Licensing guidance for private equity firms

On 7 January 2020, the Securities and Futures Commission (SFC) issued a circular to clarify licensing requirements for private equity (PE) firms (the Circular).

In anticipation of the Hong Kong government’s introduction of a limited partnership regime for funds, the SFC has worked with the industry to facilitate eligible PE firms to operate in the Hong Kong market. The Circular addressed common licensing issues arising from PE operations, and is part of the SFC’s initiative to promote Hong Kong as an onshore fund management hub.

Licensing guidance

The SFC has not created a new licensing regime for PE firms. Depending on their business activities in Hong Kong, persons involved in the operations and management of PE funds may need to be licensed for one or more of the existing types of regulated activities under the Securities and Futures Ordinance (SFO).

Managing investments in private companies

Managing securities and/or futures contracts portfolios is type 9 (asset management) regulated activity, so, providing such services in Hong Kong requires a type 9 licence.

Broadly speaking, shares and debentures of Hong Kong private companies are not “securities” for SFO purposes. However, in considering whether a type 9 licence is required, the SFC will look at the composition of the entire investment portfolio. If a PE fund is established as a special purpose vehicle (SPV), which itself is a non-Hong Kong private company or its underlying investments are “securities”, the manager of the SPV will be managing a securities portfolio and thus will need a type 9 licence for providing asset management services in Hong Kong.

Marketing funds and co-investments

The scope of type 1 (dealing in securities) regulated activity covers the act of inducing others to enter into securities transactions. An individual or firm marketing funds and soliciting securities investment opportunities in Hong Kong will require a type 1 licence.

A PE fund manager licensed for type 9 regulated activity will be exempted from licensing for type 1 regulated activity if it only:

• markets the fund it manages; and/or
• offers co-investment opportunities for the underlying investments of a fund it manages, during the course of capital raising for the fund.

Investment discretion for type 9

The SFC distinguishes type 9 from other dealing or advisory types of regulated activities with investment discretion. A fund manager applying for a type 9 needs to demonstrate its discretionary investment authority for a fund in the following areas:

• investment decision-making process for the fund
• proposed licensed individuals’ roles and involvement in the fund’s decision-making process (e.g. whether a senior licensed person will be appointed and given sufficient authority to make investment decisions throughout the fund’s life cycle)
• documentation evidencing delegation of investment authority

General Partner (GP)

A GP which assumes ultimate responsibility for the management and control of a limited partnership fund and is remunerated for performing its duties in Hong Kong needs a type 9 licence.

However, the GP will not require a type 9 licence if it fully delegates its management and control responsibilities to a type 9 licensed corporation. Without an SFC licence, the GP must not represent to any fund investors and prospects that it provides asset management services.

Investment Committee (IC)

An IC member who is based in Hong Kong and plays a dominant role in making investment decisions for a PE fund (whether individually or jointly with other offshore IC members) needs a type 9 licence. Other members who do not have voting rights or veto power for the fund’s investment decisions do not need Type 9 licences.

Industry experience of Responsible Officer (RO)

Applicants applying to be ROs of a PE firm can rely on experience in non-regulated activities. The SFC will recognise the applicants experience in a broad range of activities, including:

• research, valuation and due diligence of companies in the industries related to the PE firm’s businesses
• management consulting and business strategy advice to companies related to the PE firm’s businesses
• managing and monitoring the underlying investments of any PE funds for investors
• corporate structuring (e.g. management buyouts and privatisations)

What PE firms need to do?

PE firms (whether licensed with the SFC or not) need to carefully review their business activities and fund arrangements in order to ensure that:

• their existing SFC licences are sufficient for all their services in Hong Kong; and
• they can rely on applicable licensing exemptions to continue with the operations of their non-regulated business activities.

It is time for PE firms to review services agreements and day-to-day interactions with funds and investors. In particular, the fund’s governance framework and documents need to clearly reflect how the investment decisions are made and who is delegated with authority to make them. For those licensed for type 9 regulated activity, it is important to put these documents in your records.