On 7 November 2002 Beijing announced the Qualified Foreign Institutional Investors (QFII) rules which will allow access to the PRC A-share market, exchange traded government bonds, convertible bonds and corporate bonds to the following qualifying institutions:

In addition, all these institutions must have over US$10 billion under management.

Foreign investors will be required to deposit their funds into special yuan accounts at approved custodian banks. Foreign banks (with paid up capital of US$1 billion) whose branches have continuously operated in China for over three years may apply to become custodian banks. To attract medium to long term investments, priority consideration will be given to close-ended China funds or institutions whose pension funds, insurance funds or mutual funds have shown good investment records in other markets.

With the rules for the establishment of Fund Management Companies with Foreign Investment having come into effect on 1 July 2002, the longawaited establishment of the first Sino-foreign joint venture fund management companies is close to becoming a reality. The China Securities Regulatory Commission (CSRC) has approved the preparation of the establishment of a number of joint ventures and it is expected that further approvals will be announced shortly.

There is a two stage approval process with an initial 'preparatory' approval being given, the second stage involving an application to commence business once the preparation has been completed. The new fund management companies will then have to apply for approval of their first funds before these can be launched.

The initial joint ventures receiving first stage approval have been formed through the establishment of a new fund manager rather than by way of the acquisition of a stake in an existing PRC fund management company. Negotiations with the multiple shareholders in existing PRC fund management companies, together with completion of comprehensive due diligence, appear to be taking longer than negotiations to form a new entity with only one (or a few selected) PRC partner(s). Foreign investors may also find it easier to obtain an acceptable level of management control when negotiating the establishment of a new entity.

The Monetary Authority of Singapore (MAS) has announced that it will issue new guidelines for retail hedge funds by the end of this year. The new guidelines will be of interest to fund managers wishing to roll out retail hedge funds in Singapore. They will not apply to products offered to institutional and sophisticated investors as restricted schemes.

Under the proposed new guidelines, the previous required minimum subscription level (S$100,000) will be reduced to zero for capital-guaranteed hedge funds and S$20,000 for 'funds of hedge funds'. The minimum subscription level for other hedge funds will remain at S$100,000 per investor. The reforms mean that hedge funds will no longer be the domain of the wealthy.

The changes come as a result of discussions between the MAS and the industry and recognise the varying degrees of risk associated with different hedge fund products. They are also part of a broader push by the Singapore Government to foster the development of hedge funds and the financial services industry in general in Singapore.

To support the implementation of the Securities and Futures Act and the Financial Advisers Act (the remaining provisions of which came into operation on 1 October 2002), the MAS has released a package of notices and guidelines which will be phased in over the next year. The notices and guidelines detail new requirements under the new legislation and include administrative procedures and criteria for the grant of licences, 'know your client' and record keeping standards, requirements on information to clients and product information disclosure and guidelines on standards of conduct for financial advisers.

The package also includes a notice which implements cooling-off periods for individual investors in unit trusts. Listed unit trusts are exempt from the new requirements. The move comes as a result of increased concern over pressure selling and mis-selling.

Australia is about to introduce new tax exemptions for venture capital investments designed to benefit and attract overseas private equity funds, financial investors and pension funds. The concessions will make investment in Australia more attractive to overseas markets and will apply to Australian venture capital limited partnerships, broadly along the lines of established limited partnership structures, Australian venture capital funds of funds and tax exempt residents of certain jurisdictions. The exemptions include tax flow-through of profits and losses of investment vehicles, to the underlying investors. It appears that the Australian Government has also accepted in principle that the 'carry' on a fund manager's portion of an investment should be taxed under capital gains tax rules rather than treated as income. As the capital gains tax rate for investments held for more than 12 months is half the top marginal income tax rate, this would be a big boost for the industry.

The Securities and Futures Commission's (SFC) Consultation Paper on Guidelines on Hedge Funds Reporting Requirements drew a large number of submissions from fund managers, law firms (including Deacons) and industry groups. SFC authorised hedge funds will be required to comply with these Guidelines once they are finalised. The Guidelines are in addition to the disclosure requirements for traditional funds set out in Appendix E of the Code on Unit Trusts and Mutual Funds. With the first hedge funds expected to be authorised before the end of this year, the SFC should present its conclusions and the final Guidelines shortly. The key features of the proposed Guidelines and industry concerns and suggestions in relation to these features were:

• Adoption of international accounting standards (IAS) for all hedge funds' financial reports: In order to promote consistency and enable meaningful comparison of hedge funds, the Guidelines propose that annual and semiannual financial reports be prepared using IAS. In the majority of the submissions to the Consultation Paper, concern was expressed that existing hedge funds which originate from the United States and which apply US GAAP would be discouraged from seeking authorisation in Hong Kong due to the additional costs associated with producing two sets of reports. It was suggested that the SFC should consider permitting exemptions to IAS, particularly for US GAAP as it is widely recognised as an acceptable accounting standard.

• Quarterly reports to be issued in both English and Chinese one month after the relevant quarter-end: Many believed that it would be difficult for both single strategy hedge funds and funds of hedge funds to meet the time frame for quarterly reports. In addition there was concern that in general it would be too burdensome for managers to prepare reports in Chinese within the proposed one month time frame. It was suggested that the reporting deadline for quarterly reports be extended to 45-60 days after the relevant quarter-end and it was also suggested that the SFC require quarterly reports to be produced only in English.

• Detailed portfolio review including performance and risk measures:
  
  - Disclosure of the top 10 holdings of a fund: There were objections to this requirement in a number of submissions on the grounds that such disclosure would be irrelevant and possibly misleading to investors since the information may be outdated by the time investors receive it. Alternative risk and return statistics were suggested in the submissions.
  
  - Disclosure of the Sharpe ratio as a performance statistic: In several submissions it was noted that the Sharpe ratio may be misleading to investors because it does not measure the downside risk of a fund. It was suggested that managers should be required to provide a footnote explaining its limitations or provide additional indicators of risk adjusted returns.

The Securities and Futures Commission (SFC) has gazetted rules (Rules) which introduce new exemptions for sections 80 and 80B of the Securities Ordinance (these exemptions are identical to those made under the Securities and Futures Ordinance, which has not yet come into force). The Rules will become effective on 15 November 2002. Section 80 prohibits uncovered short selling. The Rules extend the current exemptions from section 80 to all categories of market makers registered with the Stock Exchange and the Futures Exchange in the performance of market making obligations and hedging of market making positions. Section 80B sets out reporting and record keeping requirements for covered short selling transactions and the Rules introduce alternative means for sellers placing short selling orders pursuant to a stock borrowing and lending agreement to comply with section 80B. The SFC has advised that it will issue a revised Guidance Note on Short Selling Reporting and Stock Lending Record Keeping Requirements later this year.

Financial institutions in Hong Kong should be reviewing their money laundering procedures in light of the enactment of the United Nations (Anti-Terrorism Measures) Ordinance. Certain provisions of this Ordinance came into effect in August this year. The Ordinance makes financing of terrorists a criminal offence and requires the reporting of knowledge or suspicion of terrorist financing to the relevant authorities. The Financial Action Task Force also issued specific guidance in detection of terrorist financing by financial institutions in April this year. Regulatory authorities in Hong Kong circulate lists of terrorist suspects and non co-operative countries and territories to financial institutions.

In this issue we highlight the draft Financial Resources Rules (draft FRRs) under the new regime and also discuss practical considerations arising from the Securities and Futures Ordinance's (SFO) single licensing regime.

Financial Resources Rules: Essentially the draft FRRs were prepared to follow the Financial Resources Rules under the present securities regime, subject to some amendments including:

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