Alternative Investment Management Association Representing the global hedge fund industry
The recent relaxation in licensing regulations by the Hong Kong Securities and Futures Commission (SFC) may provide a further boost to the territory's already booming funds industry.
Hedge fund assets under management in Hong Kong now total some US$33.5 billion1. The number of Asian hedge funds has quadrupled to more than 700 since 2002, while assets under management have increased nearly tenfold to US$120 billion2.
However, it has been perceived that Hong Kong is a costlier and harder place to establish a hedge fund than Singapore, largely due to the Lion City's lighter regulatory touch. Last year, Eurekahedge estimated that 24 hedge funds start-ups were established in Singapore compared to just eight in Hong Kong.
The SFCs new regulations go some way towards correcting that perception and this article summarises these new regulations.
The "SFC Adopts a Pragmatic Approach to Licensing Fund Managers" circular (“The Circular”, issued on 11 June 2007) is principally targeted at hedge fund managers3 who are, or where parent companies are, regulated by the Securities and Exchange Commission (SEC) in the United States and/or the Financial Services Authority (FSA) in the United Kingdom, who have a good compliance track record and serve only "professional investors”4 . If a hedge fund group satisfies these criteria, an expedited licensing process may be followed by the SFC. From current experience this can reduce the licensing process to as little as four-six weeks.
The SFC are keen to mention that the streamlined approach will be, "considered on a case-by-case basis"; they stress that they are happy (and actively encourage) prospective applicants to meet relevant SFC team members from the licensing intermediaries department. It is via this initial meeting that the SFC intends to begin to understand the applicant's business, both globally and in Hong Kong and assess the "risk" level of such an applicant.
The Circular expresses the key areas on which the SFC will focus when reviewing a fund manager application, namely risk management, valuation, internal controls and management of conflicts of interest. Applicants should consider these areas when preparing for an SFC meeting and, as part of the application itself, when drafting the applicant's business plan.
Competency Requirements for Responsible Officers (ROs)
The Circular confirms a number of changes to the SFCs approach, particularly in terms of the ROs competency requirements. By way of background, under the Securities and Futures Ordinance (SFO) each licensed corporation (i.e. an entity other than a bank which is regulated by the SFC), is required to have two ROs. As expressed in The Circular, one must be based on Hong Kong and at least one must be "immediately contactable" at all times. A RO is required to be fit and proper5 and have sufficient authority within the relevant entity in order to manage and supervise the relevant regulated activity. Additionally, in order to be a RO four competency requirements must be satisfied. These are6:
• Academic/Industry Qualification, i.e., to have passed one of the "recognised industry qualifications" or (have taken a degree in designated fields7 or such other degrees with passes in at least two courses in the designated fields) or to have a Professional qualification8.
• Industry Experience, i.e., at least three years in the industry (i.e. asset management) over the last six years.
• Management Experience, i.e., a minimum of two years proven management skill and experience.
• Regulatory Knowledge - to have passed one of the local regulatory framework papers.
The Circular introduces two key helpful changes:
(i) in relation to suitable applicants, the interpretation of "relevant industry experience" (the second competency requirement and to date largely rigidly stuck to), may be relaxed in the case of ROs who have spent an equivalent amount of time i.e. 3 years or more in a broad range of activities and investment strategies including asset management, proprietary trading, research, private equity, special situations, as well as experience in dealing with other alternative investments, (direct hedge fund experience).
Similarly, individuals wishing to be ROs of a hedge fund with at least 3 years' experience in the sales, marketing and risk management of hedge funds, (indirect hedge fund experience), may be granted RO status but subject to a "non-sole" condition; this means that the individual must, when actively participating in or when directly supervising the business for which the firm is licensed, do so under the advice of another RO who is not subject to the "non-sole" condition. It therefore follows that where there are only two ROs, only one RO may be subject to the "non-sole" condition.
The "non-sole" condition is not new and is currently used in circumstances where a ROs relevant industry experience is in either of the two scenarios above and/or where a RO, regardless of his experience, is based overseas (as is permissible). It would seem to follow that for the new streamlined approach to be applicable, the RO with direct hedge fund experience needs to be in Hong Kong. However, from experience this need not always be the case.
(ii) the local framework regulatory examination9 requirements, (the fourth element of the RO competency requirements), may be waived where;
• a RO applicant has over 8 years of industry experience in recognised markets (being those identified in Parts 2 and 3 of Schedule 1 of the SFO), or alternatively, is already registered or licensed in the UK or US for investment management or advisory business;
• the applicant firm will only serve professional investors (within the meaning of the SFO);
• the applicant firm is able to confirm that regulatory and compliance support will be provided to the relevant RO applicant; and
• the RO applicant agrees to take a post-licensing refresher course on local regulations.
Consequently, in practice the applicant RO may not be required to pass any of the requisite local regulatory framework examinations.
This exemption is very closely based on existing guidelines, save that "limited scope" may now include serving "professional investors” only, (as an alternative to holding a senior position such as CEO). The relevant individual may qualify where they hold an appropriate licence in the UK or US (instead of having substantial related experience) and a post-licensing refresher course on local regulations is attended. There is no mention of the "non-sole" condition being applied in such circumstances and we would anticipate it will not apply in every case. The SFC has yet to confirm the nature of the "post-licensing refresher course". In certain circumstances as an alternative to examinations, the SFC has allowed RO candidates to attend the Hong Kong Securities Institute course entitled, “ Professional Certificate in SFC Regulated Activities for Re-entrance to Securities and Investment Markets”, or FTC Kaplan Paper 1 and Paper 6 preparatory courses. We assume that this will continue.
On a case-by-case basis, the examination exemption may be available for those with either direct hedge fund experience or indirect hedge fund experience.
The Circular is also silent on the other main RO competency requirements - the management experience requirement discussed above. We think it safe to assume that this requirement will remain and therefore applicants will need to demonstrate the actual management experience in the relevant area - whether in the area of direct hedge fund experience or indirect hedge fund experience. Furthermore, the academic qualification, (the first RO competency requirement and referred to above), has in some cases previously caused applicants difficulties. Despite the Circular's silence we assume the SFC will adopt a pragmatic approach to this requirement in the spirit of their intentions.
Existing Licensed Corporations and ROs
Although the focus of the Circular is on new fund manager applicants, equally the principles of the Circular may be applied to existing licensed corporations with an asset management licence, where they wish to appoint additional or replacement responsible officers. In the right circumstances, the Circular may be relied upon by existing ROs to remove conditions such as the "non-sole" condition imposed originally as a result of a preserved lack of experience.
The SFCs approach has been much welcomed, particularly at a time when Singapore appeared to be stealing a march on Hong Kong as a hedge fund centre. To date the process, in the right circumstances, has become faster and easier. The key is to have the right ROs with relevant experience and where possible attend a meeting with appropriate SFC personnel. To ensure the best results, applicants would be advised to be thoroughly prepared for such a meeting, so as to enable the SFC to approach the application in a suitable and pragmatic manner.
1 - Eurekahedge based on official data.
2 - Eurekahedge and GFIA.
3 - The SFC acknowledges that the general guidelines in the Circular might apply to fund managers other than hedge fund managers and with which we tend to agree. We also believe the guidelines might apply to start ups in certain circumstances. However, before time is spent on an application based on the Circular it will be important to meet and discuss with the SFC the business intention and to understand the SFC's view as to the applicability of this Circular before embarking on what might alternatively be a long drawn out process.
4 - The term "professional investor" is defined in Schedule 1 of the Securities and Futures Ordinance (to include fund managers, banks, insurance companies, pension funds) and the Securities and Futures (Professional Investor) Rules which prescribe certain additional individuals and institutions as being professional investors.
5 - As defined in the SFCs Fit and Proper Guidelines.
6 - As set out in the SFCs Guidelines on Competency.
7 - Accounting, Business Administration, Economics, Finance and Law.
8 - Law, Accounting or Finance.
9 - Local regulatory framework examinations are set by the Hong Kong Securities Institute (HKSI).Back to Listing