The pace of Hong Kong's race to put hedge funds onto the retail market is slowing. Although a small, but still significant queue has formed to register products, some unexpected potholes have appeared as managers, lawyers and the regulators attempt to reconcile differing requirements. That there would be teething troubles was seen as inevitable, given the pioneering aspect of the Securities and Futures Commission's initiative in opening the way for hedge funds to be offered to the wider public. The SFC was having to set standards that would allow freedom of fund management while ensuring maximum investor protection. No precedent was available, as in other jurisdictions hedge funds remain exempt products, although Singapore has also taken steps to regulate the public offering of the vehicles.

Most market professionals now doubt that any funds will actually be on sale much before the end of the year, instead of by the third quarter as had once been expected. Even so, this would represent rapid progress, as it would mean that hedge funds were on sale to the public within around one year from when the wheels starting to turn. The key to the registration process was the publication in May of the SFC's guidelines, which followed a comprehensive consultation with the industry. New provisions relating to hedge funds were incorporated in Chapter 8.7 of the Hong Kong Code on Unit Trusts and Mutual Funds. The headline issues were the minimum subscription limits on the funds, which was the preferred method of limiting the hedge fund distribution to those with deeper pockets, and, supposedly, greater sophistication in investment matters. Fund of funds products would require a minimum investment of $US10, 000, while the more focussed single strategy funds required US$50,000. The commission also laid down rules on the experience of the managers in their chosen fields, and the minimum size of a fund. This cleared the way for hedge fund managers who wished to target Hong Kong investors to start the process of building and registering suitable products. No-one has been killed in the rush. Only around 15 or so applications have been put forward, according to insiders. Most will be for fund of funds, which are expected to have a wider appeal to the retail market because of their diversity.

"Some managers are attempting to take a short cut by taking an existing fund off the shelf, others are building products specifically for the Hong Kong market", says Rory Gallaher, a partner with law firm Deacons. A crucial issue in presenting a product is the domicile of the manager, who must be in a jurisdiction recognised by the SFC. These include the US, the UK, Dublin and Luxembourg.

Even this is not enough to ensure automatic registration, as the Commission will examine the fund to make sure it complies with its own criteria. Even with traditional funds, the jurisdiction scheme is becoming less and less significant, as the SFC examines all applications, and requires managers to comply with any particular aspect of the code, explains Gallaher. Despite the comprehensive consultation that led to the publication of the code, managers would still like to see the rules modified, or waivers issued as the differences between the SFC's rules and the mechanics of individual funds have emerged. "It's only when people concentrate on a particular product that they want to get authorised that they realise it doesn't quite fit in. There are definitely areas where people want to make changes," says Gallaher. "There is more involved than people thought," confirms James Walker of rival lawyers Clifford Chance. "To some extent mistakenly, people thought they could take an existing product, whether incorporated in the US or the Caymans and try and get it authorised," he adds.The chances of any major changes to the May code is regarded as low by lawyers and other advisors - and the SFC is saying nothing about the process in public. "The SFC is going to apply those rules strictly in the early stages. I can understand that, though it doesn't work for us," comments one fund manager seeking registration.

Structural issues have caused few problems, according to one lawyer, although some fund managers believe the requirement for five year's experience in hedge funds, and a minimum of US$100 million under management will cause problems. There has been some movement on the issue of experience, according to lawyers. The initial requirement that the fund must have two investment executives with five years experience in a fund with the same strategy has been modified. Now only two years out of the five have to have been spent in the same sort of strategy, a concession that recognises that some strategies just don't run for five years in this business. Despite that shift, at least one major fund manager reports difficulty in convincing the commission that his fund - one of the world's biggest unit trust players - actually has five years experience in hedge funds. Down in the finer print, issues taking up registration time include performance fees. Many hedge fund managers are used to taking their fees on a quarterly basis, but the commission insists that the existing rules for standard unit trusts will apply, so they can only be collected annually, even if they are accrued on a more frequent basis. With the majority of products to be launched in Hong Kong expected to be fund of funds, some practitioners complain that some of the rules on the structure of these funds are too onerous.

A minimum of five other funds must form part of the overall fund, but none can be another fund of funds, and both lawyers and fund managers are querying that requirement, when the whole concept of such products is to diversify risk.

A clause which rules that if a manager has a feeder fund, both the fund and the feeder have to be authorised in Hong Kong is also causing some problems. "What is the point in having a feeder," asked one applicant. "Sometimes a fund may not wish to be authorised in Hong Kong, or may be obligated not to by the way in which it was set up." Umbrella funds are also facing a requirement to provide proof that the assets of the fund authorised in Hong Kong are ring-fenced from the assets of all other funds under management. For funds invested in the Cayman Islands this could be a problem, for although the cell company rules have been introduced, which separate the assets of individual funds under the umbrella, existing products will still have to go through the commission's hoops. It's not just this sort of fine print that causes some hassles - the commission is also cracking down on the presentation of registration documents. On June 24, the Investment Products Division issued a letter calling for standardisation of fund authorisation procedures. This set out which documents had to be submitted, including marketing approvals. All documents were to be heavily annotated in the margin with reference to the sections of the code to which they applied. While there is a general recognition that the SFC has been doing its best to break new ground, there is unanimous opinion that the process is going to take much longer than expected. Defenders of the SFC argue that its staff are on a learning curve, and are already heavily committed to the flow of standard products such as guaranteed funds, which continue to flood the market. The consensus now is that first registrations will be completed by August or September, but the real marketing of hedge funds in Hong Kong will not take place until the end of the year.