PE firms look to move fund management companies onshore - AVCJ Forum

The traditional approach in Asia has been to base the fund and fund management business in an offshore jurisdiction – typically Cayman – and create a sub-advisor within the region to take the lead on deal sourcing and execution. Few managers are prepared to abandon Cayman as a domicile, simply because LPs are comfortable with it.

“When you are selling a China fund you already have enough trouble selling the investment thesis, the team and the opportunity, you want to keep the fund structure as plain vanilla as possible,” said Stuart Schonberger, a founding partner at China-focused CDH Investments. Moreover, he noted that when established managers switch jurisdictions, “it’s like changing auditors – a big red flag,” and LPs will question it regardless of whether change is for the best.

As for the other parts of the investment management process, location is very much up for debate. For downstream investment entities, the jurisdiction of incorporation has always been dictated by tax advantages and ease of use – it could be Hong Kong, Mauritius, the British Virgin Islands, or any number of other international financial centers. For fund management companies, some private equity firms are already looking beyond Cayman.

A key factor is the economic substance legislation introduced by Cayman last year. Regulators decreed that most fund management entities – as opposed to funds – must demonstrate local substance or relocate elsewhere. The terms were subsequently loosened, enabling management entities to remain with limited substance provided they do nothing more than offer non-binding investment advice.

However, some believe this arrangement is unworkable. “You must do the core revenue-generating activity from Cayman if you want to be a Cayman manager,” said Markus Federle, a senior managing director and general counsel at Samena Capital. “I don’t know how you could localize sourcing and execute investments and do the heavy lifting in asset management from Cayman.”

Paul Christopher, a Hong Kong-based partner at Mourant, observed that some managers have established substance in Cayman, while others are changing the way in which they use the jurisdiction. Samena, which invests in Asia, the Middle East and North Africa, ended up moving the management company for all its funds to Dubai. Regulation – specifically a desire to bring the entity onshore – was just as much of a consideration as economic substance.

“Regulators are less likely to accept onshore advisor-offshore manager structures,” he said. “They want to regulate advisors but the advisor can just say he is not managing the fund and he is not responsible for decisions made by the investment committee.”

Federle noted that the Dubai Financial Services Authority (DFSA) ran into this problem with Abraaj Group, which imploded in 2018 over concerns about its internal governance, resulting in the prosecution of several executives for fraud. DFSA quizzed Abraaj, only to be informed by the firm that Cayman was home to the decision-making entity and the regulator was therefore stepping outside its remit in asking those questions.

Several jurisdictions – such as Hong Kong, Singapore, Ireland and Luxembourg – have introduced or improved limited partnership regimes in recent years. The aim is to take market share from Cayman as private equity firms look to establish every aspect of their business, from fund to fund management company to downstream investment entities, in a single onshore location.

The Hong Kong limited partnership was rolled out earlier this year and so far, 42 structures have been registered. Most of the managers are either raising money from mainland China or investing in mainland China. Cayman retains a substantial lead – approximately 28,000 fund structures are registered in the jurisdiction – that would take years to reel in. However, the likes of Hong Kong hope that reputational concerns could work in their favor.

“Larger fund managers may use it because they see the trend that happened in the US and Europe concerning fund monitoring. Investors are becoming increasingly reputational sensitive about being affiliated to offshore centers,” said Anson Law, a senior manager in the market development division at Hong Kong Monetary Authority. He added that the motivations for smaller private equity firms are likely to involve cost and convenience.

Hong Kong’s limited partnership structure is accompanied by potential advantages in terms of market access. Law claimed that the double taxation treaties with mainland China and India – which account for two-thirds of Asian PE deal flow – are best in class. It is easier to leverage these treaties for downstream investments when the manager has substance in Hong Kong. Using Hong Kong as a fund domicile is not a prerequisite, but it is an incentive to locate more functions in the territory.

“That issue of permanent establishment provides an opportunity,” said CDH’s Schonberger. “Hong Kong has tremendous advantages if you are focused on China, and now there is another alternative in the market, it’s good for a GP. We will be following this and seeing how we can use it to our best advantage.”

CDH relocated its fund management company from Cayman to Singapore about a decade ago. Schonberger said that, at the time, there was very little choice. One of the reasons for choosing Singapore was transparency. “The Monetary Authority of Singapore is stricter and more recognized as a corporate governance leader than Cayman,” he added.

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• Topics
• Fundraising
• GPs
• Advisory
• AVCJ Events
• CDH Investments Management
• Samena Capital
• Fund formation
• Asia
• Hong Kong Monetary Authority (HKMA)