Charltons has significant experience advising on all stages of a private equity fund’s life cycle, including structuring and formation, marketing, portfolio investments and exits, redemptions, restructurings and termination. We advise on fund establishment and operations in Hong Kong, China and offshore. Our fund clients range from global fund managers to smaller start-up managers. Clients receive smart and practical advice from multidisciplinary lawyers with broad regulatory and transactional experience across funds and financial services, M&A, private equity and venture capital, lending and capital markets.
Investors in Hong Kong private equity funds are typically professional investors based both in Hong Kong and offshore. They include insurance companies, pension funds and financial institutions as well as wealthy individuals, investment offices of high-net worth families and funds of funds.
Until recently, the choice of fund vehicles in Hong Kong was very limited. However, this changed with the introduction of the open-ended fund company (OFC) in 2018 and the limited partnership fund (LPF) in 2020. Therefore, prior to the introduction of the OFC and the LPF, it was relatively rare for private equity fund vehicles to be domiciled in Hong Kong and the majority of private equity funds managed from Hong Kong are domiciled in offshore jurisdictions, for example the Cayman Islands or the British Virgin Islands.
A commonly used structure is the limited partnership structure under which a general partner has responsibility for the limited partnership’s day-to-day management. Investors are limited partners whose liability is limited to the amount of their contribution to the partnership.
Licensing Requirement for Private Equity Funds
In the absence of an applicable exemption, a licence from Hong Kong’s Securities and Futures Commission (SFC) is required if the fund, its principals or managers carry on any regulated activity in Hong Kong. Licences that are commonly required are: (i) for Type 1 (dealing in securities); and (ii) Type 4 (advising on securities).
The term “dealing in securities” is widely defined to include where a person, whether as principal or agent, makes or offers to make an agreement with another person, or induces or attempts to induce another person to enter into or offer to enter into an agreement to acquire, dispose of, subscribe for or underwrite securities. The definition of securities includes shares, debentures and bonds issued by a company, rights and options relating to any of the foregoing and interests in a collective investment scheme (i.e. a fund). The securities of a private company as defined in section 11 of the Hong Kong Companies Ordinance (Cap. 622) are excluded from the definition of “securities”. Thus a PE fund which deals only in the shares of a Hong Kong private limited company is not required to be SFC licensed in order to deal in, or advise on, such securities.
Where fund management activities are carried on in Hong Kong in relation to securities, the fund manager needs to be licensed for Type 9 (asset management) regulated activity.
Publicly Offered Funds
Regulation
The principal legislation covering the offering of funds in Hong Kong is the Securities and Futures Ordinance (Cap. 571) (SFO) which contains restrictions on public offers of collective investment schemes (CIS), which would include most funds. In order for a fund to be offered publicly in Hong Kong, the fund and any document by which interests in the fund are to be offered must be authorised by the SFC. Authorisation of the fund requires that it meets the requirements of the SFC’s Code on Unit Trusts and Mutual Funds. These requirements include the following general restrictions on the investments the fund is allowed to make:
A CIS cannot hold more than 10% of its NAV in the securities of one issuer or more than 10% of the ordinary shares of one single issuer; and
A CIS cannot hold more than 15% of its NAV in unquoted or unlisted shares;
The maximum borrowing of a scheme may not exceed 10 of its NAV. Regulated funds are also prohibited from investing in any type of real estate (including buildings) or interests in real estate excluding investing in shares in real estate companies and interests in REITs. Specific requirements for particular types of funds are set out in Chapter 8 of the Code on Unit Trusts and Mutual Funds. These include, money market or cash management funds, guaranteed funds, index funds, hedge funds and funds of hedge funds.
Invitations to invest in a CIS and public announcements in relation to it must be authorised by the SFC before they are issued in Hong Kong. SFC approval is also required before any change to:
a CIS’ constitutive or offering documents;
changes of trustee/custodian, management company, investment delegates and Hong Kong representative and their regulatory status; and ;
any other changes that may have a material adverse impact on investors’ rights or interests (including changes that may limit investors’ ability in exercising their rights.
In addition to the aforementioned changes that require the approval of the SFC, other changes that also require the approval include:
material changes in investment objectives, policies and restrictions;
introduction of new fees and charges, or increase in fees and charges payable out of the property of the CIS or by investors; and
material changes to dealing arrangements, pricing arrangements or distribution policy of the CIS
There are also requirements for the distribution of financial statements which must be published in respect of the financial year of the CIS. Annual statements and reports must be issued within 4 months of the financial year-end and provided to holders and to the SFC. Interim accounts must be provided within 2 months of the end of the relevant period.
Privately Offered Funds
At the end of August 2021, there were a total of 2,048 SFC-authorised unit trusts and mutual funds. A large number of investment funds are however offered in reliance on the exemptions from the SFC authorisation requirement. The main exemption from the requirement to obtain SFC authorisation is for CIS that are offered only to “professional investors” as defined in the SFO and the Securities and Futures (Professional Investor) Rules. The definition of “professional investors” currently include banks, authorised intermediaries (e.g. licensed dealers and fund managers), regulated pension funds and insurance companies and high net worth individuals (having a portfolio of at least HK$8 million) and high net worth companies (having total assets of HK$40 million or a portfolio of at least HK$8 million). An offer which is structured so that it is not an offer “to the public” (i.e. a private placement) will also be excepted from the SFC authorisation requirement.
Type 1 and Type 4 licenses may however be required for any party dealing in, or advising on, funds in Hong Kong.
Listing Funds in Hong Kong
There are two possible routes for listing funds in Hong Kong on the Hong Kong Stock Exchange: Chapter 20 (authorised collective investment schemes) and Chapter 21 (investment companies).
Chapter 20 Listings
Chapter 20 only allows listing funds in Hong Kong which have been authorised by the SFC for public offering. Funds listed under Chapter 20 are subject to the restrictions on investment and borrowing set out in the SFC’s Code on Unit Trusts and Mutual Funds. However, authorisation by the SFC does not guarantee that listing will be granted by the HKEX and the HKEX has a discretion to accept or reject applications for listing of the interests in an authorised CIS.
Chapter 21 Listings
Funds listed under Chapter 21 of the HKEX Listing Rules, on the other hand, do not need to be authorised by the SFC and are not required to comply with the restrictions and requirements of the Code on Unit Trusts and Mutual Funds. However, because Chapter 21 listed funds are not authorised by the SFC, they cannot be marketed or offered to the public in Hong Kong. These funds can therefore only be offered offshore or to Hong Kong investors who qualify as “professional investors” under the Securities and Futures Ordinance.
The requirements for Chapter 21 listings were tightened in September 2014 with the HKEX’s update of its Guidance Letter HKEx-GL17-10 on Chapter 21 listings. The updated Guidance Letter imposed several restrictions to ensure that Ch.21 funds are marketed only to professional investors, as summarised in the table below.
Restrictions imposed by the Guidance Letter
Minimum Board Lot and Subscription Size
Funds must have a board lot size and minimum subscription size of at least HK$500,000 (subject to adjustment for special circumstances)
Intermediaries involved in selling interests in the fund must satisfy themselves that buyers are “professional investors” within the definition under the SFO (Cap 571)
A principles-based approach is allowed for intermediaries to determine whether clients meet the qualification thresholds under the Professional Investor Rules
The offering structure must be generally acceptable to the Exchange
Minimum Number of Shareholders
A Ch.21 fund must have at least 300 shareholders, unless a waiver is obtained. No waiver has been granted since 2004 (when required minimum no. of shareholders was increased to 300).
Minimum Market Cap.
Although Ch.21 funds are not subject to the market cap. requirement under Rule 8.09, in practice, a Ch. 21 fund must have a minimum market cap. of HK$150 mln because of the requirements for a subscription size of HK$500,000 per placee and a minimum of 300 shareholders.
Prospectus Registration
Although Ch.21 funds are not subject to the market cap. requirement under Rule 8.09, in practice, a Ch. 21 fund must have a minimum market cap. of HK$150 mln because of the requirements for a subscription size of HK$500,000 per placee and a minimum of 300 shareholders.
Criticisms of the Ch.21 Regime
The Chapter 21 regime has hardly changed since it was first introduced in 1989.
In terms of specific criticisms of Chapter 21, it is the requirement for a minimum of 300 professional investors which makes a Ch. 21 listing virtually impossible to achieve and explains the complete lack of interest in listing funds in Hong Kong. As at the end of 2020, there were 24 Chapter 21 listings on the HKEX.
HKEX Listing Rule 21.04 exempts Ch.21-listed funds from compliance with the minimum public float requirement of HKEX Listing Rule 8.08(a). In light of that it seems nonsensical that they are not also exempted from the requirement for a minimum of 300 shareholders, particularly given the restriction on marketing only to professional investors within the definition in the SFO.
The Guidance Letter clearly contemplates the possibility of a waiver of the requirement. To date we are only aware of one Chapter 21 listing applicant that has been granted a waiver of the 300 shareholder requirement. Gateway Energy and Resource Holdings, Ltd. obtained a waiver in 2012 which would have allowed it to have just 140 shareholders on listing.
