Limited Partnership Funds

A. The problems of offshore type funds relating to private funds

EVOLVING INTERNATIONAL AND OFFSHORE TAX LAW AND RISK

PE fund systems in the Cayman Islands have traditionally been branded as business-friendly and more regulatory relaxed. However, series of regulatory changes introduced in the Cayman Islands, including the introduction of economic substance requirements, have led to an increase in compliance with time and costs. These may precipitate a change in the common perception of the Cayman Islands as the “gold standard” of private equity.

HONG KONG'S LPF AS A RESPONSE TO CAYMAN ISLAND'S FUNDS LAW

As the trend for establishing funds and conducting private equity businesses shifts back from offshore jurisdictions to onshore, investment managers may need to reassess their preferences and give more consideration to the increasingly favourable and cost-effective opportunities in Hong Kong. On 31 August 2020, the Limited Partnership Fund Ordinance (Cap. 637) (“the Ordinance”) came into force in Hong Kong, allowing private funds to be registered in the form of limited partnerships. Over 300 LPFs have been registered in less than a year since the ordinance became effective.

B. Outline of the LPF legislation and the mechanism of the LPF

LPFs do not have separate legal entities. They are based on partnership agreements between the general partner (“GP”), who is responsible for managing the fund, and the limited partner (“LP”) who does not have day-to-day management control, with the objective of deriving profits from the fund investments.

Partners have full freedom to conclude contracts among themselves. The lack of restrictions on minimum capital contribution and investment scope also renders it an attractive fund structure for a number of different investment purposes. It can be adopted and used as the main fund, feeder fund or co-investment vehicle.

The Ordinance requires the LPFs to have a registered office in Hong Kong and registration with the Hong Kong Companies Registry (“CR”). But it is different from the existing open-ended fund companies which are to be registered and/or authorised by the Securities and Futures Commission of Hong Kong (“SFC”)

C. The parties involved in LPF

GP

The GP has unlimited liability for all debts and obligations of the LPF, and bears the ultimate responsibility for the management and control of the LPF. The GP can be:

  • a private company limited by shares incorporated in Hong Kong;
  • a registered non-Hong Kong company;
  • a Hong Kong or overseas limited partnership (with or without legal personality); or
  • a natural person who is at least 18 years old.

It has the duty to appoint an investment manager (“IM”), an auditor, and an authorised representative if the GP is a LPF or a non-Hong Kong limited partnership with no legal personality.

LP

The LP has distributions entitlement to the economic return of the LPF. The LP has no day-to-day management rights or control over the assets. The LP can be:

  • corporations;
  • partnerships;
  • unincorporated bodies or any other entity; or
  • natural persons (as trustee or in the person’s own or any representative capacity).

Its liability is limited to the agreed contribution it makes, unless the LP has participated in the day-to-day management of the LPF, subject to the non-exhaustive exemptions granted under the “safe harbour”.

IM

The IM must be appointed by the GP to carry out day-to-day investment management functions of the LPF. It must be any of the following:

  • a Hong Kong incorporated company;
  • a registered non-Hong Kong company;
  • a Hong Kong resident who is at least 18 years old; and
  • the GP itself.

AUDITOR

The auditor must be appointed by the GP to carry out annual audits of the financial statements of the LPF and must be independent of the GP, the IM and also the authorized representative (“AR”) (if applicable) of the LPF.

RESPONSIBLE PERSON

The responsible person must be appointed by the GP to carry out the anti-money laundering and counter-terrorist financing (AML) measures set out in Schedule 2 to the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (AMLO). It must be any of the following:

  • an authorised institution
  • a corporation licensed by the SFC
  • an accounting professional; or
  • a legal professional.

AUTHORISED REPRESENTATIVE

The AR must be appointed by the GP to be responsible for the management and control of the LPF if the GP is an LPF or a non-Hong Kong limited partnership with no legal personality. It must be any of the following:

  • a Hong Kong incorporated company
  • a registered non-Hong Kong company; or
  • a Hong Kong resident that is at least 18 years old

It is jointly and severally liable for all debts and obligations of the LPF with the GP and shares the ultimate responsibility for the management and control of the LPF with the GP.

To register a fund as an LPF, the proposed GP of the LPF must make an application to the CR, which is required to be submitted on behalf of such GP by a Hong Kong law firm or a solicitor.

D. The difference between LPFs and Cayman ELPs

The LPF has often been compared with the Cayman Islands’ exempted limited partnership (“ELP”). Despite the ELP’s reputation as being the more conventional fund vehicle, it is now arguable that the LPF is more business friendly and cost-effective.

 

ELP

LPF

Registration body

Cayman Islands Monetary Authority (the “CIMA”)

CR

Does not need SFC authorisation unless it is offered to retail investors

Registration documents

A Private Placement Memorandum, summary of terms or marketing materials containing certain prescribed information must be submitted to the CIMA

CR application form

Privacy

Not part of any public records

On-going compliance

Annual filing

Annual filing and notification of change

AML/ CTD

Required to appoint:

  • An anti-money laundering compliance officer
  • A money laundering reporting officer
  • A deputy money laundering reporting officer

Required to appoint a responsible person to be responsible for the implementation of AML measures

Custodian

Must have a custodian unless exempted

Not required to appoint a custodian as long as proper custody arrangements for the safekeeping of the fund assets are put in place in accordance with the partnership agreement

Valuers

Must be performed by an independent third party

No specified requirements

Accounting Standard

Obliged to adopt either the IFRS or GAAP in the US, Japan, Switzerland or any other non-high risk jurisdictions

No specified requirements

Set up time

Around one to two weeks to set up

Within 4 working days from applications being made

Incorporation fees

Registration fee: USD5,500

A lodgment and registration fee of USD390

Annual fees

USD1,463 for regulated ELPs and USD2,439 for non-regulated ELPs

USD13.55

Fund managers or investors should also note that whilst an on-shore LPF is likely to only engage Hong Kong legal counsels, establishing an ELP with business operation in Hong Kong may require legal advice from both Cayman Islands and Hong Kong legal counsels, the cost of which may need to be factored into consideration in the long term.

E. Tax advantages

An LPF is eligible for profits tax exemption under the laws and regulations of Hong Kong subject to a number of conditions stated in the unified fund exemption regime.

Transfers or redemptions of interest in LPFs will not attract stamp duty, as an interest in an LPF does not fall under the definition of Hong Kong stock according to the Stamp Duty Ordinance (Cap. 117).

F. Recent development

Currently, most of the active funds in Hong Kong are offshore funds. In order to attract the offshore investment funds to establish and operate in Hong Kong instead, the chief executive of Hong Kong has taken steps to introduce the Limited Partnership Fund and Business Registration Legislation (Amendment) Bill 2021 (“Proposed Bill”) to the Legislative Council to incorporate a re-domiciliation arrangement for offshore funds to be registered as LPFs in Hong Kong.

PROPOSED RE-DOMICILIATION ARRANGEMENT

Under the Proposed Bill, there are some procedural requirements for offshore funds to apply for the re-domiciliation to become Hong Kong’s LPFs. It is intended that a specific application form and application process will be in place to facilitate the re-domiciliation. The latest draft application form requires the applicant to provide i) the name and place of establishment of the applicant fund, and ii) a statement confirming the details of the applicant fund’s registration in Hong Kong as well as a confirmation of its deregistration from its place of establishment. The proposed fees payable includes a lodging application fee of HK$479 and a registration fee of HK$2,555. The application will be made to the CR by the GP of the fund and be submitted by a Hong Kong law firm or a solicitor on behalf of the proposed general partner. If the application for re-domiciliation is successful, the CR will register the fund as an LPF and a certificate of registration will then be issued.

Upon the successful registration of the non-Hong Kong fund as LPF, the original partnership will be bound by the Ordinance starting from its date of registration. The re-domiciliation of LPF will not create a new legal entity, nor affect any contract made or resolution passed or render any legal proceedings commenced defective. More importantly, it is not the legislative intention for re-domiciliation to be a transfer or a change in the beneficial ownership of the assets of the fund nor attract any stamp duty through the re-domiciliation.

G. Pitfall and areas to watch out for operating a LPF

LICENSING REQUIREMENTS

Generally, the GP, IM or other relevant person(s) is only required to obtain the relevant SFC license(s) if they or the fund carries out regulated activities in Hong Kong. This would be the case where:

i. the GP or IM conducts fund or asset management business in Hong Kong;

ii. the IM has discretionary investment authority invested in him by investors;

iii. investment advice is being given (Type 4 regulated activities);

iv. the investment committee makes investment decisions on behalf of the fund’s investors in Hong Kong; and

v. if the LPF has a distributor or placement agent (in which case its fund marketing activities may also constitute Type 1 regulated activities of “dealing in securities.”)

Further, the GPs will not need to be licensed if the asset management functions have been delegated to the IM which is a licensed or registered entity to carry on such regulated activity.

Secondly, when considering whether it is necessary to obtain a Type 9 license, the nature of the underlying assets relating to the services or products provided by the fund is crucial. If the fund merely holds or manages real estates located in Hong Kong or elsewhere (rather than manages a collective real estate investment scheme authorised by the SFC), it will not constitute a Type 9 regulated activity. Where the fund’s investment portfolio involves securities, it will depend on the nature of the company in question. If the shares were issued by an oversea or Hong Kong listed company or an offshore company registered outside Hong Kong, then it may constitute Type 9 regulated activity. On the contrary, if the fund only holds private companies incorporated in Hong Kong and the companies are not engaged in activities regulated by the SFC, the fund does not need to apply for a Type 9 regulated license. If the GP or IM is a Type 9 licensee, it will have to comply with the SFC’s Fund Manager Code of Conduct.

ANTI-MONEY LAUNDERING

Under the Ordinance, the GPs have a duty to appoint a responsible person to carry out the measures that are set out in Section 2 of the AMLO. The responsible person must be either an authorised institution, a licensed corporation, an accounting professional or a legal professional.

CONCLUSION

The Government’s continuing effort to attract foreign funds to operate in Hong Kong has shown its determination to boost Hong Kong’s fund industry. This new business investment vehicle can be seen as a development in the asset management industry and investment fund managers who are based in Hong Kong ought to consider the LPFs as a cost-effective alternative to offshore limited partnerships, such as the Cayman Island’s ELP, when considering the establishment of a new business or investment entity in Hong Kong. 

 

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Partner & Head of Capital Markets – China, Ince China Appointed Attesting Officer

Eric is a banking and corporate finance specialist. He has extensive experience in corporate finance and cross-border project finance. On the corporate finance front, Eric advises a number of companies on their restructuring and subsequent IPOs in Hong Kong and foreign securities markets, as well as transactions and continuing obligations post-listing. He also works on numerous joint ventures and M&A transactions in Hong Kong and China. Additionally, Eric represents leading Chinese companies and organizations doing business in Hong Kong and provides advice in a range of areas including banking, insurance, securities and real estate investment.  

Eric is familiar with China business and he is a China Appointed Attesting Officer appointed by the Ministry of Justice of the People’s Republic of China. He is also part of the first batch of Hong Kong lawyers to set up a joint venture law firm in the Shenzhen Qianhai Cooperation Zone, and obtained a working permit issued by the Guangdong Ministry of Justice which allows him to practise Hong Kong law in mainland China.