Open-end Fund and Open-ended Fund Company
What is an OEF
Open-end fund ("OEF") is a type of mutual fund that invests in a pool of assets, including stocks, bonds, and money market instruments. Because there is no limit to the amount of shares the fund can issue, it is a flexible scheme that allows for continual input and withdrawals from pool participants. The price of an OEF is reflected by its net asset value ("NAV"), which is determined by the number of shares purchased and sold each day. Unlike close-end funds, where investors may see their gains or losses immediately after a transaction, NAV is only priced once a day, so investors can only see how much money they have made or lost by selling or buying an OEF at the conclusion of the trading day. OEFs would also not be traded on the open market since they can only be sold back to the companies who issued them, not to other investors.
It is a legal requirement that OFC's assets should be managed by an SFC-authorized investment manager and safekept by a qualified custodian under Part IVA of the SFO.
Setting up an OFC
Open-ended fund company ("OFC") is an OEF in corporate structure. Different from companies regulated by the Companies Ordinance (Cap. 622), OFCs do not engage in general commercial or industrial undertakings. Detailed legal and regulatory requirements for OFCs are set out in the Security and Futures Ordinance (Cap.571) ("SFO"), the Securities and Futures (Open-ended Fund Companies) Rules ("OFC Rules"), and the Code on Open-ended Fund Companies ("OFC Code"). The management board of OFCs should also refer to the Securities and Futures (Open-ended Fund Companies) (Fees) Regulation for the fees chargeable by the SFC and the Company Registry.
Unlike LPFs, successful establishment of OFCs requires both approval by the Securities and Futures Commission ("SFC") and registration with the Companies Registry. A board of directors, which must be approved by the SFC, would have the obligation and statutory duty of care to monitor the OFCs. After obtaining SFC’s approval, the OFC will be incorporated under Part IVA of the SFO. Upon applying for registration with the Companies Registry, the instrument of incorporation of the OFC should be filed in compliance with the requirements set out in Part IVA of the SFO. Notably, such an instrument must specify that “the object of the OFC is the operation of the company as a collective investment scheme.” It is a legal requirement that OFC's assets should be managed by an SFC-authorized investment manager and safekept by a qualified custodian under Part IVA of the SFO. For each financial year, an appointed independent auditor must review the OFC’s financial reports.
If the fund chosen requires active management, investors should expect increased fees and expenditures.
Pros and cons of OFC
Since OFCs invest in a portfolio of assets, this feature helps diversify risks for investors. From the investors’ perspective, OFC may appear to be more assuring because it will be managed by SFC-licensed investment manager and its properties will be entrusted to an independent custodian. Besides, OFC is an easily accessible and low-cost solution for pooling money from different levels of investors because of its little to no requirement on investment capitals. From shareholders’ perspective, they are not liable for the debts and liabilities incurred from the OFCs.
On the other hand, as a trade-off to its great security, open-end fund has relatively low yields. If the fund chosen requires active management, investors should expect increased fees and expenditures. Furthermore, statutory administrative requirements for OFCs set out in the OFC Code, OFC Rules, and the SFO may limit the scheme's flexibility and incur extra costs for compliance.
From a tax perspective, profits earned from transactions in most classes of assets can be free from profits tax under the UFE, regardless of whether they are qualifying transactions or incidental transactions. However, income from assets not excluded in Schedule 16C of the IRO, in particular "general business enterprises for commercial or industrial purposes", may not be eligible for the exemption. It is therefore crucial for fund managers to engage legal and tax advisors to review the structure before incorporating the OFCs.
Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.
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