Will the new LPF regime make Hong Kong more attractive than Cayman?

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The new regime came into force last year to help promote the jurisdiction as a leading private equity hub in Asia. Will Hong Kong become a super-competitor to traditional offshore domiciles?

Hong Kong has made a strong statement of intent after introducing its Limited Partnership Funds (LPF) regime on  August 31, 2020.

In our recent webinar “The first 90 days of the Limited Partnership Fund Regime”, panellists reflected on what has been accomplished during the regime’s first three months and discussed the benefits of setting up an LPF as well as potential future developments.

Panel moderator, Apex Group Managing Director Hong Kong, Wilbur Chiu, called the LPF one of three building blocks for reforms of the jurisdiction’s funds sector.

At the time of the webinar, there were 54 registered LPFs on the Company Register. Anson Law, a Senior Manager of the Market Development Division at the Hong Kong Monetary Authority (“HKMA”), said this is a “very solid start”, and that he expected to “see this regime flourish”.

In two polls of webinar listeners, Apex found that while 73% had a degree of familiarity with the LPF regime, 60% were undecided on whether they would consider adopting the LPF in the next six to 12 months.

Flexible structure

When designing the regime, the HKMA sought to make it as flexible as possible. There is no restriction on investment strategy, no restriction on the amount of capital, no requirement on the number of investors, and the watchdog does not ask for investor information.

The flexibility has enabled the market to put this vehicle to different uses. Law explained. “Predominately, many of them are using it for venture capital or private equity investment vehicles, either as a project fund or a main fund,” he said. “But, I am also seeing at least one party using this vehicle for a liquid investment strategy and another party using this as a feeder structure. One family office is using it as a holding structure for their assets.”

According to the panellists the users of the LPF structure can be broadly split into three categories. The first group are the large cap, top tier investment managers; the second group are mid-cap managers, and the third group are emerging investment managers.

“The top tier managers are making preparations to ensure that any fund vehicle project that they establish today, is resilient to international challenges in the areas of regulation and tax,” said Law. “Large investors, in particular those based in Europe, as well as on the Chinese mainland, are gradually trying to avoid being affiliated to offshore fund structures. For mid-tier investment managers using the LPF, their concern is mostly about tax efficiency, while emerging fund managers are more cost sensitive.”

Robust and practical structure

Fiona Fong, Partner at Deacons, said the law firm is receiving a rising number of inquiries about the LPF and has met with a lot of managers who are looking for alternatives to the traditional offshore jurisdictions.

It is a “very practical structure that is easy to use and understand,” especially for private equity fund managers, she said. It is formed by a general partner entering into a limited partnership agreement with one or more LPs, which is how traditional private equity funds are formed. “It is fair to say that the LPF operates in a way that most private equity fund managers and investors are familiar with,” Fong added.

One benefit to setting up an LPF in Hong Kong is the well-regulated environment that gives confidence to investors coming there to invest. Fong explained: “The Securities and Futures Commission regulates all fund managers doing business in Hong Kong, irrespective of whether your fund is here or domiciled elsewhere in the world. Yet, they are not overly restrictive with private funds; they regulate the conduct of the manager, not the product itself.”

Low costs

Another benefit is low set-up costs and control of ongoing maintenance costs. Fong said fund managers pay around HKD 3,000 in registration and allotments fees to the Hong Kong government, which is “a cost saving compared to other traditional offshore jurisdictions such as the Cayman Islands.”

Cost considerations were important for Vectr Ventures, one of the early LPF adopters. The venture capital fund, based in Hong Kong historically, used the Cayman and British Virgin Islands (“BVI”) offshore structures for tax neutrality and very light regulations.

Jimmy Shum Lin, Managing Director at the business, said the company had noticed an “increase in onerous regulatory burdens” over the years from using Cayman and BVI structures, which led to higher costs. Being a “very cost conscious” emerging manager, this led to it considering the LPF. “We really wanted to choose a vehicle that makes sense for us, for our strategy and for the size of our operations,” said Shum Lin. He added that setting up the LPF was “very easy” and a lot of the paperwork was “very similar” to that required for Cayman and BVI structures.

When the HKMA designed the LPF regime, it looked at six jurisdictions: Cayman Islands, Luxembourg, the US state of Delaware, Singapore, the UK, and Australia. “We looked at what worked for them, and what didn’t work for them. We made Hong Kong the largest common denominator for good features,” said Law. “If you compare us head on with any one jurisdiction out there, you’ll find that our safe harbour provisions are much more comprehensive, and the degree of flexibility in terms of contract freedom in the LPF regime is much more commercially friendly than to set up in traditional offshore or other offshore domiciles.” he added.

There are also market access benefits to setting up an LPF. Investors from the Greater Bay Area and other parts of China know and generally have confidence in Hong Kong, which gives funds domiciled there an advantage from a capital raising perspective. Hong Kong’s “sound” legal system could help investors who need to have protection to give them reassurance that their rights can be enforced, Fong explained.

Vectr Ventures is already seeing these benefits. “We’ve been working with a lot of local service providers here,” said Shum Lin. “And we think it’s made a lot of sense for us, especially as an emerging fund manager – not only from the perspective of cost savings, but because the Hong Kong ecosystem as a whole is a dominant player in the funds industry.”

For now, Vectr Ventures will continue to use a combination of both Cayman and the LPF, as “the more tools you have in your toolkit, the better,” said Shum Lin. Although he added: “in terms of how drastically we’ll move towards one specific direction, whether it is onshore LPF, or whether it’s Cayman or whether there’s a combination of both, I think that remains to be seen.”

Financial incentives could help to boost LPFs

Apex’s Chiu said this is one topic that his clients “bring up most of the time.” He noted that when Singapore introduced its new corporate structure for investment funds in January 2020 — the Variable Capital Company (“VCC”) – the jurisdiction covered about 70% of the set-up costs.

The LPF could also become more popular if the government pushes ahead with a proposed tax concession regime for carried interest issued by private equity funds operating in Hong Kong – as set out in an August 2020 consultation paper. Shum Lin said his firm is monitoring these developments, and added that getting this right, could make the Hong Kong LPF regime “super competitive”.

Overall, the panel agreed that the LPF was likely to enhance choice for fund managers, expand Hong Kong’s infrastructure, and support the growth of its asset management industry still further.

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As part of our global business covering 45 offices, our locally based team of more than 40 professionals in Hong Kong understands your local needs and delivers on-the-ground fund administration services to our hedge fund and private equity clients. We can help through the entire LPF life cycle from registration to dissolution.

Talk to us today to learn more about how we can help.

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