Author: Rory Gallaher
Service Area: Financial Services
Date: September 2013
Country: Hong Kong


Financial Services Newsletter
Issue 6 of 2013: September


Supplement X of CEPA permits majority ownership of a sino-foreign fund management company by a Hong Kong qualified financial institution

by Machiuanna Chu ( and Yang Shen (

Supplement X to the Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA) took effect on 29 August 2013 to further open up the mainland financial services market to Hong Kong institutions. The CEPA is a free trade agreement between Mainland China and Hong Kong that offers Hong Kong companies preferential access to the Mainland market.

A significant development for the asset management industry under Supplement X of CEPA is the opportunity for "qualified Hong Kong-funded financial institutions" to hold majority stakes in a joint venture fund management company in the Mainland. Until now, foreign equity participation in a sino-foreign joint venture fund management company in China could not exceed 49%.

It is not entirely clear at this stage what are the specific criteria for a "Qualified Hong Kong-funded Financial Institution". Supplement X does not provide a precise definition. Based on past practice, it is expected that the relevant regulators, in this case the CSRC (China Securities Regulatory Commission), will issue specific guidelines to set out the criteria for Qualified Hong Kong-funded Financial Institutions in the next few months. In any event, the Qualified Hong Kong-funded Financial Institution is expected to fulfil the requirements of a "Hong Kong Service Provider" under CEPA.

A Hong Kong Service Provider, among other things, is required to be established in Hong Kong, having three to five years (depending on industry sector) of substantive operations in Hong Kong staffed with 50% Hong Kong residents. A Hong Kong company recently acquired by a foreign entity may not qualify unless such acquisition took place more than one year before the company applies for the Hong Kong Service Provider qualification.

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Hong Kong OTC derivatives regulation – Amending legislation introduced
by Scott Carnachan (

The Securities and Futures (Amendment) Bill 2013 was gazetted on 28 June 2013. It is currently being considered by the Legislative Council.

The Bill amends the Securities and Futures Ordinance (SFO) to create the framework for regulation of OTC derivatives in Hong Kong. The framework reflects the conclusions of the public consultation exercise, which were published in July 2012 (available here). The Bill also creates new regulated activities relating to OTC derivative transactions and sets out the transitional arrangements for persons who currently engage in OTC derivatives transactions in Hong Kong. Supplementary consultation conclusions giving guidance on the regulators' thinking about the scope of the new regulated activities and the transitional provisions contained in the Bill were published on 6 September 2013 and are available here.

In addition, the Bill:

  • amends Part XV 'Disclosure of Interests' of the SFO to require that notifications and reports under this Part are filed electronically, and
  • amends the SFO and the Organized and Serious Crimes Ordinance to enable criminal courts to make disgorgement orders for the purpose of recouping illegal gains from committing a market misconduct offence.

For summaries of the Bill provisions relating to OTC derivatives and the transitional arrangements that will apply to existing licensed asset managers, please see our September client alert, which is available here.

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SFC licensing and compliance hints
by Rebecca Yip (

New SFC forms: The SFC will roll out new licensing forms with effect from 1 October 2013 (and has helpfully given the industry almost one month to cope with the transition). Two points about the new forms are worth highlighting:

  1. the declaration sections on all of the forms now state that the SFC may take criminal action against any person who makes a false or misleading representation in connection with the application or notification (previously the forms only referred to disciplinary action);
  2. on new corporate licence applications, the SFC now requires the applicant to confirm as part of the declaration that it has been authorized in writing by its substantial shareholders to apply on their behalf for approval. We do not think it will be necessary to provide a copy of the written authorisation to the SFC but clearly it must be in place at the time the declaration is made.

If you are currently working on any applications or notifications, it would be best to have the forms finalised and submitted to the SFC by the end of September; otherwise, you should start working on the new forms instead.

"Watch your words; they become actions": This is not just a quote; but a rule to remember in dealing with the SFC. We advise clients to be careful about what is said or submitted to the SFC and to keep clear records of the same, whether in the context of a licence application or an on-going notification filing. For example, the SFC imposes licensing conditions based on the information and representations contained in an applicant's business plan. Licensed companies and individuals must act in accordance with what has been communicated to the SFC.

CPT: We are about to go into the final quarter of the CPT year, so it is timely to do a CPT hours stock-take on all licensed individuals. If your company has licensed individuals who still have CPT hours to complete this year, they need to take action soon.

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SFC routine inspection update
by Jane McBride ( and
Nick Chiu (

SEC registrants: One of the questions SFC licensees who are also SEC registrants sometimes ask is how to ensure that their internal policies and procedures are "ready" for a possible inspection by different regulators. There is no easy answer to this question. The documents need to be reviewed by lawyers in each relevant jurisdiction to ensure that all the relevant local requirements are covered. Our general approach in terms of how to manage the drafting of a compliance manual for an SFC licensee, with a view to minimising time spent while maintaining consistent high standards across jurisdictions will depend on whether:

  • it is part of a larger group (whether containing an SEC registrant or not) – we try to use the group's existing compliance manual and only supplement with Hong Kong specific requirements where really necessary;
  • it is a newly established Hong Kong business, seeking SEC registration at the same time as SFC licensing– in principle we would suggest trying to use one set of policies and procedures (typically the more comprehensive requirements) but amending these so that they work for both jurisdictions; or
  • it is an existing standalone SFC licensee, seeking SEC registration - in principle we would suggest trying to use the existing SFC compliance manual and just supplementing that with the SEC specific requirements.

The SEC expects a registrant to review its policies and procedures and the effectiveness of their implementation at least annually. Any compliance matters that arose during the year should be documented in a yearly compliance review. According to the SEC's paper earlier this year entitled "Examination Priorities for 2013", its examination focuses include fraud prevention, corporate governance, technology, safety of assets, conflicts of interest related to compensation arrangements, allocation of investment opportunities and marketing and performance advertising.

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US update: JOBS Act
by Ethan W. Johnson, Morgan, Lewis & Bockius LLP (

The SEC has recently adopted Rule 506(c) to permit public solicitation and advertising by funds in private placements in the US. Sales in the US in Rule 506(c) offerings may only be made to accredited investors. A fund must take reasonable steps to verify this. The SEC has explained that a fund using Rule 506(c) must make an objective determination whether it has taken reasonable steps. According to the SEC, a fund will not be considered to have taken reasonable steps to verify accredited investor status if it requires only that a subscriber tick a box in a questionnaire, absent other information about the purchaser indicating accredited investor status. The definition of "accredited investor" remains unchanged.

The SEC has provided a non-exclusive list of ways for funds to satisfy the verification requirements. The accredited investor status of a corporation, partnership or other entity may be verified through financial statements, regulatory filings and the like. For natural persons:

  • A fund may review tax returns for the two most recent years to determine whether the person satisfies the income test. The fund should also obtain a written representation from the subscriber confirming that the subscriber expects to reach the required income level during the current year.
  • A fund may consider the following to determine if a subscriber's net worth qualifies him or her as an accredited investor: (i) for assets, bank statements, brokerage statements or other statements of securities holdings, tax assessments and independent appraisal reports, and (ii) for liabilities, a consumer credit report. The fund should also obtain written confirmation from the purchaser that all liabilities necessary to make the net worth determination have been disclosed.
  • A fund may rely on a written confirmation from an SEC-registered broker-dealer or investment adviser, a licensed attorney or certified public accountant in good standing, that the purchaser is an accredited investor.

If a person who purchased securities as an accredited investor prior to the effective date of Rule 506(c) wishes to purchase additional securities in a Rule 506(c) offering, the fund may rely on a written certification that the subscriber still qualifies as an accredited investor.

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Recent Deacons' publications


Construction Newsletter, Issue 1 of 2013: September


Recent developments in Hong Kong short sale rules

China Legal Update, Issue 5 of 2013: August

Litigation & Dispute Resolution Newsletter, Issue 3 of 2013: August


New streamlined measures for changes to SFC-authorised funds


FAQs on AIFMD for Hong Kong based managers

China Legal Update, Issue 4 of 2013: June

Personal Injury Awards - Higher Multipliers for Future Losses? An Update

Human Resources and Pensions Newsletter, Issue 3 of 2013: June

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Hong Kong Investment Funds Association - 7th Annual Conference

Deacons is proud to be a sponsor of the HKIFA's 7th annual conference to be held on Monday 23 September 2013 at the JW Marriott Hotel. The event will be focusing on the theme of "Capitalizing on Mainland Opportunities". We look forward to seeing you there.

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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.