Launching a hedge fund in Hong Kong
By Gaven Cheong, Partner, Simmons & Simmons LLP
Published: 12 July 2017
So you want to launch your own hedge fund! That’s great – you’ve taken the first important step in a challenging and complicated process that requires skilled consideration to deliver success. But where to from here? If there’s one golden rule I would give to any start-up manager, it’s this – speak to the right adviser! And by “adviser”, I don’t just mean a funds lawyer – a lot of new managers may choose to speak with fund administrators, prime brokers, Cayman Islands counsel or any of the “Big 4” accounting firms as a starting point before delving further into conversations with other service providers. The important thing is to identify an adviser who is well established and familiar with the jurisdiction in which you want to manage your fund, in terms of local norms, regulatory and tax requirements, and investor preferences.
What are some of the preliminary things you should be thinking about once you have decided that you want to launch a hedge fund?
Consider current employment situation
The existing employment documentations should be reviewed to consider whether there are any restrictions in setting up a new hedge fund business. In particular, the focus should be on complying with the existing employment obligations. For instance, when setting up the new fund, you must ensure that you continue to act in the best interests of the existing employer and be aware of any restriction in soliciting any colleague to leave the current company.
Choose and protect your brand identity
Before launching a new hedge funds business, it is extremely important to ensure that the names or trademarks you propose to use for your management business and funds do not overlap with existing names which are in use or registered trademarks. This is to avoid any unnecessary future rebranding (or at worst, litigation for trademark or copyright infringement) which can be costly and disruptive to your business. This exercise would involve performing checks on relevant registers in the country in which the fund entities will be domiciled, to ensure that the chosen fund names are available for use.
Decide on your management entity business structure
The most simple and common structure involves an offshore manager as it creates flexibility and potential tax benefits. However, some start-ups are established using more customised arrangements. Upon deciding on the structure, the management entitles will then need to be incorporated, followed by the preparation of relevant operating agreements, such as a shareholders’ agreement for the offshore manager.
Decide on your fund structure
The majority of hedge funds we have launched for our clients are domiciled in the Cayman Islands, which is relatively straightforward with generally less onerous ongoing obligations. Especially for managers looking to raise capital in this region (ie Pan-Asia), the Cayman Islands is a popular jurisdictional choice given investor familiarity with its laws and its structures, and the well developed legal and operational infrastructure that has been built up in this region to support such structures.
While the Cayman Islands is most commonly used, we are also able to advise start-ups using other fund domiciles, including the British Virgin Islands.
In determining the fund structure, you should consider your prospective investors, tax positions, investor expectation, cost and operational factors. Common fund structures include standalone and parallel funds, segregated portfolio companies (SPCs) and the master-feeder structure, each with distinct advantages and shortcomings depending on the need of the individual hedge fund. We have, in addition to the above, extensive experience with alternative approaches to fund structures, including, for example, the use of additional types of feeder funds, dual master funds, and the use of ‘hybrid’ structures (for example, structures that can accommodate closed and open-ended sub-funds, or that can deal with pockets for illiquid assets).
Prepare SFC application
Certain activities require regulation by the Hong Kong Securities and Futures Commission (SFC) if carried out in Hong Kong. These activities include, for example, dealing and advising in securities. These activities are widely defined in the SFO (the Securities and Futures Ordinance) and will most likely affect the operation of a hedge fund business. Carrying out these activities without obtaining an SFC licence is a criminal offence. The process of applying for an SFC licence, which generally takes about 20 weeks, requires the proper completion and submission of certain prescribed forms.
Agree seeding arrangements
It is important for a start-up hedge fund manager to be able to raise sufficient capital for the new fund to invest either at launch or shortly afterwards in order to optimise the investment strategy, meet the costs of increased compliance and provide comfort to potential investors. Seed capital is an up-front investment from a third party investor, which allows a hedge fund manager to deal with the concerns above and to launch a fund with an amount of capital that demonstrates to other potential investors and the market more generally that it is a business of substance.
It is, therefore, important for a start-up hedge fund manager to secure a seed deal. In recent years, due to the reduced availability of seed capital, it has been very competitive for start-up hedge fund managers to secure a seed deal on favourable terms. Ideally, a good seed deal that works for all parties involves careful balancing of the need to provide the seed investor with a sufficient economic interest and control over the business in order to provide them with comfort as to how it is being run, against ensuring that the hedge fund manager does not cede too much control or interests in profit streams or capital for what will hopefully become a successful hedge fund management business in the future.
Now that you’ve attended to the preliminaries, the next step is to consider the key work streams to actually launching your fund, understanding the documents and agreements that are required to be put in place and choosing service providers for the fund.
Plan your launch
Given the complexity of starting a new fund business, we advise start-up hedge fund managers to plan the launch of the new fund carefully so that things will not fall through the cracks. The launch plan should include different work streams, including manager set-up, fund set-up, marketing requirements, trading documentation and seeding. We offer our start-up clients access to a centralised document repository where documents may be stored and shared, which will be particularly useful in organising the documentation of the fund.
Negotiate a lease for your business premises
In parallel with setting up the hedge fund management entities and preparing the documentation for the fund launch, the negotiation of a lease agreement will likely take place when looking for business premises. As the landlord and the tenant have different priorities, the negotiation exercise seeks to balance the conflicting interests of the two. Start-up hedge fund managers should be aware of the key terms of the lease agreement, including, for example, payment of rent, rent review and break clause.
Your team of analysts and portfolio managers will need to be employed by the regulated entity in Hong Kong. This means needing to have employment agreements in place, and work visas (if they are not already Hong Kong residents).
Decide on directors and service providers
The choice of directors and service providers are important as they play significant roles in the fund. The decision will depend on the specific needs of the fund and we have extensive experience in advising in this regard. Independent offshore directors have now become an indispensable part of any fund launch, especially one that is focused on raising genuine third party capital from institutional investors. Having an independent board is important not only from a corporate governance perspective, but also for tax reasons (to avoid having your offshore fund brought onshore!).
We can assist with not only referrals to professional independent third parties that offer directorship services, but can also assist with reviewing and negotiating your director appointment agreements.
Prepare fund offering documents and agreements
The key legal documents required for a new corporate hedge fund include:
- Prospectus or Private Placement Memorandum (PPM)
- Articles of Association
- Subscription/Redemption Forms
- Investment Management Agreement
- Management Agreement
- Distribution Agreement
- Administration Agreement
- Prime Brokerage Agreement
- ISDA Documents
These documents are important and require careful drafting as they govern the relationships of different parties to a fund.
Negotiate prime brokerage agreements
The documentation under which a prime broker is appointed is complex and often very favourable to the prime broker – precisely how one sided is a matter for negotiation.
While bearing in mind that product-specific additional documentation may also be required, the key terms documenting the fund’s relationship with its prime broker will be found in a prime brokerage agreement.
Negotiate administration agreements
Administration agreements document the provision of fund administration services to the fund by an administrator. The administrator is one of the fund’s most important service providers. Start-up hedge fund managers should ensure that the appropriate services are being provided to the fund and that the fund agrees to terms that are market standard and do not expose the fund to greater liability than is essential. The typical services provided by an administrator include transfer agency services, anti-money laundering services, services in relation to the calculation and publication of fund net asset value, tax services and the preparation of unaudited financial statements.
The big day has arrived! Once your fund documents have gone through their various rounds of comments and input from your various service providers, and you have finalised versions on hand, here are some of the other things you need to think about before you finally press the launch button:
- Have you secured all the licences / regulatory approvals to operate your fund?
- Are your PB accounts / bank accounts opened and operational?
- Have you registered your fund with CIMA (including your directors)?
- Do your fund documents have all the necessary disclosures to ensure that they comply with local private placement requirements?
- Have you got your board minutes and launch resolutions (both Cayman Islands and Hong Kong) in order?
We have looked briefly at the various things a start-up manager should consider when launching a new hedge fund.
Launching a new fund is indeed a complex process as the planning and preparation of documents require a lot of negotiation, knowledge and care. Key decision points have to be identified and triggered in a way that is optimal from both a cost and timing perspective.
To contact the author:
Gaven Cheong, Partner at Simmons & Simmons: [email protected]