Streamlined requirements for eligible ETFs adopting a master-feeder structure
Introduction
On 16 December
2019, the Securities and Futures Commission (“SFC”) first introduced in its circular a streamlined approach with
regard to the authorization of index tracking feeder exchange traded funds (“ETF”) adopting a master-feeder
structure (the “2019 Circular”).
Since then, an SFC-authorized feeder ETF may invest its assets in an
overseas-listed master ETF without SFC authorization when the requirements
provided in the 2019 Circular are met. With a view to offer more investment
choices to investors, the SFC has recently conducted a review and issued a
supplemental circular on 25 February 2022 to further streamline the
requirements for eligible ETFs adopting a master-feeder structure as set out in
the 2019 Circular (the “Supplemental
Circular”, and together with the 2019 Circular, the “Circulars”).
Background
In general, funds that are offered to the public in Hong Kong are
subject to the prior authorization of the SFC pursuant to the Securities and
Futures Ordinance (Cap. 571) (“SFO”)
and the ETFs listed on The Stock Exchange of Hong Kong Limited are of no
exception. The SFC’s Code on Unit Trusts and Mutual Funds (the “UT Code”) sets out the basic
requirements that an SFC-authorized fund must comply with. It is provided under
Chapter 7.12 of the UT Code that a fund will be authorized by the SFC as a
feeder fund provided that it is investing 90% or more of its total net asset
value in a single collective investment scheme which must be a master fund
authorized by the SFC. This in turn means that an index-tracking ETF adopting a
master-feeder structure would only be permitted if both the feeder ETF and the
master ETF are authorized by the SFC.
However, with the procedures for obtaining SFC authorization being
onerous and often expensive, many master ETFs already listed overseas, despite
them having met the listing requirements in their respective home jurisdictions
with long-standing establishments, could not nevertheless be used for setting
up index-tracking ETFs adopting a master-feeder structure in Hong Kong due to
the stringent requirements under the UT Code. As the industry has been asking
for more flexibility in this regard, the SFC has, in the 2019 Circular which is
now to be read together with the Supplemental Circular, offered to
allow an SFC-authorized index tracking feeder ETF to invest its assets in an
unauthorized overseas-listed master ETF if certain conditions are met.
General principles
According to the Circulars, the SFC authorization will be given
on a case-by-case basis and taking into account the following two principles:
1. there are satisfactory safeguards and measures in place to address
investor protection concerns; and
2. there are demonstrable benefits to the Hong Kong market, taking into
account factors such as the size and significance of the master ETF, its track
record and whether its underlying index is acceptable to the SFC.
Requirements
Master ETF
The
master ETF should, at a minimum, meet the following key requirements pursuant
to the Circulars:
1. the master ETF
must be a scheme regulated in a recognized jurisdiction. Currently, schemes
already in compliance in substance with certain provisions of the UT Code by
virtue of prior authorizations obtained in recognized jurisdictions like
Australia, France, Germany, Malaysia, Netherlands, Switzerland, Taiwan,
Thailand, the UK and the USA are among those that are recognized by the SFC in
this respect;
2. the master ETF must also be managed by a management company in an
acceptable inspection regime or a scheme eligible under a mutual recognition of
funds arrangement;
3. the master ETF, together with its management company and
trustee/custodian, must have a good compliance record with the rules and
regulations of its home jurisdiction and for the master ETF itself, the listing
venue;
4. the master ETF must have a fund size of not less than USD 400
million and a track record of more than 1 year at the time of the feeder ETF’s
listing on the Stock Exchange of Hong Kong. This requirement has been relaxed under
the Supplemental Circular in contrast with the prior fund size and track record
requirements of not less than USD 1 billion and more than 5 years respectively;
5. the master ETF must adopt
physical replication of the underlying index through either a full replication
or a representative sampling strategy; and
6. the master ETF’s engagement in securities
financing transactions should not exceed 50% of its total net asset value unless there are
comparable safeguards and disclosure.
Feeder ETF
An index
tracking feeder ETF investing in an overseas-listed master ETF seeking SFC
authorization in reliance on the streamlined approach for public offering in
Hong Kong should meet the following requirements:
1. the feeder ETF must be a Hong
Kong-domiciled ETF authorized by the SFC and be managed
by a management company which is licensed or registered for Type 9 regulated
activity and has a good compliance record;
2. the management company of the feeder ETF should report to the SFC as
soon as practicable if the master ETF ceases to comply with the requirements
set out in the Circulars and take appropriate remedial action to promptly
rectify the situation; and
3. the management
company of the feeder ETF should put in place appropriate arrangements to
inform Hong Kong investors of any material change to, or event that has a
significant adverse impact on, the master ETF in a timely manner.
In any
event, the feeder ETF should also comply with the applicable requirements in
the Overarching Principles Section and the UT Code, Investment-Linked Assurance
Schemes and Unlisted Structured Investment Products and all other applicable
regulatory requirements and guidelines as may be issued by the SFC from time to
time.
Conclusion
As expressed by the SFC in the Circulars, the
streamlined approach is expected to facilitate the growth of the Hong Kong ETF
market while maintaining an appropriate
level of investor protection. It is anticipated that, with the more relaxed
regime now in place, greater flexibility is given to ETF issuers and asset
managers to set up index-tracking ETF adopting a master-feeder structure that
invests in an overseas-listed master ETF such that more investment choices
could be offered in the Hong Kong market in which is to the benefit of retail
investors.
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Important: The law and procedure on
this subject are very specialised and
complicated. This article is just a very general outline for reference and
cannot be relied upon as legal advice in any individual case. If any advice
or assistance is needed, please contact our solicitors. |
Published by ONC Lawyers © 2022 |