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.
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:
What are the key benefits and disadvantages of selecting Hong Kong as opposed to Singapore from a hedge fund managers' perspective?
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.
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.
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
- 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").
- 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.
(a) Onshore Fund Managers and Distributors
Small fund managers with less than 30 qualified investors are exempt from licensing requirements. To conduct one or more of the regulated financial services activities, all other fund managers and distributors (unless otherwise exempt) need to hold a single license, which is either (i) a Capital Markets Services license or (ii) a Financial Advisers license.
The Securities and Futures Act ("SFA") regulates the following activities and issues a Capital Markets Services Licence ("CMSL") to persons engaged in:
- Dealing in securities;
- Trading in futures contracts;
- Leveraged foreign exchange trading;
- Advising on corporate finance;
- Fund management;
- Real estate investment trust ("REIT") management;
- Securities financing; and
- Providing custodial services for securities.
The Financial Advisers Act ("FAA") regulates the following activities and issues a Financial Advisers Licence ("FAL") to persons engaged in:
- Providing advice on investment products, including securities (which includes unit trusts), futures contracts, foreign exchange and leveraged foreign exchange contracts, and life insurance policies (which includes investment-linked life insurance products) and structured products;
- Issuing reports on investment products;
- Marketing collective investment schemes (i.e., unit trusts); and
- Arranging life insurance products.
Except for fund managers with less than 30 qualified investors (or those who are exempted under other conditions), any corporation or person who wishes to carry on business in any of the above regulated activities needs to obtain the requisite CMSL/FAL license or CMSL/FAL Representative license. A hedge fund manager operating under the exemption can market funds managed by itself, but cannot market third-party funds without a license. Importantly, there are no capital requirements for fund managers operating under an exemption. However, exempt managers are required to comply with similar market conduct and practices as licensed bodies.
(b) Offshore Fund Managers
Offshore fund managers marketing offshore funds to Singapore investors must be licensed or regulated in the offshore jurisdiction and must be 'fit and proper' (as per the MAS Guidelines on Fit and Proper Criteria).
(a) Onshore Funds to Retail Investors
- Disclosure requirements: All hedge fund marketing
material including the cover page of the hedge fund prospectus
should disclose the inherent risks of investing in a hedge fund and
important information, such as:
- Some investments may not be actively traded and may involve uncertainties;
- Only limited information on how the schemes will be managed will be available;
- That there is limited liquidity; and
- Most of the underlying hedge funds are subject to minimal regulation.
- Minimum initial subscription requirement: Different
categories of funds have the following minimum subscription
- For Single Hedge Funds, S$100,000 per investor;
- For Fund of Hedge Funds ("FoHF"), S$20,000 per investor; and
- For capital protected/guaranteed hedge funds, no minimum subscription amount.
- Qualifications of Fund Managers: Hedge fund managers should have at least 2 executives. Each executive must have at least 5 years of hedge fund management experience. An additional requirement of 3 years FoFH management experience is required for managers of FoFHs.
- Investing in other schemes: A Singapore single hedge fund may invest in another single hedge fund which is not a feeder fund. Similarly, a Singapore FoHF may invest in another FoHF, which should only invest directly in other hedge funds and not through another FoHF or feeder fund.
- Limited liability: The liability of investors must be limited to their investment in the scheme.
- Diversification of FoHFs: A FoHF should be diversified across at least 15 hedge fund managers.
(b) Offshore Funds to Retail Investors
An offshore fund can be marketed to retail investors in Singapore subject to the following conditions:
- The fund must be recognized by the MAS. The fund manager must be licensed or regulated in the offshore jurisdiction (where its principal place of business is based) and must be 'fit and proper';
- The offshore fund's prospectus or profile statement must be approved by the MAS;
- The offshore jurisdiction in which the scheme is constituted must offer adequate protection to investors in Singapore, comparable to that provided by the Singapore Securities and Futures Act ("SFA") for onshore funds;
- The investment guidelines of the offshore jurisdiction that govern offshore funds must be substantially similar to that of Singapore's;
- There must be a Singapore based representative for the fund to act as a liaison between investors and the foreign manager (such representative must be an individual, a company incorporated in Singapore, or a foreign company registered in Singapore under the Companies Act);
- A prospectus in compliance with the SFA must be lodged and registered with the MAS; and
- The fund manager (together with its related companies) must manage at least S$500m of discretionary funds in Singapore.
- The minimum initial subscription requirement for different
categories of funds is as follows:
- For Single Hedge Funds, S$100,000 per investor;
- FoHFs, S$20,000 per investor; and
- For capital protected/guaranteed hedge funds, no minimum subscription amount.
(c) Marketing Exemptions
- Marketing Onshore and Offshore Funds to Accredited Investors and Other Relevant Persons: Onshore and offshore hedge funds that are marketed to "accredited investors" (as defined in Sec 4(A) of the SFA) do not require the submission of a prospectus or any other offering document to the MAS6.
- Marketing Onshore and Offshore Funds to Institutional Investors: Onshore and offshore hedge funds that are offered to "institutional investors" (as defined in Sec 4(A) of the SFA) are exempt from prospectus requirements and there is no requirement for submitting any other offering document to the MAS. Furthermore, there are no minimum subscription requirements.
(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.
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.
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.