In Asia, many hedge funds have traditionally been the preserve of private banking customers and distributed through private placement, and had a very high minimum investment, effectively targeting only high net worth investors and out of reach of the majority of retail investors. In 2002, to facilitate access by retail investors to hedge funds without opening up a loosely regulatedenvironment, both Hong Kong and Singapore, through their respective regulatory bodies – the Securities and Futures Commission in Hong Kong (SFC) and the Monetary Authority of Singapore (MAS), introduced specific guidelines and regulations to allow the sale of hedge funds to retail public investors. This move has created a major boost to the amount of hedge fund assets, as well as the number of available hedge funds and their investors.
This article draws a comparison between Hong Kong and Singapore as hedge fund management centres, focusing on the regulatory framework, the policy initiatives and the available strategies of these jurisdictions. Although both of these international financial centres have different characteristics, in terms of the sectors represented, trading patterns, costs and strategies used, they have similarities as well, such as the quality of communication technology and infrastructure, the availability of quality brokerage, legal and accounting services, the regulatory environment, low taxation rates, and the demand of the hedge fund products by individuals and businesses in each jurisdiction.
This article will then look briefly at the emerging hedge fund market in China.
Generally, in comparing whether Hong Kong or Singapore is a preferred hedge fund management centre, one should look at the driving forces of the market, the types of strategies, the costs, the regulatory and policy framework and crucially, the taxation regimes.
The growth of the Hong Kong fund industry is largely driven by the fact that it is a relatively large, liquid and accessible market, completely open to foreign investment. Its fund management business is dominated by international firms establishing offices in the territory, and local-based managers play a relatively small though increasing role. Fig.2 shows that funds sourced from the non-Hong Kong investors have consistently accounted for over 60% of the fund management business in Hong Kong.
Although the Hong Kong government has subjected the industry to regulation, it has not sought to deliberately promote the industry through its policy framework. Singapore, on the other hand, adopts a government-led economic philosophy, and since the 1990s, its government continues targeting the development of the fund management as a key area for development of Singapore's financial sector.
The MAS is very successful in promoting the growth of the hedge fund industry, by providing a range of incentives to encourage international fund managers to set up and operate in Singapore. For example, Singapore attracts managers by offering a more comfortable life style and an easier licensing application procedure than many other jurisdictions, including Hong Kong.
A distinct advantage for Hong Kong is its close proximity to China. Hong Kong is thus a natural choice for hedge fund managers who wish to trade using Chinese jurisdictional strategies, and a place where many major Chinese companies are running their internal hedge fund businesses. Singapore, on the other hand, while having a smaller industry than Hong Kong, provides managers with different investment strategies particularly aimed at those with an Indian, Japanese and Korean jurisdictional focus.
In authorising the sale of hedge funds to retail investors in Hong Kong, in 2002, the SFC issued guidelines on the regulatory requirements for the sale and the on-going reporting obligations, as well as a circular to financial intermediaries on their obligations to assess whether hedge funds are suitable investments for their clients. Hong Kong, with a tighter and more comprehensive regulatory scheme, provides protection for hedge fund investors, especially retail investors who may not have enough skill and knowledge to invest in the more sophisticated vehicles.
Singapore's regulatory environment is comparatively more relaxed for hedge fund managers to set up and operate compared to other regional locations, and is very friendly for boutique operations. The government continues to come up with policies that put Singapore's investment fund industry in a highly competitive environment for foreign investors.
Although compared to Singapore, Hong Kong is ahead as a fund management centre in terms of business volume, it has a higher cost structure, especially the direct business costs, as well as a stricter regulatory regime. In Singapore, hedge funds can be set up in a week, whereas in Hong Kong it can take as long as four months to obtain a licence from the SFC to operate as a hedge fund manager.
It has been questioned whether Hong Kong can continue to be a popular jurisdiction for the hedge fund market or even as an international financial centre, when there are only 39 years left before the end of the 'One Country, Two Systems' principle. This principle was proposed by the former Chinese leader Deng Xiaoping to allow Hong Kong to retain its financial and economic system with a high degree of autonomy for at least 50 years after reunification in 1997. With a continuing increase of personal wealth and the Chinese government working to advance economic development and promoting foreign financing and imports, in the absence of significant change in political circumstances, there is no doubt that Hong Kong's hedge fund market will continue to flourish after the 2047 deadline.
Recently, in competing for the position of being the most tax-friendly jurisdiction for setting up a hedge fund, as well as attracting the expansion of established hedge funds from the US and Europe into the Asia Pacific region, both Hong Kong and Singapore have changed their tax exemption regime for hedge funds.
In Hong Kong, with the introduction of the new law on profits tax exemption for offshore funds in 2006, offshore funds would, if specific requirements are complied with, be exempted from potential profits tax liability in respect of certain transactions. Offshore funds with investment managers or investment advisers in Hong Kong who have full discretionary power would be exempted from profits tax on profits derived in Hong Kong from six types of specified transactions if they are carried out or arranged by specified persons.
However, if an offshore fund is tax exempt under the new law, certain Hong Kong resident investors are deemed to have derived assessable profits from the fund even when no distribution has been made. These deeming provisions would not apply where the fund is bona fide widely held.
Previously, funds that met certain criteria were protected from Singapore tax even if the discretionary management of the funds was carried out in Singapore. This tax exemption regime required (inter alia) not more than 20% of the total value of the issued shares of the fund (where it is a company) to be owned by Singapore citizens or residents. This is often referred to as the '80:20 rule'. From 1 September 2007, subject to conditions, the above tax exemption schemehas been liberalised and the '80:20 rule' has been removed to give certainty to tax exemption to foreign investors whose funds are managed in Singapore and provide fund managers based in Singapore with greater flexibility in sourcing for mandates from investors.
Although China is still arguably not a very popular place for the establishment of hedge funds because of its regulatory environment and taxation regime, nevertheless, it is home to many investment opportunities.
Traditionally, overseas hedge funds are not common in China but there have been positive signs that Chinese regulators take a practical and progressive approach towards hedge funds setting up there. Hedge funds are now very active in investing in China, driven by its economic growth, opening of the financial markets and the strength of the currency.
The number of existing hedge funds in China has increased from 14 in 2001 to 89 in 2007, and the total assets under management have increased from US$0.184 billion to US$12 billion in the same time. This is the result of the China's strong economy and the government's proactive approach to stimulating domestic demand for hedge funds.
The Chinese fund industry is now growing so rapidly that if the current trends continue it will soon become a net exporter of capital. Recently, the Qualified Domestic Institutional Investor (QDII) scheme, has been a hot topic across the fund industry in Asia. This allows Chinese financial institutions to invest their clients' money in markets outside China, subject to specific restrictions. Initially, such funds invested only in low-risk, low return currency markets and bonds but, in September 2007, China's first stock-oriented fund under the QDII scheme was launched. This fund is available, after a maximum three-month lock-up period, for redemption and purchase on a daily basis, with its net asset value published on every trading day. It can invest in 48 overseas equity markets including Hong Kong, US and Japan.
Both Hong Kong and Singapore have their own distinct advantages as hedge fund management centres. Whilst the Singapore government is more active in promoting the hedge fund industry through its policy framework and has a more relaxed regulatory environment for the hedge fund mangers to set up and operate, Hong Kong has a tighter and more comprehensive regulatory scheme and thus provides protection for hedge fund investors. Both Hong Kong and Singapore have very favourable taxation regimes for the provision of offshore hedge fund services and offshore hedge fund investors. In China there are many investment opportunities and its fund industry is growing rapidly. With Chinese regulators taking a practical and progressive approach towards the creation of hedge funds and increasing policy initiatives to develop its legal and capital markets, it will not be long before China becomes a giant in the hedge fund markets in Asia and globally.
Judy Lee is a partner in the corporate and commercial practice at the Hong Kong office of leading offshore law firm Appleby