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31 May 2021
CaelusWatch: What’s going on in the global private equities space? (II) | Hong Kong
by Candice Wan, Analyst, Caelus Hong Kong Office

COVID-19 has undoubtedly affected the financial performance of portfolio companies, fundraising and exit activities of private equity (PE) funds in one way or another. Although the pandemic has upended the economy, the PE industry in Hong Kong remains buoyant. According to the Asian Venture Capital Journal, Hong Kong ranked second in Asia after Mainland China in 2019 for total capital under management by private equity funds (excluding real estate funds), which amounted to US$161 billion.

Let’s take a look at the recent developments of the fund industry in Hong Kong.

1. Fund formation and structuring: the OFC and HKLPF regimes
As specified in Budget 2021-2022, subsidies will be provided to cover 70% of the expenses paid to local professional service providers for OFCs set up in or re-domiciled to Hong Kong in the coming three years, subject to a cap of $1 million per OFC.

Other than the open-ended fund company (OFC) structure that has been introduced on 30 July 2018, the Limited Partnership Fund (LPF) Ordinance came into effect on 31 August 2020, which is a competitive legal framework that is similar to the Cayman exempted limited partnership. This new Hong Kong framework allows domicile and operational management to be combined in the same jurisdiction. This offers private equity firms the flexibility to register and operate their Asian funds in Hong Kong.

What’s more, a bill will be heard by the Hong Kong Legislative Council in the coming months, as the Hong Kong Monetary Authority (HKMA) will be working to finalize a re-domiciliation mechanism that provides a flexible and effective way to transform existing offshore funds into onshore funds.

However, PE funds that marketed to international investors, like those managed by Caelus, are usually set up in offshore jurisdictions as they are more familiar to investors. For instance, the British Virgin Islands Segregated Portfolio Companies (SPC), the Cayman Islands SPC, and the Luxembourg SICAR have been popular offshore fund structures for years, amongst which the Cayman Islands is the leading jurisdiction for establishing offshore investment funds. As of 30 June 2020, the Cayman Islands Monetary Authority (CIMA) reported that the total number of Cayman domiciled funds was 10,709. Fund managers might still prefer offshore jurisdictions for commercial reasons.

2. Tax concession on carried interest enacted on 7 May 2021
On top of the profits tax exemption for funds that took effect in April 2019, the Inland Revenue (Amendment) (Tax Concessions for Carried Interest) Ordinance 2021 (the “new law”) was enacted on 7 May 2021. The amended Inland Revenue Ordinance (Cap. 112) provides tax concessions for carried interest distributed by, received by, accrued to, eligible private equity funds on or after 1 April 2020.

For the tax concessions to apply, qualifying carried interest recipients have to fulfil substantial activities requirements including the number of qualified full-time employees and operating expenditure incurred in Hong Kong. In addition, the new law also expands to the assets that are held and administered by a special purpose vehicle under a fund for the purpose of profits tax exemption. This helps attract more PE market participants to establish and manage onshore funds with Hong Kong as base, and increases the attractiveness of Hong Kong as a destination for funds to operate.

3. The possibility of SPAC listings in Hong Kong
Hong Kong’s IPO market continued its strong momentum from the second half of last year, achieving a historic high in Q1 2021, with total funds raised hitting US$13.9 billion. Apart from traditional IPOs, special purpose acquisition companies (SPACs) are also being considered as an exit option for PE funds in Hong Kong. (More on SPACs:

However, Hong Kong has been skeptical about non-IPO listings. Despite the government proposing the reform of listing rules to accommodate SPAC listings and boost Hong Kong’s financial competitiveness, the Securities and Futures Commission reportedly has hesitations about allowing SPACs in Hong Kong. The HKEX has also tightened its rules on backdoor listings and shell activities in recent years, making it less possible for the SPAC frenzy to reach Hong Kong.

As regulators in Hong Kong and Mainland China have been streamlining listing procedures and requirements, some companies might be less keen to choose the SPAC route, but rather take the time to follow the traditional but simplified path. Moreover, SPACs could easily be overshadowed by other options such as the Chapter 18A route, which enables pre-revenue biotech companies to list on the Main Board.

4. The Future Fund’s Hong Kong Growth Portfolio and the HKMA’s Long-Term Growth Portfolio
Aside from global and regional PE sponsors, the Hong Kong government has also been making alternative investments to achieve higher return with a medium-to-long-term objective.

Often being referred to as the Hong Kong version of Temasek, Singapore’s sovereign fund, the Future Fund was established in 2016 as one of Hong Kong government’s fiscal measures to cope with the foreseeable long-term fiscal challenges arising from the city’s ageing population and slower economic growth. As announced in the Financial Secretary’s 2020-2021 Budget, part of the Future Fund would be used to set up a new portfolio called Hong Kong Growth Portfolio (HKGP). HK$22 billion (or 10% of the Future Fund) will be allocated to the HKGP to invest in alternative assets, and also make strategic investments in projects and funds with a Hong Kong nexus that would benefit the people or economy of Hong Kong. The Governance Committee of HKGP is chaired by the Financial Secretary and six non-officials who have rich experience in investment are appointed as members to provide strategic steering for the HKGP.

Besides, around 60% of the Future Fund’s interest rate is linked to the performance of the HKMA’s existing Long-Term Growth Portfolio (LTGP) which invests in global private equity and overseas real estate. As of 31 December 2020, the LTGP totaled HK$406.4 billion, with PE amounting to HK$299.7 billion and real estate at HK$106.7 billion. It records an annualized IRR of 13.7% since its inception in 2009.

It is encouraging to see that the government is taking initiatives to invest in projects that make direct contribution to Hong Kong’s future. Moreover, rather than being a 100% government-controlled fund, the participation of the non-officials from the private sector in the asset allocation of the HKGP will help live out the investment objective of the portfolio. Without as many limitations of political obligations, adopting advice from a more commercial mindset could help the HKGP achieve relatively higher returns than the rest of the “conservative” portfolios and fiscal reserves held by the government.

As one of the key international financial centers, Hong Kong has a large pool of finance talent with deep professional expertise, a robust legal framework and a sound financial system that provide valuable support to PE funds operating in the area. Looking forward, Hong Kong would only be able to enhance its competitiveness and become the leading asset management and PE hub in Asia with collaborations and effective communication between the government and the industry.

The author is a Securities and Futures Commission licensee, and no part of the author’s compensation was, is, or will be, directly or indirectly, related to the specific material contained herein. The author does not personally hold the mentioned relevant shares.

The commentary, news, research, analysis, prices and other information published in this column can only be viewed as general market information, which is for reference only and does not constitute investment advice. Caelus Asset Management Limited is not responsible for errors, inaccuracies or omissions in the information, and does not guarantee the accuracy or completeness of the information, text, diagrams, connections or other items contained therein. The company shall not be liable for any special, indirect, joint or consequential damages caused by the materials, including but not limited to loss, loss of income or loss of profit.