Henri Arslanian, Director
UBS Prime Services, Business Consulting Services
A number of regulatory developments have taken place over recent weeks in the Asia Pacific region that may have a practical impact on hedge funds trading or operating in the region. This article sets out some of these developments in Hong Kong, India, Taiwan, Japan, Malaysia and Korea.
Subject to the legislative process, the new Hong Kong short selling reporting regime should come into effect on 18 June 2012.
What is the proposed reporting regime?
- Under the proposed regime, a short position that hits the threshold of 0.02% of the issued share capital of a listed company, or a market value of HK$30 million, whichever is lower, has to be reported to the SFC on a weekly basis. It is important to note that the reporting requirement will only apply to companies comprised in the Hang Seng Index or the Hang Seng China Enterprises Index and other financial stocks specified by the SFC.
- The SFC is proposing that a person/entity (e.g. fund) will be required to report to the SFC short positions on a net basis and not on a gross basis as originally proposed.
Who is responsible for the reporting and when and how does this reporting need to take place ?
- The SFC expects that generally the person/entity who beneficially owns the short position has the obligation to report. So, if a fund takes the form of a corporate entity, it is expected that the corporate entity will be responsible for the reporting.
- However, the SFC clarified that a party who has the statutory obligation to report may authorise its agent (e.g. investment manager) to do so on its behalf, though the principal would remain legally responsible for the reporting.
- It is expected that the reports must be submitted electronically by the second business day of the following week and the SFC will set up an electronic reporting facility and prescribe a template to be used for reporting.
Does it apply to OTC products?
- The reporting requirement applies only to short positions resulted from trading shares on the Stock Exchange of Hong Kong Ltd and other trading venues that may be specified by the SFC. Short positions created via OTC trading and economic short positions created by the use of derivatives will be excluded from reporting purposes.
Will the provided information be published and what are the penalties?
- The SFC will publish aggregated short positions for each stock, on an anonymous basis, one week after the receipt of the reports. The SFC backed away from making the breach of reporting requirement a strict liability offence to making it only an offence if it is without reasonable excuse.
The Finance Minister of India introduced the latest budget proposal in the Indian parliament on 16 March 2012. Two noteworthy proposals that may be of relevance to hedge funds are (a) the Indirect Transfer Rules and (b) the General Anti Avoidance Rules (GAAR).
What are the Indirect Transfer Rules proposals?
- We understand that the taxing provisions have been widened to cover any transfer of shares or interest by any foreign entity where such shares or the interest derives, directly or indirectly, its value substantially from assets located in India.
What are the GAAR proposals?
- The GAAR proposals are far reaching and may provide wide powers to the tax authorities in determining and taxing aggressive tax planning arrangements.
- GAAR provisions empower the tax authorities to declare an arrangement as an “impermissible avoidance arrangement”. We understand that an impermissible avoidance arrangement generally means an arrangement, the main purpose or one of the main purposes of which is to obtain a tax benefit and that lacks commercial substance or is deemed to lack commercial substance, in whole or in part. The consequences may include the denial of treaty benefit (e.g. India-Mauritius DTAA).
When does this come into force and what are the capital gains tax (“CGT”) levels?
- We understand that these rules came into force on 1 April 2012. The Indian CGT levels are 15% for equities (held for less than one year) and 30% for futures and options.
India QFI Regime
In January 2012, the Indian government announced that Qualified Foreign Investors (QFI) that meet certain requirements may now invest directly in the Indian equity markets. The QFI regime is different from the existing Foreign Institutional Investor (FII) regime that many hedge funds may be familiar with. Whilst many hedge funds may not be able to benefit from the QFI regime, this represents an important development intended to widen the class of investors, attract more foreign funds, reduce market volatility and deepen the Indian capital markets.
- The announcement sets out that QFIs that meet the prescribed KYC requirements may invest in equity shares listed on the recognized stock exchanges and in equity shares offered to the public in India through initial and follow-on public offerings.
Who can qualify as a QFI?
- A QFI is a person resident in a country that is compliant with the Financial Action Task Force (FATF) standards and that is a signatory to the International Organization of Securities Commission's Multilateral Memorandum of Understanding. In addition, such a person shall not be a resident of India and shall not be registered with SEBI as a FII or sub-account. The term “person” also includes a body corporate incorporated under the laws of a country outside of India.
Can a Cayman Islands/BVI/Mauritius domiciled hedge fund become a QFI?
- As set out above, the QFI is only available for persons resident in countries that are FATF compliant. We understand that SEBI does not currently consider the Cayman Islands, the BVI or Mauritius as being “compliant with FATF standards” as they are not FATF member countries. As a consequence, we understand that hedge funds domiciled in such jurisdictions may not currently qualify as QFIs.
How is the QFI regime practically different from the existing FII/Sub-Account regime?
In many ways, the QFI regime is narrower and more restrictive than the traditional FII/sub-account regime. For example, we understand that some of the differences of the QFI regime compared to the FII regime include:
- The QFI regime only allows investment in equities and, subject to certain limits, in mutual fund units (i.e. excludes derivatives or fixed income products);
- A QFI is not allowed to open an onshore cash account and needs to operate through a Qualified Depository Participant (QDP);
- The QDP shall purchase the equity at the instruction of the respective QFI within five working days failing which the funds would be immediately repatriated back to the QFI’s designated overseas bank account; or
- A QFI shall also not hold more than five per cent. of the paid up capital of a company at any time and the aggregate shareholding of all QFIs shall not exceed ten percent of a company at any time.
The Taiwanese Ministry of Finance announced in April 2012 its proposal for levying CGT on securities and futures trading.
What is the proposal about?
- We understand that under the current proposal, institutional investors will be levied CGT under the Alternative Minimum Tax scheme with a lower threshold and higher tax rate.
What about Foreign Institutional Investors?
- We understand that Foreign Institutional Investors (FINIs) without a permanent establishment in Taiwan should be exempt from CGT.
What instruments are subject to CGT?
- We understand that the CGT generally applies to securities (e.g. exchanges listed stocks, emerging market stocks, unlisted stocks, governments bonds, corporate bonds, financial debentures, warrants, Taiwan Depository Receipts), futures and options (e.g. futures and options traded in Taiwan Futures Exchanges).
What is the CGT rate and the CGT threshold?
- We understand that under the current proposal, the CGT rate for institutional investors will be increased to 12% from the current 10%, and the CGT threshold will be set at NT$500,000 from the current NT$2m.
- By way of comparison, we understand that the CGT rate for large retail investors is 20% with a threshold of NT$3m.
- We also understand that capital losses from securities, futures and options trading can be offset with capital gains within the same year. We also understand that excess capital loss can be can be carried over for the following 5 years.
When does this come into force?
- Whilst the above are only at the proposal stage, we understand that this should come into force in 2013. The impact on market volumes and liquidity is still unknown but it is important to note that retail flows are estimated to account for around 60% of the Taiwan Stock Exchange volume.
Recent changes to Japan’s Financial Instruments and Exchange Act (FIEA) created additional regulations on short selling in relation to public offerings.
What is the new amendment?
- In summary, effective 1 December 2011, any person that engages in a short sale of shares of an issuer during the period between (i) the day immediately following the public announcement of the public offering or secondary offering by the issuer and (ii) the time when the offering price is set, will be prohibited from using the shares that it acquires from the public offering to return the shares borrowed for the short sale.
- This rule is somewhat similar to the previous version of Rule 105 of Regulation M under the U.S. Securities Exchange Act of 1934.
How does this apply to managers managing multiple funds?
- We understand that this restriction is not considered applicable where the short selling and subscription to a public offering or secondary offering are performed by different investment decisions or in separate accounts, unless the borrowed position related to the short sale is closed with the security obtained through the offering.
Effective 9 January 2012, changes in regulations in Malaysia provide that a lender who sells loaned securities under a securities borrowing and lending (SBL) agreement before recalling the loaned securities shall be deemed as having a right to vest the securities in a purchaser of the securities if certain conditions are met.
What is the new amendment?
- In general, a person must not sell securities unless he has reasonable grounds to believe he has a right to vest the securities in a purchaser. An exception is being made under the Capital Markets and Services (Securities Borrowing and Lending) Regulations 2012, which came into effect on 9 January 2012 (“Regulations”).
- The Regulations provide that for the purposes of subsection 98(1) of the Capital Markets and Services Act 2007, a lender who sells loaned securities under a SBL transaction before recalling the loaned securities shall be deemed as having a right to vest the securities in a purchaser of the securities if certain conditions are met.
What is the practical impact of the Regulations?
- A lender who sells loaned securities under a SBL transaction before recalling the loaned securities shall be deemed to have a presently exercisable and unconditional right to vest the securities in a purchaser of the securities, subject to certain conditions.
- This is likely to increase the short inventory in Malaysia as lenders will be keener to lend out shares. Previously, regulations in Malaysia did not deem that a lender had such a right to vest the securities which caused a buy-in to occur for the lender who sold the loaned securities.
On 12 March 2012, the Financial Services Commission of Korea (FSC) announced that it intends to introduce a reporting regime for large short positions.
What is the proposed reporting regime?
- Whilst the details are not know yet, we understand that under the proposed regime, it will become mandatory for investors to report short positions that exceed a certain threshold to both market authorities and the KRX.
When will more details be available?
- Further details such as the trigger level, frequency, and timing of reporting will be reflected in the Regulation on Financial Investment Business to be implemented within Q3 2012.
* The views expressed are those of the author and do not necessarily represent those of UBS.
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