Spotlight: recent developments in asset management in Hong Kong

All questions

Overview of recent activity

Financial markets generally, including the asset and wealth management industry, have been facing unprecedented challenges. Nonetheless, Hong Kong is well placed to remain in, and indeed strengthen, its position as a competitive full-service asset and wealth management centre and a preferred place of fund domicile, and as the pre-eminent offshore renminbi centre.

The government and the Hong Kong Securities and Futures Commission (SFC) have been pursuing a number of initiatives in this regard. The SFC has implemented mutual recognition of funds (MRF) arrangements with Australia, Taiwan, Malaysia, the Mainland of China, France, the United Kingdom, Luxembourg, the Netherlands, Switzerland and Thailand.

The open-ended fund companies (OFC) regime, which provides a corporate vehicle for use by open-ended funds (including hedge funds), took effect on 30 July 2018. The limited partnership fund (LPF) regime, which is aimed primarily at the private equity industry, took effect on 31 August 2020. Alongside the introduction of these new fund vehicles, recent legislative changes to the Hong Kong tax code have:

1. unified the profits tax exemptions for privately offered funds so that they apply (for transactions in specified assets and subject to meeting certain conditions) equally to onshore and offshore funds and to investments in both local and overseas private companies (with effect from 1 April 2019); and
2. introduced a zero per cent concessionary tax rate for carried interest paid by eligible private equity funds operating in Hong Kong to their managers (with retroactive effect from 1 April 2020).

The number of Hong Kong-domiciled funds increased 6.8 per cent to 865 as at 31 December 2021 as compared to 810 as at 31 December 2020.² In addition, the number of authorised collective investment schemes rose from 2,789 as at 31 December 2021 to 2,839 as at 31 December 2021.³

Going forward, Hong Kong looks set to continue to develop as a leading centre for the asset management industry for a number of reasons, including its rigorous but flexible and accommodating regulatory regime, its fund vehicle options and tax incentives at both fund and fund manager level, its proximity to the Mainland of China markets, its flexible tax regime and its world-class financial infrastructure. Hong Kong also looks set to benefit from traditionally popular offshore fund domicile jurisdictions such as the Cayman Islands facing evermore burdensome regulatory requirements driven by pressure from the OECD, such as economic substance requirements and more stringent reporting requirements.

General introduction to regulatory framework

The principal source of regulation of the asset management industry in Hong Kong is the Securities and Futures Ordinance (SFO)⁴ and its subsidiary codes, guidelines and circulars, and the principal regulator is the SFC.

Retail funds in Hong Kong (funds offered to the Hong Kong public) must be authorised by the SFC, whereas non-retail funds generally structure and conduct themselves in such a manner as to avoid the need to be authorised, and thereby regulated, by the SFC. Unauthorised funds, whose investors are predominantly institutions, have an aggregate net asset value thought to be in excess of the figure for authorised funds, although this is hard to quantify in the absence of any obligation to file accounts.

Even where non-retail funds are able to avoid the requirement to be authorised, the regulatory regime generally requires their Hong Kong-based fund managers to be licensed by the SFC, whether they manage retail funds or non-retail funds.

The principal source of regulation in respect of both authorisation and licensing is the SFO, and the key codes are:

1. the SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products;
2. the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct);
3. the SFC’s Fund Manager Code of Conduct (FMCC);
4. the SFC’s Code on Open-ended Fund Companies;
5. the SFC’s Code on Pooled Retirement Funds; and
6. the Code on Real Estate Investment Trusts and the SFC’s Code on MPF Products.

i Authorisation by the SFC

The asset management structures utilised in Hong Kong and discussed below are collective investment schemes for the purposes of the SFO.⁵ Under Section 103(1) of the SFO, it is an offence for a person to issue any advertisement, invitation or document that to his or her knowledge is or contains an invitation to the public to acquire an interest in or participate in any collective investment scheme unless the issue is authorised by the SFC under Section 105(1) of the SFO, or is exempted by any other relevant provision.

A common way to structure a fund that is in the form of a corporation (and issues shares to investors) to avoid the requirement to be authorised by the SFC is by ensuring that the advertisement, invitation or document relating to the offer relates to an offer specified in Part 1 of the Seventeenth Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance,⁶ such as an offer to no more than 50 persons, for which Section 103(2)(ga) of the SFO provides a specific exemption.

Another common way to structure a fund so as to avoid the requirement to be authorised by the SFC is by offering and marketing the fund only to professional investors, for which Section 103(3)(k) of the SFO provides a specific exemption. The definition of professional investors includes:

1. recognised exchange companies, recognised clearing houses, recognised exchange controllers, recognised investor compensation companies or authorised persons for providing automated trader services;
2. intermediaries or other persons carrying on the business of the provision of investment services regulated under the law of any place outside Hong Kong (and their wholly owned subsidiaries, holding companies and wholly owned subsidiaries of their holding companies);
3. authorised institutions or overseas banks (and their wholly owned subsidiaries, holding companies and wholly owned subsidiaries of their holding companies);
4. authorised insurers;
5. schemes (i.e., authorised collective investment schemes or similar overseas schemes, registered schemes under the Mandatory Provident Fund Schemes Ordinance (MPFSO)⁷ or the Occupational Retirement Schemes Ordinance (ORSO));⁸
6. governments, institutions that perform functions of a central bank or multilateral agencies;
7. trust corporations with total trust assets of not less than HK$40 million (or its equivalent in foreign currency);
8. corporations or partnerships with a portfolio of not less than HK$8 million (or its equivalent in foreign currency) or total assets of not less than HK$40 million (or its equivalent in foreign currency);
9. high net worth individuals with a portfolio of not less than HK$8 million (or its equivalent in foreign currency);
10. corporations that have as their principal business the holding of investments and are wholly owned by one or more professional investors; and
11. holding companies that wholly own another corporation that is itself a qualified professional investor.

The current position is that advertisements of investment products intended for sale only to professional investors may however be issued to the general public (even though they are not suitable for retail investors).⁹ To better protect the interests of the public, the SFC proposes to amend the Section 103(3)(k) SFO exemption so that advertisements of investment products that are intended to be sold only to professional investors should be issued only to professional investors (and not to the general public).¹⁰

ii Licensing by the SFC

The requirement for a fund manager to be licensed under the SFO arises because the fund manager will be carrying on a business¹¹ in one or more of the following¹² specified regulated activities:

1. Type 1: dealing in securities;
2. Type 2: dealing in futures contracts;
3. Type 3: leveraged foreign exchange trading;
4. Type 4: advising on securities;
5. Type 5: advising on futures contracts;
6. Type 6: advising on corporate finance;
7. Type 7: providing automated trading services;
8. Type 8: securities margin financing;
9. Type 9: asset management;
10. Type 10: providing credit rating services;
11. Type 11: dealing in over the counter (OTC) derivative products or advising on OTC derivative products;¹³ and
12. Type 12: providing client clearing services for OTC derivative transactions.¹⁴

The general position under Hong Kong law is that if the fund manager is not performing any activities in Hong Kong it will not need to be licensed. However, the licensing provisions of the SFO can have extraterritorial effect where a person actively markets, to the public of Hong Kong, services falling within one of the regulated activities listed above.¹⁵ Again, the licensing regime should not capture funds that are offered to not more than 50 persons.

Given the diversity of activities that fund managers conduct, the type of licence required will vary from case to case and, for each regulated activity, there are exemptions from licensing that need to be looked at on a case-by-case basis. For information, a typical hedge fund manager will hold a licence only in respect of Type 9 (asset management) regulated activity.

In considering a licensing application, the SFC seeks, among other criteria, to ensure that managers are fit and proper and have adequate resources. Licensed persons are subject to, inter alia, continuing reporting obligations, restrictions on unsolicited calls, and obligations to pay annual fees, to submit annual returns and to manage risks prudently.¹⁶ Substantial shareholders, officers and any other person who is or is to be employed by, or associated with, a licensed corporation for the purposes of the regulated activity for which the application is made, must also satisfy the fit and proper test.¹⁷

iii Other regimes

In addition to the SFO regime, other statutes, subsidiary codes, guidelines and circulars apply to specific sectors of asset management. For example, investment-linked assurance schemes (ILAS), which are discussed below, are life insurance policies issued by an insurance company, and are subject to both the SFO and the Insurance Ordinance (IO).¹⁸

A fund established in Hong Kong will also be subject to the rules and regulations applicable to its structure: for example, the Companies Ordinance (CO),¹⁹ the Partnership Ordinance,²⁰ the Limited Partnership Ordinance,²¹ the Limited Partnership Fund Ordinance (LPFO)²² or the Trustee Ordinance.²³

Specific sectors of asset management also fall under the ambit of other regulators, in addition to being under the regulation of the SFC. For example, schemes registered under the MPFSO (MPF schemes), which are discussed below, are regulated by both the Mandatory Provident Fund Schemes Authority (MPFA) and the SFC. Both regulators issue their own codes, and MPF schemes are expected to comply with both codes.

Funds listed on the Stock Exchange of Hong Kong Limited (SEHK) are also subject to the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (Hong Kong Listing Rules).

Common asset management structures

Various legal structures are used for the different sectors of asset management in Hong Kong.

Hedge funds managed from Hong Kong have commonly been structured as companies or limited partnerships domiciled offshore in a tax-neutral jurisdiction such as the Cayman Islands. Far less often, they have been structured as unit trusts constituted under trust deeds governed by Hong Kong law. However, the SFC has developed a new OFC regime that offers the hedge fund industry (as well as the open-ended funds industry more broadly) an additional choice of Hong Kong-domiciled investment fund vehicle. This regime came into operation on 30 July 2018. Further information can be found in Section VII.ii.

Most private equity funds managed from Hong Kong have also historically been established in offshore tax-neutral jurisdictions such as the Cayman Islands, commonly as limited partnerships. However, the SFC has developed a new LPF regime that offers the private equity industry (as well as other funds traditionally structured as limited partnerships) an additional choice of a Hong Kong-domiciled investment fund vehicle. This regime came into operation on 31 August 2020. Further information can be found in Section VII.iii.

With effect from 1 November 2021, the SFO and the LPFO have been amended to allow non-Hong Kong fund corporations and non-Hong Kong funds to apply for registration as OFCs and LPFs in Hong Kong respectively.²⁴ The re-domiciliation permits non-Hong Kong fund corporations and non-Hong Kong funds to have the same rights and obligations as other OFCs and LPFs in Hong Kong.

The majority of pension funds available to Hong Kong residents are in the form of MPF schemes (which are generally master trust schemes consisting of multiple constituent funds that are themselves invested in either feeder funds or portfolio managed funds) or schemes registered under the ORSO (ORSO schemes). Further information can be found in Section VII.ii.

ILAS, which are utilised in insurance fund management in Hong Kong, are life insurance policies whose premiums are invested in underlying funds that can be offshore or onshore and of varying legal structure. Further information can be found in Section VII.i.

Real estate investment trusts (REITs) are collective investment schemes constituted as trusts that invest primarily in real estate with the aim to provide returns to holders derived from the rental income of the real estate. Further information can be found in Section VII.iii.

Main sources of investment

Hong Kong continues to be a preferred location for international investors. Contributions from non-Hong Kong investors accounted for 64 per cent of the non-REIT asset and wealth management business²⁵ in 2020.

Despite a significant fall from 2015 levels, the renminbi remains a major source of investment in Hong Kong’s asset management industry, with total outstanding yuan customer deposits and certificates of deposit of 757 billion yuan as at the end of 2020.²⁶

Key trends

The SFC is focused on ensuring that the regulations governing public funds in Hong Kong align with international standards and market developments.

The SFC’s Licensing Handbook was updated on 1 January 2022 to provide further guidance on financial technology (such as virtual asset (VA) fund managers, VA fund distributors, VA trading platforms, security token offerings and bitcoin futures), family offices and custodians of private OFCs.²⁷ Further information can be found in Section VIII.ii.

Following the SFC’s publication of consultation conclusions on 20 August 2021 in relation to the management and disclosure of climate-related risks by fund managers, the FMCC will be amended to require fund managers overseeing collective investment schemes to consider climate-related risks for investment and risk management processes.²⁸ The new amendments seek to improve governance, investment management, risk management and disclosure by fund managers in respect of climate-related risks. Further information can be found in Section VIII.iv.

The market has seen the SFC taking a more robust approach in its inspection and enforcement actions. The SFC also proposes to expand its powers to allow it to take remedial and other orders against a regulated person.²⁹ At present, a breach of the Code of Conduct by a regulated person in itself cannot give rise to a cause of action under Section 213 of the SFO. The proposed amendments enable the SFC to apply its powers under Section 213 of the SFO against an intermediary for a breach of the Code of Conduct.

Sectoral regulation

i Insurance

Generally, any company wishing to carry on insurance business in or from Hong Kong must apply to the Insurance Authority (IA) for authorisation to do so under the IO. The requirements for authorisation include capital and solvency requirements, adequacy of reinsurance arrangements, as well as fit and proper requirements in relation to the directors and key persons (such as officers responsible for risk management, compliance, financial control, audit and actuarial functions) of the insurer. Once authorised, insurers remain subject to various requirements, including in relation to their investment in and the holding of assets.

The IA also took over the regulation of insurance intermediaries (i.e., agents and brokers) from the three self-regulatory organisations that previously existed in Hong Kong³⁰ under a new statutory licensing regime that came into operation on 23 September 2019.

On 29 March 2021, the IO was revised to give the IA statutory powers to regulate insurance groups, introduce the special purpose insurers (SPI) regime and facilitate the issuance of insurance-linked securities (ILS) by SPIs. Subsidiary legislation, such as the Insurance (Group Capital) Rules,³¹ was also introduced on the same date to facilitate the implementation of the insurance group supervision framework and the SPI regime. This brings Hong Kong in line with the recommendations of the International Association of Insurance Supervisors (IAIS) and the IAIS principles. On 14 May 2021, the IA assumed the group supervisor role for the AIA, FWD and Prudential groups.

ILAS

One of the key products used by insurance companies in Hong Kong are ILAS, which fall within the definition of Class C of long-term business under the IO³² and are also classified as collective investment schemes under the SFO.

ILAS are life insurance policies whose premiums are invested in funds chosen by the policyholder, the benefits of the ILAS policy then being linked to the performance of those investment options. As at 31 March 2022, there were 300 SFC-authorised ILAS.³³

As noted in Section II, collective investment schemes, including ILAS, must fall within a relevant exemption under Section 103 of the SFO if they are to avoid the requirement to be authorised by the SFC. As ILAS will generally be marketed to the public in Hong Kong, it is unlikely that any of the exemptions will apply, and accordingly insurers are generally required to seek authorisation for the marketing of ILAS.

The requirements for SFC authorisation of ILAS include the requirement that the insurer has obtained authorisation to carry on Class C of long-term business;³⁴ detailed disclosure requirements for scheme documentation;³⁵ and requirements in relation to fees and charges.³⁶

Ongoing requirements for authorised ILAS include reporting obligations and the requirement to seek prior authorisation from the SFC for any changes to the scheme materials, unless an exemption applies.³⁷

The SFC has published guidance stating that insurers, corporate insurance brokers and insurance intermediaries engaging in promoting, offering or selling ILAS to the public, or who advise members of the public concerning ILAS, are not, by virtue of those particular activities, required to be licensed under the SFO for the purpose of advising on securities (i.e., Type 4 regulated activity) or dealing in securities (i.e., Type 1 regulated activity).³⁸

The Hong Kong Monetary Authority (HKMA) and the SFC, in consultation with the IA, published guidance on 11 October 2021 to caution intermediaries on the suitability obligations and requirements for ILS and related products.³⁹ In particular, intermediaries should verify the identity of the target investors of ILS (which are generally unsuitable for retail investors) by checking their selling restrictions.

On 1 November 2021, the SFC published a circular to introduce an enhanced process for applications for authorisation of new ILAS whereby the SFC will classify new ILAS applications as standard applications or non-standard applications with varying processing times for granting of authorisations.⁴⁰ The SFC also published supplemental guidance to issuers of SFC-authorised ILAS on the application of certain existing requirements under the Guidance on Internal Product Approval Process to ILAS.⁴¹ The additional guidance covers requirements in relation to product design and fees, complex ILAS products, review and monitoring and enhanced disclosure. These measures took effect on 1 November 2021 and therefore apply to new ILAS applications submitted on or after that date. Existing SFC-authorised ILAS issuers have a transition period of 18 months (expiring on 30 April 2023) to comply with the enhanced requirements.

ii Pensions

Retirement schemes in Hong Kong are governed primarily by ORSO and MPFSO. The MPFA is the primary regulator.

ORSO

ORSO, which became effective in 1993, does not impose a requirement on employers to provide a retirement scheme, but rather aims to ensure that occupational retirement schemes established voluntarily are properly regulated.

Schemes that are covered by ORSO are required to apply for either registration or exemption under ORSO. ORSO exemptions may be allowed for offshore schemes that are registered or approved by a recognised overseas authority, or for schemes with not more than either 10 per cent or 50 of their members, whichever is less, who are holders of a Hong Kong permanent identity card.

Whether registered or exempted under ORSO, such schemes are subject to certain ongoing requirements.

MPFSO

MPFSO, which became effective in 2000, imposes a requirement on employers to ensure that all relevant employees are members of a registered provident fund scheme, as well as ongoing requirements for such schemes.

When MPFSO was introduced, pre-existing ORSO schemes (whether registered or exempted under ORSO) were permitted to apply for an exemption from certain provisions of MPFSO.

Owing to the interaction of the ORSO and MPFSO regimes, retirement schemes in Hong Kong are usually ORSO schemes that are neither MPF-exempted nor MPF-registered (acting as a top-up or supplement to MPF).

On 22 October 2021, the Mandatory Provident Fund Schemes (Amendment) Bill 2021 was passed to implement the eMPF Platform. The eMPF Platform standardises, streamlines and automates the administration processes of MPF schemes and thus increases the operational efficiency of the MPF system. The government will specify the date of the mandatory use of the eMPF Platform by individual trustees and their MPF schemes in an orderly manner starting from 2023. The eMPF Platform is targeted to become fully functional in around 2025.

The SFC updated its Code on Pooled Retirement Funds on 1 December 2021 to enhance the requirements for the operation of pooled retirement funds, clarify obligations of pooled retirement funds’ key operators (such as product providers, trustees, management companies and insurance companies) and increase flexibility from an operational and disclosure perspective.⁴²

iii Real property

Real property funds in Hong Kong are commonly in the form of REITs, which are considered collective investment schemes for the purposes of the SFO. As noted in Section II, a collective investment scheme, including a REIT, must fall within a relevant exemption under Section 103 of the SFO if it is to avoid the requirement to be authorised by the SFC. As REITs will generally be marketed to the public in Hong Kong, it is unlikely that any of the exemptions will apply.

The SFC has issued a Code on Real Estate Investment Trusts (REIT Code) establishing authorisation and ongoing requirements for REITs. The REIT Code provides that an authorised REIT must have a trustee, a management company and a principal valuer to value the real estate held under the scheme, which are, in each case, acceptable to the SFC. It is also a condition for a REIT to be authorised that it will be listed on the SEHK within a period acceptable to the SFC. Once listed, a REIT is subject to the Hong Kong Listing Rules.

An SFC-authorised REIT may hold real estate located in Hong Kong or overseas, directly or indirectly, through special purpose vehicles that are legally and beneficially owned by the REIT.

The REIT Code imposes various ongoing requirements, including that at least 75 per cent of the gross asset value of the scheme must be invested in real estate generating recurrent rental income;⁴³ and the REIT is obliged to distribute to unitholders as dividends each year an amount not less than 90 per cent of its audited annual net income after tax.⁴⁴

The REIT Code was amended on 4 December 2020 to provide Hong Kong REITs with more flexibility in making investments. The changes include allowing REITs to make investments in minority-owned properties (subject to various conditions) and in property development projects in excess of the existing limit of 10 per cent of gross asset value (GAV) subject to unitholders’ approval (and other conditions), increasing the borrowing limit for REITs from 45 to 50 per cent of GAV, as well as broadly aligning the requirements for REITs’ connected party transactions and notifiable transactions with the requirements for listed companies.

The REIT Code will be further amended on 5 August 2022 in relation to conduct requirements for bookbuilding and placing activities.⁴⁵ The amendments clarify that Chapter 3A of the Hong Kong Listing Rules and related provisions relating to the sponsor overall coordinator, overall coordinator and other capital market intermediaries applies to offerings involving bookbuilding activities for interests in a REIT by a new REIT applicant or an SFC-authorised REIT.

As at 31 March 2022, there were 11 authorised REITs.⁴⁶

iv Hedge funds

Hong Kong’s regulatory regime does not provide a clear definition of a hedge fund, but the SFC takes the view that non-traditional funds that possess characteristics and utilise investment strategies that are different from traditional funds will generally be regarded as hedge funds.

As noted in Section II, a collective investment scheme, including a hedge fund, must fall within a relevant exemption under Section 103 of the SFO if it is to avoid the requirement to be authorised by the SFC. Most non-retail hedge funds structure and conduct themselves in such a manner as to avoid the need to be authorised by relying on these exemptions.

Authorisation of hedge funds

The Code on Unit Trusts and Mutual Funds (UT Code) is the applicable SFC code for authorised hedge funds, and contains a special section⁴⁷ that deals with collective investment schemes that are hedge funds. As well as ongoing requirements, the UT Code sets out the factors the SFC will consider in determining whether to authorise a hedge fund.

SFC-authorised hedge funds (whether local or foreign) can be marketed to the public in Hong Kong subject to a minimum subscription of US$50,000, or, for funds of hedge funds, US$10,000.⁴⁸

Regulation of typical hedge fund activities

Certain activities typically carried out by hedge funds, whether authorised or not, are regulated as follows:

1. there is a prohibition on on-exchange naked short selling, unless exempted;⁴⁹
2. subject to certain limited exemptions contained in the Hong Kong Listing Rules, on-exchange covered short sales may only be effected in certain securities designated by the SEHK, and all such short-selling activities must be executed at or through the SEHK;
3. the Securities and Futures (Contracts Limits and Reportable Positions) Rules⁵⁰ prescribe limits and reporting positions applicable to futures contracts and stock options contracts traded on the SEHK or the Hong Kong Futures Exchange Limited;
4. if a hedge fund is interested in more than 5 per cent of voting shares in a corporation listed on the SEHK, it has an obligation to make a disclosure that arises upon the occurrence of certain relevant events, including the crossing of certain percentage threshold positions and a change in the nature of their interest in the shares. Short positions also need to be disclosed;⁵¹ and
5. the Securities and Futures (Short-Position Reporting) Rules⁵² set out additional short-position disclosure requirements. A short seller will need to compute his or her short position in certain listed shares on the SEHK at the end of the last trading day of each week to determine whether it amounts to, or exceeds, 0.02 per cent of the issued share capital of that particular listed company, or the value of the short position amounts to or exceeds HK$30 million, whichever is lower. If the short position amounts to or exceeds such threshold, then the gross short position must be reported to the SFC.

Listing

It is possible for a hedge fund to be listed on the SEHK. An authorised hedge fund’s listing on the SEHK would follow Chapter 20 of the Hong Kong Listing Rules. An unauthorised hedge fund’s listing on the SEHK would follow Chapter 21 of the Hong Kong Listing Rules.

v Private equity

Private equity funds are generally not regulated as a specific class of investment. However, as noted in Section II, the SFO regulates the authorisation and operation of collective investment schemes, which are broadly defined and can include private equity funds. However, private equity funds will generally structure and conduct themselves so as to avoid the need to be authorised, and so regulated, by the SFC, by relying on the exemption for offers made only to professional investors.

Under the SFO, a private equity fund’s promoter, principals and manager need to be licensed if they carry out a regulated activity in Hong Kong. The most relevant regulated activities for private equity fund managers are dealing in securities (Type 1), advising on securities (Type 4) and asset management (Type 9). In practice, the licensing requirements mainly concern the fund manager who manages and carries out investment activities for the fund.

The SFC issued a circular on 7 January 2020 to clarify licensing obligations of private equity firms that conduct business in Hong Kong, including licensing requirements for private equity firms’ general partners, investment committee members and fund marketing activities. The circular also clarifies how the SFC assesses private equity firms’ discretionary investment authority and investments in securities of private companies, as well as the industry experience requirement for their responsible officers.

Acquisitions by private equity funds of companies listed on the SEHK or stakes in such companies are fairly common, and are governed by various laws or regulations, or both, including the CO, the Hong Kong Codes on Takeovers and Mergers and Share Buy-backs and the Hong Kong Listing Rules.

As described in Sections VII.i and VII.iii, the government has introduced extensions to the profits tax exemptions and a new zero per cent concessionary tax rate for carried interest that are expected to attract more private equity funds to Hong Kong.

In addition, the new legislative framework for limited partnership funds, which came into operation on 31 August 2020, is intended to encourage more private equity funds to choose Hong Kong as their domicile of choice. See Section VIII.iii for further details.

vi Family offices

On 7 January 2020, alongside its issuance of a circular to clarify licensing obligations of private equity firms that conduct business in Hong Kong, the SFC also issued a circular addressing how the SFC’s licensing regime applies to family offices intending to carry out asset management or other services in Hong Kong.⁵³ The SFC clarified there is no separate licensing regime for family offices in Hong Kong. The SFC’s licensing regime is activity-based. Therefore, if a family office does not provide services that amount to regulated activities or those services fall within the permitted exceptions, no SFC licensing is required under the SFO. However, if a family office carries out asset management services (such as real estate investment scheme management and securities or futures contracts management),⁵⁴ it may need to hold a licence for Type 9 regulated activity (asset management) if it does not fall within any of the exceptions. The family offices circular explains the potential licensing implications for both single and multi-family offices, and describes licensing exceptions or carve-outs that may be available depending on how a family office operates.

The SFC’s chief executive officer, Ashley Alder, commented at the time of the issuance of the two circulars that private equity firms and family offices are two key building blocks of any leading asset and wealth management centre, highlighting the importance of these two sectors to the Hong Kong asset management industry.

vii Other sectorsRetail unit trusts and mutual funds

A large part of the retail asset management market in Hong Kong is in the form of non-specialised unit trusts and mutual funds (both of which fall within the meaning of collective investment scheme under the SFO) authorised by the SFC. The majority of these retail funds (by both number and net asset value) are equity funds (199 Hong Kong domiciled and 757 non-Hong Kong domiciled as at 31 March 2022) and bond funds (174 Hong Kong domiciled and 358 non-Hong Kong domiciled as at 31 March 2022).⁵⁵

Retail funds that are mutual funds or unit trusts are subject to the general regulatory framework noted in Section II, and to the provisions of the UT Code.

Exchange-traded funds

The exchange-traded fund (ETF) segment is one of the fastest-growing segments in the asset management industry in Asia, and Hong Kong is at the forefront of this trend, with 160 ETFs listed on the SEHK as at 31 March 2022.⁵⁶

As noted in Section II, a collective investment scheme (including index funds such as ETFs) that is offered to the Hong Kong public must be authorised by the SFC unless a relevant exemption under Section 103 of the SFO can be relied upon. To be authorised, ETFs are expected to comply with the relevant provisions of the UT Code,⁵⁷ which also provides ongoing requirements for authorised schemes.

The SEHK provides a listing avenue for authorised ETFs under Chapter 20 of the Hong Kong Listing Rules, and is responsible for overseeing their compliance with the Hong Kong Listing Rules.

The SFC may also enter into mutual recognition arrangements with other jurisdictions from time to time to facilitate cross-listing and offering of ETFs in each other’s market.

Since February 2015, a stamp duty waiver has been in effect for trading in ETF shares or units that are listed or traded on the SEHK, as a means to lower transaction costs and further promote the growth of the ETF market.

Leveraged and inverse products, crude oil futures ETFs

Adding to the diversity of the products in Hong Kong’s ETF market, in June 2016 the SFC authorised the first batch of leveraged and inverse products structured as ETFs. From 9 January 2017, the SFC accepted applications for the authorisation of leveraged and inverse products that track liquid and broadly based Hong Kong and non-Mainland of China foreign equity indices. The SFC has also stated that it is willing to consider, on a case-by-case basis, the authorisation of funds tracking non-equity indices, provided that they meet the relevant requirements of the UT Code. As at 31 March 2022, 28 leveraged and inverse products were listed on the SEHK.⁵⁸

In 2016, the SFC authorised the first crude oil futures ETF and the first ETFs with multiple trading counters. In 2019, the SFC relaxed the leverage cap for inverse products to a factor of two-times negative (-2x). On 23 June 2020, the SFC issued a supplemental circular confirming that the SFC will accept applications for authorisation of leveraged and inverse products tracking Mainland of China equity indices.⁵⁹ A leveraged product tracking a Mainland of China equity index may have a leverage factor up to two times (2x), but the leverage factor cap of a Mainland of China equity index inverse product is limited to negative one times (-1x). Currently only a swap-based replication structure is accepted for leveraged and inverse products tracking Mainland of China equity indices – a futures-based replication structure is not yet acceptable. However, the SFC has indicated that it will continue to review the eligible replication structures for leveraged and inverse products for public sale in Hong Kong.

Tax law

Hong Kong has three separate types of income tax: property tax, salaries tax and profits tax. Of the three income taxes, profits tax is the most relevant to asset management funds, their investment managers and their investors. Unlike many other jurisdictions, Hong Kong does not have a separate capital gains tax regime.

Hong Kong stamp duty is chargeable on certain transactions.

i Profits tax – funds

Hong Kong adopts a territorial source principle of taxation.

Under the Inland Revenue Ordinance (IRO),⁶⁰ profits tax is charged on persons carrying on a trade, profession or business in Hong Kong; and in respect of income profits (and excluding capital gains profits) arising in or derived from Hong Kong from that trade, profession or business.

The Inland Revenue (Amendment) (No. 3) Ordinance was enacted on 29 March 2018 and introduced a two-tier tax regime. For the years of assessment from 2018–2019 onwards, the applicable rate of profit tax for corporations is 8.25 per cent for the first HK$2 million of profits and 16.5 per cent for profits over HK$2 million. The application of the two-tiered rates is restricted to only one enterprise nominated among connected entities.

Carrying on a trade, profession or business in Hong Kong

A low threshold is required to fall within the scope of carrying on a trade, profession or business in Hong Kong.

In some cases, a non-Hong Kong resident fund, by using a Hong Kong investment manager, may be regarded as falling within that scope. The non-Hong Kong resident funds exemption referred to below was introduced to alleviate this concern.

Note that the locality of a fund’s central management and control is not a determinative factor when considering whether it carries on a trade, profession or business in Hong Kong.

Income arising in or derived from Hong Kong

If the above test of carrying on a trade, profession or business in Hong Kong is satisfied, profits tax will (subject to exemptions) be chargeable if the income arises in or is derived from Hong Kong. This is a factual question that is determined by looking to see what the taxpayer has done to earn the relevant profit. A test often applied in difficult cases is where the operations take place from which the profits in substance arise. Note that the place where a taxpayer’s profits arise is not necessarily the place where he or she carries on business.

Inland Revenue Department guidelines and case law assist in determining the locality where income arises or is derived from. Two principles relevant to funds are as follows:

1. listed shares and other securities: profits from the sale of listed shares and other securities arise at the location of the stock exchange where those shares and other securities in question are traded; and
2. unlisted shares and other securities: profits from the sale of unlisted shares and securities arise at the place where the contracts of sale and purchase are effected (regardless of where the relevant issuer is incorporated or carries on business).

Exemptions to profits taxPublicly offered or authorised and regulated funds

The following types of fund are exempt from profits tax:

1. mutual funds, unit trusts and similar investment schemes that are SFC-authorised (and thus available for general distribution to the Hong Kong public); and
2. other mutual funds, unit trusts and similar investment schemes where the Commissioner of Inland Revenue is satisfied that the relevant fund is (1) bona fide widely held and (2) complies with the requirements of an acceptable non-Hong Kong supervisory authority. Further details on how the Commissioner of Inland Revenue applies (1) and (2) are set out in the Inland Revenue Departmental Interpretation and Practice Notes.⁶¹

Privately offered funds

The Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Ordinance 2019 was enacted on 1 April 2019, which unified the profits tax exemptions for privately offered funds so that they apply (for transactions in specified assets and subject to meeting certain conditions) equally to onshore and offshore funds, irrespective of their structure, location of central management and control, size or the purpose they serve, and to investments in both local and overseas private companies. The unifying changes therefore include the repeal of the specific profits tax exemption introduced for Hong Kong-incorporated OFCs, as well as amending the existing profits tax exemption for non-residents to carve-out entities falling within the new definition of fund in the IRO (which is largely similar to the definition of collective investment scheme in the SFO).

If an entity falls within the new definition of fund in the IRO, then its qualifying transactions and transactions incidental thereto (incidental transactions), or in the case of a Hong Kong-incorporated OFC all of its transactions, will be exempt from profits tax, provided:

1. the fund is a qualified investment fund;⁶² or
2. the qualifying transactions are carried out in Hong Kong by a specified person (being a corporation licensed by, or a financial institution registered with, the SFC), or arranged in Hong Kong by a specified person.

The above exemption does not apply to assessable profits earned from incidental transactions if the fund’s trading receipts from incidental transactions in a given tax year exceed 5 per cent of the total of the fund’s trading receipts from qualifying transactions and incidental transactions in such tax year.

Qualifying transactions are transactions in assets of a class specified in Schedule 16C to the IRO (Qualifying Assets), which include:

1. securities;⁶³
2. shares, stocks, debentures, loan stocks, funds, bonds or notes of, or issued by, a private company;
3. futures contracts;
4. foreign exchange contracts under which the parties to the contracts agree to exchange different currencies on a particular date;
5. deposits other than those made by way of a money-lending business, deposits made with a bank and certificates of deposit;
6. exchange-traded commodities;
7. foreign currencies;
8. OTC derivative products; and
9. an investee company’s shares co-invested by a partner fund and the Innovation and Technology Venture Fund Corporation (ITVFC) under the Innovation and Technology Venture Fund (ITVF) Scheme.⁶⁴

A key feature of the new profits tax exemption is the removal of the tainting features of the previous regime, such that the tax-exempt profits of a fund are not tainted even if such fund is taxed on its non-qualifying transactions.

The new exemption is available not only at the fund level, but also to special purpose entities (SPEs) set up by the fund for the sole purpose of holding and administering qualifying assets and carrying out transactions in such assets on behalf of the fund, to such extent as corresponds to the percentage of shares or interests that the fund holds in the SPE.

Certain measures have also been introduced to minimise the risk of tax evasion, including:

1. in respect of any private company in which a fund invests (other than a private company that directly or indirectly holds immovable property in Hong Kong, or share capital in another private company that directly or indirectly holds immovable property in Hong Kong), the profits tax exemption will not be available to the fund in respect of its investment in the company unless one of the tests below is satisfied:
   • the fund holds its investment in the company for at least two years (the holding period test);
   • the fund does not have control over the company (the control test); or
   • the company holds (directly or indirectly) short-term assets the aggregate value of which does not exceed 50 per cent of the value of the company’s assets (the short-term assets test); and
2. in respect of any private company in which a fund invests that directly or indirectly holds immovable property in Hong Kong, or share capital in another private company that directly or indirectly holds immovable property in Hong Kong:
   • if the aggregate value of such immovable property and share capital held by the private company exceeds 10 per cent of the value of its assets, then the profits tax exemption is not available to the fund in respect of its investment in the company; and
   • if the aggregate value of such immovable property and share capital held by the private company is equal to or less than 10 per cent of the value of its assets, then the profits tax exemption will not be available to the fund in respect of its investment in the company unless the holding period test, the control test or the short-term assets test is met.⁶⁵

On 30 June 2020, the Inland Revenue Department (IRD) published Departmental Interpretation and Practice Note No. 61 – Profits Tax Exemption for Funds (DIPN 61), which clarifies the IRD’s interpretation and application of the new unified profits tax exemption.

ii Profits tax – investors

The same general principles of profits tax discussed above in respect of funds also apply to the taxation of investors.

An investor, however, typically holds investments for investment purposes (rather than as part of a trade, profession or business). In such a case, profits or income derived from his or her investments fall outside the charge to profits tax. In addition to the above, specific exclusions may also apply, in particular, an investor’s gain from disposing of shares or units in a fund will usually be a capital gain (and therefore fall outside the charge to profits tax); and dividends received by an investor are not chargeable to profits tax.⁶⁶

iii Profits tax – fund managers

The same general principles of profits tax discussed above in respect of funds and investors also apply to the taxation of fund managers.

On 7 May 2021, the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Ordinance came into effect. This amended the IRO to introduce a concessionary zero per cent tax rate for carried interest paid by eligible private equity funds operating in Hong Kong to their managers. The concessionary tax treatment applies retroactively to eligible carried interest received by or accrued to qualifying private equity fund managers on or after 1 April 2020.

The concessionary treatment is available to private funds with an average of at least two employees in Hong Kong carrying out investment management services and at least HK$2 million of operating expenditure incurred in Hong Kong in each relevant year of assessment.

Eligible funds need to apply to the HKMA for certification⁶⁷ – this is a one-off test, based on whether the fund makes private equity investments and is likely to meet the local employment and spending requirements referred to above.

Qualifying transactions under the new regime are limited to shares, stocks, debentures, loan stocks, funds, bonds or notes of private companies, or shares or comparable interests in SPEs set up to hold such companies.

Eligible recipients include:

1. corporations licensed by or financial institutions registered with the SFC;
2. other persons providing investment management services in Hong Kong to a certified qualified investment fund;⁶⁸ and
3. employees of the foregoing persons providing investment management services in Hong Kong on behalf of such persons.

iv Double taxation agreements

As at 23 November 2021, Hong Kong had comprehensive double taxation agreements with Austria, Belarus, Belgium, Brunei, Cambodia, Canada, China, the Czech Republic, Estonia, Finland, France, Georgia, Guernsey, Hungary, India, Indonesia, Ireland, Italy, Japan, Jersey, Kuwait, Latvia, Liechtenstein, Luxembourg, Macau SAR, the Mainland of China, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Pakistan, Portugal, Qatar, Romania, Russia, Saudi Arabia, Serbia, South Africa, South Korea, Spain, Switzerland, Thailand, the United Arab Emirates, the United Kingdom and Vietnam. The terms set out in double taxation agreements take precedence over the other provisions of the IRO.⁶⁹

v Stamp duty

Stamp duty is chargeable on transfers of real property, the issue of certain bearer instruments and the transfer (but not the issue or redemption) of Hong Kong stock. In practice, stamp duty on Hong Kong stock is usually chargeable with respect to shares in Hong Kong-incorporated companies or companies listed on the SEHK. An interest in the recently introduced Hong Kong limited partnership fund vehicle is not Hong Kong stock for these purposes, and so transfers (and issuances and redemptions) of limited partnership fund interests should not be subject to Hong Kong stamp duty.

Although stamp duty may be chargeable on unit trusts, bonds and bearer instruments, these are often structured so as to fall outside the charge of stamp duty. For example, for Hong Kong unit trust schemes (other than those traded on the SEHK), most transfers do not incur stamp duty because they are effected through issuance of new units and cancellation of existing units by the manager of the scheme instead of sale and purchase between investors. Allotments, transfers and redemptions of shares in open-ended fund companies are treated for stamp duty purposes as if they were units under a unit trust scheme.⁷⁰ Stamp duty is also not chargeable on trading in ETF shares or units that are listed or traded on the SEHK.

Effective from 1 August 2021, the rate of stamp duty chargeable on the transfer of shares in a Hong Kong-incorporated or an SEHK-listed company is 0.26 per cent of the consideration for (or, in the case of gifts, the value of) the shares.⁷¹

Tax law4

Outlook

i Cooperation arrangements with the mainland and other jurisdictions

Hong Kong is expected to further develop its role as an offshore renminbi business centre, with the SFC continuing to promote offshore renminbi-denominated investment products in Hong Kong. The government’s focus is to strengthen Hong Kong’s offshore renminbi businesses by developing mutual market access arrangements and expanding investigatory assistance and the exchange of information. In particular, the SFC, the HKMA and the SEHK have formed a working group to explore and promote the trading of renminbi-denominated securities in Hong Kong.

Wealth Management Connect, a scheme for the Guangdong–Hong Kong–Macau Greater Bay Area, was launched in September 2021 by the People’s Bank of China, the China Banking and Insurance and Regulatory Commission, the China Securities Regulatory Commission, the State Administration of Foreign Exchange, the HKMA and the Monetary Authority of Macao. The purpose of Wealth Management Connect is to allow individual residents in the Greater Bay Area to carry out cross-boundary investment in wealth management products distributed by banks in the Greater Bay Area.

The scheme has a southbound and a northbound component, depending on the residency of the investors. A memorandum of understanding on the scheme was entered into on 5 February 2021, aiming to provide a framework for exchange of supervisory information and enforcement cooperation in the three jurisdictions.⁷²

Shanghai–Hong Kong Stock Connect and Shenzhen–Hong Kong Stock Connect were launched in 2014 and 2016 respectively as two-way arrangements under which Hong Kong and international investors can directly access the mainland A-share market, and mainland investors can directly access Hong Kong’s stock market. On 27 May 2022, the China Securities Regulatory Commission and the SFC jointly announced the implementation details for inclusion of eligible ETFs under Stock Connect.⁷³ The formal implementation is expected to take place around the end of July 2022. Once implemented, there will be mutual market access, and mainland and Hong Kong investors will be permitted to trade eligible stocks and ETFs listed on each other’s exchange through local securities firms or brokers. The HKSE has published a circular on the eligibility criteria of ETFs to be included in northbound and southbound trading.⁷⁴ Factors include fund size, turnover and whether the index tracked by the fund follows mainly eligible stocks on Stock Connect. In particular, mainland ETFs should have average daily assets of no less than 1.5 billion yuan over the past six months whereas Hong Kong ETFs should have an average daily asset value of no less than HK$1.7 billion over the past six months. Furthermore, the HKSE launched the MSCI China A 50 Connect Index Futures in October 2021, which allows international investors to manage their portfolios of eligible A shares on Stock Connect.⁷⁵ The underlying index includes 50 major names from the key stocks listed on the Shanghai Stock Exchange and the Shenzhen Stock Exchange.

In June 2022, the SEHK announced that mainland China and Hong Kong will launch a new ‘Swap Connect’ scheme in January 2023 to allow mutual access to interest rate swaps trading to promote financial derivatives markets. The scheme will deepen connectivity between mainland China and international markets.

Other initiatives include:

1. Bond Connect, an arrangement launched in July 2017 to enable mainland and overseas investors to trade bonds on the mainland and Hong Kong bond markets through the connectivity established between the financial infrastructure institutions in the mainland and Hong Kong;
2. the Mainland–Hong Kong MRF initiative launched in 2015, under which the China Securities Regulatory Commission and the SFC allow mainland and Hong Kong funds that meet the relevant eligibility requirements to follow streamlined procedures to obtain authorisation or approval for offering to retail investors in each other’s market; and
3. mutual recognition of funds arrangements entered into by the SFC with each of the Australian Securities and Investment Commission, the France Autorité des Marchés Financiers, the Securities and Futures Commission of Malaysia, the Netherlands Autoriteit Financiële Markten, the Swiss Financial Market Supervisory Authority, the Taiwan Financial Supervisory Commission, the Securities and Exchange Commission of Thailand and the UK Financial Conduct Authority. The agreements allow eligible Hong Kong public funds and respective foreign funds to be distributed in the other’s markets through a streamlined process. The SFC is continuing to explore MRF arrangements with other overseas jurisdictions.

ii Cryptocurrencies and other VAs

VAs have become part of mainstream finance. To address market developments, the SFC and the HKMA jointly published a circular on VA-related activities on 28 January 2022 to provide guidance on the distribution of VA-related⁷⁶ products, the provision of VA dealing services and the provision of VA advisory services.⁷⁷

There is mixed practice on the regulation of distribution of VA-related products (which is sometimes unregulated, regulated only for anti-money laundering and counter-financing of terrorism purposes or only subject to light touch regulation). The underlying assets of VA-related products are also often unregulated and are therefore more susceptible to risks such as lack of pricing transparency and potential market manipulation. The SFC and the HKMA consider VA-related products to likely constitute complex products and to fall within the complex products regime.⁷⁸ The SFC’s website contains a non-exhaustive list of examples of non-complex products and complex products. For better regulation, the SFC and the HKMA have introduced the following investor protection measures on the distribution of VA-related products:

1. Selling restrictions: VA-related products that are considered complex products should only be distributed to professional investors. This does not apply to VA-related derivative products that are traded on regulated exchanges set out in Schedule 3 to the Securities and Futures (Financial Resources) Rules⁷⁹ and exchange-traded VA derivative funds that are authorised or permitted to be offered to retail investors by the respective regulator in a designated jurisdiction. Intermediaries should ensure that the relevant selling restrictions in Hong Kong (such as the prohibition of offering investments to the Hong Kong public without the SFC’s authorisation) and other relevant jurisdictions are complied with.
2. VA knowledge test: intermediaries should check whether their clients have knowledge of investing in VA or VA-related products prior to executing any related transactions. If there is no requisite knowledge, an intermediary should only proceed if doing so would be in the client’s best interests and if it has informed and trained the client on the nature and the risks of the VA. Intermediaries should also check that their clients have sufficient funds to assume the risks and losses.

Intermediaries should also pay attention to suitability obligations such as ensuring that recommendations or solicitations are suitable for clients, conducting due diligence on the VA products and (where the VA-related product is a derivative product) ensuring compliance with the relevant provisions of the Code of Conduct.

The SFC and the HKMA also require intermediaries to use SFC-licensed VA trading platforms (licensed pursuant to Section 116 of the SFO) to provide VA dealing services and have specified that such services may only be provided to professional investors. This applies regardless of whether the VAs are securities and the provision of VA dealing services is subject to licensing or registration conditions.⁸⁰ Furthermore, only intermediaries licensed or registered for Type 1 regulated activities may provide VA dealing services.

Only intermediaries licensed or registered for Type 1 or Type 4 regulated activities are permitted to provide VA advisory services. The SFC and the HKMA’s regulatory requirements on providing advisory services apply to VA advisory services, regardless of the nature of the VA. In particular, intermediaries should follow the conduct requirements for VA-advisory services stipulated by the SFC and the HKMA.⁸¹ VA-advisory services should only be offered to professional investors, and intermediaries should consider the suitability obligations and conduct VA knowledge tests before providing such services.

These measures will apply after a six-month transition period for intermediaries with existing VA-related activities. Intermediaries who do not have existing VA-related activities will need to comply with all the requirements in the joint circular before providing such services.

In addition to the above, in July 2022 the government gazetted amendments to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance⁸² to introduce a licensing regime for VA service providers. Broadly, the licensing regime will cover cryptocurrency exchanges that would otherwise be unregulated under the SFO. This will cover, for example, bitcoin exchanges. At first, the exchanges may only provide services to professional investors. The new regime is expected to come into effect on 1 March 2023.

iii Proposed regulatory regime for depositaries of SFC-authorised collective investment schemes

On 27 September 2019, the SFC published a consultation paper on a proposed regulatory regime for depositaries (trustees and custodians) of SFC-authorised collective investment schemes. The consultation paper notes that trustees and custodians of public funds in Hong Kong are currently not subject to any specific licensing regime for, or direct ongoing regulatory supervision of, their trustee or custodial function for public funds; and that the lack of a specific, direct regulatory handle gives rise to practical difficulties in ensuring appropriate regulation and supervision of these entities in their provision of trustee and custodial services to public funds. In view of this, as part of the SFC’s asset management strategy to strengthen Hong Kong as an international, full service asset management centre and to enhance the regulation of public funds, the SFC proposes to introduce a new regulated activity under the SFO: Type 13 regulated activity (RA 13) – acting as a depositary (trustee or custodian) of an SFC-authorised collective investment scheme.

The proposed scope of RA 13 is intended to cover top-level trustees and custodians (i.e., the entity at the top of the custodial chain). For a relevant collective investment scheme structured in the form of a unit trust, this entity will be the trustee. For a relevant collective investment scheme structured in any other form such as an OFC authorised under the SFO or a mutual fund corporation, it will be the global or top custodian. A depositary’s nominees, agents and delegates, such as a sub-custodian or the global custodian appointed by a top-level trustee, will not fall within the proposed scope of RA 13. While top-level trustees and custodians may delegate their functions to third parties, the responsibilities of an RA 13 depositary with respect to these functions remain with the depositary.

The SFC released consultation conclusions on 22 February 2022 and the market generally responded positively to the proposals, which, if implemented, would enhance Hong Kong’s position as a leading asset management centre. However, there were questions on the scope of RA 13 and its application to individuals who are staff of a depositary and comments on the requirements of the depositaries in the proposed schedule to the Code of Conduct. Ahead of implementation, the SFC is launching another consultation on the proposed amendments to subsidiary legislation and the SFC’s codes and guidelines.⁸³

iv Climate change

The SFC published consultation conclusions on 20 August 2021 on the proposed requirements for fund managers to take climate-related risks into consideration in their investment and risk management processes and make appropriate disclosures to meet investors’ growing demands for climate risk information and combat greenwashing.⁸⁴ Following the consultation, the SFC will amend the FMCC to set out expected baseline requirements and standards to facilitate fund managers’ compliance.⁸⁵ The climate-related risk requirements apply to fund managers with investment management discretion over collective investment schemes. Additional measures apply to fund managers that have investment management discretion over funds equal to or in excess of HK$8 billion (large fund managers). The baseline requirements and enhanced standards cover four areas: governance, investment management, risk management and disclosure as outlined below:

1. Governance: fund managers should define the board or the board committee’s role in overseeing the incorporation of climate-related considerations into investment and risk management processes, check progress with respect to goals on climate-related issues, determine how the board or board committee carries out these roles (i.e., processes, frequencies). Fund managers should also allocate roles and responsibilities to management-level positions or management committees and establish policies and procedures to manage climate-related risks and develop action plans to achieve climate-related goals.
2. Investment management: fund managers should identify climate-related risks for their investment strategies and funds that they manage and incorporate climate-related risks into the investment management processes. Furthermore, fund managers should take reasonable steps to assess how climate-related risks will affect the performance of underlying investments.
3. Risk management: fund managers should incorporate climate-related risks in their risk management procedures and ensure that appropriate steps have been carried out to identify, assess, manage and monitor (using appropriate tools and metrics) relevant and material climate-related risks for each investment strategy and fund they manage. In addition, large fund managers should comply with enhanced measures, which include:
   • assessing the relevance and utility scenario analysis with respect to the resilience of investment strategies to climate-related risks and developing plans to implement scenario analysis where relevant; and
   • taking reasonable steps to identify the carbon portfolio footprints of the Scope 1 and Scope 2 greenhouse gas emissions associated with the funds’ underlying investments and defining the calculation methodology and underlying assumptions.
4. Disclosure: fund managers should generally adopt a proportionate approach and make adequate disclosures of information to their fund investors. Disclosures should be reviewed at least annually and updated whenever appropriate. Fund managers should also ensure that (1) their governance-related disclosures describe the governance structure, the board and management’s roles and oversight with respect to climate-related risks and issues, and (2) their investment management and risk management-related disclosures cover the steps taken to incorporate relevant and material climate-related risks into the investment management process and processes (including tools and metrics) for identifying, assessing, managing and monitoring climate-related risks (and to disclose exceptions if the climate-related risks are deemed to be irrelevant), at the entity level. Enhanced standards that apply to large fund managers include describing the engagement policy at the entity level and providing portfolio carbon footprints of the Scope 1 and Scope 2 greenhouse gas emissions relating to a fund’s underlying investments at the fund level and indicating the calculation methodology where possible.

The amendments will become effective for fund managers on 20 November 2022 and large fund managers on 20 August 2022 (with respect to the baseline requirements) and 20 November 2022 (with respect to the enhanced standards).