Foreign private equity firms are still struggling to decipher the “messy” regulatory environment in Hong Kong for those with offices in the city, says the counsel at one international PE manager.
But more clarity will soon be needed, given that the Hong Kong government said in February it would consider offering profit tax exemptions to foreign PE firms with offices registered with the Securities and Futures Commission. (Such exemptions are already in place for mutual funds and hedge funds with licensed operations registered in Hong Kong.)
Hong Kong’s ambition to become a domiciling centre through tax and legal reforms will push the SFC to focus more on PE registration, argues Stuart Somer, director at compliance consulting firm Complyport Hong Kong.
The SFC declined to comment.
Whether foreign PE managers should register with the watchdog or can make do with an exemption has long been an area of uncertainty.
“With the law written the way it is, the only way you can be a mutual fund or hedge fund manager in Hong Kong is by being regulated,” says John Levack, vice chairman of the Hong Kong Venture Capital Association. “[The profit tax exemption] will be extended to PE and, perhaps initially, the only PE firms that may benefit will be those regulated ones.
“But we believe the exemption should apply to all PE firms,” he notes. “So there are some specifics as to why a firm may choose to get regulated.”
The February announcement had again sent private equity firms rushing to lawyers and regulators to determine whether licensing their operations in Hong Kong is a prudent move. But law firms are struggling to provide clear advice on the issue, says the unnamed Asia counsel.
Somer confirms: “Under the Securities and Futures Ordinance, the requirement that a private equity fund manager be licensed is not clearly spelled out. It is a grey area, and historically there have been firms operating without an SFC licence.”
Many offshore firms have previously avoided the hassle of licensing their operations locally by designating their Hong Kong office solely as an advisory entity – in other words, they only advise the offshore parent group and don’t invest money.
Not registering an office in Hong Kong also allows offshore firms to steer clear of potential taxes. Hong Kong tax law suggests that an offshore PE fund could be taxed if it has, for example, a high number of senior executives based in the city, says Levack.
“As a result, firms structure responsibilities very carefully to ensure the Hong Kong activity is limited to ‘providing advice’ and that managing the fund is performed offshore of Hong Kong,” he says.
Reasons for the lack of clarity on PE regulation are varied. One source, who used to work closely with the regulator, suggests the SFC views private equity as posing low systemic risk. Events such as the Lehman minibond crisis in 2008 have led the SFC to prioritise other initiatives, such as investor-protection laws.
Another reason the SFC does not have clear-cut PE rules has to do with its definition of securities, which it classifies as public shares or debentures. An entity dealing in or advising on private equity does not fall under this category.
While private equity firms are not required to register, many Hong Kong-based service providers and custodians will not service them if they don’t, say industry observers.
“[Service providers] just don’t need the risk,” says Somer. “If things go wrong, the administrator gets sued too, even if all the wrongdoing is caused solely by the fund manager.”