Fund Finance Laws and Regulations 2023 - Singapore overview

Fundraising activity in Southeast Asia – 2022¹

Looking back

2022 has not been the best of years for fundraising, and activity has slowed down dramatically.  As of September 2022, only one Southeast Asia-focused private equity fund had achieved closing.  This was Mitsubishi-backed, ASEAN-focused AIGF Advisors, which announced the final close of its second fund at US$126 million in August.  This is in stark contrast to the record year in 2021 in which seven funds achieved nearly US$3 billion in fresh capital.  At the time of writing and considering the current pace towards year end, 2022 is likely to go down as the weakest of the past five years.

Reasons for slowdown

Southeast Asia has not been immune to the macro-economic and geopolitical turbulence.  The strong economic rebound early in 2022 for most countries is losing momentum.  Russia’s invasion of Ukraine and China’s strict zero COVID policy and related lockdowns together with the deepening turmoil in its real estate sector have dampened deal-making sentiments in this region.

Looking ahead – 2023

Fortunately, the outlook for 2023 looks more promising based on interim closings data published by DealStreetAsia, and the following six Southeast Asia-focused funds achieved interim close to raise US$1.47 billion: Hildrics Asia Growth Fund I; Fullerton Thai PE; Growtheum Capital Partners Fund I; Tropical Asia Forest Fund 2; ASEAN Frontier Markets Fund; and Creador V.

More broadly, Southeast Asia remains one of the brighter spots and is expected to enjoy a strong recovery.  IMF expects Vietnam to benefit most from disruption of global supply chains with an expected 7% growth.  The Philippines is also expected to see a 6.5% expansion, while growth in Indonesia and Malaysia will top 5%. ²

Is Southeast Asia attracting more liquidity?

It appears so.  Despite the marked slowdown in fundraising activity, the rate of investments in the digitalisation and technology sector in Southeast Asia has grown.  The number of venture investments rose by 4.3% to 862 and the aggregate deal value grew by 158% to over US$21 billion in 2021.

According to the World Economic Forum, during the COVID-19 pandemic, over 60 million people in ASEAN became online consumers.  The pandemic has pushed a vast number of people to embrace technology as a means of mitigating COVID-related challenges, particularly lockdowns.

Now, two-thirds of Asia’s population are mobile users and many predict that there is still room for expansion, with the fastest growing regions being Indonesia and the Philippines.

Despite worldwide and regional slowdown, Southeast Asia still continues to be one of the top investment destinations.  In particular, there are news reports of continued flow of liquidity from Greater China to Southeast Asia.  Perhaps reflective of this, the SuperReturn Asia conference held in Singapore in September 2022 created a buzz when it saw a record 1,500 delegates, including 500 limited partners, attending in person.

In the same month, digital financial services group Fazz raised US$100 million and Indonesia’s Xendit, which bills itself as Southeast Asia’s alternative to payments processing platform Stripe, announced fundraising of US$300 million in May 2022.

According to Preqin’s forecast³,  venture capital in the Asia-Pacific (APAC) region will still be the strongest asset class where the Compound Annual Growth Rate (CAGR) for 2021–2027 (forecast) is expected to be 16.04%, followed by infrastructure at 12.51%, private equity at 11.59%, natural resources at 11.15%, private debt at 9.14% and real estate at 9.12%.

Denominator effect in public market affecting private market

Preqin highlighted that, following a strong sell-off in public markets, some allocators are grappling with a phenomenon known as the “denominator effect”: some investors have found that the sharp fall in public markets since the beginning of 2022 has led to an over-investment in illiquid assets such as, for example, real estate and infrastructure.

Private Equity International reported⁴ in November 2022 that private equity’s stellar performance in 2021 and resilience relative to the public markets in 2022 has left some investors overallocated to the asset class.  This denominator effect has prompted some to reduce their ticket sizes or commit to fewer vehicles, affecting fundraising in the private markets.

The article cited that Apollo Global Management will keep its latest flagship fund open well into 2023 as potential investors grapple with the allocation constraints described above.
In Singapore, the outlook for the SPAC market is reflective of the sentiments towards the public market between 2021 and 2022.

The Business Times wrote an article on 5 June 2022 titled “SPACs were all the rage.  Now, not so much”.  The listing of SPACs led Singapore’s IPO market to its busiest half year in five years in the first half of 2021.  SPACs are special purpose acquisition companies; more specifically, shell entities that sell shares to the public and use those funds to buy an operating business.  Investors get their money back if the SPAC has not found a business to buy within a two-year window.

The global SPAC boom is now cooling, having been fuelled by long periods of low interest rates that pushed investors to riskier corners for higher return.  Most venture capitalists regarded SPACs as a quicker way to take technology startups public.

Unfortunately, with the rapidly rising interest rate environment, investors have more frequently invoked their contractual right to redeem their shares in a SPAC.  However, experts feel that it may be too early to tell whether Singapore SPACs will lose steam, as three of Singapore’s SPACs are backed by experienced and reputable sponsors in the mergers and acquisitions space and have ample time to look for targets⁵.

Conclusion

In view of the above, it is not surprising to learn that, according to the Preqin Insights survey, private equity investors are of the view that the key challenges affecting deal activity for the next 12 months will be: (1) the exit environment; (2) asset valuation; (3) rising interest rates; (4) stock market volatility; and (5) the geopolitical landscape.

What was talked about at the inaugural Fund Finance Symposium in Singapore?

After a three-year hiatus, the first in-person APAC Fund Finance Symposium took place in Singapore on 3 November 2022.  This was also the first-ever Fund Finance Symposium to be held in the country.

Symposium panellists highlighted that given the challenges of the current market and liquidity crunch, product diversification is key.  There is a need to “get creative” in financing structures, and to look beyond the traditional capital call facility to meet the current leverage needs of funds.

Commercially, for financiers, there is talk about looking at the right value proposition when lending, and the need to focus on product diversification for clients.

Enter: “Fund Finance 2.0”.  This is not a new term, and is one that has been talked about at length in the APAC market as well as overseas in the US and Europe.

For a long time, particularly in the APAC region, there were doubts as to whether there would be any uptake in alternative structures; however, in 2022, panellists were able to confidently say for the first time that such structures are entering the market.

The three most common alternative fund finance structures discussed were: NAV Facilities; Hybrid Facilities; and GP Facilities.  There was also mention of private credit and preferred equity structures.

In the face of tightening liquidity, NAV and Hybrid Facilities in particular were identified as potential financing solutions to the increasing levels of fund assets under management.  Preqin expects the size to almost double by 2027 compared to current levels.

It was also observed that such structures could require significantly more involvement of the financier on an ongoing basis to assess valuations and key performance indicators.

Most experts agreed that alternative structures have only really started to enter the market in the past 12–18 months and not all transactions make it across the finish line.  These alternative structures are expected to become more prevalent as traditional subscription line facilities do not fully address the growing challenges and complexities faced by fund managers.

Singapore’s investment fund vehicle – VCC 2.0 

The Variable Capital Company (VCC) is a new specialised corporate structure in Singapore that can be used as one or more collective investment schemes (whether open- or closed-ended).  The VCC is constituted under the VCC Act, which came into force in 2020, and is touted as a “game-changer”.

To encourage industry adoption of the VCC framework in Singapore, the Monetary Authority of Singapore (MAS) launched the Variable Capital Companies Grant Scheme, which will help to defray the costs involved in incorporating or registering a VCC by co-funding up to 70% of eligible expenses paid to Singapore-based service providers.

The grant is capped at S$150,000 for each application, with a maximum of three VCCs per fund manager.  An extension to the grant scheme is being reviewed but it is otherwise due to lapse on 15 January 2023.

According to the Alternative Investment Management Association (AIMA), by mid-2022, over 540 VCCs had been established in Singapore.  The figures indicate that around one-third of those were closed-ended private equity or venture capital funds, 20% were hedge funds, 28% were multi-family offices or external asset managers, and 14% were traditional long only.  In addition, there were 15 redomiciliations, as asset managers in the region explore its potential.

The VCC has found favour with fund managers operating different investment strategies such as hedge funds, venture capital funds and private equity funds.  It has also drawn many wealth management players, keen to establish fund platforms for their high-net-worth clients, and family offices.

What makes the VCC attractive as a fund vehicle?

The VCC functions as a corporate structure tailored specifically for investment funds.  More specifically, it is incorporated under the VCC Act, instead of the Companies Act, to allow it to function as a fund vehicle instead of as a generic corporate entity.  Despite being administered by Singapore’s corporate regulator, the Accounting and Corporate Regulatory Authority (ACRA), and unlike other companies registered with ACRA, the VCC’s register of shareholders is not made public, although the register must be disclosed to public authorities upon request for regulatory, supervisory and law enforcement purposes.

In addition to the grant mentioned above, there are numerous tax incentives offered to a VCC.  These include, in particular, tax incentives under Section 13O (Singapore Resident Fund) and Section 13U (Enhanced Tier Fund) of the Singapore Income Tax Act.  In effect, for eligible funds, all income from designated investments will be tax free, resulting in no tax outcome, similar to that of a Cayman fund.

The Section 13O scheme exempts specified income received by an approved company in Singapore from tax, where such income is derived from designated investments in funds managed in Singapore by a licensed or exempt resident fund manager.  It will not be applicable if all of the approved Singapore companies’ issued securities are beneficially owned by Singapore persons.  The fund must incur at least S$200,000 in global business expenses a year and the fund’s administrator must be based in Singapore.

The Section 13U scheme applies to funds with a minimum size of S$50 million that are managed or advised by a Singapore fund manager, which can be an exempted Singapore family office or a licensed multi-family office.  The fund manager must employ at least three investment professionals in Singapore who are substantively engaged in an investment management or advisory role, and the fund must incur at least S$200,000 in business spending in Singapore, which typically covers investment management fees payable to the fund manager.

In addition, if its constitution so allows, a VCC will have the flexibility to issue and redeem shares without having to seek shareholders’ approval.  As a VCC is not subject to the same restrictions on capital reduction as those of a company structure, it allows investors to exit their investments in the investment fund when they so wish, as redemption proceeds can be paid out of profits or capital.  A VCC is also not subject to the restriction of only being able to pay dividends out of profits and, accordingly, can pay dividends using its capital as well.

More broadly, the VCC may be established as a standalone fund or as an umbrella fund with multiple sub-funds.  The umbrella fund structure creates economies of scale.  Sub-funds under the same umbrella fund can share a common board of directors and use the same service providers, including the same fund manager, custodian, auditor and administrative agent.  As a safeguard for VCC shareholders and to enhance creditor protection, the VCC Act provides for the statutory ring-fencing of assets and liabilities of each sub-fund from the other sub-funds.

The VCC will allow for a wider scope of accounting standards to be used in preparing financial statements, which helps to serve the needs of global investors.  Apart from Singapore accounting standards and recommended accounting principles, International Financial Reporting Standards and US Generally Accepted Accounting Principles can be used by VCCs.

Looking ahead, it has been reported that MAS is in the process of revising its VCC fund structure to expand the pool of fund managers that can use the scheme and to make fund conversions and multiple offshore fund redomiciliation easier.  The MAS is keen to expand the reach of the scheme further to attract more asset managers to launch new funds using the new vehicle.

What is next – VCC 2.0

The MAS is revising its VCC structure to attract a wider pool of managers to Singapore.  It issued a consultation paper on the VCC in 2019 and responded to the feedback received in 2020.  This academic dialogue has been useful to elicit industry views of what is top of the wish list.

The much-anticipated revisions to the VCC fund structure are expected to include an expansion to the pool of fund managers that can use the vehicle, and a process to make fund conversions and multiple offshore fund redomiciliation easier.

At present, only managers who hold capital markets services licences for fund management (or managers who fall within certain exemptions) are permitted to use the VCC.  This is limiting as it potentially excludes a wide pool of single-family offices and real estate fund managers who are exempt from licensing under Singapore’s Securities and Futures Act.

The concern is that if the licensing requirement is relaxed, it may result in too many VCCs being used for private wealth vehicles.  However, there tends to be a stronger desire to encourage more traditional asset classes like private equity, real estate and infrastructure to look at the Singapore VCC as a potential vehicle.

In spite of the competing views, developments in this sphere are always useful as many feel that this is all part of the path to developing the VCC structure into a globally recognised investment vehicle that can compete with the likes of offshore fund structures.

The other key change expected to be made to the VCC is to improve the manner in which existing fund structures may be converted into VCCs.  Prior to the VCC, fund managers who wanted to set up a private fund in Singapore typically used the limited partnership, unit trust, or private limited company structures.

If a fund manager wishes to convert its existing fund vehicle to a VCC structure, it is only possible to do so by setting up a new VCC and subsequently transferring the assets from the existing fund to the VCC.  This is a tiresome process and also triggers potentially significant tax consequences such as stamp duty.

In addition to fund conversion, the MAS is also looking into allowing the redomiciliation of multiple offshore funds into a single VCC.  Currently, managers are only allowed to redomicile one offshore standalone or umbrella fund into one Singapore standalone or umbrella VCC, respectively.

Sustainable Finance

The MAS’ vision for Singapore is to be a leading centre for Green and Sustainable Finance both in Asia and globally, and it has spearheaded a number of initiatives in this space to facilitate the championing of this cause.  We set out briefly a few key developments in 2022 below.

Disclosure and Reporting Guidelines for Retail ESG Funds

To mitigate the risk of greenwashing for Retail ESG Funds, the MAS published a circular⁶  on 28 July 2022, which will take effect on 1 January 2023, to apply to prospectuses of retail environmental, social and governance (ESG) funds (i.e. Retail ESG Funds) that are lodged with the MAS on or after 1 January 2023. 

In brief, a fund that is sold to retail investors in Singapore using ESG factors as a key investment focus and strategy, or represents itself as an ESG-focused scheme, will need to justify its ESG labelling.  This includes the required details on a scheme’s ESG focus, investment strategy, reference benchmark and risks associated with such ESG focus.

Second consultation paper on Green Taxonomy

Singapore’s Green Finance Industry Taskforce (GFIT) published a second consultation paper on 12 May 2022, which sets out details of thresholds and criteria for a revised Singapore taxonomy for Singapore-based financial institutions to identify “green” activities or activities transitioning towards green.

This paper follows the publication of the January 2021 paper, which introduced a proposed taxonomy for Singapore-based financial institutions to identify activities that can be considered “green” or transitioning towards green.  Similar to the taxonomy being developed in the EU, the paper broadly introduced a “traffic light” system for classifying activities as green (environmentally sustainable), amber (transition), or red (harmful) based on their contributions to a proposed set of environmental objectives.

The second consultation paper sets out threshold criteria for economic activities in three sectors – energy, transport and real estate.  The paper also provides more details of the application of traffic light system by sub-categorising activities in the above sectors and proposes detailed benchmarks and thresholds for these activities. 

GFIT is expected to finalise this Green Taxonomy in 2023.

ESG Registry

On 18 May 2022, fintech company Hashstacs (Stacs) launched a blockchain-based platform known as ESGpedia, which powers the new ESG Registry.  The objective of having this registry is to make it easier for financial institutions to access companies’ sustainability data from multiple certification bodies and verified sources.  This platform is one of the four digital utility platforms housed under Project Greenprint, which the MAS is developing in partnership with the industry.

Let’s go back to basics – Security Package 101

In this section, we consider some of the typical security package considerations for a fund finance transaction.  The key concepts for the taking and perfection of security common to a fund finance transaction (fortunately) remained unchanged and are consistent with similar concepts in other established common law jurisdictions such as England & Wales.

One of the key aspects of a fund finance transaction is the security package.  This will typically be secured by: (1) the unfunded capital commitments of the fund’s investors; (2) the right to make capital calls from investors and receive proceeds of such capital calls; (3) the bank accounts into which the capital contributions are funded; and (4) the rights within the underlying fund documentation, in particular the right to enforce against such investors of the fund.

It is important to conduct good and thorough due diligence of the fund documentation to ensure that a financier has as many unfettered rights as possible in respect of the above when its security is enforced.  A good lawyer not only advises on what is required under law, but also on best practice in the market or (if unable to adopt best practice) the risks involved.

An assignment of the rights pursuant to the fund documentation and a charge over bank accounts will be standard forms of security taken under a typical financing.  Under Singapore law, an assignment is effective if: (1) it is an absolute assignment; (2) it is made in writing under the hand of the assignor; and (3) express notice in writing has been given to the counterparty (i.e. the investor).  Strictly speaking, no acknowledgment is required but it is usually taken (or attempts to ask for it will be made) to incorporate additional protections for the financiers.

These protections include, for example: (1) an undertaking by the investor to pay directly to the secured account; (2) representation by the investor that it will not exercise any set-off or counterclaim of the amount it owes to the fund entity; and (3) a confirmation that it received no prior notice of assignment or security.

For charges, registration at ACRA is required if it is granted by a Singapore company or a foreign company registered in Singapore.  This will be relevant if, for example, the security is entered into by the general partner of the fund entity, and that general partner is a company incorporated or registered under the Companies Act.  The charge must be registered within 30 days of the date of creation of the charge, and an unregistered registrable charge is void against a liquidator and any creditor of the company, such that the creditor would effectively be an unsecured creditor in a liquidation.

One key point to flag is that the charge registration regime has a public notification aspect to it.  The nature of the security and the fact of that the fund company has obtained financing will become public knowledge.  In addition, it is legal requirement that a copy of the charge document must be kept available at the company’s place of business for its creditor’s inspection without fee and any person may, upon application to the company and payment of a nominal fee, be furnished with a copy of such instrument.

The year ahead

In October 2022, the MAS reported that the Singapore economy is projected to slow further at a “below-trend pace” in 2023 amid growing challenges in the external environment.  It also said that dampened global and regional trade flows will adversely affect many sectors in Singapore even as global supply frictions continue to ease.  Many expect that the Singapore economy is in for a bumpy ride in 2023.