Deacons Financial Services Practice Group recently assisted an international fund manager in obtaining SFC approval for the first retail 130/30 fund to be authorised in Hong Kong.

130/30 funds and their progeny are a hybrid between traditional market neutral long only funds and hedge funds in that they typically adopt a long/short strategy which enables the fund manager to buy long and sell short with a view to outperforming the market whilst maintaining a net long position of 100% of the fund’s net asset value. These funds have commonly been structured as "130/30" funds due to the fact the 130% long and 30% short investment ratio is seen to carry the optimum compromise between risk and reward. However, variations of this strategy, ranging from 105/5 to 150/50 funds, have been launched in Europe in the past few years.

The typical strategy of a 130/30 fund is to go long up to 130% of the fund’s net asset value in high growth securities whilst being able to short simultaneously up to 30% of the fund’s net asset value in underperforming securities. This strategy enables a fund manager to benefit from the advantages of short selling which are typically denied to traditional hedge fund managers.

In Hong Kong, SFC authorisation of the first 130/30 product is another example of the SFC’s pragmatic, flexible and market responsive regulatory approach and this may serve to attract other retail funds with similar strategies to Hong Kong. However, it remains to be seen how regulators will view these other variations of long/short funds and where the boundaries will eventually be drawn.

Back to Top

Singapore Funds: Removal of the 80/20 Rule

On 31 August 2007, the Monetary Authority of Singapore (MAS) issued a circular which removed the so-called 80/20 rule. The 80/20 rule was one of the conditions for a non-resident fund to qualify for tax exemption under section 13C of the Singapore Income Tax Act.

The new scheme, set out in the MAS circular dated 1 November 2006, grants tax exemptions to funds approved by the MAS between 17 February 2006 to 16 February 2011, for specified income from any designated investments for the life of the fund. The 80/20 rule required that to be approved for exemption, a fund must undertake not to have more than 20% of its issued shares beneficially owned, directly or indirectly, by persons who are citizens of Singapore or resident in Singapore.

The recent circular introduces two new concepts:

(a) Qualifying Fund

As long as a fund is not 100% beneficially owned by Singapore investors, it will be treated as a Qualifying Fund for the purposes of the scheme. Thus, for example, if 99% of interests in the fund are owned by Singapore investors and only 1% of the fund is owned by foreign investors, it would still be a Qualifying Fund.

(b) Qualifying Investors

There are various rules concerning whether an investor may be regarded as a non- Singapore investor (a Qualifying Investor). For non-resident corporate investors to be treated as Qualifying Investors, they should not have a permanent establishment ("PE") in Singapore or if they do, the investments into the Qualifying Fund must not be made out of funds from the PE. They must carry out substantial business activities for genuine commercial reasons and not have as their sole purpose the avoidance or reduction of tax.

Singapore corporate investors and other non-resident corporates who do not fulfil the above conditions will still be regarded as Qualifying Investors if they do not breach the following limits:

(i) where there are less than 10 investors in the Qualifying Fund, such a corporate investor (together with its associates) should not beneficially own more than 30% of the total interests in the Fund; and

(ii) where there are 10 or more investors in the Qualifying Fund, the threshold goes up to 50%.

The percentage interest is determined as at the last day of the financial year of the Qualifying Fund. A grace period of one month may be granted to non-Qualifying Investors in order to meet the threshold tests if such investors can prove that the limits are exceeded due to reasons beyond their reasonable control.

An investor who is not a Qualifying Investor in a Qualifying Fund will have to pay a "financial amount" to the tax authorities. This is essentially an amount based on the corporate tax rate applied on the percentage of profits of the Qualifying Fund for the financial year corresponding to such investor's percentage interest in the Qualifying Fund. Such an investor may be taxed again on its remittance into Singapore of distributions from the Qualifying Fund.

Thus, the new scheme shifts the fiscal burden, if any, from the fund to the investors who are not Qualifying Investors.

The new scheme also imposes new reporting requirements on the Singapore fund manager. The fund manager will have to issue an annual statement to each investor, reporting various details relevant to the above tests. If the Qualifying Fund has any non-Qualifying Investors, the fund manager needs to submit a declaration form to the tax authorities. Certain details of such investors are required to be included in the form. In addition, the Singapore fund manager would not be able to enjoy the 10% concessionary tax rate under the Financial Sector Incentive for Fund Managers incentive scheme if there are non-Qualifying Investors.

The new scheme became effective from 1 September 2007. New funds set up on or after that date will come under the new scheme. For existing funds, they may choose to come under the new rules with effect from the same date, or from their next financial year.

Back to Top

SFC FAQs: Records and Documents

On 1 August 2007, the SFC updated the Licensing Related Frequently Asked Questions (FAQs) on its website under the heading, "Other Topics relating to the Securities and Futures Ordinance (SFO)".

The updated FAQs assist licensed corporations or licensed applicants in understanding the SFC’s view relating to premises for keeping records or documents. The SFC has clarified that it will only approve premises located in Hong Kong to be used by licensed corporations for keeping records or documents. If certain records or documents of the licensed corporations are kept in overseas premises (eg. by an overseas services provider) the SFC requires identical records or documents to be kept in the premises in Hong Kong approved by the SFC in an appropriate form (including electronic). This is because the SFC may enter the licensed corporation's Hong Kong premises to inspect records or documents of the licensed corporation, which will enable an audit to be conveniently and properly carried out according to the Securities and Futures (Keeping of Records) Rules.

Back to Top

Deacons Compliance Services

Deacons Compliance Services provides practical compliance solutions to Financial Services Practice Group (FSPG) Clients. We work with newcomers to Hong Kong to set up hedge funds, private equity, real estate or traditional asset management businesses and also with long established financial institutions that are looking for additional support from experienced compliance and regulatory professionals.

During the past year, in addition to assisting corporations and individuals in obtaining their SFC licences, we have also worked with traditional and alternative asset managers to complete special projects, including reviewing and updating compliance manuals, developing compliance policies, operations manuals and trading procedures and much more.

Deacons Compliance Services clients who have committed to a monthly retainer arrangement also enjoy the benefit of our regulatory reporting and reminder service, in addition to access to our Compliance Services helpline. Other areas where we have been active are: helping our clients to find practical solutions to day to day compliance questions and issues that have arisen in the course of business conduct; conducting regulatory due diligence exercises, to assist the client in understanding and complying with their Hong Kong regulatory obligations; and working with hedge funds and traditional asset managers to conduct operational risk assessments and develop strategies to manage and mitigate those risks.

We have conducted "mock inspections" for both hedge fund managers and traditional asset management businesses. The scope of a mock inspection can be tailored to your needs, size and business activities, and will stand you in good stead when your regulator pays you a visit.

Our growing and experienced team of compliance and regulatory professionals are ready to assist you to: sort out the regulatory obligations you need to comply with in Hong Kong; complete that important project that keeps getting put to the bottom of the pile because of resource constraints; answer your compliance questions; and, help you assess the operational risks your asset management business is facing and assist you to develop and implement controls to manage and mitigate those risks.

Back to Top

Deacons Financial Services Seminar Series

Financial Services Practice Group will offer two seminars in October. Please note that email confirmation will be sent three days prior to the seminar.

Back to Top

Whilst every effort has been made to ensure the accuracy of this publication, it is for general guidance only and should not be treated as a substitute for specific advice.