Private Equity Regulation SNAPSHOT in HONG KONG, China and Singapore
From 2005 to 2011, the Greater China region, including Mainland China, Hong Kong, Macau and Taiwan, was the hottest Asia-Pacific place for international private equity investment choices. In 2007, the total value of private equity investments in the Greater China region was US$21 billion. Although the investment value was reduced as a result of the global financial crisis from 2008 to 2010, the value has rebounded to US$28 billion in 2011 - even higher than the level recorded in 2007.
In Southeast Asia, private equity investment has also been badly affected by the global financial crisis since 2008. However, unlike the Great China region, total private equity investment has not recovered to the level before the crisis. In 2011, the total private equity investment in Southeast Asia was US$9 billion.
According to Preqin, buyout activity has been the single major activity in the global private equity investment market. In the Asia-Pacific market, private equity buyout activities have risen steadily since 2009 to Q3 2012 i.e. after the global financial crisis. During this period, the average number of transaction was 57 deals per quarter and the mean value of each deal was about US$150 million. Merger market data shows that China and Hong Kong saw the second greatest private equity buyout activity with a total number of 36 deals during Q1-Q3 2012. In addition, most of these deals concerned the financial services and consumer sectors. In the same period, the total number of deals completed in the Southeast Asia was 14. In this sub-region, most of the deals concerned the energy, mining, financial services and utilities sectors. With the increase in private equity transactions throughout the region, we can see that national governments have changed their tax and private equity regulatory policy to cater for the increasingly frequent trading activities demand. In this article, we will highlight some of the changes in Mainland China, Hong Kong and Singapore, the financial hub of the Southeast Asia.
PRC Government has Revised the Draft of Securities Investment Fund Law
In mid-2012, a draft amendment to the Law on Securities Investment Funds was issued by The China Securities Regulatory Commission and it is now under second reading by the National People’s Congress of the People’s Republic of China. In the draft amendment, it is proposed that the existing non-regulated private equity firms should be covered by legal consideration for future supervision. The proposal for regulating private equity firms is to cope with the rapid growth of private equity market trading activities over the past decade. The Law of the People’s Republic of China on Securities Investment Funds was implemented in 2004 for the healthy development of funds and securities market, however, it is still in the development stage. Nevertheless, private equity is becoming increasingly important in the financial sector of China and, as such, the Chinese government has been revising the law to include non-public funds in the regulatory framework in order to protect investors.
Up until the end of 2011, there were 69 fund management company managed funds in mainland China and the net asset value was about RMB 2.2 thousand billion. The value was about nine-fold that of the value in 2003 and float capitalization accounted for about 7.7% of the market capitalization of the Shanghai and Shenzhen stock markets. Securities investment funds have become the most important institutional investors in the securities market and have great influence on society and the markets. Meanwhile, the Chinese government has continued to deepen the reform of the economic and financial systems and capital markets development.
The followings are the major reasons for the change of the fund regulation in mainland China:
First, there is a lack of legal provision in private fundraising, including private securities investment funds and private equity funds. Mainland Chinese SMEs financing dependence on private equity funding has become more active than previously and has become a choice of wealth management tools for local investors. However, the current provision of the fund law in China cannot fully meet the needs of the new situation of private equity market development and supervision. The lack of clear regulatory foundations for the private fund establishment, operation, raising and investor behaviors would harm the interests of private equity investors. Some unruly elements just make use of the name of “private equity” fund raising for fraudulent purposes and this vulnerability for fraud could potentially be a significant social problem.
Secondly, the current legal provisions for private fund management are insufficient in protecting the interests of investors. This is due to the current fund enforcement system not strictly preventing the fund management company or fund manager participating in the insider trading. Furthermore, under the current fund management mechanism in China, investors also lack the opportunity to vote/ballot or become otherwise involved in the decision making process of investment options.
As well as the fund administrative examination and approval system is obsolete and has been difficult to adapt to competition in the current fund industry and investors needs. The narrowed investment fund choices limit the fund market competitiveness and dynamism of industry development. It also applies a requirement for the fund managers to provide investors with more choice and better financial services. Additionally, the outdated system also limits the financing opportunity of local enterprises.
In summary, there are five main focuses on regulating private funds in the newly proposed regulations.
- All fund managers are required to register with the state council securities regulatory authority or fund industry associations to apply for registration.
- Establish a qualified investors system. Provision in private fundraising can only come from sophisticated investors who should achieve a required level of income and asset size . In other words, qualified investors are required to have proven ability to identify risk and affordability against risk.
- Exempt private fund financing from registration but post-filing is necessary.
- Prohibit all private fundraising activity from open publicity and promotion.
- Legal contract regulation is strictly required for activities between private fund trusts and custodians.
Tax Exemption for Private Equity Funds in Hong Kong
According to the Hong Kong Trade Development Council, Hong Kong is the second largest private equity centre in Asia. At the end of 2011, more than US$68 billion private equity capital, accounting for 18% of the total capital pool of Asia, was managed in Hong Kong. In order to secure more private equity investment opportunities the Hong Kong government has recently proposed to launch an incentive scheme for private equity investments. In the 2013-14 Budget, the Financial Secretary proposed some tax measures including profits tax exemption for private equity funds. In the proposal, profits tax exemption for offshore funds will be extended to include transactions in private firms which are offshore registered or incorporated, or, do not possess any Hong Kong properties nor running any business in Hong Kong. If the proposed amendment is implemented, private equity funds will be allowed to enjoy the same tax exemption as offshore funds. In addition to this tax benefit, the Financial Secretary also plans to amend the current law to release the restriction that only investments funds established in Hong Kong are allowed to take the form of trusts.
The mentioned tax incentives and amendments are expected to attract a lot of Mainland Chinese investment firms to raise private equity funds in Hong Kong. In an interview with South China Morning Post, Mr. John Levack, vice-chairman of the Hong Kong Venture Capital and Private Equity Association, opined that these new policies would attract a lot of mainland investment firms to set up offices and launch private equity funds in Hong Kong. Moreover, it would also create new financial job opportunities in Hong Kong.
Singapore – an Investment Hub in South East Asia
In Southeast Asia, private equity transactions have increased from US$1.3 billion in 2011 to US$3.6 billion in 2012. As the most developed country and financial center of the region, Singapore is the preferred location for private equity firms. In 2012, some international private equity firms, including General Atlantic, Blackstone and Kohlberg Kravis Roberts, have set up offices in Singapore.
The Monetary Authority of Singapore (MAS) has implemented an enhanced regulatory regime for fund management companies (FMCs) in August, 2012. Amendments have been made to three sets of regulations including.
1. Securities and Future (Licensing and Conduct of Business) Regulations
2. Securities and Futures (Financial and Margin Requirements) Regulations
3. Financial Advisers Regulations
The enhanced regulatory regime requires all fund management companies to comply with enhanced capital and conduct requirements. These requirements include independent valuation and custody of investor assets. Moreover, the fund management companies are also required to undergo independent annual audits by external auditors. The companies are also required to have an adequate risk management framework suitable for the type and size of investments managed by the fund management companies. The MAS has also launched a new Registered Fund Management Companies (RFMC) regime to replace the Exempt Fund Manager (EFM) regime currently in practice. Under the EFM, a fund manager is exempted from obtaining a license if he/she is managing funds on behalf of not more than 30 qualified investors. As a result of the implementation of the RFMC regime, the EFMs now need to apply for a license or register with MAS.
Currently, fund management companies established in Singapore need to pay a corporate tax rate of 17%. If a company plans to expand its operation in Singapore and meets the stipulated conditions, it can make an application to the Monetary Authority of Singapore (MAS) for a beneficial tax rate of 10%. The 7% cut is attractive to the fund management companies.
Keeping Abreast of Private Equity Market Changes
The prosperity and ongoing economic development of the Asia Pacific region continues to attract international private equity funds to participate in regional investment amongst various industries. Regional enterprises also demand the injection from investors to accelerate development and expand the markets. The private equity market landscape is continuing to evolve as most of the regional regulations on private equity funds have not been well developed nor are as mature as those found in more developed countries. It also takes time to integrate with local culture, norms, resources and political considerations. As such, many governments have started to review and improve their regulations concerning private equity fund activities to help protect investors. Meanwhile, they are also launching different incentive schemes to attract private equity fund investments to their countries.