Session V: Developments in International Fund Regulation

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1 Session V: Developments in International Fund Regulation Christian Büche, Partner, K&L Gates Frankfurt Elizabeth Gray, Partner, K&L Gates Sydney Betsy-Ann Howe, Partner, K&L Gates Sydney Michael Wong, Partner, K&L Gates Hong Kong Copyright 2015 by K&L Gates LLP. All rights reserved.

3 Third-Country Access to the EU

4 Current Regulation under MiFID (i) Third-Country Firm MiFID does not provide for a harmonized regime for third-country firms within EU Up to 28 different local laws may have to be observed Usually license requirements apply in each member state Many third-country investment firms rely on "reverse solicitation" Source: 123

5 Current Regulation under MiFID (ii) Third-Country Firm 100% Common practice: Subsidiary Establish subsidiary in one Member State Obtain license from local supervisory authority to provide investment services Outsource activities from subsidiary to TCF Passport into other member states Passport available for branches or cross-border business Source: 124

6 New Regulation under MiFIR Third-Country Firm Available from 3 January 2017 No branches or subsidiaries required in the EU Available only for specific client categories: eligible counterparties and professional investors Registration with register of thirdcountry firms kept with ESMA equivalence decision by European Commission TCF is licensed and effectively supervised cooperation agreement Transitional period of three years "Reverse Solicitation" A46 (5) MiFIR "source: 125

of application with information in accordance with [RTS 5] Application Pre-Assessment by ESMA Assessment within

days after submission of complete application Decision by ESMA regarding Registration Provision of Investment

7 How can we obtain registration? Equivalence decision is adopted by European Commission; otherwise local laws continue to be applicable Submission of application with information in accordance with [RTS 5] Application Pre-Assessment by ESMA Assessment within 30 working days whether application is complete Deadline to provide additional information Within 180 working days after submission of complete application Decision by ESMA regarding Registration Provision of Investment Services Information of clients in writing regarding registration and supervisory authority Offer to clients to submit disputes to jurisdiction of court in member state Comply with MiFID II and MiFIR 126

8 New Regulation under MiFID II Third-Country Firm Available from 3 January 2017 Branch authorisation required at discretion of each member state Client categories: retail clients and professional clients section II of annex II Harmonised requirements for branches: proper authorisation and supervision in home state cooperation agreements in place sufficient initial capital at least one manager appointed for branch agreement in place in accordance with Art. 26 OECD Model Tax Convention on Income and on Capital membership in investor-compensation scheme recognized by Directive 97/9/EC Authorisation to be granted within six months "Reverse Solicitation" A42 MiFID II Source: 127

9 Developments in International Fund Regulations (Germany)

10 Loan Originating Funds (i) The Past Loan Purchasing Funds (LPF) vs. Loan Originating Funds (LOF) Not allowed: origination, prolongation, or restructuring of loans In practice: use of fronting banks, subordinated loans For third-country AIF: Reverse Solicitation The Present BaFin permitted LOF by 12/05/2015 EU Regulation: UCITS, AIF, EuVECA, EuSEF, ELTIF Various member states have permitted LOF, e.g. Italy, Ireland, Malta ESMA takes the view that LOF are permissible as AIFMD does not provide for product rules Applies explicitly only to AIF established in Germany The Future Minimum requirements for LOF in the EU upcoming discussion paper by ESMA 129

11 Loan Originating Funds (ii) Scope AIF only UCITS not permitted Sub-Threshold AIF EU or Third-Country AIF? Specific Requirements intended to be introduced in Germany Member states remain competent for product rules under AIFMD Consumer protection Shadow banking 130

12 Loan Originating Funds (iii) Non-binding "recommendations" by BaFin Only closed-ended special-aif; i.e. with only professional or semi-professional investors No consumer loans No conflicts of interest; e.g. loans to the AIFM, the depositary or delegees Limited leverage (ELTIF: 30%; Malta: no leverage; Italy: 150%; Ireland: 200%) No deposits from investors because of CRR Risk management, in particular MaRisk No maturity transformation Risk spreading Minimum liquidity requirements Less strict requirements for shareholder loans Impact on LPF Prolongations or restructurings are permitted Open-ended special-aif: less than 50% of assets can be invested in loans Closed-ended special-aif: adequate risk management 131

13 Update on Marketing

14 Update on Marketing of AIF Segregated Mandates Investor Information Amended Marketing FAQ as of 20 March 2015 Funds of One Notifications for Sub- Threshold EU-AIFMs Marketing by Portfolio Managers 133

16 Trends in the Australian IM industry 2014/15 Continued growth consolidated AUM AUD2.1 Trillion Signing of FTAs China, Korea, Japan Bipartisan support for significant reform to support the growth of the IM Industry Foreign sourced AUM predominantly from Japan, NZ, USA and UK Growing asset classes Equities Most things global Fixed-income Small increase in foreign AUM managed in Australia 4%-5% of total AUM Henderson buys Perennial fund managers Increased M&A activity Westpac sells majority holding in BTIM JPMAM acquires AVIVA IGS 135

17 Key regulatory developments Foreshadowing of the development of multiple fund structures (May 2015) Financial system enquiry David Murray Report (December 2014) Asia Region Funds Passport (Draft rules released February 2015) 136

18 Multiple fund structures Current CIV structure managed investment schemes only Government has foreshadowed the development of multiple fund structures Corporate CIVs and LP CIVs expected Government Options Paper to be issued third or fourth quarter

19 Financial System Inquiry Some key recommendations: Introduction of a product design and distribution obligation; Introduction of a proactive product intervention power; Removing regulatory impediments to innovative product disclosure and communication with consumers; Giving priority to removing regulatory architecture impeding cross-border transactions and mutual recognition arrangements. 138

20 Figure 12: Recommendations to improve consumer outcomes 139

21 Asia Region Funds Passport Draft rules released on 27 February 2015 Members of the Passport Working Group: Australia, New Zealand, Korea, Singapore, Thailand and the Phillippines [Japan involved in discussions] Multilateral framework intended to facilitate crossborder marketing of managed funds Pilot scheme expected to start in

22 Regulatory arrangements MOU between Passport Members MOU between Regulators Common Regulatory Arrangements Host Economy Laws & Regulations Passport Rules Home Economy Laws and Regulations 141

23 Eligibility Test FUM Financial resources test Track record Qualifications of officers Requirement Responsible for the operation of collective investment schemes with a total value of at least USD 500 million Net equity of over USD 1 million plus additional capital of x AUM in excess of USD 500 million, capped at USD 20 million Five years experience Officers with the relevant qualifications Organisational arrangements test Good standing Principal place of business Meets certain organisational requirements in relation to reporting lines, internal control mechanisms for asset management, records and registers of members and adequate risk monitoring, compliance framework and procedures to manage conflicts of interest Be deemed to have good standing Home economy 142

24 Fund criteria Flexibility around permissible fund structures Custody and independent oversight requirements Investment management delegation permitted Fund liquidity requirements will need to be satisfied Investment restrictions will apply 143

25 Distribution Host economy laws will apply Local distributor will be required Local distribution document (or wrapper) will be required Local translation will be required 144

26 Application process Establish a new registered managed investment scheme or consider passporting an existing registered managed investment scheme Consider: FUM Financial resources Track record Qualifications of officers Organisational arrangements Portfolio allocation restrictions Fee structure Lodge Passport Application with ASIC Application to contain: RE details and custodian Name and Passport Fund objectives Details of key officers Constitution Consent to the disclosure of information between regulators and others Consent to the publication of the application (or part of) Unique Passport Fund code Lodge application to offer interests in Host Economy with Host Regulator Consider: Host laws and regulations that may apply, for example, disclosure documentation, communication with members and any advertising requirements Translation of documents Marketing strategy Engaging a local distributor Public Register Twenty-oneday assessment or exposure period Target Investors 145

27 Timetable Approximate Timing April 2015 May 2015 July 2015 August 2015 Milestone Public consultations on Passport MOU annexes conclude Working Group continues to engage with other economies to encourage their participation Working Group considers public submissions Further public consultation Working Group finalise MOU and annexes September 2015 Willing and ready economies will become party to the Passport MOU + 12 months from economies becoming party to the Passport MOU Economies which are party to the MOU (Passport member economies) will endeavour to implement changes to legislation and regulation where necessary to give effect to the Passport arrangements within 12 months after becoming party to the MOU When at least economies give effect to the Passport arrangements, eligible Collective Investment Schemes in these economies can access the Passport arrangements 146

28 Australian Taxation Issues for Funds and Fund Managers

29 Outbound Investment The tax treatment of outbound investments by Australian residents, including resident companies and unit trusts, varies depending on the nature of the outbound investment, the character of the resident entity and the underlying investors. In Australia, the most significant form of collective investment vehicle is managed funds (largely unit trusts and superannuation funds) because these are tax transparent Income from offshore investment is generally subject to tax either when earned (including under the anti-tax-deferral rules) or on repatriation, with a credit provided for certain foreign taxes paid (such as dividend withholding taxes). Limited partnerships (LP) are deemed to be companies for Australian tax purposes unless they are established in a jurisdiction which imposes tax on the limited partners in respect of the income or profits for the year. The significance of the characterisation of a LP as a company is that Australia s controlled foreign company rules can apply to investments in foreign LPs depending upon the level of Australian ownership in the LP. Foreign Income Tax Offset (FITO) rules apply to allow investors who pay foreign tax on income that is also taxable in Australia to obtain a tax offset for the amount of foreign tax paid. 148

30 Outbound Investment Tax nirvana No tax return lodgement requirements in foreign jurisdictions No tax leakage full credit / offset for any foreign tax paid ie any foreign tax paid must be available for a foreign tax credit or offset and the rate of that foreign tax should not be more than the rate of tax payable in Australia No taxation by attribution of undistributed income for Australian tax purposes only want to be taxed on actual income received Capital gains tax discount (Super Funds and individuals) on disposal of investment 149

31 Outbound Investment Investment via Cayman LP US Blocker Co Australian Institutional Investor Super Fund/Corporate Cayman Fund (Limited Partnership) US Blocker Co Aust Cayman Islands U.S. Australian Tax Considerations Australian investor Is Cayman fund treated as a foreign hybrid (tax transparent) or a company? If a foreign hybrid, CFC rules do not apply. If CFC rules apply, determine the level of Australian ownership in Cayman Fund if a CFC, then income is taxed on an attribution basis rather than a realisation basis Tax rate for Super Funds is 15% and Corporates 30% FITO are Australian investors entitled to FITO in relation to US withholding tax paid by Cayman Fund on distributions from US Blocker? Disposal Capital Gains Tax discount US Blockers US Blockers pays tax in US on US investments and file tax returns US WHT only on non-portfolio interest and dividends US Assets US Assets 150

32 Outbound Investment Investment via Australian feeder Australian Institutional Investor Super Fund/Corporate Tax Issues Australian institutional investor Taxed in Australia on distributions from AUT at relevant tax rate 15% or 30% Australian unit trust US Limited Partnership (USLP) Aust U.S. Australian Unit Trust Pass through (trust) for Australian tax purposes Taxed as a corporation for US tax purposes Subject to tax in US and file US tax return on distributions from USLP (query using a blocker) Branch profits/withholding at 30% may apply to certain distributions (DTA may reduce rate) FITO available for US tax paid CGT discount may apply on disposal of underlying assets if USLP a foreign hybrid CFC rules will not apply to USLP unless AUT controls USLP USLP Tax transparent entity for US and Australian (foreign hybrid) tax purposes US Assets 151

33 Inbound Investment Managed Investment Trusts (MIT) Investments in MIT offer significant tax concessions compared to investments in Australian companies and non-mit trusts. Concessions are available for both foreign residents and Australian residents and allow: foreign residents to access a reduced rate of withholding tax on most distributions (currently 15% and in some limited cases, 10%); and Australian residents to access the capital gains tax ("CGT") discount on capital gain distributions 152

34 What is an MIT? Broadly, a trust will be considered an MIT if the following requirements are met: the trustee of the trust is an Australian resident, or the central management and control of the trust is in Australia; the trust carries out most of its investment management activities in relation to Australian assets in Australia; the trust does not carry on or control an active trading business, ie must carry on passive investment activities (eg investing in Australian rental property); the trust is a managed investment scheme (within the meaning of the Corporations Act 2001 (Cth)); the trust is sufficiently 'widely-held' and not 'closely-held'; and the trust is operated or managed by an appropriately regulated entity. Payments from a MIT are called fund payments 153

35 MIT withholding rates The withholding tax rate for fund payments (except to the extent that they are, or are attributable to fund payments from, a clean building managed investment trust ) is 15% if the recipient is resident in a jurisdiction with which Australia has effective exchange of information (EOI) arrangements for tax matters for example, the UK, Belgium, British Virgin Islands, Denmark, France, Germany, Gibraltar, Ireland, Isle of Man, Jersey, Malta, Netherlands and the USA are EOI countries). If the recipient is not resident in such a jurisdiction, the withholding tax rate is 30%. A reduced withholding tax rate of 10% applies to the extent that the fund payments are from, or are attributable to, a clean building managed investment trust if the recipient is resident in a jurisdiction with which Australia has effective EOI arrangements for tax matters. 154

36 A-MIT Proposals On 9 April 2015 draft legislation was released which proposed a new tax system for certain trusts. The new rules will apply to attribution managed investment trusts (AMITs) The purpose of this legislation is to modernise the tax rules for eligible trusts and enhance the international competitiveness of Australian managed funds. A trust will qualify as an A-MIT if, generally: the trust is a MIT; and its members have 'clearly defined interests'. 155

37 Taxation of A-MITS Attribution regime: for income tax purposes, A-MITs will be able to attribute amounts of income, exempt income, tax offsets and credits to members on a fair and reasonable basis. Attribution for multiple classes of members: if the interests in the income and capital of an A-MIT are divided into classes, an A-MIT will be able to apply the attribution regime separately to each class of interests Character flow through: amounts derived or received by an A-MIT, that are attributed to members, retain the character they had in the hands of the trustee for income tax purposes Treatment of 'unders and overs': provision will be made to reconcile any variances in amounts attributed by using the unders and overs regime. 156

38 Eligibility of Existing Trusts to be Treated as A- MITs Trustees of existing MITs will need to embark on due diligence activities to determine whether changes are required to be made to trust deeds, other constituent documents, product disclosures and other investor material in order to apply the new A-MIT tax system. As part of the 2015 Budget, the Australian government announced that the start date of the proposed regime for A-MITs will be deferred to 1 July However, ability to elect to opt in from 1 July 2015 will be available. 157

39 Australian Investment Manager Regime

40 Investment Manager Regime New rules are designed to remove tax impediments to investing in Australia, with the intention of attracting foreign investment and promoting the use of Australian fund managers. The IMR Regime operates as follows: Gains and losses from portfolio and passive investments into Australia investments in a widely held foreign fund would be disregarded. Under the current law, certain gains and losses from portfolio and passive investments into Australia, when pooled in a widely held foreign fund, may be subject to Australian income tax. Foreign entities that engage an independent Australian fund manager to invest into Australia will disregard Australian income tax consequences arising in respect of certain gains and losses from those investments (including portfolio and nonportfolio foreign investments and portfolio Australian investments) to the extent that the returns or gains are not attributable to Australian real property. 159

42 Mutual Recognition of Funds Scheme

43 What is the Mutual Recognition of Funds Scheme A memorandum of understanding between the SFC and the PRC signed on 22 May 2015 Enables distribution of Hong Kong funds and Mainland China funds to be distributed in each other s markets Streamlined vetting process Quota of RMB300 million each way Effective on 1 July

44 Benefits of the Mutual Recognition of Funds Scheme Provide access to the US$2 trillion PRC retail funds market Allow international investors access to PRC investments through investments in PRC funds Hong Kong economy creation of jobs in the Hong Kong asset management industry Global economy increase capital inflows to overseas markets 163

45 General Principles Streamlined Vetting Process Hong Kong funds that are authorised by the SFC are deemed to have complied with CSRC requirements for authorisation Hong Kong funds are required to comply with the CSRC eligibility requirements before they can be distributed in Mainland China Operation Hong Kong funds must operate and be managed in accordance with Hong Kong law and its constitutive documents 164

46 General Principles (cont.) Sale and Distribution The sale and distribution of Hong Kong funds in Mainland China must comply with Chinese laws and regulations Equal Treatment Chinese investors in Hong Kong funds must receive fair and the same treatment as Hong Kong investors 165

47 Eligibility Type of Funds Equity funds Bond funds Mixed bond and equity funds Index tracking funds (ETFs to be confirmed) 166

48 Eligibility Specific Fund Requirements Established in Hong Kong Operated in accordance with Hong Kong law Authorised and regulated by the SFC Trust structure Trustee and custodian comply with SFC requirements Established for more than one year Minimum fund size of not less than RMB200 million Must not primarily invest in the PRC markets Amount invested by PRC investors must not exceed 50% of the NAV of the Fund 167

49 Eligibility Fund Manager Operated in Hong Kong Holder of a Type 9 (Asset Management) licence issued by the SFC Have not been subject to major disciplinary action from the SFC during the past three years Restriction on delegation of management duties to a non- Hong Kong entity or institution 168

50 Distribution in the PRC Operational Requirements Appointment of the mainland agent: Must be duly licensed by the CSRC to manage a publicly offered fund or to provide fund custodian services in Mainland China Duties and responsibilities include: Registration of the fund with the CSRC and regulatory reporting Ensure compliance with rules and regulations Publication of information of the fund Sale and distribution of the fund Settlement of payments 169

51 Distribution in the PRC Operational Requirements (cont.) Appointment of a qualified distribution agent: Either the investment manager or the mainland agent of the fund may enter into the distribution agreement with the distribution agent Publication of fund documents in approved newspapers and website Documentation Compliance with certain disclosure and documentation requirements All documents distributed must be in simplified Chinese English source documents must be translated into Simplified Chinese 170

52 Quota Initial aggregate quota of RMB300 million Individual quota will be allocated to each fund will based on the set percentage of the amount of assets under management Approximately 100 funds in Hong Kong are currently eligible for the MRF 171

53 Updates on Shanghai-Hong Kong Stock Connect

54 Recent Trends Northbound Hedge funds Approval by Luxembourg regulators Quota underutilised Preferred over QFII and RQFII for investment in A-Shares Shenzhen-Hong Kong Stock Connect 173

55 Beneficial Ownership Issue Technical issue PRC law does not recognise legal and beneficial ownership HK law does not recognise a trust over SSE Shares where PRC law does not provide for such a trust HKSCC as beneficial owner, not the investors Rights to take direct legal action Chinese law does not approve or prohibit a beneficial owner to take legal action to enforce rights 174

56 Beneficial Ownership Issue FAQs clarification by CSRC and HKSCC Certification of ownership as proof of beneficial ownership CCASS General Rules provide that HKSCC will assist CCASS participant or its client in bringing legal action in Mainland China FAQs and CCASS General Rules are not law in the PRC and HK 175

57 Pre-Trade Delivery Seller of A-shares in Hong Kong must pre-deliver the stocks to their broker a day prior to the actual trade Counterparty risks between investors and brokers Special Segregated Accounts (SPSA) Remove the risks of delivery of shares to brokers. This differs from the trading processes familiar to many institutional investors, and there are concerns it may create additional counterparty risk between investors and brokers. Ability to select multiple brokers. 176

Link n Learn: AIFMD Distribution August 2016 Update

Link n Learn: AIFMD Distribution August 2016 Update Speakers Paola Liszka-Draper Senior Manager Advisory & Consulting Deloitte Luxembourg T: +352 45145 2803 E: pliszkadraper@deloitte.lu Derina Bannon Manager