The Hong Kong Advantage: New LPF Regime Strengthens its Position as Asia's Asset Management Hub

February 22, 2021

With the recent introduction of Limited Partnership Fund (“LPF”) Ordinance, Hong Kong is reinforcing its position as a premier asset-management hub in Asia. We explore how this governance compares to other regulatory regimes and why it will allow the territory to further leverage global and regional trends.

Global assets under management (“AUM”) topped the US$100 trillion mark for the first time in 2019, with much of this expansion being driven by momentum in Asia[1]. This trend of Asia-powered growth is expected to continue, with China likely to remain in pole position. Hong Kong, with its geographical and political proximity to China, is also upholding and expanding its role as a critical platform for capturing opportunities – especially those arising from foreign capital inflows, given ongoing capital controls on the mainland.

The Hong Kong Asset Management Proposition

The synergies between the two are seen in the Greater Bay Area, as the cross-boundary Wealth Management Connect Scheme was announced in mid-2020. The scheme is a blueprint that aims to promote greater internationalisation of the renminbi through more permissive capital-control regulations within the region[2]. This move will also boost Hong Kong's position as a global offshore renminbi hub.

Hong Kong’s new LPF Ordinance, which came into effect in August 2020, will help the city capitalise on two powerful sub-trends – the rise of family offices from the “new rich” and the influx of private equity funds. There has been a 44% growth in Asia-Pacific family offices since 2017[3]. And, spurred by the search for yield in an era of rock-bottom interest rates, private equity is booming – net asset value has grown twice as fast as the public markets[4]. Much of this money is flowing to Asia.

Key Advantages of the New LPF Ordinance

How does Hong Kong's new LPF Ordinance enable it to capitalise on these trends? Here is a summary of the advantages private funds can enjoy under the new ordinance:

  1. Preferential tax treatment: Removal of capital and stamp duty on contributions, transfers, or withdrawals to the LPF from LPs (limited partners). No capital gains tax and further potential tax exemption under the Profits Tax Exemption for Funds provision
  2. Greater privacy: Information on LPs is not publicly disclosed
  3. Operational flexibility: Stemming from the greater freedom of contracts – governing capital contributions and profit distributions – among the partners, plus “safe harbor" provisions. The disclosure framework is also considered reasonable and balanced
  4. Ease of formation: No minimum capital requirements and a “fund of one” can be formed
  5. Economic substance alignment: The fund's domicile can match economic substance requirements

While the LPF ordinance currently provides tax benefits, other incentives could emerge – namely the carried interest tax concession. After an industry consultation in 2020, the proposals have been further refined. As of January 2021, the latest recommendations include a 0% profits tax on eligible carried interest. LPFs can also exclude 100% of eligible carried interest from employment when calculating salaries tax[5].

When enacted into legislation, these proposals will place Hong Kong on par, or even above, the two other commonly used tax-advantaged jurisdictions in the region: Singapore and the Cayman Islands.

A Brief Comparison of LPF Regimes

Singapore and the Cayman Islands have traditionally been considered as alternative markets for establishing funds. Singapore is closer in nature to Hong Kong, being much more than a ground for setting up offshore entities for tax optimisation purposes. In terms of broad AUM, Hong Kong accounts for about USD3.7 trillion compared to Singapore's USD3.0 trillion as at end 2019[6]. For private equity funds, Hong Kong boasted USD160 billion – four times Singapore's USD40 billion.

To note, these statistics were prior to Hong Kong's new LPF ordinance. Today, their LPF regimes stand on a similar footing. The main similarities in all three jurisdictions' current LPF regimes are:

  • No capital duties on contributions from LPs or stamp duties on transfers of interests by LPs
  • Limited Partnership Agreements are required, but significant contractual flexibility is permitted
  • Unlimited liability on the part of the General Partners (“GPs”)
  • The role of LPs is limited to their capital commitment (unless participating in management). There is also a non-exhaustive list of safe-harbor activities (those regarded as not participating in management)
  • Funds have no separate "legal personality" from GPs

Differences remain. For instance, GPs in Hong Kong LPFs have more responsibilities, such as appointing an investment manager and independent auditor or arranging for the proper custody of the LPF's assets. Both Hong Kong and Singapore only permit the domestic migration of funds, while the Cayman Islands does allow for the migration of specific fund-related entities from foreign jurisdictions.

There is an ongoing shift in global dynamics that will provide advantages to Hong Kong and Singapore over offshore-focused jurisdictions like the Cayman Islands. The change in question – which has only been accelerated by the COVID-19 pandemic – is the internationalisation of tax standards and the resulting move from offshore to onshore.

Understanding the Global Offshore-to-Onshore Shift

With global governments contemplating how to pay for the fiscal stimulus used to combat the pandemic-induced economic recession, the issue of tax avoidance has taken on a new urgency. This can be seen in initiatives like the OECD's BEPS (base erosion and profit shifting) framework. Over 135 markets – including Hong Kong, Singapore, and the Cayman Islands – are members[7].

This poses a regulatory risk for fund managers who establish funds in offshore jurisdictions without concrete "economic substance". Markets that cater to onshore entities – such as Hong Kong – will have a growing advantage. Funds in such territories can also benefit from the efficiencies stemming from centralising both fund domiciles and actual operations in a single location.

Hong Kong – Positioning Itself as Asia's Asset Management Hub

It can be argued that Hong Kong was already Asia's prime asset management hub before the new LPF ordinance was enacted. The new regulations, timed to capitalise on current global dynamics, can only add to its attractiveness. Include promotional initiatives, such as Invest HK and the Family Office Association, and there appears to be little doubt as to the future of Hong Kong as the focal point for asset management in Asia.

 

[1] https://www.theasset.com/asset-servicing/41974/global-asset-manager-aum-tops-us100-trillion-for-first-time-

[2] https://assets.kpmg/content/dam/kpmg/cn/pdf/en/2020/07/cross-boundary-wealth-management-connect-scheme.pdf

[3] https://fundselectorasia.com/hong-kong-promotes-family-offices/

[4] https://www.mckinsey.com/~/media/McKinsey/Industries/Private%20Equity%20and%20Principal%20Investors/Our%20Insights/Private%20markets%20come%20of%20age/Private-markets-come-of-age-McKinsey-Global-Private-Markets-Review-2019-vF.ashx

[5] https://www.pwccn.com/en/asset-management/carried-interest-tax-concession-jan2021.pdf

[6] https://www.straitstimes.com/business/banking/singapores-assets-under-management-jumped-157-to-4-trillion-in-2019-mas

[7] https://www.oecd.org/tax/beps/

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