Do Hong Kong Private Equity Firms Need to be Licensed with the SFC?
The short answer is, in most cases, yes.
In the majority of cases (bar a few exceptions which are outlined in our article), companies (and indeed their representatives) that engage in private equity / private credit-related activities in Hong Kong are required to be licensed with Hong Kong’s securities regulator, the Securities and Futures Commission (“SFC“).
In recent years, in connection with the licensing of private equity firms, industry participants want to understand “What’s changed?”.
- Additional clarity has been provided by the SFC to on what is and what isn’t considered as a ‘security’.
- There has been a shift in the SFC’s focus when it comes to proactively regulating these types of companies (due perhaps to the growing presence of private equity / private credit firms globally and within the Asia-pacific region).
Three main considerations
Let’s take a step back and look at what triggers a licensing requirement with the SFC. In doing so, we must consider three primary factors:
- Whether a company is ‘carrying on a business in Hong Kong’.
- The physical location of a company’s representatives when conducting certain activities.
- Whether the activities that these representatives are conducting on behalf of a company are considered as being ‘regulated activities’.
Consideration 1
Whether a company is ‘carrying on a business in Hong Kong’.
A company is generally considered by the SFC to be carrying on a business in Hong Kong if one or more of the following are true:
- The company is incorporated in Hong Kong.
- The company has an office in Hong Kong.
- The company employs people in Hong Kong.
- The company has a bank account in Hong Kong.
Where a private equity / private credit firm is incorporated as a Hong Kong company, has an office in Hong Kong, employs staff who reside in Hong Kong, and has a Hong Kong bank account, these firms would most definitely be considered as ‘carrying on a business in Hong Kong’.
Consideration 2
Physical location of a company’s representatives when conducting certain activities.
Put simply, the SFC does not regulate what people do overseas.
The SFC states within its various licensing materials that in order for someone to be considered as requiring an SFC license, they must be conducting regulated activities whilst physically present in Hong Kong. This implies, therefore, that where people conduct regulated activities outside of Hong Kong, an SFC licensing requirement is not triggered.
It is true that the SFC’s expectation is that anyone who is licensed with the SFC ensures that they comply with the relevant laws and regulations of overseas regulators when conducting activities outside of Hong Kong, and not doing so would put into question the ‘fitness and properness’ of the individual (i.e., if you break the law overseas, you probably won’t be considered as being fit and proper to be licensed with the SFC in Hong Kong).
However, the SFC regulates the activities individuals conduct in Hong Kong.
Therefore, if an individual is a resident of Hong Kong but goes overseas to engage in business activities, in most cases, this is not under the SFC’s regulatory remit.
It is generally understood within the industry that in the past, many private equity / private credit professionals would travel to the jurisdiction of investment to ‘do the deal’ (i.e., to negotiate terms of investment and sign relevant investment documents) as this was the most effective way to do business and in the course of doing so, the individual would also not be conducting these activities when physically in Hong Kong (and thus not triggering an SFC licensing requirement).
Consideration 3
Whether the activities conducted by the firms’ representatives are considered as ‘regulated activities’.
There are 10 different types of ‘regulated activities’ which are defined under the Securities and Futures Ordinance (“SFO“) that require a license with the SFC, but the main ones which are applicable to private equity / private credit companies are:
- Type 1 (dealing in securities)
- Type 4 (advising on securities)
- Type 9 (asset management)
The key consideration is that in order to be considered as conducting one or all of these types of regulated activities, the individual must be dealing in / advising on / managing assets which are considered as being ‘securities’ as defined under the SFO.
Historically, many industry professionals took the view that ‘securities’ generally referred to assets which are listed on an exchange as well as any funds (listed or unlisted).
Indeed, this stance was somewhat supported by the fact that there is an exemption within the definition of ‘securities’ under the SFO which states that “securities… does not include (i) shares or debentures of a company that is a private company within the meaning of Section 11 of the Companies Ordinance”. This definition has not changed since the SFO was enacted in 2003.
What was not so widely known until recently, however, is that ‘a private company within the meaning of Section 11 of the Companies Ordinance’ refers to private companies that are incorporated in Hong Kong.
Therefore, in short, the shares and debentures of a Hong Kong private company are not considered as being ‘securities’ meaning that individuals can deal in / advise on / manage these assets without being considered as conducting regulated activities (and thus do not need a license with the SFC).
The shares and debentures of a non-Hong Kong private company, however, are considered as being ‘securities’ and therefore dealing in / advising on / managing these assets is a regulated activity if an individual does so whilst being physically present in Hong Kong (thus triggering an SFC licensing requirement).
Types of activities that trigger a licensing requirement
Below are some examples of activities that are conducted by Private Equity / Private Credit professionals that may trigger an SFC licensing requirement.
Type 1 (Dealing in Securities)
- Negotiating a term sheet with respect to terms relating to the shares / debentures of a non-Hong Kong private company.
- Raising capital from investors (whether Hong Kong or overseas investors) to invest into a Private Equity / Private Credit fund.
Type 4 (Advising on Securities)
Providing a recommendation to a third-party to buy / sell the shares / debentures of a non-Hong Kong private company.
Type 9 (Asset Management)
Managing with investment discretion a Private Equity / Private Credit fund that invests into shares / debentures of non-Hong Kong private companies.
Practical examples
Type 1 (Dealing in Securities)
Where a representative of a Private Equity / Private Credit investment firm is sitting in their Hong Kong office negotiating a term sheet with the CEO of a potential non-Hong Kong portfolio company as an investment committee member of an affiliated Cayman General Partner, that individual would likely be considered as conducting regulated activity (Type 1) in Hong Kong and thus be required to be licensed with the SFC.
Type 4 (Advising on Securities)
Where an individual is sitting in their Hong Kong office advising a General Partner to buy the shares of a non-Hong Kong private company, that individual would likely be considered as conducting regulated activity in Hong Kong (Type 4) and thus be required to be licensed with the SFC.
Type 9 (Asset Management)
Where an individual is in Hong Kong working for a Hong Kong company and managing a private credit fund that invests into the debt of non-Hong Kong private companies, that individual would likely be considered as conducted regulated activity (Type 9) in Hong Kong and thus be required to be licensed with the SFC.
Industry reaction
The SFC released its circular relating to the licensing of private equity firms in 2020 and at the time the SFC noted that there were around 100 Private Equity firms in Hong Kong that were licensed with the SFC. We would estimate that in 2020 there would have been 500+ Private Equity / Private Credit firms operating in Hong Kong which means that the majority of these companies were doing so in an unlicensed capacity.
Granted, some of these companies would have been operating under certain SFC licensing exemptions (e.g., only performing research activities and providing investment recommendations to affiliates within their wholly-owned group), however some, we suspect, were not.
Over the years, we have noticed an increase in the number of Hong Kong companies who are conducting / seeking to conduct private equity / private credit-related and are applying for the relevant licenses with the SFC. The risk of not doing so can be severe, with companies and individuals facing regulatory enforcement from the SFC, which can take the form of fines and / or industry suspensions / bans.
