Jake's View

Financial advisory council bends over backwards for private equity funds

PUBLISHED : Sunday, 01 December, 2013, 5:38am
UPDATED : Sunday, 01 December, 2013, 5:38am

The Hong Kong government should consider introducing a change in the law to allow private equity funds to be set up as limited partnerships, so as to further enhance the city's fund industry, a member of a government advisory body says.

South China Morning Post
November 28

The advisory body is the much ballyhooed Financial Services Development Council, which has now finally started releasing discussion papers on the reforms it recommends.

Strange to say, however, the paper it just released on private equity funds had nothing to say about limited partnerships other than that they will be considered in future. (Memo to FSDC head Laura Cha Shih May-lung: If you want people to consider your ideas, publish them first).

But as this talking shop wants to jump ahead of itself in this matter of limited partnerships, let's consider them here. The idea is that you have a few general partners who, as usual in a partnership, have management responsibility, share profits in defined proportions and bear responsibility for debts.

In addition to these general partners, however, you have any number of limited liability partners who get a dividend, can lose no more money than they put in and, critically, have no management control.

Heard of the essential element of this one before?

Cast your mind back to a company called Alibaba that recently tried a management structure like this on our stock exchange and was told to get lost. If you must control an enterprise, make sure you hold most of the equity, it was told.

And, to my mind, all the more so in private equity, which means investment in companies not publicly traded on an exchange. There is more scope for cheats here than in publicly traded securities. Let's make sure that if they cheat anyone they cheat themselves more.

But other places allow limited partnership, advocates protest.

Yes, indeed they do, which makes us different. We don't. We're not Singapore. We have standards and we stick to them. It's the only reliable way to maintain this town as a financial centre in the long term.

And now for the recommendations this paper on private equity actually made, rather than just suggested it would make. They all come down to demanding exemptions from tax and regulation.

Take note here that financial secretary John Tsang Chun-wah already granted the key tax exemptions in his budget last year. There will be no profits tax on private equity funds that do all their business outside of Hong Kong and hold no Hong Kong properties.

But this is not good enough for promoters of private equity. They also want tax exemption for activities outside of pure private equity and for investment in Hong Kong up to a certain proportion of their assets. And they want no legal trouble if they happen to go over these limits, just a polite reminder to return to them.

Once again, the murkiness of private equity is all the more reason to refuse these proposals. These people should be satisfied with the concessions. I would have expected a "Thank you", not a "Gimme more!"

Similarly, I can see no good reason why we should grant private equity managers any exemption from the licensing requirements of the Securities and Future Commission, certainly not if they are granted these limited partnerships.

The paper complains that in many cases private equity managers will not be granted SFC licences if they apply. This leads to an obvious question to the paper's authors: Do you mean to say these people would not qualify for licences?

If so, why should the SFC ever consider granting them licences? If, however, you mean to say that SFC would unfairly deny them licences for which they qualify, then say so directly and quit beating around the bush.

What we have here in short is a paper which purports to offer long-term recommendations for financial reform but actually proposes short-sighted, self-serving market distortions.

It's not uncommon. Do we expect butchers to be vegetarians? Do we expect bakers to recommend carbohydrate-free diets? Private equity practitioners like best what serves their interests best.

Let's just bear it in mind.