Hogan Lovells

Through the unveiling of the Limited Partnership Fund (LPF) regime, Hong Kong makes clear its intention to join the Cayman Islands and Luxembourg as a viable alternative for Asia-focused asset managers seeking fund domicile.

The Hong Kong Government passed the Limited Partnership Fund Bill on July 9, 2020, with the new LPF regime set to take effect on August 31, 2020. The LPF regime is the product of collaboration by asset managers in Hong Kong and the Hong Kong Government, and it has been designed with the goal of cementing Hong Kong as Asia’s leading private equity hub.

While much fanfare has been made by certain industry voices about the new fund regime, it should probably be tempered until more is known, especially in light of the global economic conditions brought on by the COVID-19 pandemic and the regional civic uncertainty. In the short term, it is anticipated that the Cayman Islands and Luxembourg will remain as the “gold standard” for fund managers valuing the certainty and stability commensurate of robust and well-established investment funds laws and courts.

That being said, it is hard to ignore the key incentives aimed at Hong Kong-based fund managers who are willing to bring their funds onshore – especially in light of the increased regulatory and registration requirements introduced by the Cayman Islands and other offshore jurisdictions in 2019 and early 2020. Perhaps most notably, there is speculation surrounding imminent changes to the tax treatment of carried interest. In a 2020-21 budgetary speech, the Financial Secretary of Hong Kong announced the government’s intention to provide tax concessions on carried interest. Currently, performance fees or carried interest attributable to fund managers are treated as taxable profits, since the disposition of fund assets generally constitutes a transaction in the nature of trade, though this is a facts and circumstances standard. A two-tier tax regime applies to taxable profits: 8.25% for partners in a partnership on their respective pro rata shares of the first HKD 2 million of assessable tax and 16.5% on any amounts thereafter.

Furthermore, Hong Kong does not currently tax capital gains. While there has been speculation over whether carried interest will be treated as capital gains for tax purposes, it is too early to draw conclusions with certainty. The Hong Kong Government may institute a reduction in rates present under the existing two-tiered tax rate structure or limit the scope of the tax exemptions to certain qualifying transactions. Nevertheless, the future tax concession remains the single most compelling economic reason to-date for a Hong Kong-domiciled investment vehicle and could spur a frenzy of fundraising activity in Hong Kong, depending on the degree of the concession.

The terms of the carried interest tax concession are currently in the consultation stage, which is set to end September 4, 2020. We will publish a separate client alert outlining the final details of the concession once it has been passed into law.

Below are some high-level takeaways from the LPF regime, as currently constructed:

Structure and Governance:

  • Structure: LPFs will be traditional limited partnerships with a General Partner and a minimum of one Limited Partner, whereby the General Partner will assume unlimited liability for the debts and obligations of the partnership (nothing new here compared with other regimes globally). The General Partner must appoint an Investment Manager, and may appoint itself as Investment Manager if it meets certain criteria (more on the Investment Manager registration requirements below). The LPF will not have a legal personality, and the General Partner and Limited Partners will be afforded freedom to contract (e.g., negotiate partnership agreement terms and side letters).
  • Legal Statute and Registration: The legal statute governing the LPFs will be the Limited Partnership Fund Ordinance (LPFO). LPFs will be required to register with the Registrar of Companies (RoC), an application to which must be submitted in person by a Hong Kong law firm or Hong Kong-qualified solicitor.
  • Accounting Treatment: There will be no limitations on the use of certain accounting methods, which will promote continuity across funds for sponsors and streamline investor reporting.
  • Dissolution: LPFs may be dissolved voluntarily. If the General Partner declares bankruptcy, dissolves, or otherwise ceases to be the General Partner of the LPF, if there is not a replacement designated within 30 days, the LPF will automatically dissolve. In each of the foregoing cases, the General Partner must provide notice to the RoC within 15 days of dissolution.

Key Constituents and Duties:

  • Investment Manager: Any person or entity, whether the General Partner or otherwise, deemed to be the Investment Manager must obtain a license to conduct Type 9 asset management activity from the Hong Kong Securities and Futures Commission (SFC), as specified under Section 114 of the Securities and Futures Ordinance.
  • AML/CFT Appointee: The General Partner must appoint a “responsible person” to carry out Anti-Money Laundering (AML) and counter-terrorist financing measures, which is a requirement established by the LPFO. This role may be occupied by a variety of institutions and professionals, including SFC-registered entities, banks, and legal professionals.
  • Key Operational Obligations: The fund sponsor must maintain compliance with the LPFO and comply with RoC inquiries. The RoC has broad regulatory authority over LPFs and their operations. The LPF must also maintain a registered office in Hong Kong and a Hong Kong business registration, as specified under the Business Registration Ordinance. Additionally, the LPF must appoint a third-party fund administrator to oversee NAV calculations and certain other investor services.

While a great deal of uncertainty remains, there are reasons for cautious optimism surrounding the new LPF regime, which is due in no small part to the Hong Kong Government’s clear willingness to heed advice from Hong Kong fund sponsors and other stakeholders. It remains to be seen whether global alternative asset managers and investors will embrace Hong Kong funds or stick to what they know. Only time will tell if Hong Kong will gain global prominence or go the way of other ambitious, regionally-focused jurisdictions.

As always, we will continue to monitor global fund formation trends and developments, and provide updates in real time.

In particular, look out for our next alert when the Limited Partnership Fund Ordinance comes into force on 31 August 2020. We will be looking at the LPF regime in more detail with commentary focusing on efforts being made to enhance Hong Kong's position as a family office/private wealth hub.

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