Hong Kong introduced the open-ended fund company (OFC) regime in 2018 to provide an option for collective investment funds to be established in corporate form. For many Hong Kong-based fund managers, the default hedge fund structure has historically been an offshore limited liability company: the OFC regime offers an alternative domestic legal structure. The advantages for a Hong Kong manager in setting up an OFC over an offshore fund mostly centre on the simplicity and savings in management time and money in dealing with a single jurisdiction and a single regulator. However, interest in launching OFCs was at the outset lukewarm, largely due to drawbacks, such as investment restrictions, affecting private funds and their managers.

In September 2020, the Hong Kong Securities and Futures Commission (SFC) introduced welcome enhancements to increase the competitiveness of the private OFC. Shortly after, the government promised financial incentives to promote the regime, and issued a much anticipated proposal to allow offshore funds to migrate to Hong Kong.

Key features of the private OFC

Structure

An OFC is a Hong Kong-incorporated company with separate legal entity status. Designed as a fund vehicle, it has greater flexibility than conventional companies incorporated under Hong Kong’s Companies Ordinance. OFCs can be set up either as standalone funds or as umbrella funds with segregated liability between its subfunds. Investors hold shares that are transferable and redeemable. The OFC will have shareholderinvestors, a board of directors responsible for its governance, a fund manager and a custodian of assets. The fund manager has to be licensed or registered with the SFC for type 9 (asset management) regulated activities.

Regulator

The SFC is the primary body responsible for the registration and regulation of OFCs. The Companies Registry (CR) is responsible for the incorporation and administration of the OFC’s statutory corporate filings.

Establishment

OFCs benefit from a simple, one-stop process for registration, incorporation and business registration which requires direct dealings only with the SFC. The SFC will then notify the CR of the registration of an OFC and the CR will issue a certificate of incorporation. Business registration with the Inland Revenue Department is conducted in the same manner.

Taxation

Upon the introduction of the regime, a major drawback related to the limited and complex exemption from taxation for private OFCs. This was addressed in 2019 when Hong Kong enacted legislation which extended a tax exemption for offshore funds to those domiciled in Hong Kong, subject to certain conditions, and removed any advantage enjoyed previously by overseas domiciled funds to qualify for relief from Hong Kong profits tax.

Enhancements to the OFC regime

On 11 September 2020, following a market consultation, the SFC published its Consultation Conclusions on Proposed Enhancements to the OFC Regime which introduced a number of reforms to better meet the needs of the industry.

Removal of investment restrictions

One change was to remove the requirement for a private OFC to invest at least 90% of its gross asset value in securities and futures contracts as defined under the Securities and Futures Ordinance. Private OFCs now face no restrictions on the types of investments they can make or on the size of their position in any given investment, subject only to any investment restrictions in their offering document.

Expansion of entities eligible to act as custodians

Until the enhancements took effect, the custodian of an OFC had to be a Hong Kong or overseas bank, or a trustee of a registered scheme under Hong Kong’s Mandatory Provident Fund Schemes Ordinance. The SFC has expanded the category of eligible entities, to include entities licensed or registered with the SFC for type 1 regulated activity (dealing in securities). This allows for an OFC to appoint its broker (provided it is appropriately licensed) as its custodian. The SFC also confirmed that an OFC may appoint multiple custodians; a hedge fund structured as a private OFC may appoint both a cash custodian and one or more prime brokers as the top-level
custodians.

Re-domiciliation of offshore funds to Hong Kong

For many Hong Kong based fund managers, an obvious missing piece to the regime was the lack of a practical re-domiciliation mechanism to migrate their existing offshore funds to Hong Kong. Responding to this feedback the SFC confirmed that it will introduce such an infrastructure, and a proposal was put forward by
the Financial Services and the Treasury Bureau of the Hong Kong government on 1 February 2021. Given the increasing regulatory complexities and costs for corporate funds established in overseas jurisdictions in recent years, the opportunity to transfer to Hong Kong is a welcome development. Under the proposal, existing funds can redomicile and register an OFC in Hong Kong provided they meet the same eligibility requirements for a new fund to be registered as an OFC. The existing fund’s identity will be preserved upon re-domiciliation, which translates into numerous benefits:

• Any contract made or resolution passed prior to re-domiciliation 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 arise.

The proposal is expected to be introduced to Hong Kong’s Legislative Council in the second quarter of 2021. We expect re-domiciliation to appeal to offshore hedge funds that are managed from Hong Kong.

Government subsidy scheme

In May 2021, the SFC announced the commencement of a grant scheme to assist with OFC set-up costs. The government has allocated HK$270 million to the scheme, which covers 70% of the expenses paid to Hong Kong based-service providers for the establishment or re-domiciliation of OFCs in Hong Kong, subject to a cap of HK$1 million per OFC. It is available on a first-come-first-served basis and is limited to a maximum of three OFCs per fund manager. The government has the right to claw back the grant if the OFC commences winding-up or terminates the registration within two years of its incorporation or re-domiciliation.

Conclusion

Hong Kong continues to support the growth of its fund management sector. The synergies of the recent reforms provide greater flexibility and more certainty to fund managers seeking to ‘onshore’ their funds in Hong Kong. Following the government’s announcement of financial subsidies, we’ve seen a noticeable uptick in interest and anticipate that the use of, and opportunities arising from the OFC will continue to increase once investors become more familiar with the regime.

The information contained herein is for general guidance only, reflecting the position as at 16 June 2021, and should not be relied upon as, or treated as a substitute for, specific advice. Deacons accepts no responsibility for any loss which may arise from reliance on any of the information contained in these materials. No representation or warranty, express or implied, is given as to the accuracy, validity, timeliness or completeness of any such information.