In the blizzard of increased regulation from the United States and European Union, in particular the Dodd Frank Wall Street Reform and Consumer Protection Act and the Alternative Investment Fund Managers Directive (AIFMD), Asia’s two competing international financial centres – Hong Kong and Singapore, have traditionally taken different approaches to the further regulation of hedge fund managers. In the former, since the enactment of the Securities and Futures Ordinance (SFO) in 2003, no exempt status has been available. In the latter, there has long been an exemption for hedge fund managers. In the Special Administrative Region, since the global financial crisis the licensing regime has remained unchanged while in the ‘Lion City’ the regulatory regime is undergoing fundamental reform.
Following the Review of the Regulatory Regime for Fund Management Companies and Exempt Financial Intermediaries issued in April 2010, the Monetary Authority of Singapore (MAS) published in September 2011 a further consultation paper Proposed Enhancements and Draft Legislative Amendments to Give Effect to the Regulatory Regime for Fund Management Companies (Second Consultation) seeking comments on its proposed revised regime for the regulation of Fund Management Companies (FMCs) based in Singapore. The Second Consultation, which updated some of the legislative changes proposed in the first and also suggested some other measures closed in October 2011. The proposed legislative amendments (Proposed Changes) are expected to take effect during the first half of 2012. If adopted in their current form the Proposed Changes may have significant consequences for both those considering launching a FMC based in Singapore and also for existing FMCs located in Singapore.
While the exact scope and effect of the changes remains to be seen, the Proposed Changes are a move away from the MAS’s relatively light touch regulatory policy and would increase the regulatory requirements with which FMCs of all types need to comply. The Proposed Changes will align the regulatory regime in Singapore more closely with the regulatory framework in place in other financial hubs, such as Hong Kong. However, the requirements of Singapore’s new regime will have cost and time implications for all FMCs, including for larger FMCs which may already be required to hold a Capital Markets Services (CMS) licence or which may have applied for a licence voluntarily.
This article sets out a brief review of the requirements for fund managers in each of Hong Kong and Singapore and a comparison of the areas of the regulatory regime in Singapore which are set to change with the equivalent requirements of an entity licensed in Hong Kong.
Current licensing requirements
Currently individuals or entities conducting fund management activities in Singapore must either hold a CMS licence or be exempt from holding such a licence. Under the present law, a FMC in Singapore who undertakes fund management on behalf of not more that 30 ’qualified investors’ may be exempt provided: (1) that the relevant exemption criteria under the Securities and Futures Act of Singapore (SFA) is met; and (2) it is fit and proper with the relevant expertise and skills to provide fund management services to investors. For this purpose, a ‘qualified investor’ includes an accredited investor or a fund offered in Singapore (e.g. a hedge fund) whose underlying investors are all accredited investors (an ‘accredited investor’ is an individual whose net assets exceed S$10 million (approximately US$8 million)). A fund not offered in Singapore may be a ‘qualified investor’ where such an offer is made outside of Singapore only to accredited investors or to investors in an equivalent class under the laws of the jurisdiction in which the offer is made.
As many hedge funds qualify as one qualified investor, this exemption is currently relied upon by many hedge fund managers and sub-managers operating in Singapore. Under the current regulatory regime, entities which operate under the exemption from the requirement to hold a CMS licence are subject to less extensive requirements than those which apply to those which do. However, the Proposed Changes will cause all FMCs to be regulated in some form regardless of their regulatory status.
Under Hong Kong’s equivalent to the SFA, the Securities and Futures Ordinance, if an individual or entity carries out any regulated activities in Hong Kong then it must be licensed by the Securities and Futures Commission of Hong Kong (SFC). There is no exempt status, as is currently available in Singapore, and the type of license required depends upon the type of regulated activity to be carried out although most fund managers operating in Hong Kong are required to have a Type 9 (asset management) licence. In the past this has provided an incentive for smaller hedge fund start ups to locate in Singapore.
Proposed changes in Singapore
The Proposed Changes, once in force, will mean that an FMC (including an FMC exempt from the need to hold a CMS licence) with assets under management (AUM) of less than S$250 million (approximately US$195 million) will be regulated in different bands. Three new categories of FMC will be created as follows:
- Registered FMC – An FMC whose AUM does not exceed S$250 million and which does not serve more than 30 qualified investors (of which not more than 15 are funds whose underlying investors must all be accredited investors). This is the successor status to the old exempt FMC regime and was previously described by the MAS as ‘Notified FMC’. Like the exempt FMC, a Registered FMC will notify the MAS only. However, notwithstanding this, it is now to be subject to (i) eligibility criteria, (ii) business conduct rules, and (iii) capital requirements (although a Registered FMC does not hold a CMS licence). Once the AUM of an FMC rises above S$250 million it is required to become either an A/I LFMC or a Licensed Retail FMC – see below;
- Licensed Accredited/Institutional FMC (A/I LFMC) – An FMC which serves only accredited and/or institutional investors. The underlying investors of funds managed by an A/I LFMC must all be accredited investors and/or institutional investors. An A/I LFMC may apply for a CMS licence if it meets the relevant criteria.
- Licensed Retail FMC – An FMC which serves all types of investors, including retail investors. Such an FMC may also only commence business following the grant of a CMS licence.
Accordingly any exempt FMC, currently able to take the benefit of the existing exemption criteria under the SFA, will be classified as a Registered FMC. However, it will no longer be able rely on that status in the event that its AUM exceeds S$250 million. While such an FMC will not necessarily be subject to the full requirements of the amended SFA, a new FMC wishing to market a fund or other investment vehicle to retail investors will now have to comply with additional requirements which previously it might have been possible to avoid.
Other Singapore requirements
Working capital requirements
Following the implementation of the Proposed Changes, a Registered FMC will be required to maintain base capital of at least S$250,000 (approximately US$195,000) at all times. This is the same base capital requirement which currently applies to all holders of a CMS licence for fund management which serve only accredited investors and/or institutional investors. Compared to the exempt FMC status, this is a significant change.
In Hong Kong the SFC requires that an investment management business registered for Type 9 (asset management) regulated activities under the SFO must maintain a minimum liquid capital of HK$120,000 (approximately US$15,400) in Hong Kong at all times. Minimum paid up share capital requirements also apply where client assets will be held by the licensed entity. However, most funds managed or advised by Hong Kong based fund managers and investment advisers appoint third party custodians and so this requirement usually does not apply, i.e. there are in effect no paid up capital requirements for hedge fund managers.
A Licensed Retail FMC will be required to hold an additional base capital of 10% of the 3-year average of gross income (from which staff bonuses, commission expenses and interest expenses may be deducted) rather than 10% of the annual revenue of the most recent financial year, subject to a minimum of S$100,000 (approximately US$80,000). By contrast, a retail fund manager in Hong Kong must have a paid up share capital of not less than HK$1 million (approximately US$130,000) although if such a fund manager needs to hold client assets the minimum paid up capital requirement increases to HK$5 million (approximately US$640,000).
Currently, an exempt FMC is not required to maintain a minimum capital base. Therefore, the start-up costs of a Registered FMC wishing to launch in Singapore will be significantly increased. Running costs of established FMCs currently operating under an exemption will also be increased.
At present a holder of a CMS licence in fund management is required to appoint: (i) at least two directors with experience in the financial services industry, including managerial experience in a supervisory capacity; and (ii) a minimum of two Singapore representatives. This is similar to the requirements in Hong Kong in relation to the appointment under the SFO of Responsible Officers (ROs) by a licensed entity.
Under the MAS proposals, a Registered FMC (which would currently be exempt from the need to hold a CMS licence) will now be required to employ on a full time basis at least two Singapore residents each of whom must have at least five years relevant experience. These individuals may also be the relevant FMC’s representatives but one must be appointed as the chief executive officer (CEO) and also be an executive director of that FMC. By way of example, if the two directors of a Registered FMC are also portfolio managers they could each act as a representative. Licensed A/I LFMCs are subject to the same director and staffing requirements. Although not currently a requirement for an exempt FMC, these proposals are broadly reflected in the MAS’s ‘guidance’ set out in its Frequently Asked Questions relating to exempt FMCs with which the exempt FMCs are presently encouraged to comply. A Licensed Retail FMC will have a higher burden and will be required to employ three full time Singapore resident representatives and its CEO must have at least 10 years relevant experience. In addition, the CEO, directors and representatives of an FMC must satisfy the MAS’ ‘fit and proper’ guidelines.
Currently, an appointed representative of an FMC which holds a CMS licence is also required to sit and pass relevant modules of the Capital Markets and Financial Advisory Services (CMFAS) examinations, although exemptions are available for individuals who possess specified qualifications and experience or who confine their regulated activities to a limited segment of the market. Continuing education requirements also apply. Representatives of an exempt FMC are not required to take CMFAS examinations and this is not expected to change. However, a new examination module is proposed which will test the knowledge of securities and futures of those who handle or transact in “Specified Investment Products” as part of their fund management activities. The requirement to take this exam applies both to current and new representatives of Licensed Retail FMCs.
In Hong Kong all front office staff of a licensed corporation must usually be licensed as accredited licensed representatives. Each licensed corporation must also appoint as an RO, two licensed representatives with necessary experience approved by the SFC. Of the ROs, at least one must be available in Hong Kong (i.e. be resident) and one must be a director of the licensed corporation. All executive directors of a SFC licensed corporation must usually be ROs. There are exam requirements for an RO although these may be waived for an RO residing overseas in certain circumstances. Under the SFO each RO is generally required to possess at least three years relevant industry experience over the six years immediately prior to the date of the application. (Where an RO is not in possession of a recognised academic or industry qualification that RO must satisfy the SFC that he has five years of relevant industry experience over the past eight years). For a retail fund manager there is an additional SFC requirement that the licensed corporation has not less than two key personnel (who can be the ROs) each of whom must have not less than five years fund management experience in respect of regulated (i.e. public) funds.
On balance the Proposed Changes suggest that Singapore’s new regime as regards key personnel/principals of hedge fund managers is being significantly tightened with higher barriers to entry for a Registered FMC than those in Hong Kong.
Currently an FMC holding a CMS licence is required to appoint an independent auditor to audit its financial statements on an annual basis although an exempt FMC has not been so required. Under the Proposed Changes, a Registered FMC (although still not a holder of a CMS licence) will also be subject to similar requirements. A Registered FMC will be required to appoint an independent auditor to audit its financial statements and provide the MAS with an audit report on the Registered FMC’s compliance with the criteria and requirements applicable to their regulatory status. In particular, the auditor will be required to report on the Registered FMC’s compliance with the following: (i) the restrictions on clientele and AUM; (ii) the minimum base capital requirement; (iii) the key business conduct rules such as independent custody, valuation of clients’ assets and client reporting; and (iv) the implementation of a risk management framework.
Under the SFO, there is a similar obligation on licensed corporations such as fund managers which are required to appoint an auditor within a month of being granted a licence.
Following the introduction of the new rules, an FMC will be required to place its customers’ moneys and assets with a custodian. In addition, the MAS will expect a third party administrator to be appointed or for conflicts of interest to be dealt with appropriately where the FMC will provide administration services to funds or investment vehicles which it manages.
Accordingly an FMC would no longer be able to take advantage of the cost saving in not appointing a third party custodian to hold client assets although many investors and industry standards would already expect a third party custodian to be appointed.
In Hong Kong, the SFO does not require client money to be held by a third party custodian. However, as noted above, additional capital requirements apply if a fund manager holds client assets. As a result hedge funds managed from Hong Kong will nearly always have a custodian or a prime broker and custodian – which in any event is a clear expectation of the SFC.
Risk management framework
All FMCs (both licensed and registered) will be required to put in place a formalised risk management framework. This will be a new requirement for exempt FMCs which are not currently required to hold a CMS licence and will further increase the regulatory burden on such entities.
In Hong Kong each licensed corporation is required to prepare a compliance manual and a business plan (including a risk management framework) which is submitted to the SFC together with the application for its licence.
Existing exempt FMCs will either need to register with the MAS or apply for a CMS licence following the implementation of the Proposed Changes, although a six month transitional period will be granted. Such exempt FMCs and new FMC applicants will be required to submit an online application for a CMS licence or to file as a Registered FMC (as applicable) via a new online submission system to be launched by the MAS.
This online system will also allow FMCs to make other ongoing regulatory submissions, such as notifying the MAS of the appointment of directors and making annual declarations.
With intended effect from 1 January 2013, an annual fee of S$1,000 (approximately US$800) will be payable to the MAS by a Registered FMC. No registration fee is currently payable for those entities which fall under the exemption criteria. No change is proposed to the application fees or licence fees for an A/I LFMC or a Licensed Retail FMC and their representatives.
In Hong Kong, by comparison, the SFC’s annual fees for licensed corporations are based on a per regulated activity, per licensed representative basis. For a small hedge fund manager with a Type 9 (asset management) licence, two ROs and one licensed representative, the annual fee would total HK$16,010 (approximately US$2,000). This is less favourable than Singapore’s flat fees.
The MAS’s stated aim of the Proposed Changes is to “enhance the existing [Singapore] regime and to promote the sustainable development of the [Singapore] fund management industry”. The Proposed Changes will bring the Singapore regime closer in line with regulations elsewhere, such as in Hong Kong. As many allocators of capital to hedge funds are becoming increasingly concerned by the governance and regulation of funds and other investment vehicles in which they invest, Singapore’s decision to impose more stringent regulation on persons conducting fund management in Singapore may be seen as helpful to managers based in that jurisdiction. In addition, the MAS’s new approach could also be seen as part of the global trend towards greater regulation of hedge funds and a reaction to the risk of being considered not to meet equivalent standards (for example those under AIFMD).
Despite this, the costs and time taken to establish an investment management business in Singapore will inevitably be increased following the implementation of the new regulatory regime for FMCs. Whether the increased regulatory burden which the Proposed Changes would impose upon exempt FMCs will lead to FMCs moving or closing to avoid the costs of being regulated by the MAS cannot be predicted. However, the differences between the regulatory regime in Singapore and Hong Kong will no longer be as marked and may make Hong Kong’s established and stable regulatory position more attractive to those looking to establish Asian-based investment management businesses.
Rolfe has extensive experience in all types of collective investment schemes, including ETFs, hedge funds, private equity funds, guaranteed funds and listed investment companies. He has advised on offshore closed and open ended corporates, units trusts and limited partnerships as well as licensing, regulatory and securities issues connected with asset management generally in Hong Kong and Asia. Rolfe also has experience in bank regulation under the Banking Ordinance, mergers by way of private ordinance, SFC licensing issues as well as disclosure of interests under the Securities and Futures Ordinance.
George provides advice in relation to investment funds with a particular emphasis on the establishment, structuring and re-structuring of hedge funds and funds of hedge funds as well as private funds. He works with asset managers and other businesses operating in the financial services sector and also advises on the promotion of investment products, especially hedge funds, and on the negotiation of managed account structures.
Simmons & Simmons’ international investment funds practice was launched in 2001. Over the past decade the firm has established itself as a leading practice in both the alternative and retail funds space. Our market-leading hedge fund practice has been providing authoritative advice to hedge fund sponsors and managers since the development of this dynamic industry in Europe in the early 1990s. We have consolidated our position in Asia as a global hedge fund centre supported by the depth of our London practice.
This article first appeared in January 2012 on the Simmons & Simmons elexica. For more information, please visit www.simmons-simmons.com and www.elexica.com.