Eric Lui Partner
Limited Partnership Funds
The private equity market in Hong Kong
Hong Kong has always been a robust hub for private equity and venture capital in Asia. From the developed financial banking system to having one of the largest IPO fundraising stock markets in the world, Hong Kong’s PE market has capitalised on the city’s world class economic infrastructure to become one of the biggest PE centres of Asia. As at the end of 2019, the total asset under the management of PE funds in Hong Kong amounted to approximately US$160 bn, which was the second largest in Asia, behind China. By the end of 2019, over 565 PE and VC firms have their bases established in Hong Kong. As a platform for the inflow and outflow of investment into China, Hong Kong has consistently originated and intermediated over 60% of China’s inward foreign direct investment and outward direct investment since 2012.
A. The problems of offshore type funds and foreign regulations relating to private funds
Evolving international and offshore tax law and risk
PE fund systems in the Cayman Islands have traditionally been branded as business-friendly and as being more regulatory relaxed. However, it has been suggested that the series of regulatory changes have led to increase in compliance costs, and may precipitate a change in the common perception of the Cayman Islands as the “gold standard” of private equity.
In 2019, new reporting and economic substance requirements were introduced in an effort to meet the Organisation for Economic Co-operation and Development (OECD)’s standard for Base Erosion and Profit Shifting (“BEPS”) with regard to geographically mobile activities. On 7 February 2020 the Private Funds Law 2020 (“PFL”) and Mutual Funds (Amendment) Law (“MFL”) were enacted by the Cayman Islands, requiring the full registration of funds with the Cayman Islands Monetary Authority (“CIMA”). The combined effect is the compulsory registration of almost all types of close-ended segregated portfolio companies and exempted limited partnerships.
The Cayman Islands Government further enacted the Amendment to the Private Funds Law in July 2020, which expanded the definition of “private funds”. Under this widened definition, single project/investment funds, co-investment vehicles, alternative investment vehicles and master funds will all need to be registered with the CIMA.
Hong Kong’s LPF as a response to Cayman Island’s funds law
As the trend for establishing funds and conducting private equity businesses shifts back from offshore jurisdictions to onshore, investment managers may find themselves having to reassess their preferences and give more consideration to the increasingly favourable opportunities in Hong Kong. In contrast to the Cayman Islands’ regulatory changes, Hong Kong’s new LPF regime offers an attractive alternative choice and at a considerably lower cost. On 31 August 2020, the Limited Partnership Fund Ordinance (Cap. 637) (“the Ordinance”) came into force in Hong Kong, allowing private funds to be registered in the form of limited partnerships. In the short three months since the ordinance became effective, a total of 53 LPFs have been registered.
B. Outline of the LPF legislation and the mechanism of the LPF
LPFs do not have separate legal entities. They are based on partnership agreements between the GP, who is responsible for managing the fund, and the LP who does not have day-to-day management control, with the objective of deriving profit, gains or returns from the fund investments.
Partners have full freedom to conclude contracts among themselves. The lack of restrictions on minimum capital contribution and investment scope also renders it an attractive fund structure for a number of different investment purposes. It can be adopted and used as the main fund, feeder fund or co-investment vehicle.
The Ordinance requires LPFs to have a registered office in Hong Kong and registration with the Hong Kong Companies Registry (“CR”). But it is different from the existing open-ended fund companies which are to be registered and/or authorised by the Securities and Futures Commission of Hong Kong (“SFC”)
C. The parties involved in LPF
The GPhas unlimited liability for all debts and obligations of the LPF, and bears the ultimate responsibility for the management and control of the LPF. The GP can be:
- a private company limited by shares incorporated in Hong Kong;
- a registered non-Hong Kong company;
- a Hong Kong or overseas limited partnership (with or without legal personality); or
- a natural person who is at least 18 years old
It has the duty to appoint an investment manager (“IM”), an auditor, and an authorised representative if the GP is a LPF or a non-Hong Kong limited partnership with no legal personality
The LP has distributions entitlement to the economic return of the LPF. LPs have no day-to-day management rights or control over the assets. The LP can be:
- unincorporated bodies or any other entity; or
- natural persons (as trustee or in the person’s own or any representative capacity).
Their liability is limited to the agreed contribution it makes, unless the LP has participated in the day-to-day management of the LPF, subject to the non-exhaustive exemptions granted under the “safe harbour”
The IM must be appointed by the GP to carry out day-to-day investment management functions of the LPF. It must be any of the following:
- a Hong Kong incorporated company;
- a registered non-Hong Kong company;
- a Hong Kong resident who is at least 18 years old; and
- can be the GP itself.
The auditor must be appointed by the GP to carry out annual audits of the financial statements of the LPF must be independent of the GP, the IM and also the AR (if applicable) of the LPF
The responsible person must be appointed by the GP to carry out the anti-money laundering and counter-terrorist financing (AML) measures set out in Schedule 2 to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO). It must be any of the following:
- an authorised institution
- a corporation licensed by the SFC
- an accounting professional; or
- a legal professional.
The authorised representative must be appointed by the GP to be responsible for the management and control of the LPF if the GP is an LPF or a non-Hong Kong limited partnership with no legal personality. It must be any of the following:
- a Hong Kong incorporated company
- a registered non-Hong Kong company; or
- a Hong Kong resident that is at least 18 years old
It is jointly and severally liable for all debts and obligations of the LPF with the GP and shares the ultimate responsibility for the management and control of the LPF with the GP.
To register a fund as an LPF, the proposed GP of the LPF must make an application to the CR, which is required to be submitted on behalf of such GP by a Hong Kong law firm or a solicitor.
D. The difference between LPFs and Cayman ELPs
The LPF has often been compared with the Cayman Islands’ exempted limited partnership (“ELP”) . Despite the ELP’s reputation as being the more conventional fund vehicle, it is now arguable that the new Hong Kong LPF is more business friendly and cost effective.
|On-going compliance||Annual filing||Annual filing and notification of change|
|AML/ CTD||Required to appoint:|
• An anti-money laundering compliance officer
• A money laundering reporting officer
• A deputy money laundering reporting officer
|Required to appoint a responsible person to be responsible for the implementation of AML measures|
|Custodian||Must have a custodian unless exempted||Not required to appoint a custodian as long as proper custody arrangements for the safekeeping of the fund assets are put in place in accordance with the partnership agreement|
|Valuers||Must be performed by an independent third party||No prescribed requirements for LPFs|
|Accounting standard||Obliged to adopt either the IFRS or GAAP in the US, Japan, Switzerland or any other non-high risk jurisdictions||No specified requirements|
|Set up time||Around one to two weeks to set up||Within 4 working days from applications being made|
|Incorporation fees||Registration fee: US$5,500||A lodgment and registration fee of USD390|
|Annual fees||USD1,463 for regulated ELPs and |
USD2,439 for non-regulated ELPs
E. Tax advantages
A LPF can be eligible for profits tax exemption under the UFE regime if it fulfills the following three conditions:Fund managers or investors should also note that whilst an on-shore LPF is likely to only engage Hong Kong legal counsels, establishing an ELP in the Cayman Islands with business operation in Hong Kong may require legal advice from both Cayman Islands and Hong Kong legal counsels, the cost of which may need to be factored into consideration in the long term.
- it qualifies as a “fund” for the purposes of exemption;
- profits must be derived from qualifying transactions or incidental transactions that are subject to a 5% threshold; and
- the qualifying transaction must be carried out or arranged in Hong Kong by a “specified person,” or a “qualified investment fund,” which has more than four investors, the capital commitments made by whom exceed 90% of the aggregate capital commitments and not more than 30% of net proceeds arising out of the fund transactions are to be received by the GP, after deducting the portion attributable to its capital contributions.
Transfers or redemptions of interest in LPFs will not attract stamp duty, as an interest in a LPF does not fall under the definition of Hong Kong stock according to the Stamp Duty Ordinance (Cap. 117).
F. Recent development
Currently, most of the active funds in Hong Kong are offshore funds. In order to attract the offshore investment funds to establish and operate in Hong Kong instead, the chief executive of Hong Kong has taken steps to introduce the Limited Partnership Fund and Business Registration Legislation (Amendment) Bill 2021 (“Bill”) to the Legislative Council (“Legco”) to incorporate a re-domiciliation arrangement for offshore funds to be registered as LPFs in Hong Kong.
Proposed re-domiciliation arrangement
Under the proposed Bill, there are some procedural requirements for offshore funds to apply for the re-domiciliation to become Hong Kong’s LPFs. It is intended that a specific application form and application process will be in place to facilitate the re-domiciliation. The latest draft application form requires the applicant to provide i) the name and place of establishment of the applicant fund, and ii) a statement confirming the details of the applicant fund’s registration in Hong Kong as well as a confirmation of its deregistration from its place of establishment. The proposed fees payable includes a lodging application fee of HK$479 and a registration fee of HK$2,555. The application will be made to the CR by the GP of the fund and be submitted by a Hong Kong law firm or a solicitor on behalf of the proposed general partner. If the application for re-domiciliation is successful, the CR will register the fund as an LPF and a certificate of registration will then be issued.
Upon the successful registration of the non-Hong Kong fund as LPF, the original partnership will be bound by the Ordinance starting from its date of registration. The re-domiciliation of LPF will not create a new legal entity, nor affect any contract made or resolution passed or render any legal proceedings commenced defective. More importantly, it is not the legislative intention for re-domiciliation to be a transfer or a change in the beneficial ownership of the assets of the fund nor attract any stamp duty through the re-domiciliation.
G. Pitfall and areas to watch out for operating a LPF
Generally, a LPF is not required to be a licensed corporation nor does any of its GP or IM require to be a SFC licensed person. Whether or not an entity or a person is required to hold the appropriate SFC license depends on whether that entity or person carries out regulated activities in Hong Kong.
The GP, IM or other relevant person(s) is only required to obtain the relevant SFC license(s) if they or the fund carries out regulated activities in Hong Kong. This would be the case where:
- the GP or IM conducts fund or asset management business in Hong Kong;
- the IM has discretionary investment authority invested in him by investors;
- investment advice are being given (Type 4 regulated activities);
- the investment committee makes investment decisions on behalf of the fund’s investors in Hong Kong; and
- if the LPF has a distributor or placement agent (in which case its fund marketing activities may also constitute Type 1 regulated activities of “dealing in securities.”)
Further, GPs would not need to be licensed if all of the asset management functions have been delegated to an appointed IM which is a licensed or registered entity to carry on such regulated activity.
Secondly, when considering whether it is necessary to obtain a Type 9 license, the nature of the underlying assets relating to the services or products provided by the fund is crucial. If the fund merely holds or manages real estates located in Hong Kong or elsewhere (rather than manages a collective real estate investment scheme authorised by the SFC), it will not constitute a Type 9 regulated activity. Where the fund’s investment portfolio involves securities, it will depend on the nature of the company in question. If the shares were issued by an overseas or Hong Kong listed company or an offshore company registered outside Hong Kong, then it may constitute Type 9 regulated activity. On the contrary, if the fund only holds private companies incorporated in Hong Kong and the companies are not engaged in activities regulated by the SFC, the fund does not need to apply for a Type 9 regulated license.
If the GP or IM is a Type 9 licensee, it will have to comply with the SFC’s Fund Manager Code of Conduct, which specifies the exercise of due skill, care and diligence in appointing a custodian for the fund’s assets, or the enforcement of certain policies and procedures in the case of self-custody.
Under the Ordinance, GPs of LPFs have a duty to appoint a responsible person to carry out the measures that are set out in Section 2 of the AMLO. The responsible person must be either an authorised institution, a licensed corporation, an accounting professional or a legal professional.
The Government aims to develop Hong Kong’s position as an international asset and wealth management centre by facilitating the channeling of capital into corporations and businesses (especially to start-ups in the innovation and technology field in the Greater Bay Area). The introduction of LPFs in Hong Kong will be offered as an addition choice to the existing business vehicles of sole proprietorships, partnerships and limited liability companies to raise capital.
Besides, the Government has recently proposed the Bill to attract foreign funds to operate in Hong Kong and this further shows its determination to boost Hong Kong's fund industry. Investment fund managers who are based in Hong Kong ought to consider LPFs as a cost-effective alternative to offshore limited partnerships such as the Cayman Island’s ELP. This new business investment vehicle can be seen as a development in the asset management industry and is what investors, potential businesses and overseas fund managers should be aware of when considering the establishment of a new business or investment entity in Hong Kong.