In keeping with our interest in global financial regulatory developments, in this and two blog posts to follow, we examine recent regulatory developments and responses in the active Hong Kong private equity markets.
Historically, the most popular setup of private equity firms in Hong Kong involve a Hong Kong onshore investment adviser providing advice to an offshore investment manager or a general partner in the Cayman Islands. The Hong Kong investment adviser will typically be a wholly-owned subsidiary of the offshore entity. If structured in this manner and subject to certain additional parameters, the Hong Kong investment adviser will be able to operate without any licence in Hong Kong as the Hong Kong investment adviser will be able to rely on what is commonly referred to as the “intra-group” exemption.
However, the recently proposed requirement for a Cayman Islands investment manager to demonstrate economic substance; and the new Hong Kong profit tax exemption regime for privately offered funds, have prompted a number of private equity firms in Hong Kong to consider bringing the offshore investment manager onshore and to apply to the Hong Kong Securities and Futures Commission (the SFC) for licenses to carry out regulated activities.
The types of licenses that private equity firms need will depend on their proposed scope of activities. The most relevant regulated activities are Dealing in Securities (Type 1), Advising on Securities (Type 4), and Asset Management (Type 9). Part 1 of this blog covers Dealing in Securities.
Dealing in Securities (Type 1) is defined as making or offering to make an agreement with another person, or inducing or attempting to induce another person, to enter into or to offer to enter into an agreement (i) for or with a view to acquiring, disposing of, subscribing for or underwriting securities; or (ii) the purpose or pretended purpose of which is to secure a profit to any of the parties from the yield of securities or by reference to fluctuations in the value of securities.
The term “securities” is very broadly defined and will cover, among others, interests in collective investment schemes and co-investment vehicles. It follows that marketing interests in collective investment schemes and co-investment vehicles will also be covered under Type 1 regulated activity, unless an exemption is available.
In addition, the broad definition of “dealing in securities” means that many activities relating to “securities” are considered by the SFC to constitute dealing, including “securing a deal,” and arguably “sourcing” a deal. The most relevant part of the definition is whether, in performing its activities, the Hong Kong onshore entity is “inducing, or attempting to induce,” another person to buy or sell securities. Provided that the Hong Kong onshore entity does not stray into the realm of “securing a deal,” it should generally be possible to avoid the need for a Type 1 license.
The Type 1 license is the most onerous to obtain. The minimum regulatory capital requirement is a paid up share capital of HK$5,000,000 (approximately US$ 638,825) and a minimum liquid capital of HK$3,000,000. However, a licensed corporation is required to notify the SFC if its liquid capital falls below 120% of its minimum liquid capital so in practice, the minimum liquid capital requirement is HK$3,600,000 (approximately US$459,936).