SFC clarifies licensing obligations of PE firms and family offices which conduct business in Hong Kong

On 7 January 2020, the Securities and Futures Commission (SFC) issued two circulars to clarify aspects of the licensing obligations applicable to private equity (PE) firms and family offices which conduct business in Hong Kong.

The circulars have been issued in response to enquiries from industry participants and their professional advisers.

An overview of the key aspects covered by the circulars is set out below. New entrant PE firms and family offices should take note of the circulars when determining whether an application for a licence should be made to the SFC. Existing PE firms and family offices should also review the circulars to ensure that they comply with the relevant licensing requirements.

The SFC has set up designated email addresses for enquiries and encourages interested parties to get in touch to discuss their business plans or seek further clarification. The email addresses are enquiry.pefirm@sfc.hk enquiry.familyoffice@sfc.hk for PE firms and family offices respectively.

PE firms

The following are the key aspects discussed in the SFC’s circular to PE firms:

Licensing requirements for general partners of PE funds

• Where a general partner’s fund management activities fall within the definition of “asset management” under the Securities and Futures Ordinance (SFO), it will be required to be licensed for Type 9 regulated activity (RA). Individuals who perform asset management activities for the general partner in Hong Kong will also be required to be licensed as representatives (and where appropriate, be approved as responsible officers (ROs)). However, a general partner will not need to be licensed for Type 9 RA if it has fully delegated all of the asset management functions to another entity which is licensed/registered to carry on such activity.
• It is a criminal offence under the SFO for an unlicensed person to carry on RA or to hold itself out as carrying on RA. Consequently, an unlicensed general partner should not represent to any prospective investor that it manages a PE fund in Hong Kong.

Exercise of discretionary investment authority for Type 9 RA

• Where a Type 9 licence for asset management is being applied for (as opposed to a Type 4 or Type 5 licence for advising on securities or futures contracts respectively), the SFC generally expects the firm to be able to exercise discretionary investment authority to make investment decisions for its clients.
• When considering whether a firm has this authority, the SFC will look at the facts of each case, including the proposed investment decision-making process, the roles of the proposed licensed individuals (including ROs) and their involvement in the process, and whether the delegation of investment authority to the firm is properly documented.

Whether investment committee members need to be licensed

• In general, members of an investment committee of a PE firm who (either individually or jointly) play a dominant role in making investment decisions for the funds are required to be licensed as representatives (and where appropriate, be approved as ROs).
• However, those committee members who do not have any voting right or veto power in relation to investment decisions, and whose primary role is to provide input from a legal, compliance or internal control perspective, will generally not need to be licensed.

Investments in securities of private companies

• The definition of “asset management” under the SFO refers to (among other things) the provision of a service of managing a portfolio of securities or futures contracts. The term “securities” is wide in scope, but does not include shares or debentures of a company that is a “private company” defined under the Companies Ordinance.
• In determining whether an investment portfolio of a PE fund comprises securities or futures contracts for the purposes of Type 9 RA, the SFC will consider the composition of the entire portfolio. Where a PE fund sets up special purpose vehicles for investment holding purposes, if the underlying investments held through those vehicles fall within the definition of “securities” (even if those vehicles are excluded from the definition), or if the vehicles themselves fall within the definition of “securities”, the SFC will regard the management of the portfolio as “asset management” and the PE firm will be required to be licensed for Type 9 RA.

Offering co-investment opportunities and engaging in fund marketing activities

• Offering co-investment opportunities to others and engaging in fund marketing activities generally constitute “dealing in securities” and will require a Type 1 RA licence.
• However, the PE firm will not be required to be licensed for Type 1 RA if it is already licensed for Type 9 RA and conducts the above activities solely for the purpose of carrying on Type 9 RA.

Industry experience requirement for ROs

• The SFC takes a pragmatic approach in assessing whether an RO applicant of a PE firm has the required relevant industry experience. In addition to PE fund management, it will consider other relevant experience such as research and valuation of, or the provision of management consulting and business strategy advice to companies in related industries, and structuring of corporate transactions.
• The SFC will also take into account PE experience gained in a non-regulated situation, both in Hong Kong and overseas.

Family offices

The following are the key aspects discussed in the SFC’s circular to family offices:

SFO licensing regime is activity-based

• If the services provided by a family office do not constitute any RA, or they fall within one of the carve-outs under the SFO, the family office is not required to be licensed by the SFC. However, it must take care not to hold itself out as carrying on a business in an RA.

Whether a licence is required depends on how the family office operates

• A family office set up as a business to manage assets which include securities or futures contracts may be required to hold a Type 9 RA licence. It will also need to consider whether its activities might give rise to the need to be licensed for other RAs, such as Type 1 (dealing in securities), Type 2 (dealing in futures contracts), Type 4 (advising on securities) or Type 5 (advising on futures contracts) RA.
• In the case of a single family office, where the family appoints a trustee to hold the assets of its family trust, and the trustee operates the family office as an internal unit to manage the trust assets, the family office will not need a licence as it will not be providing asset management services to a third party. Where the family office is a separate legal entity which is wholly owned by a trustee or a company that holds the family’s assets, it should be able to rely on the intra-group carve-out and no licence will be required.
• The intra-group carve-out applies to a family office which provides asset management services solely to any of its wholly owned subsidiaries, its holding company which holds all its issued shares, or other wholly owned subsidiaries of that holding company.
• A multi-family office is less likely to be able to rely on the intra-group carve-out, but it will depend on the services it provides in Hong Kong. Where a multi-family office is granted full discretionary investment authority in respect of the provision of asset management services to more than one family in Hong Kong, it will likely be required to be licensed for Type 9 RA.