The Limited Partnership Fund Ordinance (Cap. 637) (the “LPFO”), which came into effect on August 31, 2020, introduces the limited partnership fund (“LPF”), a new entity type for private equity and venture capital funds in Hong Kong. LPF features flexibility and legal protections comparable to those found in other jurisdictions such as Delaware and the Cayman Islands. In this article, we provide a brief overview of the major provisions of the LPFO and some key features of LPFs.
Prior to the enactment of the LPFO, limited partnerships in Hong Kong were governed by the Limited Partnership Ordinance (Cap. 37), which was enacted more than a century ago and does not provide for the flexibility and requisite legal mechanisms that have become standard in the private funds industry. While there are currently other vehicles available to fund managers domiciled in Hong Kong such as unit trusts and open-ended fund companies (“OFC”s), they are better suited to public funds and hedge funds. By introducing the LPFO, Hong Kong seeks to sharpen its competitive edge in asset and wealth management and attract more fund sponsors to establish private equity and venture capital funds in Hong Kong.
OVERVIEW OF LPF REGIME
A limited partnership fund is a “fund” constituted as a limited partnership by a limited partnership agreement (“LPA”) and registered as an LPF with the Hong Kong Registrar of Companies. Under the LPFO, a “fund” is defined as an arrangement in which (a) the property is managed for business purposes by persons (“operating persons”) on behalf of other persons who do not have day-to-day control over such management (“participating persons”); (b) contributions, profits, and income are pooled; and (c) returns are distributed to one or more operating persons and participating persons. Certain specific arrangements are excluded from the definition of a “fund”. In order to be registered as an LPF, a fund must also satisfy the following conditions:
- It has one general partner who must be (a) a natural person who is at least 18 years old; (b) a Hong Kong private company limited by shares; (c) a registered non-Hong Kong company; (d) a registered Hong Kong limited partnership; (e) an LPF; or (f) a non-Hong Kong limited partnership (with or without legal personality). and at least one limited partner;
- It complies with the naming requirements under the LPFO;
- It has a registered office in Hong Kong;
- It must appoint an investment manager, who must be either (a) a Hong Kong resident, (b) a Hong Kong company or (c) a registered non-Hong Kong company. The general partner can also serve as the investment manager;
- It must appoint a responsible person to carry out anti-money laundering measures. The general partner can also serve as the responsible person, but the responsible person must meet certain eligibility requirements (see further discussion below);
- If the general partner is another LPF or a non-Hong Kong limited partnership without legal personality, it must appoint an authorized representative (see further discussion below);
- It must appoint an independent auditor;
- It is not set up for an unlawful purpose; and
- Partners of the fund are not comprised only of corporations in the same group of companies (subject to a two-year grace period from the date of registration).
Applications for LPF registration must be submitted through a Hong Kong law firm or solicitor.
Freedom of Contract
Partners of an LPF have freedom of contract in respect of the operation of the fund, and an LPF’s internal matters will be governed by its LPA. In particular, the LPFO expressly permits limited partners to negotiate the terms of certain contractual arrangements commonly seen in private equity funds, including with respect to the following matters:
- Admission and withdrawal of partners in the fund;
- Transfers of interests;
- Governance procedures;
- Investment scope and strategy;
- Powers, rights, and obligations of the partners in the fund;
- Scope of the fiduciary duties of the general partner;
- Capital contributions, distribution, clawback obligations, and other financial arrangements;
- Term of the fund;
- Reporting and valuation; and
- Dissolution procedures.
No Legal Personality
LPFs have no separate legal personality, and the general partner will have unlimited liability for all debts and obligations of the LPF. If the general partner, itself, has no legal personality, for example, because it is another LPF or a non-Hong Kong limited partnership without legal personality, the LPF must appoint an authorized representative to be responsible for the management and control of the LPF and to be jointly and severally liable with the general partner for all the debts and obligations of the LPF. The authorized representative must be either (a) a Hong Kong resident, (b) a Hong Kong company, or (c) a registered non‑Hong Kong company.
Generally, a limited partner will not have liability beyond the amount of its agreed capital commitment. However, consistent with other jurisdictions, limited partners will nevertheless be jointly and severally liable for the debts and obligations of the LPF if they are considered to take part in the management of the fund. To the comfort of investors, the LPFO sets out a non-exhaustive list of activities that are not regarded as management activities, including serving on an advisory committee, voting on fund transactions, and acting or authorizing a person to act on behalf of the LPF or the general partner.
SHOULD YOU Choose A Hong Kong LPF?
The newly enacted LPFO is comparable in many respects to limited partnership regimes in other commonly used jurisdictions such as the Cayman Islands, particularly in terms of contractual flexibility and the allocation of liabilities. That said, there are several aspects particular to the regime that sponsors and investors should consider when deciding whether to use an LPF for a private fund:
The fees for setting up and maintaining an LPF in Hong Kong are relatively low compared to other jurisdictions such as the Cayman Islands. The fees payable on application for registration of an LPF are currently prescribed at HKD3,034 (approx. USD400), and upon the filing of annual return, HKD105 (approx. USD15), both on the lower end of the spectrum.
For sponsors with an investment advisor or existing operations in Hong Kong, domiciling a fund in Hong Kong may also reduce the additional fees otherwise required when dealing with multiple service providers in several jurisdictions. For example, if a fund is structured solely within Hong Kong, the relevant work can be done entirely by Hong Kong counsel, and sponsors can thereby save the cost of engaging an additional group of service providers. The possibility of greater cost-savings will be an incentive for certain fund sponsors to make use of an LPF.
LPFs are subject to Hong Kong’s anti-money laundering (“AML”) regulatory regime. An LPF is required to appoint a responsible person to carry out statutory AML measures. Such responsible person must be (a) an authorized institution (i.e., a bank, a restricted license bank, or a deposit-taking company under the Banking Ordinance (Cap. 155), (b) a licensed corporation(i.e., a corporation that is granted a license to carry on regulated activities under the Securities Futures Ordinance (Cap. 571). (c) an accounting professional or (d) a legal professional. The general partner can serve as the responsible person as long as it falls within one of the four categories listed above.
LPFs are also required to maintain records, including a register of partners and certain investor due diligence documents such as information obtained in the course of verifying the identity of investors, files relating to investors’ accounts, and business correspondences with investors. To address investor confidentiality concerns, the LPFO expressly provides that these records will not be subject to public inspection and may be reviewed only by certain governmental bodies.
While these AML requirements may impose an administrative burden, they are generally in line with the internationally recognized Recommendations by the Financial Action Task Force and are similar to those in jurisdictions such as the Cayman Islands. Fund managers familiar with AML practices in other jurisdictions should have no difficulty complying with the AML requirements imposed on LPFs. In recent years, regulators have tightened AML regulations globally and the AML requirements under the LPFO are in line with this trend.
Unlike the case with a Hong Kong company, the transfer or redemption of LPF interests generally would not incur Hong Kong stamp duties. On the other hand, an LPF could be subject to Hong Kong profits tax unless it qualifies for the newly implemented “unified profits tax exemption” for private funds. This tax exemption generally requires the LPF to be managed by a SFC-licensed manager, or otherwise imposes various requirements on the number of outside investors that the LPF must have, the minimum proportion of capital that the investors must contribute, and the amount of returns that could be given to the sponsor and its affiliates. This tax exemption also imposes restrictions on certain categories of investments (such as investments in Hong Kong real properties) and on the proportion of fund’s investors that are Hong Kong residents. Care should be taken in considering the application of the “unified profits tax exemption” to the intended structure of the fund.
Licensing in Hong Kong
Fund sponsors may also need to consider the licensing implications if they decide to set up an LPF in Hong Kong. Under the current regulatory regime, a corporation carrying on a business in a regulated activity (e.g., asset management) in Hong Kong must be licensed with the Securities and Futures Commission of Hong Kong (the “SFC”). Unless an exemption applies, the general partner or investment manager of a fund is generally required to obtain a license from the SFC if it has the discretionary power to make investment decisions in Hong Kong.
The issue of licensing is particularly relevant to LPFs, since every LPF is required to appoint an investment manager to carry out the day-to-day investment management functions of the fund, and the investment manager must be a Hong Kong resident, a Hong Kong company, or a registered non-Hong Kong company. Caution must be taken to assess whether there is any regulated activity conducted in Hong Kong that warrants an SFC license and whether the applicable SFC licenses (if any) have been obtained by the appropriate persons. Exemptions to the licensing requirement are available, and whether a license is required will depend on the specific arrangements adopted by the fund and has to be determined on a case‑by-case basis.
The LPFO offers a limited partnership regime in Hong Kong that is comparable to other jurisdictions where fund managers frequently establish funds. While the Cayman Islands remains the most popular jurisdiction for international fundraisings by Sponsors based in Hong Kong, for certain sponsors it may make sense to use an LPF.
* Morrison & Foerster Associate Joanna Wang and Trainee Solicitor Brian Ho also made contribution to this article.