As published on ft.com, Monday 20 March, 2023.
In 2020, the global pandemic halted travel and shut borders. But at the same time, two of Asia’s biggest financial centres saw an opportunity to shift the global centre of gravity for hedge funds and the world’s wealthiest families.
Singapore established a fund structure that allows a wide range of potential users to shelter large pools of capital in discreet, lightly taxed wrappers domiciled in a well-regulated financial centre. Hong Kong made enhancements to a similar structure it had established two years earlier.
The vehicles are a direct challenge to existing offshore centres such as the British Virgin Islands, Mauritius and the Cayman Islands and their advocates predict they could herald big changes in the way money is managed.
“We see this as the start of a massive shake-up of asset management, of family offices and the whole flow of capital,” says a Singapore-based partner of one UK law firm involved in setting up the new structures in both cities. “This sets the path for [HK and Singapore] to be the heart of a new hybrid between family offices and hedge funds”.
Investor take-up, particularly in Singapore, has been rapid. The bankers, fund managers and lawyers involved in setting them up say their impact could be far more widespread and more disruptive than previously imagined, drawing assets and expertise into the region. To them, the innovations represent exactly the kind of regulatory boldness Asia needs.
“Singapore has always been the poorer cousin compared with the Cayman Islands, British Virgin Islands and even places like Mauritius,” says Ryan Lin, a lawyer at Bayfront Law, who describes the new structure as “a game-changer”.
“[The VCC] came just as Singapore became increasingly popular as a wealth and fund management hub . . . it was extremely well timed”.
The new vehicles represent a direct challenge to traditional offshore finance centres whose success has been built on privacy and low taxes and whose economies are heavily dependent on the revenue generated by financial services.
Others fear they will create a fertile space for money laundering and tax avoidance. Maíra Martini, a research and policy expert at campaign group Transparency International, says the risk with vehicles such as OFCs and VCCs is that “usually function like a black box” and “can be very attractive to the corrupt and other criminals”.
Hong Kong spotted its opportunity in the wake of the Panama Papers and Paradise Papers leaks, which in 2016 and 2017 sparked hundreds of news stories worldwide about the use, and abuse, of offshore funds in the Caribbean.
The stories made some institutions, especially public pension funds, more cautious about the reputational risks of investing in private equity and hedge funds domiciled in places like the British Virgin or Cayman Islands. Investors were looking for alternatives because the public had started to “think that people only put money into the Caymans to hide something”, says a Hong Kong-based financial adviser.
In 2018, the city’s regulators introduced its alternative, the “open-ended fund company” or OFC, which aimed to “enrich the choice of investment vehicles and facilitate the distribution of Hong Kong funds internationally”.
OFCs are corporate fund vehicles that are domiciled in Hong Kong and whose units can be offered to the public or held privately. The investments within them must be managed by an entity licensed as an asset manager in Hong Kong.
According to the adviser, who was worked on OFCs, the territory “was trying to capitalise on this trend” as well as attract lucrative business and help solidify its position as a global financial hub.
Singaporean authorities, frustrated at the tendency of local fund managers to register investment vehicles offshore rather than in Singapore itself, launched the rival Variable Capital Company or VCC in 2020. It made it easier for overseas and domestic entities to register an investment vehicle in Singapore provided they had a local entity to manage it.
Despite the “variable” moniker, VCCs can also have fixed capital — allowing them to cater to a diverse range of potential users including mutual fund groups, hedge funds, private equity, real estate firms and managers of family wealth.
The single locally incorporated structure can hold a pool of assets and multiple sub-funds, cutting down on costs. It is also covered by more than 70 double taxation agreements, making it less likely that the assets within it will be taxed twice over.
According to one lawyer who has established the vehicles, a “big differentiator” of VCCs compared to traditional structures is that they allow for easy dividend payouts to shareholders. “In a conventional entity, if you start paying dividends out of capital not out of profits, the regulators will be all over you”.
In both Hong Kong and Singapore, privacy is another, perhaps even bigger draw, since the names of shareholders are not made public. “That’s very important because if I was a shareholder and had money in multiple VCCs, I wouldn’t want people to know where I’d invested”, the lawyer adds.
Matthias Feldmann, a senior investment management partner at Clifford Chance based in Hong Kong and Singapore, points out that running costs are relatively modest. “A VCC is less expensive to operate once set up than an offshore fund vehicle . . . that is one of the key revenue streams of the government.”
For both financial centres, longstanding rivals within Asia, there were clear motivations for establishing the vehicles.
Hong Kong had an obvious target market: mainland Chinese investors and institutions, some of whom are drawn to the territory for its “familiarity and proximity”, says Sally Wong, the chief executive of the Hong Kong Investment Funds Association.
OFCs can also use so-called “connect” schemes that allow mainland and Hong Kong investors to buy into exchange traded funds and wealth management products in each other’s markets.
Singapore’s ambition was more subtly aggressive: to comprehensively shed its reputation for sleepiness and position itself, through regulatory innovation and reputational risk-taking, as the region’s new alpha predator.
The speedier take-up of VCCs in the city is a sign, say lawyers, of how successfully Singapore has managed to position itself as the “not China” option for both Chinese money — whether held inside or outside the People’s Republic — and other cash. Its safe-haven credentials have strengthened as relations between the US and China have deteriorated.
Both Hong Kong and Singapore introduced generous incentives to encourage registration of the new vehicles, cementing in the minds of investors the idea that it is now government policy to encourage their proliferation.
“The government is committed to developing Hong Kong not only as a fund distribution hub, but a fund domicile hub. This vehicle [OFC] is part of that package. It’s a strategic objective,” says Wong.
Hong Kong’s response to the launch — and rapid early take-up — of VCCs was to tweak the structure of the OFC to align it more closely with its south-east Asian rival. In 2021, the Securities and Futures Commission announced that the government would pay 70 per cent of all fees to lawyers, accountants and other professional advisers engaged to establish OFC structures up to a value of HK$1mn (about $127,000).
That is more generous than Singapore’s subsidy of S$30,000 or $23,000 — but the Lion City also offers employment passes to senior managers and owners of the funds.
In Hong Kong, the managers of more than a dozen funds said that they either had recently completed or were in the middle of establishing an OFC.
“It’s not that we have a fixed idea yet of what might be coming under this umbrella, we just want to be ready to say “yes” if, say, a Chinese tycoon calls us and says they want to put some capital into this kind of structure,” said one fund manager who set up an OFC in January.
But Hong Kong still lags behind its great rival: 40 OFCs were set up in 2021 and 64 in 2022, a leap from just eight registered in the first two years but still far below Singapore’s numbers.
Part of the reason for this is the long shadow cast by an increasingly autocratic China. Professionals advising on the structure in Hong Kong say privately that one thing limiting the scheme’s take-up is that many Chinese investors prefer to put their money in Singapore, which they regard as being further from Beijing’s reach.
“That’s the problem we [Hong Kong] face: it’s not seen as being truly offshore”, one said.
For Singapore the rush to establish the new structures has been especially pronounced. “Prior to 2020 the vast majority of Singaporean managers had their funds in offshore jurisdictions such as the Cayman Islands, Mauritius or Luxembourg. Now the tables have turned,” says Mahip Gupta, a partner at Singapore-based Dhruva Advisors.
“Since the Variable Capital Company structure was introduced, most have chosen Singapore as their fund domiciliation hub. Even new fund manager applications have significantly accelerated here.” Dhruva has set up 65 VCCs, and about a third shifted from other jurisdictions according to Gupta. “A mass onshoring of funds is taking hold,” he adds.
There were 872 VCCs registered in the city-state as of February, according to government data. That helped drive a record S$448bn ($339bn) in total asset management inflows during 2021, 15.7 per cent higher than the previous year, according to the most recent data from the Monetary Authority of Singapore, the island nation’s central bank and financial regulator.
The number of licensed and registered fund management companies in Singapore increased by 15 per cent year on year — or 146 more — to 1,108 in 2021, which is the most recent data available.
“The pace of growth surprised even the MAS,” says one hedge fund manager. “They had to add more people to meet the demand.”
Experts disagree on exactly who is using the vehicles. “For large international managers or for institutional managers targeting international investors, the VCC is not yet that common,” says Feldmann.
A hedge fund executive whose firm has used the structures says the incentives offered by both centres do little to attract large blue-chip investors. “The big guys don’t care about these small subsidies . . . It’s pocket change to them”.
But Anne Yeo, head of funds and investment management for Rajah & Tann, says VCCs have come a long way since their inception in 2020. “In the past 12 months we have observed a gradual shift in terms of the VCC being invested into by worldwide global investors”.
“My sense of it is that VCCs serve a complementary role to Cayman or other fund structures. We live in a complex world, there is no single fund structure that is just domiciled in one jurisdiction.”
Singapore’s VCCs have also been helped by the rapid expansion of another piece of its asset management industry: family offices. Large amounts of family wealth have been shifted to the city-state during the pandemic, especially from mainland China, outpacing arguably even VCCs in terms of growth.
Because they do not manage third-party funds, single family offices are not regulated by the MAS in Singapore and lawyers say they have been moving into the VCC space. The effect is the creation of an ecosystem pulling in capital from other parts of the world.
“The area where VCCs and family [wealth] overlap . . . is where single family offices decide there is an intention to take on external money and they start using a VCC structure,” says Vikna Rajah, a partner specialising in tax and trust for private clients at Rajah & Tann. The move requires them to become regulated fund managers but it is adding to the boom in numbers, he adds.
The lure of the new structures, and of the capital expected to flow into them, is also beginning to trigger a movement of financial expertise. Singapore requires VCCs to have a fund manager, responsible for due diligence and anti-money laundering controls, based in the city-state. “That’s very smart,” the hedge fund executive says. “It’s going to create a lot of jobs for lawyers, accountants and auditors.”
Investment banks and long-only pension funds in Singapore and Hong Kong report a steady recent outflow of both junior and experienced people to family offices or firms involved with the newly established structures in preparation for a flood of new capital.
At one level, say lawyers, the similarity of the two structures, and the long rivalry between Hong Kong and Singapore for the title of prime Asian financial hub, make the VCC and OFC structures look like weapons in a battle between the two. In reality, they argue, this is about a much bigger proposition to global funds: establishing the two centres as a new and improved offshore.
But by positioning themselves as rivals to centres like the Cayman Islands, both Hong Kong and Singapore are entering tricky territory. They are trying to lure away the best bits of the Caribbean islands’ lucrative business without also risking the public backlash they have faced for facilitating tax avoidance.
They must also avoid attracting capital from sanctioned groups, money launderers and others who might be drawn to the lack of public disclosure about the funds’ shareholders.
“Legitimate funds could be mixed with dirty money and used to invest across different sectors,” says Martini at Transparency International. That can make “it difficult for authorities to trace potentially stolen funds . . . to mitigate the risks of these structures being used for money laundering, transparency and regulation of fund managers are key”.
Both territories say they have put in place such measures. King Au, executive director of Hong Kong’s Financial Services Development Council, an advisory body set up by the Hong Kong government, acknowledges that OFCs could have investors from the US and Europe, potentially including Russia.
“Therefore the fund managers or the banks who distribute the products have to, [through] the regulatory obligations, screen out these unwanted clients or money,” he says.
That task falls to executives at the groups managing the funds, both in Hong Kong and Singapore. One such individual says “reams” of paperwork and due diligence checks have been required; another points out he could be spot-checked by regulators at any time and held personally liable for any wrongdoing.
Some firms may be better than others at screening their investors, says the hedge fund executive — or be more “willing to take a risk”. But he agrees that bringing the checks onshore is “the right thing”.
“To me the point is, they’re trying to make it a real jurisdiction from the start”.