Why licensing rules could hamper Hong Kong’s PE plans
Hong Kong still aspires to become a fund services hub, even as the city's prolonged social turmoil hurts its economy and tarnishes its financial status. But licensing issues could yet hold it back.
At Monday's meeting of the Legislative Council's Panel on Financial Affairs, James Lau, Hong Kong’s secretary for financial services and the treasury, restated the government's plans to institute a new limited partnership regime soon.
According to Scott Peterman, a Hong Kong-based partner at law firm Orrick, a draft of the proposed new framework is expected to circulate before year-end and is likely to be similar to the Cayman Islands model commonly used by private equity funds globally.
But in addition to the high housing costs and talent constraints that Hong Kong must to overcome to build its private equity credentials in practice, there are also question marks over how it licenses private fund managers.
As Peterman noted, even if Hong Kong’s new partnership law is broadly based on the Cayman model, one thing will likely be different: any new law will require the general partner – usually the fund manager – to be a Hong Kong company.
“And that Hong Kong general partner will itself be a regulated entity or will be advised or managed by a regulated entity, which will be a Type 9 or 1 or 4 company here in Hong Kong,” he told AsianInvestor, adding that the regulator “in many cases is pushing these types of fund managers to have a Type 1 licence.”
The type 1, 4 and 9 licences granted by Hong Kong's Securities and Futures Commission (SFC) regulate dealing in securities, advising on securities, and asset management, respectively. Fund managers in Singapore, in contrast, are allowed to apply for different licensing tiers with varying requirements, depending on which type of investor they target.
The Hong Kong SFC updated its licensing handbook in February this year, clarifying the circumstances where private equity and venture capital firms are required to apply for a licence. If a firm deals in, advises on, or manages shares or debentures of private offshore companies that fall outside the definition of “private company” under the Hong Kong Companies Ordinance, the firm will likely have to be licensed, the handbook says.
That is where problems could arise, because the way private equity fund managers are regulated could differ from that of a traditional fund manager, according to private equity professionals.
“I am not entirely in agreement with the SFC's position,” Peterman said. “I don't see regulating a venture capital fund manager in the same way that you would regulate Goldman Sachs as especially workable. I think our regulator will be the only major global regulator that would take them.”
“There has been a lot of resistance from the law firms, compliance and consultants because we know that our clients who are fund managers would prefer to be licensed as fund managers and not as broker-dealers,” he added.
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Two Hong Kong-based private equity professionals, separately, told AsianInvestor that in their view private equity fund managers ought to be regulated differently, or not regulated at all, because their investors are generally far more sophisticated than retail investors.
“I don’t think regulating private equity is a smart move; private equity is all about flexibility and all LPs [limited partners] are sophisticated investors. And [this] keeps their names off the wall in most cases,” one of the unnamed executives said.
However, simply creating new license types every time a new financial product or service emerges is not something the Hong Kong regulator is inclined to do, a source familiar with the SFC's thinking told AsianInvestor.
So private equity fund managers, or those that come in once the new limited partnership regime is established, will likely be slotted into the existing categories, “none of which is a very good fit,” Peterman said.
They could create a new type of licence or go back to the Type 9 and expand the definition of asset management to include private equity and venture capital managers, but it's unlikely, he added.
Instead, he expects the issue to be resolved in one of there ways: with managers leaving for Singapore or Shenzhen, staying just below the radar, or taking the Type 1 licence.