This article was written by Hayden Flinn, Guo Sun Lee, Jingjing Jiang, Cindy Shek and Justin Cherrington.
The Financial Services and the Treasury Bureau (FSTB) published a consultation paper on 31 July 2019 seeking comments on the proposal (Proposal) to establish a regime for limited partnership funds (LPF) in Hong Kong*. King & Wood Mallesons submitted a detailed submission on the Proposal to the FSTB during the four-week industry consultation period and held a face to face meeting with the FSTB discussing our submissions. After six months of preparation, the Limited Partnership Fund Bill (Bill) was gazetted on 20 March 2020, and will be introduced into the Legislative Council for its First Reading and Second Reading in due course. It is proposed that the Bill will come into operation on 31 August 2020.
The proposed LPF regime, together with the introduction of the open-ended fund company (OFC) regime in July 2018, and the expansion of mutual recognition of fund arrangements in recent years show the Hong Kong government’s commitment to strengthen the city’s position as an international hub for fund management activities and investment fund domiciliation.
This client alert outlines the key characteristics and requirements of the proposed LPF regime under the Bill and its major differences from the Proposal, followed by our take on the proposed LPF regime.
Driving forces for the introduction of the LPF regime
With 560 private equity and venture capital firms and around US$160 billion worth of asset under management in Hong Kong in 2019, Hong Kong is currently Asia’s second-largest private equity (PE) hub. The increasing number of Mainland Chinese PE investors (encompassing state-owned enterprises, pension and insurance funds and domestic PE funds) who are constantly expanding their inbound and outbound investment activities bring tremendous potential for Hong Kong to develop its own PE market.
Unfortunately, the current fund regime in Hong Kong is not well-equipped for such development to take place. The unit trust structure and the OFC structure, the two fund forms offered under the Hong Kong regime, are more popular amongst public funds and hedge funds since PE funds usually take the form of limited partnerships. Whilst the existing Limited Partnerships Ordinance (Cap. 37) (LPO) in Hong Kong allows the establishment of partnership, it has features which are not appealing for use in the PE fund context, for example its restrictive provisions with respect to capital contributions and distribution of profits, the lack of contractual flexibility of the partnership and the absence of a straightforward dissolution mechanism.
For these reasons, the PE industry has long been calling for the introduction of a new limited partnership regime that is catered for PE fund use.
What makes Hong Kong an ideal place of domicile?
Recently, we have seen traditionally-popular PE fund domicile jurisdictions such as the Cayman Islands introduce reforms to their laws and regulations in light of global initiatives to combat cross-border tax avoidance, money-laundering and terrorist financing. In December 2018 and June 2019, the Cayman Islands instituted the Cayman Islands International Tax Co-operation (Economic Substance) Law (Economic Substance Law) as a response to global OECD BEPS standards regarding geographically mobile activities. The Economic Substance Law introduces certain reporting and economic substance requirements for ‘relevant’ entities conducting ‘relevant activities’, and these entities will be required to report to the Cayman Tax Information Authority in respect of some of their activities on an annual basis. This impacts most Cayman Islands incorporated managers who are now required to comply with economic substance requirements and subject to more stringent regulatory oversight. Furthermore, on 7 February 2020, the Private Funds Law, 2020 came into force in the Cayman Islands, which requires, among other things, certain closed-ended funds to be registered with and regulated by the Cayman Islands Monetary Authority.
These reforms pose uncertainties to the fund formation environment. The absence of clarity and market consensus around the economic and practical impact of these changes offers an opportunity for Hong Kong to become the next alternative jurisdiction for investment funds with the LPF regime.
Hong Kong’s proximity to Mainland China and position as the financial centre in the Guangdong-Hong Kong-Macao Greater Bay Area (GBA) continues to offer Hong Kong the natural edge to stay competitive in the international market.
In addition, Hong Kong has been an organic part of the renminbi internationalisation drive, opening up channels for renminbi to benefit from its financial environment. To date, Hong Kong provides the broadest range of offshore renminbi products, and has been hosting the largest renminbi liquidity pool outside Mainland China. As Hong Kong continues to bridge the expansion of offshore renminbi activities and support the growing demand for renminbi reserves assets, we see increasing opportunities for investment funds to be domiciled in Hong Kong under the proposed LPF regime which would facilitate sponsors in managing renminbi assets portfolios through Hong Kong.
While IPOs have been a popular means of exit for many PE funds, Hong Kong continues to lead the world in IPO – offering yet another unique advantage for the proposed LPF regime.
The possibility of unifying an investment fund’s domicile, operations and management team and exit channels in one single jurisdiction avoids the complexities and costs of appointing additional layers of service providers and dealing with multiple regulators, thus making Hong Kong an ideal place of domicile.
Proposed LPF regime at a glance
Broadly, the LPF is a “fund” that is registered by the Registrar of Companies (RoC) as an LPF. It comprises one general partner (GP) and at least one limited partner (LP) and is governed by its limited partnership agreement (LPA). Key entities of an LPF include the investment manager (IM), the auditor, the responsible person (RP), and if applicable, the authorised representative (AR). Custodians are not mandatory as long as there is proper custody of assets.
The table below shows the key features of the LPF, the GP, the LP, and the key entities of the LPF.
- must satisfy the definition of “fund” as set out in the Bill
- must have one GP and at least one LP and be constituted by the LPA
- must have a registered office in Hong Kong and a business registration certificate
- has no separate legal personality
- has the freedom to contract
- has no minimum capital requirement or statutory investment restrictions
- must be any of the following:
- a private company limited by shares incorporated in Hong Kong
- a registered non-Hong Kong company
- a limited partnership (whether it is registered under the LPO or a foreign jurisdiction with or without a separate legal personality)
- an LPF
- an individual who is at least 18 years old
- has unlimited liability for all debts and obligations of the LPF
- bears the ultimate responsibility for the management and control of the LPF
- has the duty to appoint an IM, an auditor, and an AR if the GP is an LPF or a non-Hong Kong limited partnership with no legal personality
- has the duty to ensure proper custody of assets
- can be any of the following:
- an individual
- a corporation
- a partnership
- an unincorporated body
- any other entity
- has the right to participate in the economic return of the LPF but has no day-to-day management rights or control over the assets
- its liability is limited to the agreed contribution it makes, unless the limited partner has participated in the day-to-day management of the LPF, subject to the non-exhaustive exemptions granted under the “safe harbour” provisions
- must be appointed by the GP to carry out day-to-day investment management functions of the LPF
- must be any of the following:
- a Hong Kong incorporated company
- a registered non-Hong Kong company
- a Hong Kong resident that is at least 18 years old
- can be the GP itself
- must be appointed by the GP to carry out annual audits of the financial statements of the LPF
- must be independent of the GP, the IM and also the AR (if applicable) of the LPF
- 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)
- must be any of the following:
- an authorised institution
- a corporation licensed by the Securities and Futures Commission (SFC)
- an accounting professional
- a legal professional
- 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
- must be any of the following:
- a Hong Kong incorporated company
- a registered non-Hong Kong company
- a Hong Kong resident that is at least 18 years old
- is jointly and severally liable for all debts and obligations of the LPF with the GP
- 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 RoC, which is required to be submitted on behalf of such GP by a Hong Kong law firm or a solicitor. A fixed fee of HK$3,034 is payable to the RoC in respect of the application and registration of an LPF, which is relatively low compared to the prescribed fee in the Cayman Islands.
A streamlined channel is also provided to qualifying structures registered under the LPO to migrate to the LPF regime upon the submission of an application similar to what is required for the registration of a new LPF. Such migration would not result in any identity or continuity disruptions and would not trigger any profits tax and stamp duty implications.
Unlike the OFC structure, which is required to be registered and authorised by the SFC (if it is a public OFC), the LPF is only required to register with the RoC and does not need the authorisation of the SFC unless it is offered to retail investors (subject to applicable exemptions) and is not subject to any SFC-imposed investment restrictions, disclosure and operational requirements. However, if the GP or the IM of an LPF carries out regulated activities in Hong Kong as defined in the Securities and Futures Ordinance (Cap. 571) (SFO), appropriate licence(s) from the SFC must be obtained.
A certificate of registration of LPF will be issued by the RoC upon completion of registration and is conclusive evidence that the fund is registered as an LPF.
Key comparisons between the Proposal and the Bill
We identified below several major differences between the Proposal and the Bill.
Clear definition of “fund”
An LPF must meet the definition of “fund”. Unlike the Proposal which makes reference to the definition of “fund” under section 20AM of the Inland Revenue Ordinance (Cap. 112) (IRO) and the definition of “collective investment scheme” under the SFO, the definition of “fund” is set out in full under the Bill. As noted in our submission to the FSTB, this is the preferred approach as it helps to avoid any unnecessary confusion.
Notably, though the definition of “fund” under the Bill remains highly similar to the definition of “fund” under the IRO and the definition of “collective investment scheme” under the SFO, one of the exclusions applicable to those definitions has been left out of the definition under the Bill. The IRO definition and the SFO definition both excludes “an arrangement under which each of the participating persons [i.e. the investors] is a corporation in the same group of companies as the person operating the arrangements”.
It is not advisable to include such exclusion in the LPF context as PE funds are often initially set up with LPs that are affiliated to the GP (GP Affiliated LPs) for administrative and commercial reasons. Under the Bill, such exclusion has instead been replaced by our suggestion that the LPF be given a 24-month window to satisfy the requirement that not all the partners in the LPF are corporations in the same group of companies. This ensures that the LPF has sufficient time to line up and admit non-GP Affiliated LPs.
Relaxed eligibility criteria of the GP
Under the Proposal, a GP must be a Hong Kong incorporated private company limited by shares. In our submission to the FSTB, we explained that there is no comparable requirement in other jurisdictions and it is unduly restrictive as it denies the flexibility of allowing the GP to be set up in other commonly used legal forms (eg a foreign corporation or a limited partnership). The FSTB decided to remove this requirement from the Bill, as reflected in the table above.
New requirement for an AR
We understand that a main reason for the original requirement that the GP be a Hong Kong limited private company is the concern that there will be difficulties in attributing liability to a GP that has no legal personality. As noted above, such requirement has been relaxed under the Bill and the GP can now be an LPF or a non-Hong Kong limited partnership with no legal personality. To alleviate the relevant concern, such GP will now be required to appoint an AR who will share with the GP the ultimate responsibility to manage the LPF and be jointly and severally liable for any liabilities of the LPF.
Relaxed eligibility criteria of the IM
Like the Proposal, the Bill mandates that the GP delegates all day-to-day investment management functions to an IM. Whilst we consider such requirement to be unnecessary and unattractive as the GP can take on such functions itself and it imposes additional restriction on the set up of an LPF, it is worth noting that the requirement has been significantly relaxed.
Under the Bill, the IM is no longer required to be an authorised institution, an SFC-licensed entity, an accounting professional or a legal professional. Interestingly, it is specified that the GP of an LPF can act as the IM. Practically, this may be unorthodox from a legal perspective since the GP will essentially be contracting with itself in respect of such appointment. However, it is not unusual for GP to take up the investment management functions in certain PE funds so it would be interesting to see how this is applied practically.
New requirement for an RP
As indicated under the Proposal, the original eligibility criteria of the IM aims at ensuring that suitable persons are appointed to undertake the necessary AML measures. In light of the now relaxed IM eligibility criteria under the Bill, to ensure relevant AML standards are met, the GP of the LPF is now required to appoint an RP who will take over the role of conducting AML measures.
Safe harbour provisions
As noted in the table above, LPs may risk losing their limited liability if they participate in the management of the LPF. Taking into account the market practice for LPs to have some degree of management involvement or decision-making power in the LPF, a non-exhaustive list of “safe harbour” activities has been introduced in the Bill to offer bright-line guidance as to what activities would not be regarded as management of the LPF. This should be sufficiently wide to cover the standard range of management that LPs have in PE funds.
Examples of such activities include:
- acting as or appointing someone to act as an agent, officer or employee of the LPF;
- acting as or appointing someone to act as a director, shareholder, or officer of the GP;
- serving on or appointing someone to serve on a board or committee of the LPF or the GP;
- serving on or appointing someone to serve on a board or committee of portfolio companies;
- approving the GP or the IM to carry out certain actions relating to the business, prospects or transactions of the LPF; and
- taking part in certain decisions of the LPF including extension of fund term and change in investment scope.
AML concerns vs investor confidentiality
In line with international and local AML efforts, the Bill requires the RP to carry out necessary AML measures and imposes certain record-keeping obligations on the GP or the IM of the LPF. In short, it is required that records containing particulars relating to the partners, customers, transactions and controller of each partner of the LPF (AML records) should be kept at the registered office of the LPF or such other place notified to the RoC.
Although the AML records are required to be made available to the GP and LPs of the LPF, regulators and law enforcement agencies, it is made clear under the Bill that they must not be made available for public inspection. The public, however, will be able to inspect the LPF register kept by the RoC, which will contain all documents registered with and the certificate issued by the RoC. Such documents may include annual return which is required to be filed in a specified form by the GP to the RoC, amongst other notifications relating to certain changes to the LPF. It is unclear at this stage what information will be required to be provided in the annual return. However, it is worth noting that where any information is specified as being excluded from public inspection in the Bill (eg the AML records), it will not be made available to the public as part of the LPF register kept by the RoC. This shows the government’s effort to ensure a reasonably high level of confidentiality is accorded to the LPs to ensure the attractiveness of the proposed regime.
LPF will enjoy profits tax exemption as long as it meets the definition of “fund” under section 20AM of the IRO and subject to certain exemption conditions. Qualifying funds will be able to enjoy profits tax exemption on transactions in qualifying assets in Schedule 16C to the IRO and incidental transactions for any year of tax assessment.
The LPF will be treated as a separate entity from partners for tax purposes. The GP (or authorised representative, if applicable) of the LPF is responsible for lodging profits tax returns on behalf of the LPF. Both the GP (or authorised representative, if applicable) and the Manager will be responsible for ensuring the LPF complies with the requirements of the IRO.
On distribution of profits and assets by the LPF to the LPs, it is proposed that those proceeds, as well as redemption and transfer of LP interests, will not be subject to stamp duty as an interest in a LPF is not a “stock”.
While qualified LPFs may enjoy profits tax exemption, Hong Kong-based managers or advisors arranging or conducting the specified transactions remain chargeable. The IRD has stressed in their practice notes that these local service providers should be adequately compensated for their services or remunerated on an arm’s length basis.
However, it would appear that the Hong Kong Government will legislate to address the IRD view that the carried interest is typically a fee for services or a type of disguised management fee. The Financial Secretary Paul Chan Mo-po said in his budget speech in February 2020:
With a view to attracting more private equity funds to domicile and operate in Hong Kong, we plan to provide tax concession for carried interest issued by private equity funds operating in Hong Kong subject to the fulfilment of certain conditions. We will consult the industry on the proposal, and the relevant arrangement will be applicable starting from 2020-21 upon completion of the legislative exercise.
Dissolution and liquidation mechanisms
Unlike the limited partnership regime under the LPO, the LPF regime offers a straightforward dissolution mechanism. One important feature is that an LPF may be dissolved in accordance with the LPA. This offers the flexibility much needed in the PE fund context as unlike public funds or hedge funds, PE funds often have specific investment targets and cycles and hence a limited term.
Apart from dissolution in accordance with the LPA, an LPF can also be dissolved with or without a court order in certain default situations. In respect of dissolution without a court order, an LPF can be dissolved where certain default events occur in relation to the GP or the AR (if applicable) of the LPF and that the GP or the AR is not replaced within 30 days after the date of the occurrence of such default events. These events include where the GP or the AR is bankrupt, dissolved, dead, wound up, or ceases to be the GP or the AR of the LPF (as the case may be).
In respect of dissolution with a court order, a partner or a creditor of an LPF may apply to the court for the LPF to be dissolved if, for example, a partner wilfully or persistently commits a breach of the LPA, the business of the LPF can only be carried on at a loss, or it is just and equitable that the LPF be dissolved. Further, an LPF may be wound up by the court as an unregistered company in accordance with the Companies (Winding UP and Miscellaneous Provisions) Ordinance (Cap. 32).
The future vehicle of choice?
The proposed LPF regime provides a practical alternative for the domiciliation of PE funds and potentially more flexibility for fund managers to meet market demand. The limited partnership is a familiar investment vehicle for fund managers across different jurisdictions. With the Chinese government’s initiative of developing the GBA, we see the potential for the LPF regime to be embraced by fund managers in the region seeking to raise funds from Mainland Chinese investors or to raise funds to invest in China.
Given the change of the regulatory landscape in traditional offshore jurisdictions like the Cayman Islands, this proposed LPF regime also enables Hong Kong to grasp the opportunity of the shift of fund structures and activities from offshore to onshore.
Additionally, Hong Kong’s relatively extensive network of double tax agreements, as compared with other PE fund domicile jurisdictions (such as the Cayman Islands), may prove beneficial for LPFs and investors and their relevant underlying overseas investments.
*Any reference to “Hong Kong” or “Hong Kong SAR” shall be construed as a reference to “Hong Kong Special Administrative Region of the People’s Republic of China”.
The authors would like to thank Florence Lau, Boer Ma, Cheryl Ho and Hazel He for their contributions to this article.
 According to AVCJ’s data and cited by Legislative Council in its Brief on the Bill dated 18 March 2020 and accessible at: https://www.legco.gov.hk/yr19-20/english/bills/brief/b202003201_brf.pdf.
 Unlike the unit trust regime and the OFC regime, there is no bright-line requirement that there must be a custodian. This is a favourable feature as a custodian is not necessarily required for some of the assets in which PE funds may invest (eg real estate and property).
 See section 3 of the Bill, which is accessible at https://www.legco.gov.hk/yr19-20/english/bills/b202003201.pdf.
 Section 27 and Schedule 2 of the Bill.
 The initial proposed IM is deemed to be appointed as the IM of the LPF with effect from registration of the LPF, until otherwise replaced (section 20(3) of the Bill).
 The initial proposed RP is deemed to be appointed as the RP of the LPF with effect from registration of the LPF, until otherwise replaced (section 33(3) of the Bill).
 The initial proposed AR is deemed to be appointed as the AR of the LPF with effect from registration of the LPF, until otherwise replaced (section 23(4) & (5) of the Bill).
 Part 7 of the Bill.
 Under section 3 of the Bill, a “fund” is defined, in brief, as an arrangement where (i) either the property is managed as a whole by or on behalf of the operating person of the arrangement, or the contributions of the participating persons and the profits or income from which payments are made to them 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 receive profits, income, gams or other returns arising from the acquisition, holding, management or disposal of the property.
 Sections 7(1)(i) and 7(2) of the Bill. The failure to satisfy such requirement may entitle the RoC to strike the name of an LPF off the LPF register. Other circumstances in which the RoC may be entitled to do so include where the LPF is not in operation or carrying on business as a fund after 24 months of its registration or where the LPF does not have an IM or RP (section 65(2) of the Bill).
 Schedule 2 of the Bill.
 Sections 33 and 29 of the Bill.
 For definition of “controller”, please refer to section 29(6) & (7) of the Bill. The definition is largely similar to the definition of “beneficial owner” under the AMLO.
 For example, changes in the particulars relating to the AR (section 23(6) the Bill), change of GP or change in the particulars relating to the GP (section 25(1)(a) & (b) of the Bill), change in the address of the registered office of the LPF (section 25(1)(c) of the Bill), change in the investment scope or principal place of business of the LPF (section 25(1)(d) of the Bill), change of IM or change in the particulars relating to the IM (section 25(1)(e) of the Bill), and change of RP or change in the particulars relating to the RP (section 25(1)(f) of the Bill).
 Paragraph 72 of PN51 provides that management and performance fees based on a cost-plus formula are not likely to have been determined on the arm’s length basis, in particular when the investment managers or advisors performed significant functions and bore considerable risks in Hong Kong to generate the profits of the offshore funds.
 Sections 70(2) and 71 of the Bill.
 Part 6, Division 2 of the Bill.
 The “Outline Development Plan for the Guangdong-Hong Kong-Macau Greater Bay Area” was announced in February 2019, under which one of the key focus areas is to develop the Greater Bay Area into an international financial hub, including developing Guangzhou into a private equity “trading market”.