SFC takes a stand on licensing for private equity managers

9 Sep, 2019 08:27
source: Bovill

The licensing requirement for private equity managers in Hong Kong has been a grey area since the SFC regime was introduced in 2003. The SFC is now taking a clearer stand on the private equity industry. For example, additions to the Licensing Handbook issued earlier this year made it clear that offshore private companies aren’t included in private equity exemptions.

The regulator expects all private equity managers to have the appropriate licenses in Hong Kong and be subject to the right regulations. If you’re currently relying on an exemption, you should review your activities and consider whether you should be applying to the SFC for a license before the SFC comes to you.

Relying on exemptions to SFC licenses

In Hong Kong, a lot of private equity managers rely on two exemptions to stay away from getting licensed:

1. Private equity exemption:

Shares or debentures of a company that is a private company within the meaning of section 11 of the Companies Ordinance (Cap. 622) are excluded from the definition of ‘securities’ in the Securities and Futures Ordinance. So, firms that deal in, advise on or manage a portfolio of ‘private equity’ that doesn’t involve securities don’t need an SFC license.

In February 2019, the SFC issued a revised version of the Licensing Handbook, which clarifies the scope of the exemption. The SFC stated that “where a firm deals in, advises on or manages shares or debentures of private offshore companies that fall outside the definition of “private company” under the Companies Ordinance, it is likely that the firm in question will be required to be licensed.”

2. Group company exemption:

Under the SFO, you’re not required to be licensed for Type 4 (advising on securities), Type 5 (advising on futures contracts), Type 6 (advising on corporate finance) or Type 9 (asset management) regulated activity if you provide the relevant advice or services solely to your wholly owned subsidiaries, your holding company which holds all your issued shares, or other wholly owned subsidiaries of that holding company. However, this exemption does not apply when a firm is advising its group company in respect of that group company’s client assets or managing assets belonging to the group company’s clients.

Based on the SFC’s interpretation of the exemptions, most private equity managers in Hong Kong (which invest in non-HK domiciled private companies and manage/advise on client’s assets) will require an SFC license to conduct their business in Hong Kong.

Currently, there are about 100 SFC-licensed private equity firms in Hong Kong (out of approximately 3000 SFC-licensed firms). The SFC is aware that there are private equity managers that have not been licensed with the SFC. They’ve made it clear that private equity managers that conduct regulated activity in Hong Kong or actively market any services in Hong Kong, which would constitute a regulated activity, should obtain an SFC licence.

The following types of licences are the most relevant to private equity managers in Hong Kong:

1. Type 1: Dealing in securities:
This license allows a firm to conduct securities-dealing activities and the marketing or distribution of securities, including the fund itself.
2. Type 4: Advising on securities:
This license allows a firm to give advice to the fund manager or end investors or issue research reports on securities, including when or what terms to buy or sell securities.
3. Type 9: Asset management:
This license allows a firm to manage a portfolio of securities or futures contracts. It also provides incidental exemption for Type 1 and 4 activities if they are carried out solely for the purpose of the asset management activity. For example, a Type 9 firm does not need a Type 1 license to market a fund it manages and to execute transactions or conduct deal negotiation for a fund under its management.

A Type 9 license and its incidental exemption may not cover all the activities conducted by a private equity manager. For example, a firm will still need a Type 1 license if it markets funds that are not managed by it, such as funds managed by group companies. A Type 1 license is also required for offering co-investment opportunities to clients.

Whether a private equity manager will need Type 1, Type 4 or Type 9 licenses will depend on a few factors, including the scope of business in Hong Kong and whether the manager has any discretionary management power.

To obtain an SFC license, the SFC would assess the fitness and properness of an applicant based on five elements:

1. Business: including business model, operational mode, and clientele.
2. Controller: including the background of shareholders, the fitness and properness of substantial shareholders, and compliance history.
3. Management: including corporate governance structure, appointments of responsible officers, directors, and managers-in-charge.
4. Financial Strength: including the ability to meet minimum liquid capital requirement, and the ability to meet the projected costs in the first 6-12 months after license approval.
5. Internal Control: including internal control systems and risk management measures.