Guide to Marketing Funds in Hong Kong

SUMMARY OF CONTENTS

Hong Kong maintains a system which allows both domestic and overseas collective investment schemes to be authorised for public sale. The majority of funds authorised (over 94% of the 1,942 funds authorised at the end of March 2005) are overseas funds (established outside Hong Kong). Domestic and overseas open-ended funds which are to be sold to the public are treated in the same way.

INTRODUCTION

The public offer in Hong Kong of interests in a unit trust or mutual fund is governed by the Code on Unit Trusts and Mutual Funds (the “Code”). The current version of the Code came into effect in April 2003. The Code is issued by the Securities & Futures Commission of Hong Kong (“SFC”), Hong Kong’s securities regulatory authority. The Code sets out the detailed conditions for the authorisation of open-ended unit trusts, mutual funds and other similar open-ended collective investment schemes. It contains specific authorisation criteria applicable to leveraged funds, futures and options funds, guaranteed funds, index funds and hedge funds in addition to those for the more traditional equity, bond, money market and warrant funds and funds of funds. The SFC has established a committee known as the Committee on Unit Trusts to consider applications for authorisation and other matters relating to authorised funds.

There are separate requirements for “approved pooled investment funds”, collective investment schemes that can be used as investment vehicles for retirement schemes established under Hong Kong’s mandatory provident fund schemes system. This brochure will focus primarily on the authorisation and marketing of funds authorised under the Code, but will also highlight some of the additional requirements for “approved pooled investment funds”.

Authorised funds enjoy certain advantages over unauthorised funds: primarily authorisation permits advertising and sale to the public in Hong Kong. Unauthorised funds can only be marketed on a private placement basis or to professional investors.

The main statutes governing the offering of securities for public sale are the Securities and Futures Ordinance (“SFO”) and the Companies Ordinance (“CO”), which is relevant where the securities being offered are issued by a corporation (i.e. a mutual fund).

The SFO is an amending and consolidating statute which replaces a large number of statutes. It covers offers of securities and the licensing framework for intermediaries and investment products. The Code, other SFC publications and other information (such as a current list of all SFC-authorised funds) can be viewed on the SFC’s website, www.sfc.hk.

The Code traditionally applied to open-ended mutual funds and unit trusts. The SFO replaced these terms with a new and wide-ranging definition of collective investment scheme. However it does not appear that the scope of the Code will be expanded beyond open-ended unit trusts and mutual funds at present.

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ADVANTAGES OF AUTHORISATION

The major advantages resulting from SFC authorisation are:

• advertising and marketing to the public is permitted (note the Code contains guidelines on advertising);

• exemption is given from Hong Kong profits tax;

• a streamlined listing procedure for listing on the Stock Exchange of Hong Kong;

• certain other investment vehicles may invest in authorised funds with less restriction.

Authorisation is a necessity if the promoters wish to offer the units or shares to the public in Hong Kong. The Code contains guidelines on advertising.

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AUTHORISATION PROCEDURE

Review by Hong Kong legal advisers
Prior to filing an application for authorisation, the fund’s sponsor, with the assistance of its Hong Kong legal advisers, must undertake a review to check compliance with the Code. The application documents are expected to be annotated for Code compliance and to include proposals on how to deal with matters where the fund does not comply with the Code’s provisions or submissions justifying why a waiver of any particular Code provision should be granted.

Filing of application
An application form is submitted to the SFC together with the fund’s offering document and the appropriate application fee. Other documents that must be filed include, but are not limited to: the constitutive documents of the fund such as the trust deed/memorandum and articles of incorporation, management, custodian, investment management and Hong Kong representative agreements. Documents may be in draft form and should be annotated to show compliance with the Code. For managers, advisers or trustees/custodians who are not already acting in such capacity for a fund authorised in Hong Kong, additional documents are required to evidence the suitability of the fund’s operators.

SFC response
On receipt of an application, a case officer of the Investment Products Department of the SFC will review the papers filed to ensure compliance with the Code and comment on them. Issues raised will be addressed by the fund manager with the help of its legal advisers. When the case officer is satisfied, they will prepare the papers for review by a senior manager. Depending on the nature of the application, it will then be referred either to an executive director of the SFC or to the Committee on Unit Trusts. Any application from a management group that has not previously had funds authorised in Hong Kong or in respect of a product with some special feature or requiring a material waiver of a Code provision will be referred to the Committee on Unit Trusts. If the application is in respect of a straightforward fund managed by the managers of an existing authorised fund, it may be authorised by an executive director of the SFC without reference to the Committee on Unit Trusts.

Timetable
Authorisation is usually obtained within six to eight weeks if the manager is already approved, the fund is straightforward and the application is in good order. Authorisation can be granted subject to conditions and is always subject to the condition that the authorisation fee and first annual fee are paid to the SFC.

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QUALIFICATION OF MANAGERS

The Code sets out requirements for managers of funds which are authorised for sale to the public. A manager (and any person to whom investment discretion is delegated) must be regulated in a recognised jurisdiction. The SFC have indicated which jurisdictions they regard as imposing an acceptable level of regulation on overseas investment managers — these currently are Luxembourg, Australia, the UK, the US, Ireland and France (as well as Hong Kong). The list is not intended to be exhaustive and other jurisdictions may be added from time to time.
In addition, a manager must:

• have sufficient financial resources to enable it to conduct a business effectively and meet its liabilities; in particular, it must have a minimum issued and paid-up capital and capital reserves of HK$1 million (US$130,000) or its equivalent in foreign currency;

• be primarily engaged in the business of fund management;

• not lend to a material extent;

• maintain at all times a positive net asset position;

• have directors and key staff of good repute and (in the opinion of the SFC) with suitable experience.

It is important to note that if the fund manager appoints an investment manager/adviser or sub-adviser, the SFC will require evidence that the investment adviser is qualified to perform its functions.

The manager and any company to which it delegates the discretionary investment management function must be based in a suitably regulated jurisdiction.

A pro-forma fund manager group profile is set out in the Code and has to be completed by a new fund manager (or adviser with investment discretion) seeking approval from the SFC as manager of a fund to be authorised. Details of in-house procedures of the manager on compliance matters such as personal account dealing rules and transactions with connected parties are required to be completed in the profile, in addition to setting out background information on the experience of the company and its key personnel. 

Provision is made for the authorisation of self-managed funds, for example a Luxembourg SICAV managed by its board of directors.

A management company doing business in Hong Kong should normally be registered under the SFO for Type 9 (asset management) and Type 4 (advising on securities) regulated activities and if it undertakes a distribution function in Hong Kong, Type 1 (dealing in securities) regulated activity. 

A management company incorporated in Hong Kong that manages funds is also required to comply with the SFC’s Fund Manager Code of Conduct. The Fund Manager Code of Conduct sets out the SFC’s requirements for a management company’s conduct of its business, including in relation to the management company’s organisation and management structure, dealing procedures and treatment of clients.

Hong Kong representative
An overseas manager of a fund established outside Hong Kong can choose either to establish an office in, and be licensed in, Hong Kong or to appoint a Hong Kong representative. The Hong Kong representative acts as a contact point for Hong Kong investors in the fund. The representative must be approved by the SFC and meet the requirements of the Code. It has to be authorised to undertake certain minimum functions with regard to dealing in units or shares of the fund and so must be licensed or registered to conduct securities dealing activities (although delegation of the dealing function is permitted in limited circumstances). In practice, overseas funds usually appoint a Hong Kong representative. The representative may be an associate of the manager or adviser of the fund or a custodian/trust company.

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QUALIFICATION OF TRUSTEE/CUSTODIAN OF AUTHORISED FUNDS

The trustee or custodian of a fund must be acceptable to the SFC. The trustee or custodian must be independently audited and have an issued paid-up capital and non-distributable capital reserves of HK$10 million or its equivalent in foreign currency. However, if it is a wholly-owned subsidiary of a substantial financial institution its issued paid-up capital and non-distributable capital reserves can be less than HK$10 million if an acceptable letter of comfort in the prescribed form from its holding company is submitted.

A trustee or custodian must be:

• a bank licensed under Section 16 of the Banking Ordinance of Hong Kong; or

• a trust company which is a subsidiary of such a bank; or

• a trust company registered under Part VIII of the Trustee Ordinance of Hong Kong; or

• a banking corporation or trust company incorporated outside Hong Kong which is acceptable to the SFC.

Subject to specified exceptions, the trustee must be independent of the manager.

The Code also states that an acceptable trustee/custodian should either:

• on an ongoing basis be subject to regulatory supervision; or

• appoint an independent auditor to periodically review its internal controls and systems on terms of reference agreed with the SFC and should file such report with the SFC.

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CONSTITUTIVE DOCUMENTS

The Code includes requirements relating to the contents of the constitutive documents of a fund. In the case of a unit trust, the relevant document will be the trust deed. For a mutual fund, the constitutive documents will include (as a minimum) the memorandum and articles of association, the custodian agreement and the management agreement.

The Code sets minimum investment and borrowing restrictions for the fund, as well as provisions concerning the valuation of the fund’s assets, the calculation of the issue and redemption prices, the circumstances in which dealings can be suspended, the charges and fees payable from the fund and the preparation of accounts. All of these matters need to be reflected in the constitutive documents. In theory, the requirement to reflect the Code’s terms in the constitutive documents may be waived for “recognised jurisdiction” funds, but in practice the SFC frequently requires that these be addressed. If it is not practical for an existing “recognised jurisdiction” fund to amend its constitutive documents to reflect Code requirements, the SFC may in certain cases accept an undertaking of compliance from the manager or other relevant party instead.

Once a fund is authorised in Hong Kong, the constitutive documents can be altered by the management company and trustee/custodian only upon certain conditions (specified in the Code) being fulfilled and with SFC approval of the documentation. Proposed changes to the constitutive documents should be submitted to the SFC in draft, for approval.

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OFFERING DOCUMENT

Language
The Code requires the fund’s offering document to be issued in Hong Kong in both the English and Chinese languages. It is possible to apply for a waiver from this requirement, so that the fund’s offering document need only be in English or in Chinese, but only on the basis that the proposed distribution methods will be such that the fund will only be offered to persons fully conversant in the language in which the offering document is published. If a fund seeks a waiver from the requirement to issue a Chinese offering document, that implies the offering will not be a full retail offering.

Form
In the case of funds established outside Hong Kong, the offering document or other marketing materials already printed for use elsewhere can usually be used in Hong Kong provided they are supplemented with a document (a Hong Kong covering document or wrapper) containing the further information required in Hong Kong.

The offering document must contain all information necessary for investors to be able to make an informed judgement of the investment proposal. The Code contains details of the particular information required to be disclosed in the offering document. A summary or short form offering document can be used.

The offering document must always be accompanied by the fund’s most recent financial report and audited accounts (once issued) and, if more recent, its semi-annual report.

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INVESTMENT RESTRICTIONS AND OTHER REQUIREMENTS

Investment prohibitions and limitations are set out in the Code. The restrictions applicable to a particular fund will depend upon the nature of the fund. Specialised schemes are subject to special requirements. The main investment restrictions on an authorised equity fund include the following:

• holdings of securities in any one company are limited to 10% of the net asset value of the fund (“NAV”);

• a fund may not hold more than 10% of any ordinary shares issued by a single issuer;

• unquoted investments are limited to 15% of NAV;

• financial futures contracts are allowed for hedging purposes, but commodities and unhedged futures contracts are limited to 20% of NAV;

• government/public securities of the same issue are limited to 30% of NAV;

• options and warrants for hedging purposes are allowed but otherwise holdings of options and warrants are limited to 15% of NAV;

• investment in securities in which directors of the manager are personally interested is restricted;

• borrowing is limited to 25% of NAV (back to back loans do not count as borrowing);

• short selling is permitted so long as it complies with certain rules and is limited to 10% of NAV;

• holdings in other funds are restricted to 10% of NAV (but specialised funds investing wholly in one or more other funds can be authorised).

Although the Code states that applicants may apply for a waiver from compliance with any of the provisions of the Code, special circumstances would have to exist before the SFC would authorise an equity fund which did not comply with these recommended guidelines.

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RECOGNISED JURISDICTION FUNDS

The Code includes express provisions for easier authorisation of certain types of funds from certain “recognised jurisdictions”. The “recognised jurisdictions” are as follows:

France, Germany, Guernsey, Isle of Man, Jersey, Luxembourg, Ireland, the UK and the US In each case, only retail authorised funds are recognised e.g. Luxembourg Part 1 (UCITS I) Schemes.

The background is that applications for recognised jurisdiction schemes will be reviewed on the basis that the scheme’s structural and operational requirements and core investment restrictions already comply in substance with the Code. However, a detailed review is still undertaken and approval of the manager and trustee is still needed. Also, these exemptions do not extend to UCITS III schemes or specialised schemes, and do not affect Hong Kong-specific disclosure and reporting requirements and post-authorisation requirements. In practice, the perceived advantages of recognised jurisdiction schemes are limited as the SFC expects recognised jurisdiction schemes to comply with the Code and reserves the right to require such compliance as a condition of authorisation.

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SPECIALISED FUNDS

Specialised funds
A fund will be considered a specialised fund if its primary objective is not investment in equities and/or bonds or it does not otherwise meet the requirements for an equity fund.

The Code currently includes special provisions in respect of warrant funds, money market/cash management funds, leveraged funds, unit portfolio management funds (i.e. a fund investing exclusively in other funds), feeder funds, futures and options funds, index funds, guaranteed funds and hedge funds. The provisions relating to each type of scheme are different but generally include additional risk disclosure requirements. The provisions for hedge funds are quite different, as discussed below.

The SFC has also issued a separate Code on the authorisation of REITs for sale to the public in Hong Kong. 

Applications for authorisation may be made for other types of specialised schemes not covered specifically by the Code. These will be considered by the SFC on a case by case basis.

Hedge funds
In May 2002, after a process of consultation which was conducted by the SFC with industry participants, the SFC issued its long-awaited guidelines which permit hedge funds to be offered for sale to the public in Hong Kong. This is a significant development from the previous position where hedge funds have generally only been able to be sold in Hong Kong in a manner which does not constitute an offer to the public.

The first hedge funds were authorised in late November 2002: one fund of hedge funds and two single strategy hedge funds. As at September 2005, there were 13 authorised hedge funds.

The guidelines were revised in September 2005. 

The SFC has created a regulatory environment to stimulate the growth of funds of hedge funds, which will in turn act as incubators for smaller hedge funds and niche, start up managers. Fund of funds managers will act as ”gate keepers” for the industry. This has been achieved by imposing relatively high entry requirements for managers (e.g. managers of authorised hedge funds must be regulated in a jurisdiction with an acceptable inspection regime, have US$100,000,000 in hedge fund assets under management and key personnel with at least five years’ general experience in hedge fund strategies as well as two years’ experience in the particular strategies being utilised by the hedge fund). The SFC has also maintained a market segmentation approach with differing minimum levels of subscription for different hedge fund categories:

• Hedge funds offered with a 100% capital guarantee will not be subject to any
  minimum subscription.

• For funds of hedge funds, the minimum subscription will be US$10,000.

• For single strategy hedge funds, the minimum subscription will be US$50,000. In the 2005 review, it was proposed to reduce this to US$30,000, but the proposal was rejected.

At the same time, the SFC has placed very few limits on fund of funds managers’ investment discretion. Accordingly, single strategy, single manager funds should benefit indirectly from the flow of retail money into funds of hedge funds, as they will qualify for investment by authorised funds of hedge funds notwithstanding that they themselves may not qualify to raise money directly from the retail public.

Some of the key requirements to note in obtaining authorisation of a hedge fund are: 

a. Manager
Acceptable inspection regime — A key issue in obtaining authorisation of a fund is the suitability of the manager of the fund. A manager must be regulated in a jurisdiction with an inspection regime acceptable to the SFC (see above).

Experience of key personnel — There must be at least two key personnel with at least five years’ relevant experience and two years’ experience as a fund of hedge fund’s manager.

The SFC applies these criteria strictly and detailed resumés of the key personnel demonstrating compliance with these requirements is essential.

In addition, in a fund of hedge funds structure, the guidelines require that the key personnel of the underlying funds must possess at least two years’ experience in the relevant hedge fund investment strategy (provided that up to 10% of the net assets of the fund of hedge funds may comprise underlying funds managed by investment personnel with less experience). It is the responsibility of the fund of hedge funds manager to ensure compliance with this requirement.

b. Ring-fencing of fund’s assets
In an umbrella structure, legally enforceable ring-fencing must be in place to protect the assets of the various portfolios from cross liabilities. 

c. Diversification requirement
The SFC requires that a fund of hedge funds invest in at least five underlying funds and not more than 30% of its total net asset value may be invested in a single underlying fund. A fund of hedge funds is also prohibited from investing in another fund of hedge funds. A fund of hedge funds may not invest in managed accounts. The manager’s diversification strategy must be disclosed in the offering document.

d. Investment & borrowing restrictions
There must be a set of clearly defined investment and borrowing parameters disclosed. While the SFC has not imposed any investment or borrowing restrictions for single strategy funds, the manager will be required to make appropriate disclosures on the type of investments and strategies it will undertake, the expected degree of diversification or concentration of investments, the expected and maximum level of leverage and the risk factors involved in the strategy employed. The underlying funds of a fund of hedge funds and the managers of such funds do not themselves need to be authorised.

e. Reporting requirements
An authorised hedge fund will be required to issue annual, semi-annual and quarterly reports to investors. The SFC has issued its Guidelines on Hedge Funds Reporting Requirements that set out the required contents of these reports.

f. Prime broker
Where a hedge fund uses a prime broker, the guidelines set out various requirements that the prime broker must adhere to. One issue for most prime brokers has been the limit on the value of the assets which may be charged to the prime broker to secure the fund’s indebtedness. This issue was discussed in the 2005 review of the guidelines, but no change was made.

g. Independent trustee / custodian
The hedge fund must have an independent trustee or custodian.

h. Monitoring of distribution agents
The SFC, being mindful that distribution agents who have direct contact with the investing public play a big role in investor education and protection, requires the manager to take all reasonable care in the selection of its distribution agent(s) engaged in the selling of hedge funds and to provide all necessary information and training to these agents for the purpose of selling the hedge fund.

i. Performance fees
These must be paid no more frequently than annually and calculated on a high-on-high basis. Note however, that the underlying funds of a fund of hedge funds do not have to comply with this requirement.

j. Other requirements
Other issues which need to be looked into are as follows — there must be monthly dealings; the maximum interval between lodgement of a redemption request and payment of redemption monies to investors must not exceed 90 days; quarterly narrative reports must be issued to investors within a month of the period covered. In addition, the Code contains requirements as to the contents of a hedge fund’s constitutive documents, e.g.: meeting provisions, transactions with connected persons and so on.

Guaranteed funds
Guaranteed funds have been promoted extremely successfully over the last few years in Hong Kong with significant amounts of new money being raised from investors who had not previously invested in funds.

Most of the guaranteed funds launched have a four or five year fixed term with no further issues of shares or units after the initial offer closes and all shares redeemed at maturity being guaranteed a return of capital invested. In some cases a minimum return above the issue price and/or a dividend payment is also guaranteed. The guarantee does not apply to units or shares redeemed prior to maturity.

The key requirements in the Code relating to guaranteed funds put a great deal of emphasis on the guarantor. The guarantor must be a licensed banking institution or an authorised insurer in Hong Kong. It is possible, but in practice very difficult, to have another substantial financial institution approved by the SFC to act as a guarantor. Applications can be made on a case by case basis seeking to emphasise that the entity is subject to regulatory supervision and of acceptable financial standing. The SFC would expect a level of regulatory supervision (including capital adequacy requirements) to be similar to those imposed on a bank in Hong Kong.

There are certain contents requirements for the offering document of a guaranteed fund. Minimum information on the guarantor including details of its financial position must be disclosed. The deed of guarantee must form part of the offering document and there must also be an illustration to demonstrate how the guarantee mechanism will operate.

As the return at maturity is guaranteed, the usual investment restrictions to achieve diversification have been waived for guaranteed funds. A waiver request must be submitted to the SFC to disapply the requirement that not more than 10% of a fund’s assets are invested in securities of a single issuer. In practice, many guaranteed funds have invested entirely in notes issued by the guarantor or one of its affiliates.

As the manager wishes to know how much the fund can invest after its launch the practice has been for the fees which would normally be paid over the life of the fund to be deducted and paid upfront. The SFC has permitted this if it is clearly disclosed so that investors who redeem prior to maturity realise that they have paid fees for the entire life of the fund.

Although the SFC places reliance on the guarantee being in place, disclosure of the underlying assets of the fund and, in particular, what percentage of the assets will be invested in fixed interest or debt securities, is also required. As many of the guaranteed funds authorised in the last few years have invested in options or notes, the SFC also requires disclosure of the issuers/counterparties of underlying investments and the valuation methodology to be used for these investments. It must be clear that the underlying investments are liquid, for example, to confirm that notes held can be realised to meet redemption requests received by the fund during the investment term. There are prescribed risk warnings which must be included in the offering document for a guaranteed fund to emphasise that returns are subject to the credit risk of the guarantor and the issuer of the underlying investments and that the scope of the guarantee may be subject to certain conditions. In most of the guaranteed funds the guarantee applies only to any shortfall between the guaranteed value of a unit or share at the maturity date and the actual redemption price payable at that date. Most guarantees provide that should the issuer of the note or debt securities held by the fund repay these in full at maturity in accordance with their terms, there is no further liability for the guarantor. The guarantor does not bear the risk of misappropriation of the fund’s assets.

The guarantee does not have to be governed by Hong Kong law but it must not exclude the jurisdiction of the Hong Kong courts to undertake any action concerning the fund or the guarantee.

The SFC will review the proposed name of a guaranteed fund carefully to ensure that it does not give an inappropriate indication of the return likely to be achieved by investing in the guaranteed fund.

Marketing materials for a guaranteed fund must include the name of the guarantor, statements regarding fees if these are charged upfront and the aggregate amount of these fees and a statement directing investors to read the offering document in full for further details of the guarantee.

Index funds
The Code contains specific disclosure requirements for authorised index funds. These are funds (including feeder funds) which track a stock index by investing all or substantially all of the fund assets in the constituent stocks of the underlying index or in a representative sample of constituent stocks. The Code permits “sampling” if this is necessary to reduce tracking errors and the portfolio has the characteristics of the index.

The SFC will consider whether the underlying index is acceptable when reviewing an application for authorisation of an index fund. An index must:

• have a clearly defined objective and reflect the characteristics of the sector or market which it seeks to represent.

• be broadly based. Generally an index with a single constituent stock having a weighting of more than 40%, or whose top five securities represent more than 75%, would be considered too concentrated.

• be investible. The constituent securities should be liquid and not subject to any restrictions.

• be transparent and accessible to investors e.g. through relevant websites or in the press.

• be produced by a suitable provider. The index provider should have sufficient expertise and technical resources to operate the index.

The normal investment restriction limiting holdings by an authorised fund in securities of a single issuer to no more than 10% of the fund’s net asset value is not applied for an index fund. A fund’s holding of a constituent stock which represents more than 10% of the weighting of the index can match the index weighting for such stock.

Specific disclosure requirements apply to the offering document of an index fund. Information on the characteristics and composition of the index must be disclosed, including the weightings of the top 10 largest constituent stocks and a description of the index methodology. Risk warnings must be included to disclose that the index composition may change, that there will be no active management so that falls in the index will result in corresponding falls in the value of the fund, and a description of the circumstances which may lead to tracking errors, and how these will be minimised. Any licensing conditions relating to the use of the index must be disclosed and there should be a contingency plan in the event that the index is no longer available. It should be noted that prior approval of the SFC is required for the replacement of an index.

All index funds must list in their semi-annual and annual financial reports the constituent stocks which represent more than 10% of the weighting of the underlying index as at the end of the relevant financial period. The disclosure should also set out the respective weightings of those stocks. The background to this requirement is that the SFC considers that investors should be informed of material changes in the composition of the underlying index followed by an index fund since changes in composition may have an impact on the fund’s performance.

Real estate investment trusts
Real estate investment trusts (“REITs”) have been permitted in Hong Kong since August 2003. As at the end of 2005, there were three REITs listed in Hong Kong, with the first REIT listed in November 2005 and the second and third REITs listed in December 2005.

A REIT is an investment vehicle that invests in real property, such as office buildings, business parks, shopping malls, hotels and serviced apartments. It normally distributes all or almost all of its net income to investors on an annual or semi-annual basis. Interests in REITs are usually listed and traded on a stock exchange. Investors do not normally have the right to require the REIT to redeem investors’ interests (in contrast to open-ended mutual funds and unit trusts).

The requirements for Hong Kong REITs are set out in the SFC’s Code on Real Estate Investment Trusts (“REIT Code”). These requirements are summarised below.

a. Form of Hong Kong REITs
Hong Kong REITs must be established as a unit trust and governed by Hong Kong law. They must be listed on The Stock Exchange of Hong Kong Limited.

b. The Trustee
The trustee must be acceptable to the SFC. Chapter 4 of the REIT Code sets out the eligibility requirements for the trustee. In particular, the trustee must be either a bank licensed under the Hong Kong Banking Ordinance, a trust company that is a subsidiary of such a bank, or an overseas bank or trust company that is acceptable to the SFC. The trustee must be independent of the manager.

c. The Manager
The manager must be acceptable to the SFC. Chapter 5 of the REIT Code sets out the eligibility requirements for the manager. In particular, the manager must be either licensed under the SFO for real estate asset management or licensed with an overseas regulator acceptable to the SFC for this purpose. As at January 2006, regulators in Australia, Germany, Ireland, Luxembourg and the United Kingdom meet this requirement.

As a general policy, the SFC has indicated that a manager will only be permitted to manage one REIT. However, if in future a manager can demonstrate to the satisfaction of the SFC that it possesses sufficient expertise and risk control systems, the SFC may permit it to manage more than one REIT.

The REIT Code permits special product features and management fee structures on a case-by-case basis, subject to the following:

• the manager must demonstrate that the proposed feature is fair and objective and in accordance with prevailing market practice;

• the use of such features or fee structures must comply with the general principles of the REIT Code;

• investors’ interests must not be prejudiced as a result of the use of such features or fee structures;

• there must be adequate protections in place to prevent conflicts of interest; and 

• there must be full disclosure in the offering document of the feature or fee structure. 

In particular, the following management fee structures are referred to:

• Payment of management fees in units
  Management fees can be paid in units in the REIT, but only where an objective and transparent mechanism is devised for determining the price and number of units to be issued to the manager.

• Calculation of performance fees
  The SFC has indicated it is willing to take a more flexible approach to the calculation and payment of performance fees than applies to funds subject to the Code on Unit Trusts and Mutual Funds, so long as the manager can demonstrate the proposed approach is fair and reasonable and is used by managers of REITs in other relevant jurisdictions.

• Transaction-based management fees
  Transaction-based management fees are permitted to the extent that, in the opinion of the SFC, the payment of such fees align the interests of the manager with those of the unitholders of the REIT. There must be clear disclosure of any transaction-based management fee in the REIT’s offering documentation. The principle that ‘percentage-based fees payable to the manager or any of its connected persons may be disallowed as being inconsistent with the manager’s fiduciary duty’ remains.

d. Principal Valuer
The trustee must appoint a principal valuer for the REIT’s property. The principal valuer will be responsible for selecting and appointing overseas valuers. The principal valuer must be replaced after three years, and is not eligible for reappointment for a further three years from that date.

In order to be eligible for appointment, the principal valuer must: 

• perform property valuation services on a regular basis; 

• carry on the business of valuing real estate in Hong Kong; 

• have key personnel who are fellow or associate members of the Hong Kong Institute of Surveyors (”HKIS”) and who are qualified to perform property valuations; 

• have a minimum issued and paid-up share capital and capital reserves of HK$1 million or its equivalent