Legal Briefing

LEGAL BRIEFING New ordinance opens doors for investors

This aims to attract private equity and venture capital funds to set up and operate in Hong Kong.

In recent years, private equity (PE) funds are gaining popularity amongst investors and driving the growth of wealth and asset management (WAM) business. However, Hong Kong’s existing legislation for limited partnerships, the Limited Partnership Ordinance (Cap. 37) or LPO was enacted about a century ago, which makes it difficult for it to meet the needs of investment funds, which are a relatively modern invention.

Thus, a new framework for the constitution of limited partnership funds (LPFs) was gazetted in the form of the Limited Partnership Fund Bill (LPF Bill) on 20 March.

This follows the Financial Services and the Treasury Bureau (FSTB) proposal on a limited partnership regime specifically for use by investment funds in Hong Kong. The bill is now expected to be enacted as the Limited Partnership Fund Ordinance (LPFO) will come into effect on 31 August.

Simmons & Simmons’ partner Rolfe Hayden notes that the primary benefit of the LPF Bill is that it will allow Hong Kong fund managers and advisers to use a Hong Kong domiciled, domestic closed-end fund vehicle. Instead of establishing a fund offshore Hong Kong, a fund will be able to be set up in Hong Kong and enjoy similar contractual freedom as in other jurisdictions but with greater legal certainty in the Special Administrative Region.

This seeks to attract investment funds, including private equity and venture capital funds, to set up and operate in Hong Kong. It is also said to provide for the registration of funds as limited partnership funds similar to other jurisdictions, which use registration schemes such as Cayman Islands- or Delawareregistered limited partnership.

Although there are many similarities, Eversheds Sutherland partner Paul Moloney and of counsel Helen Wang said that one noteable difference is that the LPF regime requires the general partner (GP) to appoint an investment manager who can be itself but needs to be a Hong Kong resident over the age of 18, a company incorporated in Hong Kong, or an overseas company registered in Hong Kong.

This is said to be the same with Singapore’s requirements in registration, but there is no such limitation in the Cayman Islands regime, which could make it more transnational and versatile for those managers with global presence and who may not want to be perceived to have any particular ties to Hong Kong or Singapore.

What are the differences between LPF Bill and the Limited Partnership Ordinance?

The main difference between the LPF Bill and the LPO is that LPO was first enacted in 1912 and is not fit for purpose in a private equity fund context. Simmons & Simmons’ Hayden notes that the LPO has

Rolfe Hayden

Helen Wang

Paul Moloney

Allianz and NPS will launch an APAC real estate investment platform. never been really over-hauled and updated to cater for funds. For example, the LPO does not have provisions for flexibility in capital contributions and distribution of profits, or allow a fund to have the necessary contractual flexibility, or provide a straightforward winding-up mechanism. The existing law is unclear and limited in scope on the freedom of the partners to contract on the commercial terms. There is limited protection for investors with safe harbour activities also being unclear and very limited in scope,” said Eversheds Sutherland’s partners Moloney and Wang.

Moreover, there is a lack of confidentiality with information about the limited partnership and its limited partners which makes the Hong Kong limited partnership vehicle unsuitable as a private equity fund structure. Eversheds Sutherland’s partner Moloney and Wang notes that a 0.8% tax on all contributions from limited partners acts as the “final nail in the coffin” in this situation.

In contrast, the LPF Bill is designed specifically for the PE/venture capital (VC) industry, adopting many of the key points made by the industry, and the shortcomings mentioned are resolved.

How will the bill enhance the attractiveness of Hong Kong’s asset and wealth management industry?

FSTB’s proposal notes that the bill is expected to bring more jobs and business opportunities to the local fund and related industries. With the growth of PE funds, the LPF regime offers a viable structure that will enable Hong Kong to compete with other major fund centres globally.

Moloney and Wang adds that once the LPF bill has passed into law, it will promote Hong Kong as the vibrant centre in Asia not just for PE/VC fund managers but also to the WAM industry more generally. “In addition, if the LPF regime is a success, foreign private equity houses may consider the LPF regime as a factor in choosing to locate into Hong Kong as a China or regional base. Moreover Hong Kong service providers, including Hong Kong law firms, will also benefit as the fund formation ecosystem is developed further,” said Hayden.

Will Hong Kong’s office space crunch extend beyond 2020?

In an effort to address the office property shortage, the government moved to increase commercial land supply in its latest Land Sales Programme, revealing commercial sites providing a total floor area of about 3.6 million sqft to the market with most of the sites located in Kowloon East. However, as time is needed for planning and development, Knight Frank Hong Kong expects these supply will only be released to the market after 2020. So far, the report said that new supply during 2017-2020 is at an average of 1.9 million sqft per year. Following this, the office supply could accelerate in the new decade once urban districts such as CBD2 and West Kowloon have materialised. Existing stock of Grade-A office space in Hong Kong Overall Hong Kong Grade-A office stock distribution by age

New supply of Grade-A office space in 2013-2016

Rents and vacancy in Two IFC in Central

Growth of Grade-A office space in major office clusters in 2017-2020

Rents and vacancy in Kowloon East

The Hong Kong Stock Exchange headquarters

Will the stocks shrug off the national security law issue?

Hong Kong benefits from a consistent current account surplus and an ongoing capital inflow from both China and other markets.

Since Fortune published its The most likely surplus and that the HKD peg “The Death of Hong Kong” response by USagainst the USD and the US Fed’s article in 1995 (two years listed Chinese unlimited QE should ensure before the handover), the Hang companies to that interest rates in Hong Kong Seng Index (HSI) has risen 149%. this potential should stay low for the next few A Jefferies report is expecting a threat is to years. It also leverages from a similar international sentiment move their relatively stable RMB, keeping as China imposed the National listing back to Chinese companies earning Security Law on Hong Kong. Hong Kong or RMB attractive. There is also an However, the HSI will likely China. ongoing capital inflow from both benefit from 1) roughly $4.32b China and other markets if Hong (US$557b) of listing migration Kong continues to offer attractive from Chinese American depositary investment opportunities. receipt (ADRs), 2) inclusion of “We believe the proposed new-economy weighted voting National Security Law may not rights (WVR) Chinese stocks, and be the most important driver of 3) global capital inflow. perceived risk,” Lee added. “We

Even so, radical housing see the following four factors solutions are needed to keep Hong as more important: free flow Kong competitive. of capital, especially when the

“Whilst this could easily lead RMB remains non-convertible; western media and governments continued upholding of the to draw the same conclusion protection of private property as Fortune did in 1995, we are rights; continued use of the optimistic that the Hong Kong common law especially in all stock market will eventually shrug business and financial dealings; off such a risk,” said Jefferies’ an independent court.” analyst Edison Lee. Further, the downside risks will

Lee added that Hong Kong has be 1) an intensification of violent a consistent current account actions by radical protesters, and 2) the possibility that the US will punish Hong Kong and/or China for introducing this law. Lee stated that the US reaction will likely be intertwined with the escalating trade and tech war between China and the US.

Part of the escalating trade and tech war between the US is taking place in the US stock market, centering around the potential ban of Chinese companies from listing in the US, and forcing existing listed companies from China to de-list from the US.

The US argues to de-list Chinese ADRs and ban Chinese companies from listing in the US. Both Marc Rubio (US Senator - the Equitable Act) and John Kennedy (US Senator - Holding Foreign Companies Accountable Act) have introduced bills that address such issues. The Holding Foreign Companies Accountable Act was passed by the US Senate with bi-partisan support on 20 May. However, the argument to protect investor interests and prevent certain SOEs that may create perceived national security risk to the US from being able to raise capital in the market is quite strong. As a result, Jefferies expects some form of control to finally come, although it may not be a blanket ban.

“The most likely response, in our view, by US-listed Chinese companies to this potential threat is to move their listing back to Hong Kong or China, or at least do a separate listing in Hong Kong or China, as a backup. But listing in China is not ideal, since not every current ADR holder will be able to own A shares. Moreover, RMB is not yet a convertible currency, and thus raising HKD will likely be more desirable for many of these Chinese companies. Given the proposed legislation in the US, we estimate Chinese ADRs will have two to three years to plan this move,” Lee explained.

Jefferies stated that 145 China ADRs are listed in the US, of which 130 do not have a secondary listing.