Financial Services Quarterly Report - Third Quarter 2010

Contents

Retail Fund Authorization in Hong Kong: The Moving Goal Posts Far-Reaching U.S. Financial Reform Legislation Impacts Financial Service Companies Both Within and Outside of the United States CESR's Advice on Complex Financial Instruments: The Implications and Outlook for UCITS Revising the UK Remuneration Code: Considerations for Investment Managers Fund Raising for Alternative Investment Funds in Germany The Introduction of Funds Re-domiciliation Legislation in Ireland Marketing of Closed-End Investment Funds in France Russia Finally Adopts Law on Insider Trading Retail Fund Authorization in Hong Kong: The Moving Goal Posts By Angelyn Lim, Kher Sheng Lee and Jessica Shao

Introduction

On 25 June of this year, Hong Kong received a new Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products (the "Handbook")1 issued by the Hong Kong Securities and Futures Commission (the "SFC"). The Handbook is a consolidation of revisions made to the existing Code on Unit Trusts and Mutual Funds (the "Revised UT Code") and Code on Investment-Linked Assurance Schemes, and a new Code on Unlisted Structured Investment Products.

The Revised UT Code now forms the basis on which offshore funds will receive the SFC's stamp of approval in order to be distributed to the investing public of Hong Kong.

The Handbook comes after a public consultation period on proposed measures by the SFC to enhance protection for the investing public2 and strengthen the existing regulatory framework.

The Revised UT Code now forms the basis on which offshore funds will receive the SFC's stamp of approval in order to be distributed to the investing public of Hong Kong.

In the post-global financial crisis era, regulators around the world have seen fit to focus even more on enhanced measures to protect the small investor. The SFC has been no different.

This article summarises the key revisions to the general authorization requirements for investment funds, and highlights points of note for asset managers considering applying for the authorization of one or more funds in Hong Kong, for retail distribution.

Key Revisions to the General Authorization Requirements

Information to be Disclosed in the Offering Documents

Product Key Facts Statement ("Product KFS")

The Product KFS is intended to be a short (3–4 page) summary of the key features (and, in particular, the key risks) of the relevant fund, set out in plain layman language so as to be easily understood by the retail investor. The SFC has provided, on its website,3 illustrative templates of the Product KFS for six different kinds of investment products (i.e., guaranteed funds, exchange-traded funds, index funds, investment-linked assurance funds, unlisted structured investment products and general funds).

The SFC is prepared to adopt a very handson focused review of the Product KFS .

The Product KFS will form part of the offering documents, although the SFC may, under exceptional circumstances, permit an exemption in relation to certain foreign funds (e.g., certain UCITS funds), on the basis of overriding legal requirements of the home jurisdiction of those foreign funds. However, immunity from, or disclaimers or limitation of, liability with respect to the Product KFS is not permitted— issuers will assume civil and/or criminal liability for any misrepresentations in the Product KFS, whether or not such Product KFS constitutes part of the offering document of the investment product.

The SFC has indicated that, in practice (possibly due to the current teething issues of introducing the Product KFS requirement), the SFC is prepared to adopt a very hands-on focused review of the Product KFS in a bid to ensure that it is, indeed, presented in language that will be easily understood by the lay investor. The Product KFS should not be regarded as simply a "cut and paste" job from the disclosures in the main Prospectus of the fund although its contents must, obviously, be consistent with those in the "main" offering document.

Although existing authorised funds, and funds whose applications for authorization had been submitted to the SFC prior to 25 June 2010, were initially given until 24 June 2011 to produce their Product KFS, the SFC changed this position on 14 September 2010 to require certain funds, currently undergoing authorization, to produce a Product KFS now as part of the application process. This requirement applies to those funds that:

have a more than 10% exposure of their net assets to investment in the domestic PRC market; or actively use derivatives as part of their investment strategy; or will be managed by an asset management group that has not previously been approved by the SFC to manage an SFC-authorized fund. Collateral Policy and Criteria

The fund's selection criteria, nature and policy with respect to any collateral it holds (as well as a description of such collateral) must be disclosed in the fund's offering documents.

Risk Management Policy

The offering document must disclose the risk management policy (where appropriate) that has been put in place to deal with abnormal risks involved in the investment of a specialised fund.

Complaints

The offering document must disclose information regarding the issuer's approach to enquiries and complaints made by investors.

Limits on Investment in Other Funds

The previous strict 10% limit on investment in other collective investment funds has been expanded so that, while it still applies to investment in non-recognized jurisdiction funds that are not SFC-authorized, investment of up to 30% (of the fund's NAV) is now permitted in underlying funds which are "recognized jurisdiction schemes"4 but not authorized by the SFC, and in excess of 30% for those underlying funds that are SFC-authorized.

An offering document is required to be produced in both the English and Chinese languages. Although the preparation of a Chinese-language annual report is optional for all SFC-authorized investment funds, issuers must disclose clearly in the offering documents whether annual reports and interim reports will be published in bilingual versions.

Multi-Manager Fund

The key qualification requirements applicable to all management companies of funds applying for authorization by the SFC are set out in Chapter 5 of the Revised UT Code.

With respect to multi-manager funds, generally, it is expected that at least three sub-managers will be delegated the investment management function in respect of a fund's assets. When considering the key personnel qualifications of such sub-managers, the SFC may take into account (on a case-by-case basis), when assessing the investment experience of the key personnel of the sub-managers, experience in areas other than in managing public funds. This should be welcomed by fund management groups generally as the SFC's previously strict adherence to the public fund management experience requirement had not always been easy to satisfy and, arguably, need not be insisted upon at the sub-manager level.

Also to be disclosed in the fund's offering document are the due diligence processes adopted by the management company in selecting and monitoring the sub-managers on an on-going basis.

Special Funds

New requirements relating to the authorization requirements for special funds like Structured Funds are set out in Section 8.8 of the Handbook, and Section 8.9 sets out the requirements for Funds that Invest in Financial Derivative Instruments (which are not UCITS).

General Points to Note

In the post-global financial crisis era, regulators around the world have seen fit to focus even more on enhanced measures to protect the small investor. The SFC has been no different. Particularly with the lessons of the Lehman Minibond5 crisis, the SFC has substantially increased its attention on...