Hong Kong’s limited partnership fund (LPF) bill was finally approved on Thursday (July 9) and is slated to take effect on August 31, fuelling hopes that it will enable the territory to compete better with Singapore as a fund domicile and investment hub for private equity strategies.

But the city's aspirations will have to contend with the likelihood it will struggle to convince users of well-established domiciles to begin using Hong Kong as a base. And that difficulty will not have been made any simpler by the city's new National Security Law (NSL).  

Beijing introduced the new rule over the heads of the local government on June 1. It is broadly drawn, which means that a wide array of activities or comments could arguably contravene it. And the maximum prison sentences for those found guilty are life imprisonment. 

While the new law has received a great deal of international condemnation, private equity industry participants who spoke to AsianInvestor had more pragmatic concerns with Hong Kong's private equity hub aspirations.

“Overall, I think it's less of an issue of geopolitics but GPs/LPs’ inertia towards the existing Cayman Islands structure,” said one Hong Kong-based private equity expert.

He noted that large and small pan-Asian and Chinese private equity funds that began fundraising recently are still predominantly domiciled in the Cayman Islands (on which the LPF vehicle is largely modelled). He believes new funds based upon original Cayman Islands vehicles would be likely to remain there because all involved parties could simply replicate the agreements rather than go through the hassle of introducing a new HK LPF structure.

It's less of an issue of geopolitics [than] GPs/LPs’ inertia towards the existing Cayman Islands structure

Indeed, the expert said the only exception might be larger funds, which might establish a smaller parallel vehicle using the new local structure for state investors in China and Hong Kong.

An unnamed Malaysia-based private equity investor added that their firm targeted funds typically domiciled in Luxembourg, the Cayman Islands and Delaware, and that they are likely to remain domiciled in those regions.

DIMMING ASPIRATIONS

Even as Hong Kong considers ways to overcome such inertia, it could find itself being caught in the crossfire of mounting tensions between the US and China. 

As a result of Beijing introducing the new NSL, US president Donald Trump is expected to ratify legislation this week under which his administration could sanction officials, banks or state entities seen as undermining the city’s semi-autonomous status.

The US has already made its desire to reduce investment into China clear. Political pressure by the Trump administration in May led the US Federal Retirement Thrift Investment Board to pull back from an initial decision to invest in an index that includes Chinese stocks.
Patrick Yip, Deloitte

The introduction of the NSL may give the US government a reason to lean on American asset owners not to use Hong Kong domiciled vehicles that target Chinese firms.

However, investment industry experts argue the US government would be unlikely to take this approach. Patrick Yip, China vice-chair of consultancy Deloitte, said he believes the US would favour targeting specific companies for sanctions over interfering with investor asset allocations.

The unnamed Hong Kong-based expert added that most US institutional investors are return-driven, so geopolitical tensions would be unlikely to greatly affect their interest in China private equity fundraisings

A government executive involved in developing Hong Kong's LPF regime added that he believed any blockage of fund flows by the US would likely take place at the banking level, rather than the investment stage.

FOCUSING ON CHINA

While the tit-for-tat between the US and China could dim Hong Kong's overall appeal to international investors, private equity experts were at pains to point out to AsianInvestor that the LPF regime focuses on facilitating funds from limited partners from greater China, who are unlikely to be bothered about the new law. 

Effie Vasilopoulos, a partner at law firm Sidley Austin, previously told AsianInvestor early this year that Chinese and Hong Kong state institutions could well favour vehicles run under the LPF regime over Cayman Island structures. Sidley Austin was exclusively involved in drafting the LPF bill. Vasilopoulos declined to comment for this story. 

Certainly, the new LP structure was widely expected to be taken up initially by mainland Chinese and Hong Kong fund managers seeking to raise capital from international investors.

[International general partners] need mainland Chinese professionals who were educated in the west and who know the China market

Deloitte's Yip added that mainland Chinese professionals will become more inclined to work in Hong Kong if the NSL causes the anti-Beijing protests that were roiling the city to disappear.

“A lot of these [Chinese and international general partners] are interested in investing in China, so obviously they will need the language skills, the understanding of the China market and the ability to fundraise in the western world,” Yip told AsianInvestor. “They need mainland Chinese professionals who were educated in the west and who know the China market.”

The success of Hong Kong's new regime will also depend on how tax fund managers have to pay on their management fees and carried interest.

The territory’s Inland Revenue Department currently considers the latter to be compensation, which comes with a 15% and 16.5% tax rate for individuals and corporates respectively. Singapore, by contrast, provides fund managers with a 10% concessionary tax rate on their fee income and charges no tax on carried interest.

Hong Kong’s treatment of carried interest is to be reviewed. An industry consultation expected to take place over the next few weeks, with a retrospective effective date of April 1, Anson Law, senior manager of the Hong Kong Monetary Authority’s market development division, told AsianInvestor.