New chapter for northbound Mutual Recognition of Funds

The Mutual Recognition of Funds between mainland China and Hong Kong (MRF) has been in operation for nearly nine years – since July 2015, in fact. This pioneering mechanism has witnessed deep integration of both capital markets, offering investors avenues for cross-border investment and facilitating the flow of capital.

In April 2024, the China Securities Regulatory Commission (CSRC) announced five measures to enhance co-operation with Hong Kong’s capital markets, including enhanced arrangements for the MRF initiative. This enhancement signals new development opportunities for the MRF regime. This article reviews the development of northbound MRF and anticipates its post-optimisation prospects.

Current status

Some 21 Hong Kong fund managers have registered 39 Hong Kong funds with the CSRC as northbound MRF funds, which are publicly sold in mainland China. Among northbound MRF funds as a whole, global-themed funds are in the minority; most are funds with major investment in Hong Kong stocks, the PRC and the Asia-Pacific.

In recent years, the CSRC has actively promoted the deepening and improvement of the northbound MRF regime. At the end of 2022, the CSRC clarified that eligible Hong Kong approved pooled investment funds could be included in the northbound MRF scope. In April 2024, the MRF enhancement proposed to moderately relax the 50% limit on assets under management (AUM) sourced from the distribution of MRF funds in host jurisdictions. It proposed allowing the investment management functions of northbound MRF funds to be delegated to overseas asset managers within the same group.

These measures will significantly expand the range and types of Hong Kong funds participating in the northbound MRF regime, expanding investment choices for mainland investors.

Advantages

Mainland investors can invest in offshore funds through channels such as QDII/QDLP/QDIE products, northbound MRF funds, southbound ETF trading under Stock Connect, or, if they are in the Guangdong-Hong Kong-Macao Greater Bay Area, through GBA Wealth Management Connect.

Compared to other channels, the northbound MRF funds offer several advantages:

• Investors can subscribe to northbound MRF funds directly through mainland distributors without investing through domestic feeder funds, which are issued by domestic institutions and invested in offshore funds, thereby avoiding multi-layered fees and reducing investment costs.
• Northbound MRF funds are subject to an overall quota of RMB300 billion. However, there is no quota limit for a single northbound MRF fund, a single Hong Kong manager, or a single investor.
• The distribution of northbound MRF funds in mainland China is unrestricted by region, with low retail investment thresholds, making them accessible to a broader range of mainland investors.
• Northbound MRF funds cover a wide range of product types, including equity, mixed, bond and index funds.

Eligibility

Hong Kong funds participating in the northbound MRF initiative must meet the following criteria:

• Be domiciled and operating in Hong Kong under Hong Kong law, authorised for public offering and regulated by the Hong Kong Securities and Futures Commission (SFC).
• The manager is registered and operating in Hong Kong, holding a Hong Kong asset management licence, without delegating investment management functions to institutions in other countries or regions, and shall not be subject to material penalties from the SFC in the past three years or since establishment. The implementation of the MRF enhancement will allow delegation to overseas asset managers within the same group.
• The fund adopts a custody structure, with a trustee or custodian that meets the qualification requirements of the SFC.
• The fund is a conventional equity, mixed, bond or index fund (including ETFs).
• The fund has been established for more than a year. If it was re-domiciled to Hong Kong from another jurisdiction, the one-year period is calculated from the day on which the fund is re-domiciled in Hong Kong.
• The fund’s AUM shall be at least RMB200 million or an equivalent amount in foreign currency.
• The fund does not primarily invest in the mainland market.
• The value of fund units sold to mainland investors is not more than 50% of the fund’s total assets. The MRF enhancement will moderately relax the 50% limit for distribution in the mainland.
• Where the fund’s constitutive document provides for dispute resolution by way of litigation, the jurisdiction of mainland courts cannot be excluded.
• The manager must appoint the institution with a mainland retail fund management licence or fund custodian licence as the mainland agent to handle product registration, information disclosure, distribution arrangements, data exchange, fund settlement, regulatory reporting, communication, customer service and monitoring.

Compliance focus

Investment operations: Investment trading shall comply with the SFC’s regulatory requirements and the fund’s constitutive documents.

Information disclosure: Disclosure documents must be simultaneously disclosed to investors in both markets.

Distribution arrangements: A nominee holder arrangement is adopted by following the Hong Kong sales practices. Distribution activities in mainland China shall comply with laws and regulations on distribution of retail funds in mainland China.

Regulatory reporting: Where the AUM, the primary investment focus or the primary distribution targets of the northbound MRF funds ceases to meet the required conditions, the Hong Kong managers shall report to the CSRC in a timely manner. Where there is a material change to the fund type or the operational model of the northbound MRF funds, the Hong Kong managers shall resubmit a registration application to the CSRC. Meanwhile, mainland retail fund practices shall also be taken as a reference for regulatory reporting matters and procedures of the northbound MRF funds.

Future outlook

By the end of March 2024, the net outflow of northbound MRF funds was about RMB25.6 billion (USD3.5 billion), leaving substantial room within the RMB300 billion quota. The forthcoming implementation of the MRF enhancement will have a profound impact on market participants and mainland investors, ushering in new opportunities for the development of the northbound MRF regime.

Sue Sun is a partner at Llinks Law Offices. She can be contacted by phone at +86 21 3135 8661 and by email at sue.sun@llinkslaw.com
Elaine Wang is a senior associate at Llinks Law Offices. She can be contacted by phone at +86 21 3135 8752 and by email at elaine.wang@llinkslaw.com