Why Hong Kong may struggle to meet its PE ambitions

Hong Kong’s government has trumpeted its ambition to make the city the leading fund management hub in Asia more than once. To date, it’s been met mostly with indifference.  

It first established an open-ended fund regime in July 2018. Yet fund managers had almost no interest in using the new rules in setting up either a listed or private open-ended fund company in Hong Kong, as an empty list of products registered with the Securities and Future Commission on its website can attest.

But Hong Kong’s authorities are nothing if not resilient. In its latest effort to bolster the territory’s financial industry, the government intends to revamp its century-old partnership law and introduce a limited partnership regime. 

Once enacted – likely in late 2020 – the law would allow private equity fund managers to domicile their funds in Hong Kong. 

The idea is to attract more general partners (GPs) to set up private equity funds in the territory, rounding out the territory’s strengths in financial services and appealing to funds that seem to be attracting a seemingly inexhaustible inflow of capital.  

And to give the incoming regime an extra leg up, the Inland Revenue Department (IRD), Hong Kong’s tax bureau, has exempted eligible onshore and offshore funds that operate in the city from its corporate profits tax, effective April 1 this year. 

The plans to build Hong Kong’s private equity appeal make sense. The city already stands as the second-largest centre for private equity after China – private equity players operating in Hong Kong managed 15% ($160 billion) of Asia’s total capital under management as of the first quarter of 2019. 

And they have an easy way out of their investments on hand, given that Hong Kong’s stock exchange was the world’s biggest IPO fundraising hub in Asia ex-Japan in six out of the past 10 years, including 2018, said a spokesman of the Hong Kong Monetary Authority (HKMA). 

If Hong Kong can attract more GPs and limited partners (LPs) it would also bring in more professional service companies to support them. And asset owners in the region would likely find it more appealing to use Asia’s largest financial centre to invest money in private equity than offshore jurisdictions that are often perceived to live on the edges of respectable financial practice. 

Unfortunately, the incentives being discussed to date may not be sufficient to get private equity fund managers to domicile their funds in Hong Kong. GPs and LPs are largely comfortable with the existing legal and taxation frameworks of offshore jurisdictions like the Cayman Islands, after all. More directly, Singapore now boasts a decade-old tried and tested limited partnership regime – and it’s set to finalise a new fund structure to make itself even more appealing. 

A LIMITED REGIME

In theory it shouldn’t be difficult for Hong Kong to build its private equity market. The city combines international standards of rule of law and information disclosure with access to the world’s second-largest economy. 

Government officials certainly see the potential. “Private equity is critical to our asset and wealth management landscape,” said Paul Chan, financial secretary of the Hong Kong government, at the Asia Private Equity Forum 2019 on January 16.

But it’s a lot easier said than done to revamp the city’s archaic existing limited partnership ordinance, which dates back to June 1912. 

“The existing limited partnership ordinance doesn’t really contemplate private investment funds,” said Robert Woll, Hong Kong-based partner of law firm Mayer Brown. “In a financial agreement, the parties always want to minimise uncertainty and vagueness,” he added.

The new, updated limited partnership regime will have to contemplate all of the nitty gritty rules required by a Hong Kong-domiciled private equity fund, its managers and investors.

LPs will want to be “assured that they have limited liability,” said Woll, so they won’t be exposed to any risk of liability for actions taken by the GP that’s out of their control.

TAXING ISSUES

Hong Kong’s century of indifference over its limited partnership law stands in stark contrast to most popular financial jurisdictions. They typically update their rules every few years to keep them relevant.

The Cayman Islands, for example, renews its partnership laws every second or third year while Delaware in the US amends all of its corporate laws – including the partnership laws – every year, said legal expert Scott Peterman, partner of Orrick.

“It’s become the centre of corporate legal innovation,” he added.

This process of legal renewal, active fund domiciling and inevitable legal disputes, means these jurisdictions live up to the expectations of fund managers and investors. There are precedents and reference from many case laws to draw on. 

That’s not the case with Hong Kong; its new regime will be untested. And that leaves it looking less appealing to more established regimes.

This story has been adapted from a feature that originally appeared in AsianInvestor's Summer 2019 edition.