In February this year, Hong Kong Financial Secretary John Tsang Chun-wah announced that the government would propose changes in the city's investment laws to allow private equity funds to enjoy the same tax exemption as offshore funds. He added that he planned to allow Hong Kong funds a more flexible structure by amending the current law that requires investment funds established in Hong Kong only to take the form of trusts.
that the government would propose changes in the city's investment laws to allow private equity funds to enjoy the same tax exemption as offshore funds. He added that he planned to allow Hong Kong funds a more flexible structure by amending the current law that requires investment funds established in Hong Kong only to take the form of trusts.The announcements have been wholeheartedly welcomed by hedge funds and PE firms who see them as a way for Hong Kong, which currently has more than HK$9 trillion ($1.16 trillion) of fund assets under management, the second in Asia, to solidify Hong Kong’s potential to become a regional private equity centre. According to PricewaterhouseCoopers, Hong Kong is home to less than 1 percent of funds globally, but industry watchers say that the new policy along with the ongoing internationalisation of the yuan is expected to catapult Hong Kong into second place by 2020.
“This is great news since this would, for sure, encourage more private equity funds to come to Hong Kong,” says Terence Chiu, partner at Li & Partners. “We know for a fact that fund managers in Asia are all based in onshore financial centres like Shanghai, Hong Kong, Singapore and so on. Where funds are resident largely depends on tax. This move will put Hong Kong in a very strong position to become ‘Asia’s asset-management centre.’”
While Hong Kong has been an ideal distribution centre for fund managers looking to sell their fund products to Asian investors, insiders expect more hedge funds and private equity firms to set up in the SAR. Of the roughly 1,700 funds in Hong Kong, only about 300 are domiciled there, with many of the rest domiciled in Luxemburg and Dublin because of favourable tax regimes.
In 2006, Hong Kong granted a tax exemption to offshore funds investing in stocks and futures, and the region is now looking to expand the tax exemption to offshore PE funds that invest directly in companies. Tsang also wants funds domiciled in Hong Kong to be established as companies, instead of trusts, which is how they are currently required to be set up as.
The China factor
As an added benefit, the tax incentives are also expected to lure over large numbers of investment houses from the mainland to raise their first offshore PE funds in the city, a reversal of what happened a few years ago, when PE firms were heading to the mainland to raise yuan funds, attracted by reform promises by Beijing.
This is expected to greatly benefit both mainland PE firms as well as Hong Kong. Mainland firms will find it easier to raise money for their Hong Kong-based private equity funds from their China connections, and this will help Hong Kong’s long-term development and its position as a major global asset management centre.
The HK government is also in talks with mainland authorities on a possible mutual recognition agreement that would mainly pave the way for cross-border selling of fund products between the two sides. “It would be advantageous for HK-based funds to participate in cross-border transactions which will no doubt enhance their competitiveness and performance,” says Lin Lei, partner at Chinese firm Zhong Lun W&D.
The internationalisation of the yuan also adds to the allure for PE firms. “The ongoing financial liberalisation by mainland authorities will attract more overseas private equity capital into the mainland, and mainland enterprises will also use Hong Kong private equity fund managers to seek more private equity opportunities overseas,” says Chiu. “The law and regulations shall strike for the balance of interests between the fund houses and the investors.”
According to Lin, the “offer of more flexibility and diversification in fund industry operations is likely to bring more investment into Hong Kong, including schemes and products denominated in RMB.” However, he says that it will also bring with it “problems such as insufficient investment products and a lack of experienced fund managers.”
Hong Kong potential
Lawyers generally rate Hong Kong’s potential to become a regional private equity centre highly. “Hong Kong is currently among top-tier destinations attracting worldwide funds due to its legal system, geographical advantage and talent pool,” says Lin. “It is likely to become the biggest and most competitive private equity centre in the coming years, ahead of other regional competitors.”
Chiu agrees. “I rate Hong Kong highly on its potential to become a regional private equity centre,” he says. “Hong Kong has so many positive factors: its physical proximity to China, being the gateway to [the] mainland China market and the largest offshore RMB bond market, having [a] well-established system of rule of law, a low and simple tax regime, a stable currency with no foreign exchange control, being a free economy, world-class infrastructure, the strong and highly liquid Hong Kong IPO market, and so on.”
And reforms like the ones proposed by Tsang are cementing Hong Kong’s place. “The recent change in regulatory and banking law in enhancing investor protection and the proposed changes to the Companies Ordinance for better corporate governance further put Hong Kong ahead of other places to become Asia’s asset-management centre,” says Chiu. Lin foresees “the demand for suitable and sustainable regulations in connection with the private equity fund industry in order to keep up with the pace of the development of funds in Hong Kong.”
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