Hong Kong (MRF Provisions) adopted by the CSRC largely cover the same topics as the Circular, although there are a few key differences to highlight.
- the MRF Provisions specifically state that during the application process, the CSRC may seek the view of the SFC;
- the offering documents relating to the Hong Kong fund which have been approved by the SFC must include a PRC supplement which contains, amongst other information, disclosure of matters which have a significant impact on PRC investors;
- the MRF Provisions provide that the Hong Kong fund manager must prepare an announcement on the offering of fund units including information relating to account opening, registration, time of sale, channel of sale and form of sale;
- in terms of advertising, any Hong Kong fund promotion materials must be reviewed and an opinion regarding their compliance with PRC laws should be issued and filed within 5 working days of distribution or publication of those materials to the public; and
- any PRC organs engaged in the business of evaluating the products offered by the Hong Kong fund should create an effective evaluation system and use the same standards they adopt for PRC funds.
In terms of supervision, the MRF Provisions provide that:
- if the management of the Hong Kong fund is irregular or unlawful, then it will be investigated by the CSRC or the SFC depending on the place of occurrence of the irregular or unlawful activities;
- the CSRC will regulate matters regarding sales and information disclosure based on PRC laws and the SFC will regulate matters regarding investment operations of the Hong Kong fund based on Hong Kong laws. In particular, if the Hong Kong fund manager does anything irregular or unlawful when it conducts any business activities of the fund in China (e.g. in relation to sales or information disclosure), the CSRC may seek assistance from the SFC and adopt administrative and regulatory measures or impose administrative punishments against such manager; and
- the Hong Kong fund manager should adopt the 'territorial' principle in its day-to-day regulation (i.e. it should pay attention to and deal with the SFC on a day-to-day basis) but the CSRC has the right to require the manager to provide information and explanations on major regulatory matters.
The Memorandum is a significant step and demonstrates that the SFC and CSRC are finding new areas where they can work closely together to develop both the Hong Kong and Mainland financial markets. Indeed, the Memorandum states that one of the purposes of this initiative is to deepen Mainland-Hong Kong cooperation and it has also been described an "important milestone in the mutual opening of the Mainland and Hong Kong markets". In particular, it is hoped that the mutual recognition of funds between Hong Kong and the Mainland will:
- deepen the exchange and cooperation of the Mainland and Hong Kong asset management industries, broaden cross-border investment channels, and enhance the competitiveness of these funds markets;
- lay the foundation for the CSRC and the SFC to jointly develop a fund regulatory standard, promote the integration and development of the Asia asset management industry, and encourage the transformation of Asian savings into cross-border investments; and
- provide more diverse fund investment products to Mainland and Hong Kong investors, and expand the business opportunities and enhance the international competitiveness of Mainland and Hong Kong fund management firms.
In accordance with the above, the Memorandum has also established a framework for exchange of information, regular dialogue and regulatory cooperation between the SFC and the CSRC to ensure that investors will receive equal protection.
For further information, please contact:
William Hallatt, Herbert Smith Freehills
Jessica Erickson, Herbert Smith Freehills