Grounded Ingenuity | Refined Results

February 10, 2021
Gavin Cumming, Timothy Loh
In its 2021-22 budget, the Hong Kong Government highlighted its recent proposal for new legislation to facilitate the re-domiciling of offshore based hedge funds and private equity funds back to Hong Kong for registration as Open-Ended Fund Companies (“OFCs”) or limited partnership funds (“LPFs”) and proposed a new subsidy to set-up or re-domicile OFCs in Hong Kong, whether as hedge funds or mutual funds, in the coming 3 years. If you are considering a fund setup or a fund re-domiciliation and would like to discuss how the subsidy may apply to your specific circumstances, please contact one of our Hedge Fund, Private Equity or Mutual Fund lawyers.

In his budget speech for the 2021-22 Hong Kong Government budget, the Financial Secretary highlighted 2 important proposals to strengthen Hong Kong’s position as an asset management centre.

Proposed Subsidy for OFC Set-up or Re-Domiciliation

First, the Hong Kong Government proposes a subsidy for the setup or redomiciliation of OFCs in Hong Kong. The subsidy will cover 70% of the expenses paid to Hong Kong professional service providers and will be capped at HK$1 million (approx. USD125,000).

Details of the proposal have yet to be announced.

Incentive for Hedge Fund Managers

The proposal would appear to provide a significant incentive for hedge fund managers to setup their new funds in Hong Kong as OFCs. The OFC structure offers a domestic Hong Kong alternative to the Cayman segregated portfolio company (“SPC”) and exempted limited company structures that are widely used by hedge fund managers in setting up their funds. Like these Cayman structures, OFCs are open-ended vehicles, meaning that investors can subscribe for and redeem shares on an ongoing basis.

Segregation of Assets and Liabilities

Additionally, like SPCs, OFCs segregate assets and liabilities so that a hedge fund with multiple sub-funds can ensure that the assets of one sub-fund will not be available to satisfy the liabilities of another sub-fund. A major advantage of using an OFC instead of an SPC for a Hong Kong based hedge fund manager in this respect is that the segregation of assets and liabilities is assured under Hong Kong law, whereas there is ongoing uncertainty as to whether the segregation under Cayman law would be effective in Hong Kong.

Simplified Capital Raising for OFCs

Unlike Cayman vehicles, OFCs offer an easier route to capital raising. Cayman vehicles generally require a minimum investment size of US$100,000. In contrast, OFCs have no minimum investment size when dealing with professional investors and a minimum investment size of only HK$500,000 (approx. US$65,000) otherwise.

Tax Incentives for OFCs

Together with tax incentives for OFCs which are not available to Cayman vehicles, it is clear that the Hong Kong Government is making a concerted effort to encourage not only the formation of new hedge funds as OFCs in Hong Kong but also the re-domiciliation of existing hedge funds as OFCs in Hong Kong.

Incentives for Mutual Funds

In addition to being fit for hedge funds, OFCs offer an alternative to structures used for mutual funds, such as the société d'investissement à capital variable (“SICAV”) structure. It is not clear to what extent mutual fund managers will look to OFCs as the majority of SFC authorized mutual funds are European UCITS funds and it is unclear whether a subsidy would be sufficient to incentivize the use of OFCs given passport benefits of setting up a fund in Europe.

Re-Domiciliation of Hedge Funds and Private Equity Funds

Secondly, as recently announced, the Hong Kong Government is planning to introduce new legislation to facilitate the re-domicile of foreign domiciled hedge funds and private equity funds back to Hong Kong. The proposal recognizes that the vast majority of Hong Kong based hedge fund and private equity fund sponsors use non-Hong Kong fund vehicles and provides a route for them to return to Hong Kong.

At present, to re-domicile a non-Hong Kong hedge fund or private equity fund, the sponsor will need to set up a new OFC or LPF and transfer the assets and investors from the existing fund to the new fund. This is possible to do but a number of issues may arise on a case by case basis, including the possible need for investor consent, tax issues on the transfer of portfolio assets and equalization of performance fees and carried interest.

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