By Chen Sheng, Shen Di   King & Wood Mallesons’ Dispute Resolution Group

Armstrong ChenBackground

On 22nd May, 2015, China Securities Regulatory Commission (CSRC) officially signed a Memorandum of Regulatory Cooperation on the Mainland-Hong Kong Mutual Recognition of Funds Scheme (the Scheme) with Hong Kong Securities and Futures Commission (SFC), and at the same time issued the Interim Provisions for Recognised Hong Kong Funds (Interim Provisions). The Interim Provisions will be implemented since 1st July, 2015, and the initial investment quota is set at RMB 300 billion for funds flow between Hong Kong and mainland each way.

Essentially, the Scheme aims at providing new opportunities for the assets management business in mainland and Hong Kong, providing investors with more diverse fund product choices. It shall trigger significantly more capital flow among the stock markets in mainland and Hong Kong, and thus bringing mid-long term good news into both A Shares and H Shares stock exchanges. Presently the market valuation of Hong Kong stock exchange is relatively low, while the new capital flow (from mainland) may bring a new round of growth; Similarly, the foreign capital flowing into mainland market will also increase the capital supply therein, and in the light of the activist state of mainland domestic market, such new funds may be of an impetus effect in the long run. Last but not the least, the Scheme in order to balance the interests of different stakeholders, imposes strong information disclosure and compliance requirements on the fund product in order to protect investors. Having that said, there are some points to note for any recognised Hong Kong Fund (RHKF) to launch in mainland successfully.

Considerations on the choice of fund manager

1. The collaborative model for launching RHKF

Article 3 of the Interim Provisions provides that the management firm of RHKF shall appoint a qualified institution in mainland as its agent to manage the operation of the funds in mainland. Previously, there is no such a term as “fund agent” in China, but only “fund custodian” and “fund distribution agent”. According to the Law of Securities Investment Funds of PRC, assets of a particular fund must be kept by a particular custodian independent from the management firm (Manager), and such custodian must perform duties of keeping safe custody, handling clearance and settlement of funds, as well as relevant supervisory responsibilities. In China, only commercial banks which are lawfully established and acquired funds custodian qualifications are eligible to become fund custodians, while fund distribution institution refers to an agent of the Manager, who represents the Manager to sell fund units to investors. Funds distribution agents are usually commercial banks, securities companies or trustee companies.

The Interim Provisions differentiates the Manager, the fund agent (Agent) and the fund distribution institution, authorising the Manager to enter into distribution agreements with mainland distribution institutions on its own or via the Agent. Generally speaking, “Managers” refer to fund houses, namely Hong Kong fund houses, while “distribution institutions” refer to three types of eligible sales agents in mainland. According to Articles 19 and 21 of the Interim Provisions, the Agent shall be licensed by CSRC to manage or keep custody of publicly offered funds, and its main duties include: Acting for registration of product, information disclosure, arrangements for sale and distribution, exchange of data, fund settlement, provision of supervisory reports, correspondence and liaison, provision of customer service and supervisory control. According to these requirements, eligible Agents are likely to be mainland commercial banks.

Meanwhile, the relevant legislation does not provide a clear answer as to whether the Agent and the distribution institution must be two different institutions. Thus, reply from relevant supervisory bodies on whether a commercial bank can act as both Agent and distribution institution for a particular RHKF must be sought. If the answer to the query should be affirmative, the collaborative model will indeed be able to efficiently maximise profit and minimise procedure costs. Then those qualified Hong Kong Banks could accept authorisation from all Hong Kong fund houses, appointing its mainland subsidiaries to become Agents, who can then keep custody of and sell the RHKF.

2. Relevant considerations before the appointment of RHKF Manager

According to the Interim Provisions, the investment and operation of RHKF, and its sale and information disclosure documents must comply with Hong Kong laws, while the sale in mainland market must comply with relevant Chinese laws. Therefore, three relevant considerations would need to be taken into account by the Manager of RHKF before the successful launch of project:

• Firstly, whether the RHKF itself satisfied the relevant regulations of SFC;

The first consideration notes that any RHKF is set up and operates in Hong Kong, and thus is subject to the scrutiny of SFC.

• Secondly, whether the application for the registration of RHKF to CSRC satisfied the five conditions listed in Article 4 of the Interim Provisions;
The five conditions to be satisfied by the registration application under the second consideration are:

(1) The fund itself is established and operates in Hong Kong, approved to be distributed publicly under SFC scrutiny;

(2) The Manager is licensed by SFC to conduct Type 9 (Asset Management) regulated activities, whose investment management activities are not delegated to entities in any other jurisdiction. The Manager has not been the subject of any major regulatory action by SFC in the past 3 years or, if it has been established for less than 3 years, since the date of its establishment;

(3) A trustee and/or a custodian who satisfy the requirements set out by the SFC are appointed;

(4) The fund falls into one of the following types: equity funds, hybrid funds, bond funds and index funds (including exchange traded funds);

(5) The fund must have been established for more than one year, with no less than RMB 200 million (or equivalent in other currencies) assets under management, among which assets raised from distribution in mainland must be no more than 50%.

• Thirdly, whether the Agent, the appointed mainland commercial bank, satisfied the requirements provided by Chinese laws in terms of its institutional qualification, business management and personnel qualifications, and also whether the bank has effective internal control.

The third consideration notes that based on the long term development goal of fund companies, it is desirable for realising the compliance requirements amid the distribution of funds to choose a commercial bank that has good performance in its general business, human resources and internal control as a distribution institution.

Compliance considerations for domestic distribution institutions

On the other hand, the legal arrangements for distribution of RHKF by mainland commercial banks have been in a mess. There has been no clear answer on either the applicable regulations or which body should take the lead and supervise, for the scrutiny over the financial groups formed by business on securities funds of commercial banks.

However, recently the China Banking Regulatory Commission (CBRC) issued the Notice on Strengthening Management over Distribution Conducted by Commercial Banks (Notice), addressing issue on fund distribution by commercial banks. The Notice sets out that commercial banks can only engage in distribution of RHKF after acquiring approval from the relevant supervisory body. Meanwhile, the market promotion of distributed product is strictly regulated: The name and logo of the partner institution must be clarified, while the name and logo of the commercial bank should not appear on the product lest the investors would be misled. Also, RHKF product in mainland must be structured in compliance with SFC requirements and applicable Hong Kong laws, with necessary modifications and supplements to address risk factors and information specific to the mutual recognition scheme. Lastly, the personnel employed for distribution must be properly qualified, and the bank should ensure that its internal control mechanisms, such as the fire wall, should operate in good order in all times.

Recently, CBRC has also issued the Method for Regulating Funds Distribution by Commercial Banks (Draft) (Draft Method) to the Chinese banking system. The Draft Method specifies that, commercial banks should conduct white or black list management on their partner institutions, examining their qualifications and state of management. Banks shall not provide guarantee in any form for the distributed product, or intervene in the investment operation process of the product, and thereupon prevent the product realisation risk and operation risk from shifting to banks themselves. In a word, commercial banks will need to conduct stringent investigation on RHKF before engaging with the funds’ mainland distribution, rely on good internal control mechanism for risk control amid the distribution, and conduct evaluation afterwards in order to determine whether it is desirable to continue cooperation in the future.


For Hong Kong domiciled funds, the pre-requisite for successful launch in mainland is that the RHKF to be distributed in mainland must comply with the relevant SFC regulations as well as the Interim Provisions. Any collaboration is bilateral, and the mutual recognition of funds is no exception. From the Manager’s perspective, he would want to select eligible commercial banks in mainland that comply with the Draft Method as distribution institution; and from the mainland commercial bank’s perspective, due to the complexity and special characteristics of funds distribution, he would want to conduct strict pre-launch investigation, effective risk control and follow-up evaluation for any RHKF project. The process is a bilateral one in terms of understanding and evaluation. Indeed, in the light of the nature of the process, it is not unreasonable for parties to conduct due diligence investigation. However, that would significantly hampered the realisation of the vital goal of the Scheme, namely facilitating the cross-border investment between mainland and Hong Kong. Therefore, parties are advised to elect their preferred method of provision of lists of materials and relevant qualification documents, improve quality of inter-party instant communication, information disclosure and provision of timely responses, and such that they may develop mutual understanding, reduce risks, better preserve the interests of investors, and ultimately achieve a win-win situation.

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