Singapore vs. Hong Kong: Shifting sands

Coverage of the battle between Hong Kong and Singapore to become Asia's preeminent private equity hub makes liberal use of subordinating conjunctions and modal verbs.

"Unless" Hong Kong introduces an acceptable regulatory framework for the asset class then it "might" end up losing business to Singapore. Similarly, there is anecdotal evidence of CFOs being told by managing partners that relocation "should" be considered "if" they are unable to achieve clarity on tax treatment.

Are we now witnessing the thin end of the wedge burrowing its way into the argument? According to third-party administrators, Singapore has become one of the fastest-growing markets in Asia for their services.

"We have seen a huge increase in the number of managers knocking on our door in Singapore, including international managers," says Julian Carey, managing director at Tricor IAG. "LPs look at Singapore as having a regulatory structure in place for the private equity industry and that gives them a lot of comfort about investing in locally-managed funds."

Dan McNicholas, head of sector sales for alternatives in Asia at State Street, sees a similar trend, noting that the tax incentives offered by the jurisdiction are a big draw for GPs, especially those looking to raise capital locally. The regulatory requirement that Singapore-registered managers must have an administrator within the jurisdiction is also a boon for service providers.

"It's not the only reason we maintain a staff there but it is a convenience to have that capability, particularly as we deal with global managers and managers emerging from China who may prefer a Singapore structure," he adds.

Areas of imbalance

The possibility of losing mainland Chinese private equity firms to Singapore goes to the heart of Hong Kong's concerns about the asset class. The territory is said to fall short of its regional rival in three interrelated areas: regulation, tax and ability to domicile.

In terms of regulation, while a number of Hong Kong-based managers have chosen to register with the Securities & Futures Commission (SFC), the agency's response has until recently been that PE funds domiciled in the Cayman Islands with only an advisory presence locally are not its concern. They only become the concern of the SFC or other regulators if they are marketing to local investors or offering financial products in other asset classes.

As for tax, private equity firms with managers onshore and funds domiciled offshore risk triggering permanent establishment and becoming liable for local tax. Complex structures are set up to avoid this potential fate, but at the same time, the absence of local substance theoretically makes it harder for funds to take advantage of Hong Kong's double tax treaty (DTT) network.

To be fair, there has been progress. The government has promised to introduce an attractive regulatory framework for private equity and the Financial Services Development Council (FSDC) has since released specific proposals. These included extending the profits tax exemption for offshore funds to include SFC-licensed private equity funds, which would address the permanent establishment concern.

However, progress is measured in baby steps and it will take time for the territory to match Singapore's robustness.

Exemptions on most forms of income tax and capital gains are granted automatically to funds that, depending on the nature of their investor base, register with or are licensed by the Monetary Authority of Singapore. Other requirements include local management and administration and at least S$200,000 ($151,000) in local business spending each year. The system isn't perfect but it offers substance and certainty.

There is also the option domiciling a private equity fund in Singapore as opposed to just putting in place a local manager. The FSDC proposals for Hong Kong currently extend no further than allowing open-ended investment companies (OEICs) to domicile locally.

"We looked at Hong Kong and we spent a lot of time traveling to the region from the UK. We chose Singapore primarily because it is a fund domicile whereas Hong Kong is not really," says Alexander Traub, managing director for Asia at Augentius.

The independent administrator opened in Singapore two years ago. In addition to the domiciling issue, it felt that the Singapore administration market was less penetrated than Hong Kong. Augentius now has approximately 15 live clients in the region, all of whom use locally-registered fund management companies. Most use a Cayman domiciled feeder with a Singapore master fund sitting underneath.

The domiciling preferences of Augentius' clients reflect those of the wider market. However, Tata Capital is among those that opted for Singapore as a base for its funds as well as its fund management operations.

The jurisdiction is said to be gaining ground on Mauritius, a traditional favorite of India-focused managers, due to the introduction of anti-avoidance measures under the country's impending new direct tax code that would require proof of local substance in order to qualify for DTT benefits. Establishing a sufficient local presence is far easier in Singapore than Mauritius.

For Tata Capital, however, Singapore was selected as a headquarters in 2008, before uncertainty about the India-Mauritius DTT came to the fore.

"We wanted to build a long-term business in private equity and we thought Singapore was a good destination from the perspective of being able to attract global talent and resources, as well as the well-regulated market and strong financial infrastructure," says Bobby Pauly, a partner at Tata Opportunities Fund. The Tata Group's ties with Singapore, which go back more than 40 years, were also a consideration.

The administrative burden placed on Singapore-registered managers to have work carried out locally is taken seriously. Dean Collins, a partner and member of the fund formation team at O'Melveny & Myers, recalls acting for a client that used an Ireland-based administrator with an office in Hong Kong. The administrator had to give an undertaking to the MAS that it would carry out accounting functions in Singapore or the client faced losing the tax incentives.

The MAS also requires that, on top of the standard practice of using third-party custodians and auditors, PE firms ensure independent valuation and customer reporting by using a third-party service provider or setting up an in-house function that is segregated from the investment management function.

"You have to demonstrate to the MAS that you have a segregation of front and back office. That means you have to put in Chinese Walls and have separate reporting between the execution and deal sourcing sides and your back office," says Tricor IAG's Carey.

While there is no obligation to use a fund administrator, the costs attached to building a fully independent back office can make outsourcing the logical choice. Another factor is that many LPs like to see managers use third-party administrators - it suggests a commitment to transparency and compliance, and then the service providers employed might be familiar to the LPs.

Tata Capital has a dedicated back office team but also outsources certain functions. "It gives a degree of independence and we use very reputable third parties because it gives our investors comfort that the accounting and administration is up to standard," Pauly explains.

Rapid response

Speaking to AVCJ last year, John Levack, managing director of Electra Partners, said that the Hong Kong Venture Capital & Private Equity Association - where he is chair of the technical committee - had commissioned a study to look at the indirect jobs created by private equity activity. These are the kinds of white-collar ancillary services positions that third-party administrators are so readily filling in Singapore.

The question for Hong Kong - where financial services accounts for 6% of the workforce and 16% of GDP - is how quickly and decisively it can respond.

Darren Bowdern, a tax partner at KPMG China, is confident that the tax exemption for private equity funds, and the SPVs they control, will be in place by the middle of this year. However, while respecting the efficiency of the Singapore regulatory system, he doesn't believe Hong Kong needs to replicate it in full in order to remain the jurisdiction of choice for most PE managers.

First, there is simple geographic perception: GPs with a primary focus on North Asia, and particularly China, have traditionally established platforms in Hong Kong; those looking at Southeast Asia veer towards Singapore. Old habits die hard.

Second, does Hong Kong need to make tax incentives conditional on a high degree of localization? The exemption proposed by the FSDC would be extended to properly licensed entities, which could be advisors rather than fund management operations. There are many who want the exemption apply to unlicensed managers as well. Similarly, requirements for minimum local business expenditure and administration might also be skipped.

"From a tax perspective, Singapore has an advantage over Hong Kong and because of that we have seen managers set up platforms in Singapore. If Hong Kong does nothing then it is a real threat to us," says Bowdern. "But I don't see the need to stipulate that you should have administrators in Hong Kong in order to qualify for the tax exemption. As far as I am aware, this is not being contemplated."

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• Topics
• Advisory
• GPs
• Greater China
• Southeast Asia
• Fund administration
• professional services
• Singapore
• Hong Kong (China)
• State Street
• Tata Capital
• Augentius
• Tricor IAG