Hong Kong introduces Limited Partnership Fund regime

Filling the vacuum 

On 20 March 2020 the Hong Kong government gazetted the Limited Partnership Fund Bill (Bill). The Bill is scheduled to be enacted as the Limited Partnership Fund Ordinance and on the current legislative timetable will take effect on 31 August 2020. This new legislation represents a significant step towards filling the gap in the legal infrastructure in Hong Kong that has long existed for private equity (PE) style investment funds.

Currently, there is no suitable legal framework in Hong Kong for establishing a limited partnership as an investment vehicle, which is the form most widely used to attract institutional capital to PE style funds raised in the global market. The Limited Partnership Ordinance (Cap. 37) was enacted in 1912 with the intention of allowing for the establishment of professional practices such as accounting firms and law firms. The rigidity of the Limited Partnership Ordinance makes it unsuitable for an investment vehicle to be established under it. For example, a limited partner is not permitted to draw out or receive back its capital contribution during the continuance of the partnership; if any part of the contribution is drawn out or received back by a limited partner, such limited partner will be liable for the debts and obligations of the firm up to the amount drawn out or received back. Such a rule precludes distribution of profits during the life of the fund.

Better late than never

With its special ties to Mainland China, Hong Kong serves as a hub for both inbound and outbound investment activity. However, with Hong Kong's lack of a proper legal framework for PE style funds, offshore jurisdictions (predominantly, the Cayman Islands) have long been used to establish PE style funds. More recently, Singapore has gained significant traction as a center for establishing and managing PE style funds, owing to its sound legal framework and increasingly broad array of tax treaties.

The Limited Partnership Fund Bill has been introduced at a time when traditional offshore jurisdictions are under increasing pressure to conform with onshore legislative priorities, many stemming from the Great Financial Crisis of 2008-09. Largely as a result of pressure from the European Union, these offshore jurisdictions have introduced reforms to their laws and regulations to counter base erosion and profit shifting (commonly referred to as "BEPS" and historically known as "transfer pricing") and to discourage cross-border tax avoidance more generally. As a result, economic substance requirements have been introduced, which broadly speaking require management and control to be exercised from the relevant jurisdiction in which a vehicle is established; a physical presence including employees; and for the vehicle to conduct core–income generating activities and incur operating expenses in the relevant jurisdiction.

As a result , there has been a relative measure of convergence of laws and regulations between onshore and offshore jurisdictions. This in turn requires fund sponsors carefully to consider the jurisdiction in which they establish their next PE style funds.

Key features of the Limited Partnership regime

The Limited Partnership Fund Bill includes a number of features that hold out some promise for Hong Kong becoming a viable, alternative jurisdiction in which to raise PE style funds.

Eligibility and registration

The limited partnership fund shall consist of a general partner and at least one limited partner and constituted by a limited partnership agreement with its registered office in Hong Kong.¹  It shall also be registered with the Registrar of Companies by a Hong Kong law firm or solicitor admitted to practice Hong Kong law on behalf of the general partner.² 

Contractual freedom among partners³

Contrary to the Limited Partnership Ordinance, the partners of a limited partnership fund have contractual freedom with respect to the operation of the fund, which includes, but is not limited to, freedom to agree on (i) admission and withdrawal of partners, (ii) transfer of interests by limited partners, (iii) the scope of the fiduciary duties of the general partner and the remedies for breach or default, (iv) the financial arrangements such as capital contributions, withdrawal of capital contributions, distribution of proceeds and clawback obligations of the partners, (v) the life of the fund with possibility of extension, and (vi) the dissolution procedures.

Distributions to partners⁴

Withdrawal of capital contributions and distribution of profits are permitted if the fund remains solvent following such withdrawal or distribution.

Regulatory duties of the general partner

The general partner of a limited partnership fund must appoint an investment manager to carry out the day-to-day investment management functions, an auditor to carry out audits of the financial statements and a responsible person to carry out anti-money laundering measures.⁵  It shall also ensure proper custody of assets.⁶  In addition, if the general partner is itself a limited partnership fund or a non-Hong Kong limited partnership without a legal personality, it shall also appoint an authorized representative for the management and control of the fund.⁷

The general partner must also file an annual return with the Registrar of Companies and if there is any change in the particulars relating to the fund, the general partner must also file a notification with the Registrar.⁸

Activities of limited partners⁹

The Bill provides a clear guidance on limited partners' activities with respect to the fund by setting out a non-exclusive list of permitted activities which are not regarded as taking part in the management of the fund. These activities include, for instance, acting as an agent of the fund, serving on a board of committee of the fund, and serving as a director of any company the fund has invested in. 

Migration of funds¹⁰

A streamlined channel will be provided to existing funds established under the Limited Partnership Ordinance to be migrated to the new limited partnership fund regime.

Confidentiality

The identity of limited partners will not be accessible in public records. The register of partners will be kept by the fund itself at its registered office or any other place Hong Kong made known to the Registrar of Companies.¹¹

Tax treatment¹²

Limited partnership funds may enjoy profit tax exemptions as long as they meet certain conditions set out in section 20AM the Inland Revenue Ordinance (Cap. 112). Distribution of profits by the limited partnership fund to limited partners is suggested to be exempted from stamp duty as an interest in a limited partnership fund is not a "stock". Clarity around the way that carried interest is to be treated from a taxation perspective, a fundamental consideration for fund sponsors, managers and investors alike, has also been promised by the Hong Kong government.

Going back to shore?

The introduction of the Bill, and its future enactment as legislation, is a significant step towards positioning Hong Kong as an alternative jurisdiction in Asia for establishing PE-style funds. Fund managers based in Hong Kong may be particularly drawn to bringing their future funds onshore when raising capital from investors in China or for investing in China.

We will monitor the development of the law in this area, as well as the market, and assist you with analysing the implications the limited partnership fund regime may have on your business and operation to help you leverage any opportunities it may offer.

Special thanks to Lavinia Mo on her contribution to the draft of this article.

1. Section 7 of the Bill
2. Section 11 of the Bill
3. Section 16 of the Bill
4. Section 17 of the Bill
5. Sections 20, 21 and 33 of the Bill
6. Section 22 of the Bill
7. Section 23 of the Bill
8. Sections 24-25 of the Bill
9. Section 27 and Schedule 2 of the Bill
10. Sections 78-82 of the Bill
11. Section 29 of the Bill
12. Paragraphs 25-26 of Proposals to Establish a Limited Partnership Regime for Funds of the Legislative Council Panel on Financial Affairs (LC Paper No. CB(1)175/19-20(06))