The Hong Kong Limited Partnership Fund
On August 31, 2020, the Hong Kong limited partnership fund (“LPF”) regime came into effect. The LPF was introduced with the Limited Partnership Fund Ordinance (“LPFO”). With the LPF, Hong Kong is offering fund managers an opportunity to establish closed-end fund structures in the special administrative region instead of in other jurisdictions such as the Cayman Islands.
In 2018, Hong Kong already introduced a regime for open-end fund structures with the open-ended fund company (“OFC”), implemented through the Securities and Futures (Amendment) Ordinance 2016 and its subsidiary legislation. Prior to the OFC, open-end fund structures could only be set up as unit trusts. Furthermore, the OFC can be set up as a stand-alone or umbrella fund and can be used for traditional and alternative funds.
Both the LPF and the OFC further strengthen Hong Kong’s position as an international investment hub. They further offer the advantage of having the fund manager as well as the fund structure in one jurisdiction, avoiding complexities when operating in multiple jurisdictions and resulting in time and cost efficiencies. Lastly, the increasingly complex regulatory landscape of traditional offshore jurisdictions such as the Cayman Islands creates an opportunity for Hong Kong to position itself as a full service fund jurisdiction.
Main features of the LPF
While there is an existing regime for limited partnerships in Hong Kong with the Limited Partnerships Ordinance, this is not tailored for fund structures. The LPF creates a limited partnership regime comparable with that of other leading jurisdictions and which is therefore familiar and user friendly for fund managers as well as service providers. It offers substantial flexibility, thus making it suitable for various investment strategies typically employed by closed-end funds, such as private equity, venture capital and real estate.
In order to qualify as an LPF, the limited partnership must meet the definition of ‘fund’ in the LPFO. A ‘fund’ is defined as an arrangement where (i) the property is managed as a whole by the person operating the arrangement or the contributions of the persons participating in the arrangement are pooled, (ii) the participating persons do not have day-to-day control over the management of the property and (iii) the purpose or effect of the arrangement is to enable the operating person and participating persons to participate in returns arising from the property of the arrangement. An LPF, itself not a legal person, initially comprises one general partner (“GP”) and at least one limited partner (“LP”). Within two years after the registration date, the LPF must have an external partner as well. There is a substantial degree of contractual freedom in drafting the limited partnership agreement, which governs the LPF (currently, a redomiciliation to Hong Kong is not possible). Lastly, an LPF is not required to have offering documents (such as a private placement memorandum) in place.
Furthermore, the LPF must have a registered office in Hong Kong. The GP must register the fund as an LPF with the Registrar of Companies (“RoC”) and a registration fee of HKD 3,034 needs to be paid as well. Once the registration is completed, the RoC will issue a certificate of registration. Lastly, the LPF is required to file annual returns with the RoC and to notify the RoC in case of any change of particulars. Important to note is that although general details of the LPF will be available for inspection by the general public, this does not apply to any details of the LPs.
Aside from the registration with the RoC, the LPF requires no further authorisation by the Securities and Futures Commission (“SFC”), except for when the LPF is targeted at retail investors. As such, no investment restrictions apply. In addition, there are no operational or disclosure requirements applicable to the LPF.
Key entities of the LPF
An LPF consists of a GP and an LP. In addition, the GP must appoint an investment manager, an auditor, a responsible person and, in certain instances, an authorized representative. Additionally, in certain instances a custodian needs to be appointed.
The GP must be (i) a Hong Kong private company limited by shares, (ii) a non-Hong Kong company, (iii) a Hong Kong or non-Hong Kong limited partnership with or without legal personality, (iv) an LPF or (v) an individual of at least 18 years old. It has ultimate responsibility for the management and control of the LPF and has unlimited liability for all debts and obligations of the LPF. Also, the GP must ensure there are proper custody arrangements for the LPF’s assets.
LPs can be either natural or legal persons (as well as any other kind of entity). An LP does not have day-to-day management rights or control over the assets held by the fund but has the right to participate in the income and profits arising from the management of the fund’s assets. It is not liable for the debts and obligations of the fund beyond the amount of its agreed contribution. However, if an LP takes part in the management of the LPF, it is fully liable for all debts and obligations of the LPF arising while so taking part in the management, unless it can rely on any of the non-exhaustive ‘safe harbour’ provisions.
An investment manager must be appointed by the GP to carry out the day-to-day investment management functions of the LPF. This can be (i) a Hong Kong company, (ii) a non-Hong Kong company or (iii) a Hong Kong resident of at least 18 years old. The GP can also be the investment manager. In case the investment manager is carrying out regulated activities in Hong Kong, the appropriate license(s) from the SFC need to be obtained in accordance with the Securities and Futures Ordinance (“SFO”). This applies to the GP as well in case it performs the investment management functions of the LPF and, in that respect, carries out regulated activities in Hong Kong. These licensing requirements may be triggered in case of dealing in, advising on and managing of securities, which term is broadly defined in the SFO. However, amongst other exclusions, shares or debentures of a Hong Kong private company and real estate are carved out from this definition and these licensing requirements therefore do not apply in that case.
Financial statements of the LPF must be audited by an independent auditor on an annual basis. The auditor must be independent from the GP, the investment manager and the authorized representative (insofar appointed).
A responsible person must be appointed by the GP in order to carry out the anti-money laundering measures set out in Schedule 2 of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance in relation to customer due diligence and record-keeping. The responsible person is ultimately responsible for compliance with the anti-money laundering obligations set forth therein. It can only be one of the following: (i) an institution authorised by the Hong Kong Monetary Authority, (ii) a corporation licensed by the SFC, (iii) an accounting professional or (iv) a legal professional.
If the GP is itself an LPF or is a non-Hong Kong limited partnership without legal personality, it must appoint an authorized representative. Only (i) a Hong Kong company, (ii) a non-Hong Kong company or (iii) a Hong Kong resident of at least 18 years old can be appointed as authorized representative. The authorized representative is, together with the GP, responsible for the management and control of the LPF. Additionally, the authorized representative is jointly and severally liable for all debts and obligations of the LPF together with the GP.
Although the GP must ensure there are proper custody arrangements in place, it is in principle not required to appoint a third party custodian in relation to the LPF’s assets. In case the investment manager or the GP is a Type 9 – Asset management licensee, they might however be required to appoint a custodian, in line with the SFC’s Fund Manager Code of Conduct.
Taxation of the LPF
In accordance with the unified fund exemption of the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Ordinance 2019 (“IRO”), an LPF is exempted from profits tax as long as it meets the definition of ‘fund’ in the IRO. In order to benefit from the exemption, such profits must derive from ‘qualifying transactions’ or ‘incidental transactions’ as defined in the IRO. No pre-approval is required to benefit from the exemption as each LPF can assess by itself whether the exemption applies or not. Furthermore, the subscription, transfer or redemption of interests in the LPF or the distribution of profits by the LPF will not be subject to any stamp duty in Hong Kong. Lastly, the Hong Kong government expressed its intention to provide attractive tax concessions for carried interest, but these have not yet been implemented.
With the LPF, Hong Kong offers a solution to align the jurisdiction of both the fund manager and the fund structure. It does so through a familiar and practical limited partnership framework that provides certainty in relation to regulatory and tax matters and that has low set up and maintenance costs. Also, Hong Kong positions itself as a hub for investment opportunities in the fields of private equity, venture capital and real estate, not in the least because of its proximity to Mainland China.