Hong Kong’s de-facto central bank has thrown its weight behind a government initiative to revamp century-old limited partnership laws, in an effort to make the territory appealing for modern private equity funds

“Once the legal framework is out and the tax treatment is clarified, and provide more certainty, then we will probably work even harder to talk to GPs [general partners] and asset owners,” said Darryl Chan, executive director for corporate services at the Hong Kong Monetary Authority (HKMA), told the audience of the HKVCA Asia Private Equity Forum 2020 on Wednesday (January 15).

Darryl Chan, HKMA

"We believe we understand the market, we speak the market language, we know what the market concerns are. The good thing is, being part of the government, we can also reflect those views from the market to the policymakers on how to improve our ecosystem here," Chan said.

Indeed, HKMA is an investor in alternative assets, which helps to strengthen its argument. It has allocated around 6% of its HK$4.16 trillion ($535.3 billion) Exchange Fund to alternative assets, including private equity and real estate. A lot of this sum has likely been invested via the sort of funds that the updated laws would aim to attract

Anson Law, senior manager of HKMA’s market development division, told AsianInvestor on the sidelines of the event that HKMA’s dual role as both a market regulator and investor gave it the resources and network to promote Hong Kong’s updated limited partnership regime. The efforts will target primarily GPs and LPs [limited partners] based in Asia, he added.

He said the upcoming regime is intended to attract global and Hong Kong-based GPs seeking to invest in China, as well as mainland general partners looking to raise funds from overseas investors.

OFFSHORE STRUGGLES

The government’s plans may well require the full support of the HKMA. Industry participants have previously told AsianInvestor that Hong Kong could struggle to gain GPs after it updates its LP scheme.

The city lacks the track record in this space, whereas regional rival Singapore boasts a 10-year private equity fund regime, and it recently launched a new variable capital company fund structure.

But Hong Kong is seeking to launch its plans at a time when offshore fund structures such as those based in Cayman Islands gradually lose their appeal. The Organisation for Economic Co-operation and Development [OECD] now requires such offshore centres to provide a higher threshold of ‘domestic economic substance’

For example, a Cayman Islands-based fund manager that is not a tax resident elsewhere has to comply with the economic substance requirement, according to the Cayman Islands' guidelines.

Law claimed that the rising requirement to align GP fund structures with economic substance is a major driver for fund managers to establish onshore vehicles . This concern has only been amplified by asset owners and other investors expressing concern over the reputational risks of funds being located in offshore financial centres.

"Generally speaking, investors, especially European ones, are increasingly shying away from certain offshore structures and jurisdictions being labelled as tax havens," he said, “Luxembourg structures are gaining popularity and similar consolidation is expected to happen in Asia and our new vehicle can serve as the anchor for private equity funds active in Asia."

“In the future, offshore structures shouldn't work. People will go onshore," Law said, including Chinese investors.

MORE CLARITY

Having kicked off the consultation phase in 2019, the government is now drafting the bill before introducing it to the city's Legislative Council. Chris Sun, deputy secretary for financial services, Financial Services and the Treasury Bureau of the government, said the new framework should go live within this year.

“We try to be as user-friendly as possible … When it comes to Hong Kong's LPF [limited partnership fund] regime, what we hope to achieve is that it should be as efficient, as straight forward, and as easy as setting up a company in Hong Kong.” Sun told the audience in the panel discussion.

Rather than enlist the Securities and Futures Commission (SFC) to process fund applications, Sun said the responsibility will fall on Hong Kong’s Companies Registry.

He added that the application will have to be submitted through a Hong Kong law firm, along with details including the name of the fund, name of the GP, investment manager and presenter, as well as the vehicle’s investment scope and principal place of business.

Questions still remain. The new rules don’t yet stipulate fund management fees or how carried interest will be taxed. However, the city already defines carried interest on other investments as compensation rather than capital gains for the purposes of taxation. That has helped partly removed this uncertainty for GPs, unlike in Singapore, said Patrick Yip, vice chair of Deloitte China.

“Singapore doesn't have that…they don't call it anything,” said Yip. “It really pushes people to make a decision: ‘should I remain in a place where it says is compensation or should I go to a place where it says oh maybe it's capital gain, or likely it's capital gain.’”

The SFC has also provided more recent guidance for private equity firms looking to license in Hong Kong, which will likely ease earlier industry concerns.