Hong Kong: Comparative Analysis For Asia-Pacific Hedge Fund Managers: Legal And Tax Structuring In Hong Kong And Singapore

Hong Kong and Singapore remain keenly competitive jurisdictions that seek to attract hedge fund managers, far outpacing other APAC jurisdictions. However, the requirements for, and benefits of, setting up hedge funds and investment management structures differ between the two. InsightLegal Asia Consulting ( www.insightlegalasia.com) specializes in 'clarifying complexity' and herein we examine the key legal and tax structuring issues that investment managers should consider when setting up a hedge fund or fund management company in Hong Kong and Singapore; specifically, our objective is to provide a comparative analysis of the two regimes by identifying certain material legal and tax issues that should be addressed upfront when considering an Asia-pacific presence.

INTRODUCTION

Hong Kong and Singapore compete openly in most segments of the financial markets and hedge funds are no exception. In this discussion, we seek to answer the following question:

In so doing, we (i) first examine the legal and regulatory issues associated with setting up a hedge fund and fund management company in Hong Kong. Then (ii) we apply the same analysis to the Singaporean context. Finally, we (iii) consider the most material legal and tax issues likely to arise when structuring a hedge fund and techniques for addressing them proactively--and prophylactically—rather than retroactively in litigation or investigation.

PART ONE: STRUCTURING A HEDGE FUND IN HONG KONG

(A) Hong Kong Overview

Let us begin by highlighting certain obvious advantages offered by Hong Kong as a location for hedge fund managers:

• Hong Kong is China's premier offshore financial center and, in addition to serving as the pre-eminent PRC gateway, is a regional hub for prime brokerage, custodial and administrative services;
• Hong Kong's favourable low tax system grants tax exemptions to offshore funds (except for profits tax on HK "sourced" income) in terms of dividends, capital gains and interest income; furthermore, there is no stamp duty on non-HK share transfers;
• Fund managers are well regulated, which is beneficial since it lends international credibility to compliant hedge fund managers;
• Hong Kong's legal system and recognizable common law heritage is a strength, providing stability coupled with a highly market-oriented government¹; and
• Hong Kong does not restrict hedge fund managers in terms of strategies, especially in the exempt and institutional segments of the market.

(B) Hong Kong's Regulatory Framework

(i) "Hedge Funds" in Hong Kong?

Essentially, Hong Kong's Securities and Futures Ordinance ("SFO")² treats all funds as Collective Investment Schemes ("CIS"), which encompasses:

• Mutual Funds;
• Hedge Funds;
• Structured Investments (a.k.a. structured products);
• Unlisted Structured Investments; and
• MPF and ORSO schemes (mandatory mutual fund schemes for employees).

The main effect resulting from Hong Kong's regulatory approach of placing of all of the above funds under a single CIS regime is that offshore funds are overwhelmingly used (e.g., Cayman, BVI and Bermuda) due to the limited choice of HK domiciled fund structures (i.e., less aggressive permissible strategies) and slower authorization processes.

Importantly, from a tax standpoint a fund will be considered non-resident for Hong Kong tax purposes (and thus exempt from Hong Kong profits tax) if the "central management and control" of such fund is exercised outside Hong Kong, even though transactions are executed through intermediaries regulated by the Securities and Futures Commission ("SFC") in specified asset classes; namely securities, futures and FX.

For an analysis of Hong Kong tax considerations at the fund manager structuring level, please refer to the discussion in Part Three.

(ii) Licensing

The sub-manager is based in Hong Kong will be required under the SFO to obtain Type 9 license (asset management). Alternatively, a Type 4 license (advising on securities) or Type 5 license (advising on futures contracts) may be required in certain cases, which is potentially attractive in that they present lower regulatory hurdles. The key components to obtain an SFC license are as follows:

• Business plan/compliance manual: These documents set out the nature and scope of the business, operational work-flow, organizational structure and internal controls. They demonstrate to the SFC that the firm (i) understands its business, (ii) has the experience and systems to manage the business and its risks, and that it (iii) will be able to comply with SFC regulatory requirements.
• Internal Controls: The firm's risk management, compliance, valuation and conflict of interest policies and procedures are examined by the SFC, but firms whose parents are licensed or registered by the U.S. Securities and Exchange Commission or the U.K. Financial Services Authority are typically fast-tracked.
• Capital Requirements: A firm licensed for asset management is required to have paid-up capital ("PUC") of HK$5,000,000 and to maintain liquid capital of at least HK$3,000,000. If the firm does not hold client assets, there are no PUC requirements and liquid capital requirements can be reduced to as low as HK$100,000.
• Responsible Officers: Every licensed firm must have 2 individuals approved by the SFC as responsible officers ("ROs"). At least 1 RO must fully satisfy the SFC that they have adequate local regulatory knowledge, industry knowledge, relevant experience and management experience. Typically, the fund manager himself will be a RO.
• Licensing Exam: The RO must pass a regulatory examination--unless exempt--which usually applies to individuals who are, or have previously been, licensed as a RO are normally exempt from the regulatory examination. The following individuals are eligible for exemption at the SFC's discretion if:
  
  
  • The individual is licensed or registered for investment management or advisory business in the US or UK, or has more than 8 years of relevant experience in other recognized markets;
  • The firm for which the individual will act as RO will only serve professional investors;
  • The firm is able to confirm that regulatory and compliance support will be provided to the individual; and
  • The individual takes a post-licensing refresher course on local regulations.
• Relevant Experience: To satisfy the requirement for relevant experience, the SFC generally requires a RO to have at least 3 years of experience in the management of public funds (i.e. CIS sold to the public), proprietary trading, alternative investments or investment research.

(iii) Marketing

Offers and invitations to the public to acquire shares or other interests in hedge funds are subject to regulatory authorization requirements--unless exempt. Although the SFC has a regulatory framework for the authorization of hedge funds, it is rarely used. Fund managers prefer to rely on exemptions to save time and to have greater flexibility in terms of capital-raising, investor reporting and investment strategies. The most commonly used exemptions are as follows:

• Professional Investors³: SFC authorization may not be required if the hedge fund is sold only to professional investors ("PIs"). PIs includes institutional investors and non-institutional investors. The former includes bankers, dealers, insurance companies and certain regulated CIS. The latter includes:
  
  
  • High net worth individuals ("HNWIs"), meaning individuals with a portfolio of not less than HK$8 million;
  • Corporations whose sole business is to hold investments and which are wholly-owned by HNWIs (as defined above);
  • Corporations or partnerships with a portfolio of not less than HK$8 million or total assets of not less than HK$40 million;
  • Trust corporations registered under the Trustee Ordinance or regulated under the laws of a place outside Hong Kong having total assets under trust of not less than HK$40 million.
• Sophisticated Investors: Marketing materials for a hedge fund structured as a company may be exempt from the authorization requirements if the shares are offered only to persons whose ordinary business is to buy or sell shares or debentures, whether as principal or agent.
• Minimun Subscription: Marketing materials of a hedge fund structured as a company may be exempt from the authorization requirement if (i) the materials contain a prescribed warning statement, and (ii) the minimum denomination or the minimum consideration payable by any person for the shares to be subscribed is not less than HK$500,000.

PART TWO: STRUCTURING A HEDGE FUND IN SINGAPORE

(A) Singapore Hedge Fund Overview

Singapore has established itself as a key hedge fund center and competes closely with Hong Kong for market share. The growth of hedge funds in Singapore can be specifically attributed to several factors, including:

• Excellent tax and regulatory incentives for fund managers (in sharp contrast to the EU's taxation juggernauts and the ill-conceived Directive on Alternative Investment Fund Managers ("AIFMD"));
• The Monetary Authority of Singapore ("MAS") proactively promotes Singapore as a hedge fund hub, without over-burdening start-ups with excessive licensing and other regulatory hurdles⁴;
• Singaporean regulations are efficient and clear, thereby providing faster licensing and access to the market; and
• Singapore's stable economy, skilled workforce, reasonable industry regulations and a pro-business environment complement the hedge fund industry.

(B) Singapore's Regulatory Framework

(i) "Hedge Funds" in Singapore?

According to the MAS's Code on Collective Investment Schemes ("CCIS")⁵, "there are different characteristics and investment strategies that define hedge funds. Generally speaking, a hedge fund seeks to deliver an "absolute" return independent of the directional move of equity, fixed income or cash markets". In considering whether a fund constitutes a hedge fund, the MAS will consider whether the fund:

• Engages in strategies that use leverage, short selling, arbitrage or derivatives; and
• Involves investment in non-mainstream asset classes (i.e., investments other than listed equities, bonds and cash).

(ii) Hedge Fund Structures – Onshore and Offshore

1. Onshore Funds: A fund constituted in Singapore is subject to the hedge fund licensing and regulatory regime of Singapore. Onshore funds can be marketed to both domestic investors as well as foreign investors, although in practice they are primarily marketed to domestic retail investors. The permitted fund structures for onshore funds are as follows:
   
   
   • Close-ended funds (i.e., corporations);
   • Open-ended unit trust funds; and
   • Limited Liability Partnerships ("LLPs").
2. Offshore Funds: Funds constituted in offshore jurisdictions are subject to offshore legislation. Offshore funds can be offered to domestic investors in Singapore, subject to certain conditions. Sophisticated investors typically prefer offshore funds as they offer a degree of privacy.

(iii) Licensing

(iv) Marketing

(v) Hedge Fund Taxation

Singapore uses a territorial basis for taxation. In other words, companies and individuals are taxed on Singapore sourced income. Foreign sourced income (branch profits, dividends, service income, &c.) will be taxed when it is remitted--or deemed remitted--into Singapore, unless the income was already subjected to taxes in a jurisdiction with headline tax rates of at least 15%. Although the concept of locality of the source of income seems simple, its application can often be complex and contentious. No universal rule applies to every scenario.

For a fuller analysis of tax considerations when structuring a Singaporean hedge fund, see the discussion in Part Three (iv)(b).

(vii) Other Incentives

Enhanced Tier Fund Management Scheme: With effect 1 April 2009 to 31 March 2014, an enhanced tier was introduced to the existing fund management incentives for funds with a minimum size of S$50 million, at the point of application, amongst other conditions. Under the enhanced tier system restrictions are imposed on neither the residency status of the fund vehicles, nor that of investors. The enhanced tier also applies to funds that are constituted in the form of Limited Partnerships. Additionally, the 30% or 50% investment limit imposed on resident non-individual investors has been lifted for funds that fall under this enhanced tier.

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Footnotes

1 Despite frequent and highly politicized threats to the independence of the judiciary from Mainland China in relation to certain political issues—via direct and indirect channels—judicial independence for the business community remains in tact.

2 Cap 571.

3 An important change to the PI category is that now a PI must explicitly opt to be treated as such and have the implications of such explained in detail.

4 The MAS opened the door for hedge fund managers to base in Singapore at the same time that Dodd Frank, the Tobin tax and other hurdles in the US and EU were being erected. For example, in 2010, the MAS allowed smaller hedge funds with AUM of SGD250 million to operate without a fund managers licenses.

5 See: http://www.mas.gov.sg/regulations-and-financial-stability/regulations-gu...

6 Note that accredited investors must have a minimum total net asset size or annual income exceeding a certain amount prescribed by Sec 4(A) of the SFA or at a minimum of SGD 200,000 per transaction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.