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Funds of Funds:The Changing Legal Landscape
Recent developments liberalise the restrictions on "fund of funds" structures that have existed over the past three decades. Our writers survey the legal landscape in Europe, Hong Kong, and the United States.
In order to benefit from this passport, funds of funds will have to invest in units or shares of other UCITS and/or other eligible collective investment undertakings. To be considered "eligible", non-UCITS target schemes must be subject to equivalent supervision to that laid down in European Community law. In addition, investment in non-UCITS will be limited to 30% of the assets of the fund of funds.
The cascade phenomenon will be avoided, as funds of funds of funds will not be authorised under the Directive.
Diversification rules will also apply: no fund of funds will be allowed to invest more than 10% of its assets in units of a single UCITS or other collective investment scheme. However, Member States can raise this limit to a maximum of 20%.
Rules on disclosure of the duplication of management fees will have to be followed. Similar rules aim at avoiding any duplication of subscription fees where the management companies of both the investing fund and the target fund are linked to each other.
This is not the only change brought in by the amended Directive as far as products are concerned. Other examples include cash, money market UCITS or index trackers of a new type. However, it is widely felt within the European fund industry that it is in the funds of funds area that the reforms will be most successful.
It is worth mentioning that feeder funds are not part of these newly passportable products. Notwithstanding all the legal and political debate that has taken place on this subject, it should be emphasised that the local legislation of most European countries does not authorise feeder funds (among other EU Member States, Germany, the UK, Italy and Belgium still do not authorise local feeder funds). In contrast, before the adoption of UCITS III, funds of funds were already allowed in the vast majority of EU countries. This may be viewed as an indicator that, at least in certain areas, Europe is still governed by consensus.
Diversification requirements provide that a fund of funds must invest in at least five underlying funds with not more than 30% of its net assets in any one fund. The underlying funds must be authorised by the SFC or be recognised jurisdiction schemes (regulated retail funds established in the UK, USA, France, Germany, Ireland, Luxembourg, Isle of Man or the Channel Islands) although 10% of a fund of fund's assets can be invested in unauthorised non-recognised jurisdiction funds.
A fund of funds can borrow to meet redemption requests or operating expenses subject to a limit of 10% of net asset value.
A regular fund of funds is expected to focus on equity/bond investments and not more than 10% of the fund of funds' assets can be invested in warrant, leveraged or futures and option funds unless the fund of funds itself has a particular objective of investing in this type of category of funds in which case additional provisions will apply. A fund of funds is not allowed to invest in another fund of funds and the ability to double charge is restricted where a fund of funds invests in underlying funds managed by the same manager or its affiliate. All initial charges on the underlying funds must be waived in such a case. In addition, the manager of a fund of funds cannot obtain any rebate on fees and charges levied by an underlying fund.
When seeking authorisation, other general requirements of the SFC's Code will also apply, for example, regarding suitability of the operators of the fund. The fund of funds must also offer at least monthly dealing and performance fees can only be paid annually where the net asset value per unit exceeds the previous highest net asset value per unit at which the last performance fee was paid (on a "high on high basis").
Multi-manager funds are not recognised as a separate category of funds in Hong Kong. If a multi-manager fund (where the fund portfolio is allocated amongst different managers to manage as discretionary account rather than separate underlying funds), seeks authorisation the SFC would wish to approve each manager. Managers of Hong Kong authorised funds must be located in a jurisdiction with a suitable inspection regime acceptable to the SFC and the key personnel of the management company should possess at least five years' investment experience managing retail funds.
n more than 3% of the total outstanding voting stock of the acquired fund;
n securities of the acquired fund worth more than 5% of the acquiring fund's total assets; or
nl securities of SEC-registered fund worth, in the aggregate, more than 10% of the acquiring fund's total assets.
Additional limits apply to investments in closed-end funds. In general, a registered fund may not acquire the securities of an SEC registered closed-end fund, if immediately after such acquisition, the acquiring fund and other registered funds having the same investment adviser would own more than 10% of the outstanding voting stock of the closed-end fund.
Notwithstanding these restrictive general principles, significant exceptions now exist as a result of the National Securities Markets Improvement Act of 1996. Most significant are the following:
Investments in Unregistered
Funds of Affiliated Funds.
Expanded Exemptive Authority.
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