With the enactment of the LPFO, the authors expect Hong Kong to be used more often by advisers and managers for the formation of fund entities. As of July 2022, there were over 510 limited partnership funds (LPFs) registered with the Hong Kong Company Registry.

The common structure of a private fund that has a managerial or advisory presence in Hong Kong consists of:

• a fund entity formed as an LPF in Hong Kong;
• a general partner (GP) formed as a limited partnership or as a company; and
• an investment manager or adviser licensed by the Hong Kong Securities and Futures Commission (SFC).

Core fund documents include a limited partnership agreement, subscription documents, a private placement memorandum (where applicable), side letters entered into with investors (where applicable), an investment management agreement and/or an investment advisory agreement.

Persons investing in private funds set up in Hong Kong generally will not be deemed to be taking part in the management of the business of these funds (and will therefore benefit from the safeguard of limited liability) so long as these persons act as passive, economic investors in connection with the investment.

As in other leading funds jurisdictions, the LPFO sets out a non-exhaustive list of safe harbour activities that are not to be regarded as taking part in the LPF’s management, including the following.

• Serving on a board or committee of the LPF or the GP.
• Acting as an agent of the LPF or the GP.
• Advising the GP in relation to the LPF’s business.
• Voting on any of the LPF’s proposed transactions.
• Taking part in certain decisions, such as:
1. the admission or removal of partners;
2. the extension or end of the LPF’s term;
3. the incurrence of indebtedness by the LPF;
4. a change in the LPF’s investment scope; and
5. the exercise of the LPF’s rights in respect of an investment.

The SFC is the primary regulator of private funds, fund managers and advisers in Hong Kong. Hong Kong-based investment managers and advisers with SFC licences are subject to regulation under certain codes of conduct, including the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code”) and the Fund Manager Code of Conduct (FMCC), which prescribe a set of matters that are required to be disclosed to investors. The FMCC, for example, requires disclosure of cross-trades, leverage arrangements, securities lending, repo and reverse repo transactions, risk management policies, custody arrangements and so forth, which are usually contained in marketing documents, such as a term sheet or private placement memorandum.

Hong Kong is an international market with many of the same key investor types that operate in other important jurisdictions, including pension funds, insurance companies, private banks, wealth management firms, funds of funds, high net worth individuals and family offices. Some of these institutional investors are branch offices of Mainland China-based operations.

With the enactment of the LPFO, the authors expect Hong Kong to be used more often by advisers and managers for the formation of fund entities.

As described in 2.1.2 Common Process for Setting Up Investment Funds, the common structure of a private fund that has a managerial or advisory presence in Hong Kong would consist of:

• a fund entity structured as an LPF in Hong Kong;
• a general partner structured as a limited partnership or as a company; and
• an investment manager or adviser licensed by the SFC.

Due to the periodic tightening of RMB capital outflows by the monetary regulators in Mainland China, investors that have to source capital from their Mainland China affiliate(s) may encounter difficulty in funding capital calls on a timely basis. In recent years, regulators in Mainland China have revisited and tightened control on inbound and outbound investments. Prior to making a private fund investment, investors would be advised to carefully review and understand the impact of these rules, updates thereto and relevant law enforcement actions. Certain investors are subject to special regulations based on their investor type.

Private funds set up in Hong Kong that have a Hong Kong-based team of investment professionals would typically retain, directly or indirectly, a Hong Kong investment manager or adviser.

The primary securities legislation in Hong Kong is the Securities and Futures Ordinance (SFO). Activities of an investment manager or adviser could, depending on the facts and circumstances, come within various categories of regulated activities under the SFO, including:

• selling fund interests to residents in Hong Kong;
• conducting selling activities in Hong Kong;
• deal sourcing and execution of transactions;
• making recommendations and advising with respect to potential deals; and
• making investment decisions for the investment fund under management.

A Hong Kong investment manager or adviser entity, therefore, will usually be licensed under the SFC for conducting regulated activities in Hong Kong. The three types of licences that such manager or adviser is most likely to hold are Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management). Moreover, a manager registered in a jurisdiction other than Hong Kong that intends to conduct a regulated activity in Hong Kong, such as offering private fund interests to residents in Hong Kong or providing fund management or advisory services, must still comply with the private placement rule as detailed in 2.3.7 Marketing of Alternative Funds and the SFC licensing regime as detailed in 2.3 Regulatory Environment, as applicable.

The core principle behind the Hong Kong licensing regime is that applicants must demonstrate, to the satisfaction of the SFC, that such applicants are fit and proper (SFO, Section 129) to be licensed. Being fit and proper involves, broadly, being financially sound, competent, honest, reputable and reliable. To obtain an SFC licence, an applicant would need to satisfy standards relating to the competence of responsible officers and other senior management and relating also to the adequacy of financial resources.

An applicant must appoint at least two responsible officers (ROs) to be tasked with direct supervision of the conduct of each proposed regulated activity, with at least one RO being available at all times to supervise each of the proposed regulated activities and at least one RO being designated as an executive director.

In addition to ROs, any individual who carries on a regulated activity on behalf of the corporation will similarly be required to obtain a licence as a representative (LR) accredited to such corporation. As with ROs, LR applicants must satisfy the SFC that such LR has fulfilled the fit and proper requirement and must pass a related competency test.

To register a fund as an LPF, the proposed GP must arrange for a local Hong Kong law firm or solicitor to submit an application to the Hong Kong Company Registry. In addition, the GP must appoint an independent and local auditor to perform an audit of the LPF’s annual financial statements.

Non-local service providers operating in Hong Kong are not, where permitted, subject to an additional legal registration requirement solely on account of being non-local.

As indicated in 2.3.1 Regulatory Regime, if a non-local manager engages in a regulated activity from outside Hong Kong (eg, by actively marketing its services or products to the public, whether by itself or through another person on its behalf), and such activity, if undertaken in Hong Kong, would constitute the carrying on of a business in regulated activity under the SFO, then such non-local manager should adhere to the Hong Kong licensing regime as discussed herein.

As indicated in 2.3.1 Regulatory Regime, the SFO prohibits undertaking an activity (eg, the “active marketing” of a service to the public, including through persons operating outside Hong Kong) where it would constitute a regulated activity if undertaken in Hong Kong, unless such person has obtained an appropriate licence.

SFC guidance suggests that the following factors would be considered in reaching the conclusion that this “active marketing” threshold has been crossed:

• there is a detailed marketing plan to promote the relevant services;
• the services are extensively advertised via marketing means such as direct mail, advertisements in local newspapers, the use of broadcasts or other “push” technology over the internet (as compared with situations where such services are only passively available – eg, on a “take it or leave it” basis);
• the related marketing is conducted in a concerted manner and executed in accordance with a plan or schedule that indicates a continuing service rather than a one-off exercise;
• the services are packaged to target the public of Hong Kong – eg, written in Chinese and denominated in Hong Kong dollars; and
• the services are not sought out by the customers on such customers’ own initiative.

The Securities and Futures Ordinance (SFO) makes no distinction between pre-marketing and marketing of alternative funds. 

The SFO stipulates ten types of regulated activities, the most relevant of which for a private equity fund sponsor are Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management).

Type 1 regulated activity includes the making of, or offering to make, an agreement with another person or inducing, or attempting to induce, another person to enter into an agreement for, or with the view to, acquiring or disposing of securities. If a company engages in the distribution and sale of securities, such as limited partnership interests or shares in a company, a Type 1 licence would thus be required. In addition, if a company engages in deal sourcing and the execution of private equity transactions, including negotiations with a target company, then this conduct may also constitute Type 1 regulated activity.

Type 4 regulated activity includes the giving of advice on whether to acquire or dispose of securities. If a company provides investment advice, then, unless such advisory activities are wholly incidental to Type 1 regulated activity, the company will need to apply for and obtain a Type 4 licence.

Type 9 regulated activity includes the managing of a real estate investment scheme or securities or futures contracts. If a company provides portfolio management services and exercises discretionary investment authority to make investment decisions for its clients, then the company will need a Type 9 licence.

As the profile of each private fund management team or sponsor with a managerial or advisory presence in Hong Kong may differ depending on factors such as strategy, personnel, business capabilities and operational models, many firms decide to apply for one or a combination of the Type 1, 4, or 9 licences, while some other firms instead seek to rely on an exemption from the licensing requirements. Alternatively, some firms may choose to acquire a corporation that is already licensed and, through the acquisition, conduct the desired type of regulated activity. The SFO sets out various exemptions from the licensing requirements, the most relevant of which are profiled below.

A company may not need a licence for certain regulated activities if these activities are performed in a manner that is wholly incidental to the carrying out of another regulated activity for which the company is already licensed. For example, if a company holds a Type 9 licence, then that company may rely on the incidental exemption to carry out related Type 1 and Type 4 regulated activities, provided that the preceding activities are undertaken solely for the purposes of the company’s asset management business.

A company may not need a licence for Type 4 or Type 9 regulated activity if the company provides the relevant advice or services solely to:

• the company’s wholly owned subsidiaries;
• the company’s holding company that holds all of the company’s issued shares; or
• other wholly owned subsidiaries of the company’s holding company.

Offerings in Hong Kong of interests in private funds structured as partnerships or trusts (in the case of closed-end funds) are subject to regulation under the SFO. Offerings in Hong Kong of shares or debentures issued by private investment funds structured as companies (in the case of open-end funds, such as hedge funds) are subject to regulation both under the SFO and the Companies Ordinance.

Offering documents relating to securities offered to members of the Hong Kong public, whether offered by a licensed person or not, must be authorised by the SFC unless an exemption applies.

One of the most commonly used exemptions applies to offers made solely to “professional investors”, within the meaning of the SFO and its relevant subsidiary legislation. “Professional investors” broadly encompasses:

• financial institutions;
• insurance companies;
• investment companies;
• retirement schemes;
• pension plans;
• government entities; and
• certain high net worth individuals and large entities.

If fund interests are marketed in Hong Kong, the relevant investors should be provided with a supplemental Hong Kong investor questionnaire to confirm and document their professional investor status. It should be noted, however, that the admission by a fund of certain types of professional investors, including individuals, may cause such fund to be subject to enhanced compliance and due diligence requirements.

To the extent all Hong Kong offerees cannot meet the professional investor standard, another exemption is available under current market practices for offerings to not more than 50 offerees in Hong Kong. Although the offering documents for the types of private offers listed above are not required to comply with prospectus content requirements, they should include an appropriate securities legend to highlight that the offering documents have not been reviewed by any regulatory authority in Hong Kong and that investors are encouraged to seek independent professional advice.

Please refer to the private placement rule as detailed in 2.3.7 Marketing of Alternative Funds and the SFC licensing regime as detailed in 2.3 Regulatory Environment.

Please refer to the description of ongoing requirements as detailed in 2.4 Operational Requirements.

As mentioned in 2.3.7 Marketing of Alternative Funds, one exemption commonly relied upon by a private fund to facilitate private placement in Hong Kong is an offering limited to “professional investors”. The term “professional investor”, for this purpose, is defined in the SFO and its relevant subsidiary legislation, and is broadly split into three categories:

• institutional professional investors;
• individual professional investors; and
• corporate professional investors.

Institutional professional investors generally include authorised or regulated entities, such as:

• recognised exchange companies;
• recognised clearing houses;
• recognised exchange controllers;
• recognised investor compensation companies;
• authorised financial institutions; and
• authorised collective investment schemes.

Individual professional investors and corporate professional investors are usually determined based on their asset value or portfolio size, including:

• a trust corporation having been entrusted under one or more trusts of which it acts as a trustee with total assets of not less than HKD40 million;
• an individual, either alone or with any of their associates on a joint account, having a portfolio of not less than HKD8 million;
• a corporation or partnership having a portfolio of not less than HKD8 million or total assets of not less than HKD40 million; and
• a corporation whose principal business is to hold investments and that is wholly owned by a professional investor under the three points above.

The SFC is the main regulator of funds, fund managers and advisers in Hong Kong. The SFC derives its investigative, remedial and disciplinary powers from the SFO and subsidiary legislation. The SFO has empowered the SFC with multiple roles. The SFC’s principal responsibilities include maintaining and promoting the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry. The SFC’s scope of work includes licensing and supervising persons that conduct activities under the SFC’s regulatory purview.

The SFC often publishes guidance on regulatory matters and is timely to act when dealing with pressing concerns. It often consults the industry and public at large prior to enacting significant changes in regulation. In recent years, the SFC has focused on addressing irregularities in the market, developing regulatory approaches towards new, emerging asset classes such as virtual assets, strengthening oversight of fund managers and advisers, and taking account of the multi-jurisdictional nature of private equity.

The SFC, where applicable, initiates disciplinary actions against fund managers and advisers for misconduct. For example, the SFC recently reprimanded and fined an asset management company holding a Type 9 licence HKD1.75 million for its non-compliance with the European Union’s short-selling reporting requirements and its failure to promptly notify the SFC upon becoming aware of these material regulatory breaches. The SFC posts notices of enforcement actions on its website as a way of offering and providing insight into its regulatory approach and priorities. 

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