Hong Kong Monetary Authority – Opening Keynote Speech at the 33rd Annual AVCJ Private Equity & Venture Forum

Hong Kong: an Ideal Platform for Private Equity and Venture Capital  

1. Greetings and Introduction

Good morning everyone.  My great thanks to AVCJ for inviting me to open this year’s forum.  This has been a challenging year for many of us.  But I have always thought that in times like this we must not lose sight of the bigger picture or the longer term future.  Very often, it’s the future outlook which gives us the direction and confidence in dealing with the current issues and challenges. 

If we look at the remarkable growth of private markets in the past decade, there is certainly cause for us to be optimistic about the years to come.   Globally, private markets AUM grew by 170% or US$4 trillion between 2010 and 2019.  Asia, in particular, has grown from managing just 12% of global VC (venture capital) assets in 2010, to over 40% now, which is about the same size as North America.¹  Let me take this opportunity to share with you how we see the the current industry dynamics and how things may change in 2021 and beyond. 

2. Private markets outlook

We would all remember how Covid-19 has sent shockwaves across the markets, especially in first few months of the outbreak.  In response, GPs (general partners) had to focus on preserving the value of their existing portfolios and making liquidity plans to prepare companies and assets for challenging times ahead.  Due to unprecedented lockdown measures and travel restrictions, many deal sourcing and due diligence activities had to be suspended or delayed.  Uncertainties in the business environment also led to significant slow-down in investment and exit activities in the first half, across all major markets and sectors. 

As for LPs (limited partners), their approach also leaned towards being conservative.  Many of them decided to exercise caution and slowed down their pace of commitment, especially when it came to collaborating with new GPs or exploring new strategies.  Many LPs also set aside more resources for monitoring portfolios and critically revisited their asset allocation plans for the year.

The good news is, although the pandemic is still raging in various parts of the world, the capital markets are recovering from the initial shock, with signs of stabilisation since late Q2.  People are increasingly talking about a “new normal”, i.e. resuming business operations as far as possible, without compromising health and safety of staff.  As the world adapts gradually to the new normal, many GPs are returning to the market and seeking new investment opportunities.  

Looking ahead, we should expect to see certain long-term structural changes arising from pandemic-induced behaviours.  For example, the PE industry will need to be more digital and be able to adapt their operations flexibly.  Having virtual meetings is just a small first step.  GPs and LPs alike need to review, in a holistic way, what technology can do for their investment and portfolio management.

Another trend we anticipate is that sector expertise will become more important than ever to drive outperformance.  To achieve that, GPs must be able to pick winners from the high-growing segments of the economy.  It will not be an easy task and much will hinge on capabilities including a deep understanding of sector trends and landscape.

In the meantime, we need to pay heed to the rise of ESG and responsible investing.  Responsible investing is gaining more traction than ever as people are having greater concerns about social issues such as public health care and safety, racial and ethnic equality, inclusion, and justice.  In recognition of this trend, the HKMA has demonstrated leadership in responsible investing by weaving ESG factors into our investment process.  Specifically, for our private market investments,

3. Hong Kong’s all-embracing platform for PE and VC

Looking to the future, Asia is of strategic importance for private markets.  As I have mentioned at the beginning, the region now takes up a much bigger share of global AUM compared to a decade ago.  Along the way, Hong Kong has emerged as the largest PE hub in Asia after the Mainland of China.  Currently, we are home to more than US$160 billion of capital and host over 560 PE and VC firms.²  The fact that this annual forum has been held in Hong Kong for years is a testament of the city’s significance in the Asian PE space.  

Now let me share with you the HKMA’s perspectives on Hong Kong’s PE platform.  In addition to being an investor, the HKMA wears a second hat in the PE space.  We have a market development mandate and have put in tremendous efforts to build a competitive PE platform in Hong Kong.  This fits into our broader policy goal of maintaining Hong Kong’s status as a leading asset and wealth management centre.

It is no exaggeration to say that Hong Kong offers an all-embracing platform for the full spectrum of PE activities: from fundraising and deal sourcing to investment management and exit. 

In terms of fundraising, here you can access rich sources of long-term capital that is keen to invest in private assets.  In fact, many leading asset owners, such as sovereign wealth funds, pensions and endowments, have established local presence in Hong Kong to support their growing allocation to alternative investments in the region.  What’s more, as we witness rapid wealth creation in Greater China, Hong Kong is well-placed to serve the growing wealth management needs of ultra-high net worth individuals and families.  Their continued portfolio diversification has lent solid support to the supply of capital to private markets.  According to a recent industry survey, family offices on average allocate as much as 35% of their investments to alternative assets, which outsizes their average allocation to stocks.³

In terms of deal sourcing, here you can enjoy proximity to robust deal flows in the Mainland of China.  In 2019, China alone took up 40% of all deal flows in the Asia-Pacific region.⁴  A bright spot is the Greater Bay Area (GBA).  Being a market of more than 70 million people and encompassing the country’s tech hubs, the GBA offers exciting investment opportunities from the growth of unicorns, innovation and technology enterprises, to green projects and solutions.  Importantly, there is clear policy support for Hong Kong to benefit from this.  In the Outline Development Plan for the GBA, the Central Government has stated the policy objective to support the engagement of Hong Kong’s PE funds in the financing of innovation and technology enterprises in the GBA. 

In terms of investment management, here you can find abundant talent and professional service providers to take care of your investments.  Hong Kong is now home to more than 1,800 asset management firms, including close to 80 of the world’s top 100; over 45,000 certified public accountants; and 11,000 practising solicitors and barristers.  That said, we fully recognise that talent is an important asset for the alternative investment industry, and so in order to maintain competitiveness, it is crucial to put in continuous effort to groom our talent pool.

In terms of exit for investments, Hong Kong’s IPO platform offers an attractive exit option for PE.  We have claimed the crown as the world’s largest IPO destination in six out of the past 10 years.  We continued to excel this year: in the first ten months over 100 companies were listed in our stock exchange which raised a total of nearly HK$250 billion in fund.⁵

4. Recent market development initiatives that will benefit the industry

So Hong Kong has strong fundamentals supporting PE and VC activities.  But we cannot afford to be complacent.  We continue to enhance our platform to cope with challenges and shifts in the industry landscape.   

For a long time, the market practice is to domicile a PE fund offshore notwithstanding the substantial activities in Hong Kong.  But in recent years, the offshore model has become increasingly risky and costly as traditional offshore jurisdictions imposed and continuously tightened substance requirements.  You are probably familiar with the OECD’s BEPS (base erosion and profit shifting) initiative so I am not going to go into details here.  What we sense from the market is the growing interest for PE funds to explore an onshore option.  Hong Kong would be a good and logical choice given the strengths I have just described: our rich supply of capital, robust deal flow, solid support for investment management, and attractive exit route.  It makes perfect sense for PE funds to be domiciled as well as managed here.

It is against this backdrop that the Hong Kong Government has accorded high priority to sharpening Hong Kong’s competitiveness in hosting the PE business.  In recent years, a series of enhancements have been introduced, and the work is still ongoing.  As I said, the HKMA has a market development mandate.  We indeed initiated many of these enhancements and have been heavily involved in the course of policy formulation, for we believe we speak the market language and understand how the industry operates.  We are committed to cultivating a platform with adequate flexibility and commercial viability so that it will bring real benefits to the industry. 

Now please allow me to spend a few more minutes in explaining to you the enhancements we have made and planned to introduce in the pipeline.  

On the legal front, we have recently put into effect a new legal structure for PE funds.  In a nutshell, it offers a common law vehicle called limited partnership fund, or LPF, for private investment funds including PE and VC funds to domicile in Hong Kong in a GP-LP structure.  It is essentially the Hong Kong version of the limited partnership vehicles available in typical fund hubs.  By design,

I will keep it brief here and let my HKMA colleagues elaborate on this at a panel session this afternoon.  To give you a sense of the market reception, I am pleased to highlight that the LPF has achieved a most encouraging take-up so far.  In less than three months since the law came into operation in late August, over 40 LPFs have been registered.  From the HKMA’s market outreach, we have seen keen interest in the use of this new legal structure from fund managers, investors, fund lawyers and other service providers in town. 

Apart from building a user friendly legal platform, we also place equal emphasis on creating a facilitative tax environment for funds, for we fully appreciate that profitability, is a key factor in the choice of fund domicile and management.  

Last year, we rolled out the unified fund regime, which extended fund-level profits tax exemption to cover both onshore and offshore funds including PE funds.  This has paved the way for Hong Kong to become a place of choice for onshore fund operation.

We are now taking another step to deal with carried interest taxation.  The Financial Secretary announced in his Budget speech this year to provide tax concession for carried interest distributed by PE funds operating in Hong Kong, subject to the fulfilment of certain conditions.  The Government consulted the industry this summer, and we are now working with various departments to develop the scheme.  Many of you have provided valuable comments to us.  I can assure you that we will continue to seriously study the industry’s suggestions, and strive to provide a highly competitive tax treatment for carried interest.

Our target is to introduce the legislative proposal to the Legislative Council early next year.  If things go well, we will hopefully see passage of the law by summer.  So stay tuned.  In any event, despite the time required for legislation, the Budget has made it clear that the tax concession will take retrospective effect from April 2020.   

5. Closing 

To conclude, let me highlight a few take-aways:

I encourage you to take advantage of Hong Kong’s platform to capture the exciting opportunities ahead, and help nurture talent for the long-term development of the industry. 

Thank you.  I wish today’s forum a great success.