For a long time, the growth of the private equity industry in Hong Kong has been hampered by its outdated Limited Partnership Ordinance (Cap. 37) (LPO), which is ill-suited to accommodate the complex privately-negotiated arrangements that characterise private equity funds. In contrast, Singapore, Hong Kong’s main competitor as a hub for private equity sponsors in Asia, has been developing new regulatory regimes, tax incentives and structures to attract private equity funds and managers, first with the Limited Partnerships Act 2008 (Singapore LP Act), followed by the enhanced tier tax scheme and, most recently, the Variable Capital Companies Act 2018, which came into effect on 14 January 2020.
The Limited Partnership Fund Bill (LPFB) is the latest attempt by the Hong Kong government to enhance Hong Kong’s competitiveness in asset and wealth management. The LPFB modernises and significantly improves the legal framework for setting up and operating private equity funds in Hong Kong by establishing a regime for eligible funds to be registered as limited partnership funds (LPF) in Hong Kong.
The LPFB was gazetted on 20 March 2020 but is yet to be presented to the Legislative Council for its first reading. It is expected to take effect on 31 August 2020.
This legal update will:
- Briefly review the key features of the LPFB;
- Examine certain changes made to the government's proposals to establish a limited partnership regime for private funds, published by the Financial Services and the Treasury Bureau (FSTB) on 31 July 2019 (Proposals); and
- Compare and contrast how the LPF regime compares with the Singapore regime in certain respects.
Key Features of the LPFB
1. Eligibility for registration as an LPF
A fund may be registered as an LPF provided that it:-
The GP must either be:-
The Proposals had required GPs to be Hong Kong incorporated private companies limited by shares.
In response to these restrictive eligibility criteria in the Proposals, we submitted our recommendation to the FSTB that, consistent with other leading jurisdictions (including Singapore), the LPF regime should not restrict the GP of an LPF to a Hong Kong-domiciled company. Instead, it should allow sponsors to have the option to set up the GP as an individual or in any form of vehicle (such as a company, a limited partnership, a limited liability company or a limited liability partnership) in any jurisdiction.
The LPFB has relaxed the eligibility criteria for GPs.
The LP must either be:-
|4. No minimum capital requirements||There is no minimum capital requirement under the LPFB. Withdrawals and distributions of capital contributions are permitted, subject to the solvency of the LPF.|
|5. No separate legal personality||
LPFs do not have separate legal personality.
Unfortunately, the FSTB did not accept the recommendation from market participants (including Mayer Brown) that LPFs should have the option to elect to have separate legal personality at the time of registration.
Without separate legal personality, assets contributed to the LPF will have to be held by the GP, and registration of such assets will have to be made through the GP. Inability to hold assets in the name of the private funds can adversely affect the structuring options available to private equity sponsors.
For comparison, we note that this issue also affects the Singapore limited partnerships formed under the Singapore LP Act. Limited partnerships formed under the Singapore regime cannot enter into loans or other contracts or hold assets in their names. Instead, legal title to any assets of these partnerships needs to be held on trust by their GPs or nominee companies.
Notably, there is a global trend for jurisdictions to introduce separate legal personality for limited partnerships, e.g. Guernsey, the British Virgin Islands, Scotland and the State of Delaware.
|Governance, Rights and Liabilities|
|6. Governance||Partners in an LPF will have freedom of contract in respect of the operation of the fund. The LPFB provides a non-exhaustive list of matters that may be determined by the partners in the LPF.|
|7. GP’s unlimited liability and ultimate responsibility for management and control||
The GP will have unlimited liability and ultimate responsibility for the management and control of the fund.
We have set out below a few observations regarding the GP's duties and responsibilities.
Investment Manager: Typically, GPs are not required to appoint an IM because it is outside the scope of typical limited partnership legislation and is generally viewed as a matter that should be left to the LPF itself and its partners. Indeed, we submitted to the FSTB that GPs should not be required to appoint any IM or custodian, but should instead have the freedom to delegate their responsibilities to any third parties, subject to the terms and conditions of the applicable limited partnership agreement.
Although the LPFB still requires an IM to be appointed, it has relaxed the eligibility criteria of the IM, i.e. the IM (which may be the GP) need not be an authorised institution, a licensed corporation, an accounting professional or a legal professional.
Authorised Representative: Given that the eligibility criteria of the GP have been expanded to include an LPF or a non-Hong Kong limited partnership with no legal personality, the LPFB recognises the difficulties in attributing liability. To address this, the LPFB requires the GP to appoint an AR who will share the ultimate responsibility to manage the LPF and be jointly and severally liable for any liabilities of the LPF.
Responsible Person: Due to the relaxed eligibility criteria of the IM and to ensure relevant AML/CFT measures are met, the LPFB requires the GP to appoint an RP who is responsible for conducting AML/CFT measures.
Filings with the Registrar: In our submission to the FSTB we noted that the LPFB should seek to minimise the initial and ongoing administrative burdens of sponsors; simply satisfying the eligibility and registration requirements should suffice for the purposes of maintaining filing status instead of requiring the filing of annual returns. Unfortunately, this suggestion was not adopted.
Comparison with Singapore: Generally speaking, the administrative duties and responsibilities of the GP in Hong Kong are more extensive than those in Singapore. For example, under the Singapore LP Act, the registrar may require the appointment of a local manager only if the GP is not ordinarily resident in Singapore, and while the GP must maintain the accounts and records of the limited partnership and produce these for inspection upon request by the Registrar, the Singapore LP Act does not require the filing of an annual return.
|8. Limited liability of LP(s)||
LP(s) will not have day-to-day management rights or control over the underlying assets held by the LPF. An LP’s liability is limited to the capital commitment it has made, unless the LP participates in the management of the LPF.
As in other leading jurisdictions, the LPFB provides for a non-exhaustive list of safe harbour activities which are not to be regarded as taking part in the management of the LPF, including but not limited to:-
|9. Keeping of records||
The GP or IM is required to maintain a proper record of:-
These records must be kept at the registered office of the LPF or any other place in Hong Kong made known to the Registrar and are to be made available for inspection by government bodies but not for public inspection.
|Other Key Features|
|10. Publicly available records and confidentiality||
The Registrar will maintain an index of the names of every LPF and the following shall be available for public inspection:
The identities and particulars of LP(s) are not available for public inspection.
The LPFB provides a streamlined process for an existing fund established under the LPO to register as an LPF provided it meets the eligibility requirements. Upon migration, such fund would not be deemed to be dissolved nor will there be a change in legal or beneficial ownership of the assets of the fund; no profits or stamp duty implications should arise from the migration. The rights and liabilities of the fund remain unaffected after its registration.
Note, however, that the LPFB does not cater for domestication or redomiciliation of LPFs established in foreign jurisdictions. In our comments to the FSTB, we recommended that foreign partnerships be permitted to migrate to the local jurisdiction by way of a transfer, similar to the migration procedure for existing funds under the LPO. Without a redomiciliation and continuance mechanism, sponsors would have to shut down original fund platforms and transfer assets held under such platforms over to the LPF structure, incurring stamp duty and affecting existing rights, thus deterring foreign funds from redomiciling to Hong Kong.
Although this is also an issue under the Singaporean regime, this may change. The Singapore government introduced legislation to provide for the redomiciling of foreign corporations to Singapore in late 2017 and may introduce similar reforms to enable foreign partnerships to redomicile in a cost-efficient fashion.
|12. Dissolution and winding-up||An LPF may be dissolved in accordance with the fund's limited partnership agreement without the need of a court order, though court-ordered dissolution is still available under certain prescribed circumstances.|
It is expected that the LPF will be eligible for the same unified funds tax exemption that currently applies to qualifying corporate funds in Hong Kong, therefore it should not incur Hong Kong profits tax on qualifying income earned by the LPF. However its tax treatment in the country of the investment made by the LPF will depend on whether that country will consider the LPF to be a tax resident of Hong Kong. As limited partnerships generally do not, under Hong Kong’s tax treaties, qualify as a tax resident of Hong Kong, the LPF generally would not enjoy the benefits of Hong Kong’s favourable tax treaties (i.e. reduced withholding taxes on dividends or interest and avoidance of local capital gains tax when the LPF disposes of its investments). In comparison with Singapore, the same problem arises.
One can avoid this by structuring the fund as a combination of an LPF investing through a Hong Kong master holding company that would qualify as a Hong Kong tax resident.
Race against Singapore
Since 2009, Singapore has had in place a regime similar to the LPFB, which, combined with incentives under Singapore's enhanced tier tax scheme, has put it ahead in its competition with Hong Kong to attract private equity, infrastructure, real estate and credit fund managers.
Indeed, Singapore has been developing new regulatory regimes and structures in response to the commercial needs of different forms of private equity funds. In January 2020, it introduced the Variable Capital Company, which permits several collective investment schemes to be gathered under the umbrella of a single corporate entity while remaining ring-fenced from one another. Venture capital fund managers enjoy a simplified authorisation process and regulatory framework to reduce unnecessary regulatory and administrative burdens. Suggestions have also been made to permit separate legal personalities of limited partnership funds and migration provisions for foreign funds to ensure that its regime better meets modern investment practices and norms.
While the LPFB reforms represent an important first step, if Hong Kong is to distinguish itself from Singapore, it needs to be more liberal and innovative in its approach.
Moving with the Times
The LPFB is Hong Kong’s first foray in adopting robust new structures to accommodate private equity funds. Combined with the recently-enacted unified funds tax exemption, this initiative comes at an opportune time, allowing Hong Kong to capitalise on the global offshore-onshore shift and the OECD-driven regulatory crackdown on countries designated as tax havens.