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2020 - The year to get licensed - A new start for PE firms and family offices

  • Hong Kong
  • Investment funds and asset management
  • Private equity

10-01-2020

The Securities and Futures Commission of Hong Kong (“SFC”) issued two circulars on 7 January 2020 providing guidance on its approach to licensing private equity (“PE”) firms and family offices to carry out regulated activities in Hong Kong under the Securities and Futures Ordinance (“SFO”).

In this Newsletter, we look at the circulars in light of the recent drive by the SFC to license and regulate PE firms and family offices and highlight some of the key issues to consider.

Private equity firms

Background

The question of whether PE firms need to be licensed when operating in Hong Kong is a vexed one.

Many in the PE industry have been operating under misconceptions as to whether a licence is required to operate in Hong Kong. One of the main misconceptions is that managing investments in private companies would not be caught by the definition of “securities” under the SFO and accordingly such management activities does not constitute a regulated activity. However, it has always been clear from a plain reading of the SFO that only shares of Hong Kong private companies are carved out from the definition of “securities”.

General Partners

For PE funds constituted as limited partnerships where the general partner (“GP”) assumes exclusive responsibility for the management and control of the fund, the position is clear that the GP is required to be licensed for Type 9 (asset management) regulated activity if such activity is being carried out by the GP in Hong Kong. Individuals who perform such services for the GP in Hong Kong are also required to be licensed as responsible officers or licensed representatives of the GP. The GP does not, however, need a Type 9 licence where it fully delegates its discretionary asset management function to a licensed investment manager.

Investment committee members

The SFC considered the role of investment committee (“IC”) members and commented that where IC members play a dominant role in making investment decisions, the IC members should be licensed. On the other hand, where an IC member’s primary role is to provide non-investment input such as compliance and internal control functions, he or she does not need to be licensed.

The SFC’s guidance on IC members is helpful but the use of the word “dominant” does introduce an element of subjectivity in determining whether IC members need to be licensed in order to carry out their role. In some cases, it will be very clear based on the limited partnership agreement, the committee charter and the actual facts as to whether the IC members need to be licensed or not. In other cases, the answer may not be so apparent but, given the implications of getting the analysis wrong, it will be interesting to see if IC members will err on the side of caution and seek licensing, revise their duties and powers, or even resign from their positions.

Investments in securities of private companies

The SFC made special mention of the use of a special purpose vehicle (“SPV”) incorporated in Hong Kong or overseas for investment holding purposes. The SFC’s position is that, in determining whether an investment portfolio comprises “securities” under the SFO (the management of which in Hong Kong will require a Type 9 licence), the SFC will consider the composition of the entire investment portfolio. If the underlying investments held through an SPV fall within the definition of “securities” (even if the holding in the SPV does not) or the SPV itself does not fall within the definition of “securities”, the SFC will still regard the management of the portfolio as “asset management” and require the PE firms to be licensed for Type 9 regulated activity if such management is conducted in Hong Kong.

The SFC is clearly entitled to take this “look through” approach but whether it is the correct approach to adopt in each and every case is questionable. The legislative basis for this interpretation is also unclear. In our view, the situation would appear to be more fact sensitive than the circular suggests and this issue has the potential to result in detailed discussions with the SFC.

Fund marketing and co-investment opportunities

PE firms should be reminded that fund marketing activities in Hong Kong generally constitute “dealing in securities” and require a Type 1 (dealing in securities) licence from the SFC subject to certain exemptions.

In situations where co-investment opportunities are offered to other persons to invest in the underlying projects alongside the PE fund, the PE firm generally requires a Type 1 licence because the act of offering co-investment opportunities will likely be regarded as inducing the other persons to enter into securities transactions. However, where a PE firm offering co-investment opportunities is doing so for the purposes of carrying on Type 9 regulated activity and the offering of co-investment opportunities forms an integral part of fundraising or securing capital to invest in the PE fund’s underlying projects, a Type 1 licence is not required.

Family offices

Multi-family offices serving more than one family will generally require a SFC licence of one or more types of regulated activities.

Single family offices will need to consider their situation carefully as the licensing requirement is heavily dependent on the fact pattern such as its structure and how it operates. Indeed, the SFC made it clear that it is not the relationship amongst beneficiaries of a family trust or between family members that is the deciding factor, and gave examples of how certain family office structures would not require licensing.

Next step

Whilst it is not possible to say what the SFC’s approach will be in general terms, it is certainly to be hoped that the SFC will take a pragmatic approach to PE firms and family offices seeking to regularise their situation.

In 2020, PE firms and family offices can make a fresh start to the year by examining their structure, operations and business activities in Hong Kong and seek advice on their licensing requirements.

Please do not hesitate to contact any of the lawyers from the Asset Management and Regulatory team at Eversheds Sutherland in Hong Kong should you have any queries.

For more information contact

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