Think of the managed funds sector as a book - or rather, a collection of stories. Beginning in 2002 and continuing into last year, the Hong Kong story centred on guaranteed funds, a tale of sector slowdown thanks to SARS and general global turmoil.

Turn over the page to this year, and the narrative tells of resurgent activity in the managed funds sector, not just in Hong Kong but the wider Asian region, spurred on by a raft of new, non-traditional players largely from Europe and the US. The dominant themes are the alternative asset classes - hedge funds, private equity and real estate - as the market for these matures. The China story is also unfolding, with the opening up of the country's financial sector and consequent inflow of foreign fund managers.

For lawyers practising in managed funds in Hong Kong, it's a busy time after what was for most a slower 2003. "We've always had a strong practice," says Effie Vasilopoulos, a partner in Sidley Austin Brown & Wood's Hong Kong office, "but last year was the quietest I've ever been during the SARS period". It's a different story this year for Vasilopoulos, who's practised in the managed funds area for 15 years and names AIG, ING, Fidelity, the Singapore Government, Deutsche Bank and HSBC among her clients. "We have a very, very busy  franchise because in the funds arena, so much of the work that comes in has a US element," she says, adding that Sidleys is "really the only US firm at the moment that has both a strong regional presence and strong US capability in funds".

Other US firms might have something to say about that, but in any case, it's not just Sidleys that is enjoying a new wave of funds work. Practitioners such as Rory Gallaher, who heads Deacons' financial services practice group out of Hong Kong, confirm reports of a slowdown in new funds last year due to SARS but says a steady pipeline this year is generating a raft of instructions. "You just weren't able to travel around in order to get final sign-off to launch new products," Gallaher says of the SARS period, "but in the last eight to nine months, there's been a natural return to the levels of activity that we were seeing before". The split between the authorised and unauthorised side of Deacons' managed funds practice is "pretty even", says Gallaher. Over the last four years, the practice has had its fair share of guaranteed funds launches but now it's authorised hedge fund managers such as HSBC Republic, Lyxor International Asset Management, Permal, Mann and Investco that are calling on Gallaher's services. "Quite a lot of start-up managers who were keeping their heads down last year because of the very  difficult economic times that Hong Kong was going through now seem more confident about setting up on their own," Gallaher says.

Right now, hedge funds are the talk of the managed funds sector in Asia, with factors such as improved liquidity and the liberalisation of short-selling rules in certain markets   attracting new players.  According to Eurekahedge, an Asia-based consultancy focused on  alternative investment, just under 50 hedge funds - which are essentially private, unregulated investment funds specialising in high risk, short-term speculation - have been launched so far this year, with total hedge fund assets breaking through the US$1trn mark in July. Of this, almost 10% has been invested in Asia, with jurisdictions such as Singapore experiencing significant growth in the number of hedge funds under management - up from 10 to 49 over an 18-month period, Eurekahedge reports.

James Walker, who heads Clifford Chance's Asia funds practice, says the number of US and European hedge fund managers setting up operations in Asia is generating plenty of regulatory and licensing work. "We've got about seven or eight [hedge fund manager Hong Kong set ups] on the go at the moment, which is quite interesting compared with last year when there were very few people coming to Hong Kong," Walker says. "In terms of new fund launches, it was a pretty weak market, to be frank. We did, however, get involved in quite a few property related funds at the time."
 
Things are busier this year for Walker, whose practice is predominantly on the institutional side. But he says the interest in hedge funds makes him "slightly nervous", drawing   comparisons with the dotcom bubble. "There's a bit of a sense that it's all going too fast." Certainly hedge funds have their critics, who find support for their arguments in events such as the Towry Law (Asia) case, where investors in two Cayman Islands based hedge funds sold by Towry incurred losses of around US$400m. "I think it's important for people like us as service providers to make sure the clients are quality players," Walker adds.

Quality players or not, the managed funds sector in Asia still has some way to go before it reaches the scale and sophistication of that in the US or Europe. Vicki Hazelden and Nick Rogers, Hong Kong based partners of Cayman Islands firm Walkers, find Hong Kong a much smaller market. "The funds we have in Asia are tiny compared with what we're used to," says Hazelden, with Rogers comparing the average amount of a US start-up fund - around US$50-100m - with the US$2-3m of an average start-up fund in Hong Kong. "We don't think of them as any sort of novelty," Hazelden says. Walkers launched a Hong Kong office in mid-September 2003 and Hazelden and Rogers say they have had a steady stream of new funds since. The practice is mainly focused on private placement work, rather than retail funds, for clients such as BNP Paribas. Rogers describes Hong Kong's managed funds sector as still very much in the development stage. "We talk a lot about the differences between the market here and in the US with our old clients," Rogers says. "It's a young industry here. It means people are really finding their feet."

Successfully tapping into the relative youth of the managed funds sector in Asia, particularly the alternative investment market, is certainly something firms such as White & Case have in their sights. The renewed interest in hedge funds in the region has prompted the firm to launch an Asia Investment and Hedge Funds Support Group. Driven largely out of Tokyo, the group comprises around 20 lawyers across the firm's Tokyo, Singapore, Bangkok and Hong Kong offices who aim to assist clients such as fund administrators, custodians and hedge fund sponsors in setting up and operating hedge funds, as well as fund managers handling more traditional assets classes such as mutual funds and managed accounts. White & Case is also targeting growth in other areas. "We're seeing new types of funds coming to Asia such as secondary opportunity funds. We're working on one such fund now which is also attracting US hedge fund investors even though it has less liquidity than hedge funds typically  demand," says Sharon Hartline, who heads White & Case's Hong Kong funds desk.

The strength of the regulatory regime in Hong Kong, however, is proving a disincentive to some hedge fund managers. The Securities and Futures Commission (SFC) issued its Guidelines on Retail Hedge Funds in 2002 allowing retail hedge funds to be offered to the public, which have been criticised as too restrictive. While acknowledging this criticism, Hartline says the "experimental" nature of such initiatives underlies the Hong Kong government's cautious approach. "Hong Kong's very concerned about not getting a black eye - so I think they have been a little more conservative," she says. "They'll probably revisit [the guidelines] early next year and see where they might be able to loosen up the regime."

This is exactly what is planned. The SFC recently confirmed that it would review the  guidelines with a view to strengthening disclosure standards and giving more flexibility to retail hedge fund managers. On the agenda is a more streamlined and accelerated licensing application procedure as well as a relaxation of the work experience condition that must be met by "responsible officers" of funds authorised to sell products to the public.

Making the regulatory regime less onerous may well give Hong Kong an edge in the competition with Singapore as a destination of choice for international fund managers. So far, Hong Kong seems to be winning, with a greater depth of investor base and proximity to other key markets in its favour despite the Singapore government's incentives of tax breaks and other grants. But licensing and tax issues remain a concern. While it's easier for a start-up fund in Singapore to get exemption from licensing requirements, that's not the case in Hong Kong, where fund managers must meet the requirements of the Securities and Futures Ordinance that was introduced as consolidating legislation on 1 April last year.

Gallaher describes the process of obtaining a licence as "quite arduous". "In Hong Kong, you are either in the regulatory net or you don't carry on business at all," Gallaher says. "It does mean that if you're a start-up maybe a bit under-resourced that it will have quite an impact on your business if they can't actually do anything in terms of managing money for two or three months."

Walker agrees that the licensing regime is proving a headache for some. He says he advised a "very high quality" hedge fund that applied for a licence last November and only received it recently, a slow turnaround when big money is at stake.

There's also ambiguity over the tax treatment of offshore funds.  Lobbying efforts by bodies such as the Alternative Investment  Management Association of Hong Kong led to assurances from the government that such funds would not be liable for profits tax, but it's been seven months or so since anyone has sighted draft legislation to this effect, says Walker. "There's a lot of nervousness about the tax situation, particularly from the US players," he says. "It's not a great environment with which to be encouraging people to come to Hong Kong."

Singapore may have the advantage of a clearer tax regime, but Sidleys' Vasilopoulos says Hong Kong's proximity to key markets such as  Taiwan, Japan, Korea - and of course, mainland China - probably swings the balance in its favour. "Of those US managers that we're seeing who are showing an interest in setting up in Asia, I'm still seeing the majority of them opting for Hong Kong, because of a perception that there are greater commercial opportunities here and that the regulatory downside is not so onerous that it's necessarily a clear-cut decision to go to Singapore."

All eyes on China
When it comes to key markets, China is where many clients and their advisers are focusing their efforts. A large number of joint ventures are already operational in China, with the entry of foreign players as well as new domestic institutions contributing to the rapid growth of the country's managed funds industry.

Vasilopoulos says venture capital and emerging property funds are key growth areas in China for Sidleys. But Hong Kong remains the prime destination for fund managers at present. "There is still going to be a huge lag period before China develops its regulatory and compliance environment to the point that it's remotely close to Hong Kong's," Vasilopoulos says.

Deacons is also handling enquiries from international players as to how they can get a piece of the China action. The firm represented Merrill Lynch in its joint venture with the Bank of China and is also acting for several Hong Kong retail fund management groups that are exploring opportunities on the mainland. Deacons Hong Kong partner Susan Gordon says the firm is receiving regular instructions from institutions such as Schroders, BNP Paribas and American Express. "We have a core group of clients who are very active in the retail market. That's quite good I think - having a group that's not too market-sensitive." The firm is also handling a lot of Taiwan related work, Gordon says. "We've seen quite a lot of Taiwanese companies looking to set up in Hong Kong."

Tandip Singh, who heads DLA's corporate and commercial group in Singapore, says he's seeing more interest from fund managers in investing in countries such as Indonesia and Malaysia, where changes in government are ushering in expectations of a better investment climate. "I think a lot of people are slightly more comfortable that things might be improving now. I've not seen this sort of interest for the last three, four, five years actually," says Singh, who adds that he's fielding an increasing number of enquiries about potential start-up funds,
particularly private equity and venture capital, on the back of his M&A work. Singh also points to the trend in individuals - mainly investment bankers - who have gained experience in large financial institutions and are now going out on their own as one that is steadily increasing. "It's a function of the [Asian financial] crisis and the fact that it's almost over," is Singh's assessment of the interest in setting up new funds. "People are sensing that there are some opportunities that are still available."

Destinations of choice
Southeast Asia may be hotting up as an investment destination, but it's still North Asia where most of the hot money is heading. Hong Kong and mainland China continue to attract new investment, and there is an increasingly sophisticated range of products on offer. Walker, who has watched the market develop in Hong Kong over the last decade, says it's a long and you're way from the days when he advised the HK government on the launch of the first listed  exchange traded fund. "It was just great to bring that to the market, because it was a very new product and it's got a very large retail investor base," Walker says. Now, products such as hedge funds and distressed debt funds are becoming commonplace. "We closed one of those [a distressed debt fund] recently for Colony Capital of the US," Walker says. "These are really products that you wouldn't have imagined you'd be working on ten years ago."

Vasilopoulos says the evolution of fund structures that enable access to capital globally is another key development in the sector, pointing to the interest of major institutions as well as boutique fund managers in coordinating offerings that traverse markets. "We've been quite keen in setting up master-feeder structures so that people can access the US and the European capital markets rather than just Asian money," Vasilopoulos says. "That's a key area where we've been able to develop our practice because we've focused very much on coming up with structures that not only work for Hong Kong and Asia but for other key markets." Hartline backs this up, saying her practice is also active in setting up master-feeder funds. "It's a really cross-border, cross-disciplinary area," she says. "Multi-fund and multi-manager fund groups require increasingly sophisticated legal, regulatory and tax advice."

Growth in funds and practices
Growth in funds management work means growth for practices. Walkers has four lawyers in Hong Kong practising in funds work, but is looking to recruit another, says Hazelden. Deacons too has expanded in Hong Kong, also putting lawyers into Malaysia and Singapore.

Expansion is also on the cards for Sidleys' practice, says Vasilopoulos, adding that it's not an area firms can expect to dabble in. "It takes many years of daily grind to establish a practice that's at the level where ours is now," she says. The Hong Kong practice has been helped along by the strong funds practice of Sidleys in the US, where around 40 partners are dedicated to funds work. "For us, that means there's a steady stream of US clients that are looking to establish a presence in Asia. Setting up structures that uniquely marry the regional with US requirements is very much something we think we can do better than anyone else." With activity in the sector hotting up, Vasilopoulos' competitors will no doubt be
hot on her heels.