It is not uncommon for a single family office to make investments through a fund. Such a fund might take the form of an internal fund with the family office acting as manager and the family branches as “investors”. On some occasions, the family office might set up a fund with other family offices with terms tailored for their particular needs and usually these funds would invest in a small number of targeted projects. Alternatively, the family office might invest in a fund run by other managers who control how investments are made.
In Asia, many investment funds were established offshore, mostly in the Cayman Islands, due to the investors’ familiarity with the jurisdictions, the industry norm to use a limited partnership or corporate structure offered there, and the availability of legal talents qualified to practise law there.
For a long time, investment funds governed by Hong Kong law were structured as unit trusts. But the tide has started to turn as the Limited Partnership Fund Ordinance (Chapter 637 of the Laws of Hong Kong) (LPFO) came into effect in 2020 and the open-ended fund company (OFC) regime, originally introduced in July 2018 under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (SFO) Part IVA and the Securities and Futures (Open-ended Fund Companies) Rules (Cap. 571AQ of the Laws of Hong Kong), has subsequently relaxed the scope of permitted investments. Since then, there has been a gradual yet consistent growth in the number of Hong Kong domiciled funds in the form of a limited partnership fund (LPF) or an OFC. The government has recently clarified the requirements and procedures for re-domiciling offshore funds to Hong Kong.
It is anticipated that Hong Kong as a fund jurisdiction will become more attractive, thanks to potential significant savings and streamlined regulatory administration because the fund and its manager need to deal with only regulators and pay for one set of fees and costs in one single jurisdiction.
Limited Partnership Fund
In the United States, hedge funds and private equity funds are structured as limited partnerships. In Asia, alternative asset funds with no redemption rights are typically set up as limited partnership funds.
Broadly speaking, operational features of a LPF are similar to those of Cayman exempted limited partnerships (ELP). Echoing Cayman’s safe harbour provisions to confirm that a limited partner does not take part in the conduct of the business of the fund by consulting with and advising a general partner, or serving or appointing a person to serve on any board or committee, Schedule 2 to the LPFO sets out a non-exhaustive list of activities that are not regarded as management activities, including serving on a board or committee of the fund, approving or disapproving fund transactions, and acting or authorising a person to act on behalf of the LPF or the general partner.
With a much longer history, Cayman has refined and updated the ELP Law to clarify finer issues that arise when operating a fund. For instance, it is stated in the ELP Laws that, subject to the provisions of the partnership agreement, a member of any board or committee of a Cayman fund does not owe any fiduciary duty in exercising any of the rights or authorities, or otherwise in performing any of the obligations. LPFO has included a provision to clarify the fiduciary duty of limited partners but is silent as to board or committee members.
In a family office environment, if a representative of a family branch is not formally involved in the management of the fund set up in Hong Kong but would like to take up membership in a board or committee of the fund, it is less certain whether he is acting in a fiduciary capacity. A similar situation is the role of a protector in a family trust. Hong Kong law is completely silent regarding the office, duties and obligation, and fiduciary duty of a trust protector. Having said that, one is free to include relevant provisions in the limited partnership agreement or the trust deed but whether these provisions would be challenged is an unknown.
There are also minor differences that could impact on family offices. For instance, unlike an ELP, an LPF is not permitted to have more than one general partner. So a co-general partner arrangement would not be possible, meaning the sole general partner (if a company) has to deal with the division of labour at the company level.
A registered LPF would be listed on the LPF registrar which is publicly searchable. Since the LPF regime is an opt-in registration scheme and therefore not compulsorily required, a single family office, to retain privacy, can use an LPF as an internal fund vehicle and simply does not file for registration. LPFs that seek external funding would register unless the investors and management prefer otherwise.
There is another reason not to register the LPF if it is used by a single family. To be eligible for registration, there is a requirement that not all the limited partners are corporations in the same group of companies (subject to a two-year grace period from the date of registration). In a structure where the family trusts created for each family branch is using the same private trust company as trustee, and under each trust there is an asset holding company, these companies would be considered to be under the same group even if the beneficiaries of the trusts do not overlap at all.
The manager of a LPF can be an individual or a company, and there is no apparent requirement for the general partner to appoint a licensed entity to act as the manager. However, if the manager carries out activities regulated under the SFO, then the relevant licences are required. Besides family offices that provide services only to companies in the same group, a single family office not run as a business (i.e., not receiving any income, other than reimbursement of operating expenses from the family) or not having the pursuit of profit as its business objective would be exempted from licensing requirements. However, professionally run single family offices would be usually compensated at market rates and might be considered a business.
Open-ended Fund Company
Corporate structure is the standard vehicle for Asian hedge funds. Cayman segregated portfolio companies (SPCs) are also a popular choice for a fund manager seeking to attract investors interested in gaining exposure to different pools of assets which are placed in separate cells where the assets and liabilities of each cell is segregated. OFCs in Hong Kong offer a very similar solution. Singapore launched another similar legal structure, the variable capital companies (VCC) regime, in 2020.
The Hong Kong OFC regime is more stringent compared to the offshore counterparts. An OFC is required to have a minimum of two appropriately qualified and experienced natural person directors, of which one must be independent of the custodian. Cayman, for instance, has no such requirements and corporate directors are generally allowed. It is mandatory for an OFC to appoint an investment manager who is licensed by or registered with the SFC for Type 9 (asset management) regulated activity, and a custodian, who is an intermediary licensed or registered for Type 1 (dealing in securities) regulated activity, a Hong Kong or overseas bank (or a trust company which is a subsidiary of a Hong Kong or overseas bank), or a trustee of a registered scheme under the Mandatory Provident Fund Schemes Ordinance (Cap. 485 of the Laws of Hong Kong).
The SFC administers a grant scheme to provide subsidies for qualified OFCs to set up in Hong Kong covering eligible expenses incurred in relation to the incorporation or re-domiciliation of an OFC and paid to Hong Kong-based service providers such as lawyers, tax advisors, fund administrators and regulatory consultants. The grant amount for each application is equivalent to 70 per cent of the eligible expenses, subject to a cap of HK$1 million per OFC; and a maximum of three OFCs per investment manager. The grant scheme accepts applications until 2024. A similar grant scheme is available in Singapore until 2023, under which the Singapore Monetary Authority (MAS) will co-fund up to 70 per cent of qualifying expenses for the establishment of a VCC, capped at S$150,000 per application.
For single family offices, SPCs are particularly suited to arrangements where different family branches are to be given different assets of the family. A family branch can be an “investor” in some (and not all) cells, while the assets in all the cells can be managed by the same manager.
As authentic single family offices do not trigger licensing obligations in Hong Kong and are therefore not licensed, the use of OFCs seems to be completely out of the question. Even if the single family office attempts to apply for a licence, it is possible for the SFC to either turn down the application or grant a licence which restricts the activities to handling “managed accounts” and not “collective investment schemes”. So, it means a family office opting to use an OFC can only engage an external manager. However, involving a third party manager would be an issue for families who want to keep their investment strategies and family affairs private.
Singapore also offers licensing exemptions to authentic single family offices and therefore faces the same “problem”. Singapore VCCs can be, under the current regime, managed only by "permissible fund managers”, which are firms with a capital markets services licence for fund management, exempt financial institutions or registered fund management companies.
MAS was reported to be looking into possibly widening the scope of permissible fund managers to allow unlicensed single family offices to manage VCCs. We are yet to see if SFC would follow suit.
Patricia Woo is Partner of Squire, Patton Boggs, and co-head of the Firm’s Family Office cross-practice team. She is a fund, trust and tax lawyer noted for her practice in helping global ultra-high-net-worth families set up, restructure and operate family offices. Patricia publishes widely, and is a frequent speaker and press interviewee on the topic of “family office”. She is recognized in Who’s Who Legal: Thought Leaders – Private Client (1st Edition) 2020 and is a recipient of the 2021 Global Law Experts Annual Awards (Private Client Lawyer of the Year in Hong Kong 2021, Trust Lawyer of the Year in Hong Kong 2021 and Tax Lawyer of the Year in Hong Kong 2021), the Corporate INTL Magazine 2021 Global Awards (Private Client Lawyer of the Year in Hong Kong and Trust Lawyer of the Year in Hong Kong) and the High Net Worth Award Winner in Hong Kong of the 2020 International Advisory Experts Award. She is listed in the Euromoney Women in Business Law Expert Guide 2020, CityWealth Leaders List Top 10 China & Hong Kong 2019, The Legal 500 Asia Pacific 2021, Who’s Who Legal: Private Client Global Leader 2020 and CityWealth Leaders List 2020. She is also ranked in Chambers HNW 2021 and recognized in CityWealth 2019 International Powerwomen Top 100 and CityWealth 2017 IFC Powerwomen Top 200. For further information, visit: www.squirepattonboggs.com/en/professionals/w/woo-patricia