Hong Kong SFC Broadens Exemption for Master-Feeder ETFs

The Securities and Futures Commission (SFC) has published a revised Circular on streamlined requirements for eligible exchange-traded funds adopting a master-feeder structure to allow SFC-authorised feeder Exchange-traded funds (ETFs)
to invest in overseas-listed master ETFs – including actively managed
ETFs – subject to meeting specified conditions. The changes extend the
streamlined requirements for master ETFs to actively managed ETFs and
are aimed at broadening the range of investment products available to
Hong Kong investors and boosting Hong Kong’s status as an international
fund management hub.

Position under the SFC’s Code on Unit Trusts and Mutual Funds

Previously, paragraph 7.12 of the SFC’s Code on Unit Trusts and Mutual Funds (UT Code)
allowed a feeder fund to invest 90% or more of its total net asset
value in a master fund provided that both the feeder ETF and the master
ETF were authorised by the SFC.¹
However, this prevented SFC-authorised feeder ETFs from investing in
overseas-listed master ETFs, limiting the investment products available.
Additionally, the procedures for obtaining SFC authorisation are
onerous and expensive, especially when the master ETF is listed
offshore.

With the increased popularity of ETFs, the SFC received a number
of requests to allow SFC-authorised feeders to invest in overseas-listed
master ETFs without SFC authorisation. According to the SFC, the global
ETF market’s assets under management increased to US$12.7 trillion at
the end of the first quarter of 2024, while actively managed ETFs have
grown much faster than ETFs generally since 2019.

In December 2019, the SFC implemented a Circular on streamlined requirements for eligible exchange-traded funds adopting a master-feeder structure (2019 Circular)
allowing passively managed SFC-authorised feeder ETFs to invest in
eligible overseas-listed master ETFs without the master ETF needing
separate SFC authorisation. This framework was updated in February 2022
by the SFC’s Supplemental Circular on streamlined requirements for eligible exchange traded funds adopting a master-feeder structure (Supplemental Circular), which relaxed the fund size and track record requirements for eligible master ETFs.

Revisions to the Circular on Streamlined Requirements for Eligible ETFs adopting a Master-Feeder Structure

Under the revised Circular, the SFC will authorise a feeder ETF
that invests in an overseas-listed master ETF, whether the master ETF is
passively or actively managed, on a case-by-case basis. The key
requirements are that the master ETF must:

1. have satisfactory safeguards and measures in place to provide
   investor protection that is substantially the same as for SFC-authorised
   ETFs, taking into account its underlying assets, investment strategy,
   applicable rules and regulations in home jurisdiction;
2. have sizeable assets under management – the SFC has removed the
   limitation on the application of the streamlined requirements to
   particular types of schemes (essentially recognised jurisdiction schemes
   managed by a management company in an acceptable inspection regime or
   schemes eligible under a mutual recognition of funds arrangement); and
3. together with its management company and trustee/custodian, have
   a good compliance record with the rules and regulations of its home
   jurisdiction and, in the case of the master ETF, its listing venue.

The revised Circular also removes the specific fund size and track
record requirements of the 2019 Circular and Supplemental Circular.

Feeder ETF Requirements

Feeder ETFs seeking SFC authorisation for public offering in Hong Kong need to meet the following requirements:

1. the feeder ETF must be a Hong Kong-domiciled ETF authorised by the SFC;
2. the feeder ETF must be managed by a management company which is
   licensed or registered for Type 9 regulated activity and have a good
   compliance record;
3. 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 circular and take appropriate remedial
   action to promptly rectify the situation; and
4. the management company of the feeder ETF should put in place
   appropriate arrangements to inform Hong Kong investors of any material
   changes to, or events that have a significant adverse impact on, the
   master ETF in a timely manner.

The SFC may consider introducing additional requirements or conditions if it deems it necessary or appropriate.

Feeder ETFs must also comply with the relevant requirements in the
Overarching Principles Section and the UT Code of the SFC Handbook for
Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and
Unlisted Structured Investment Products, and all other applicable SFC
regulatory requirements and guidelines.

The SFC has emphasised its intention to balance the needs for
investor protection and market development in amending the master-feeder
ETF requirements. It believes the relaxation will improve Hong Kong’s
competitiveness in attracting overseas ETFs.

The SFC’s revised circular is available on the SFC website here.