Ancillary Fees in PE Funds: Disclosure and Controversy Around Monitoring Fees, Advisory Fees, and Other Charges

The UK Financial Conduct Authority’s (FCA) April 2025 consultation paper, CP25/8, on the transparency of private market valuations and fees has sent a clear signal to the global private equity (PE) industry: the era of opaque ancillary fee structures is ending. This regulatory push, combined with a 2024 landmark ruling in the Delaware Court of Chancery in Frozen Food Express Industries, LLC v. Blue Hills Capital Partners, L.P., which found a GP liable for failing to disclose monitoring fees to limited partners (LPs), has forced fund managers and their legal counsel to re-evaluate every line item in their management company revenue. In Asia, the Hong Kong Securities and Futures Commission (SFC) has not issued a specific code on PE fee disclosure, but its 2023 “Consultation Conclusions on the Proposed Amendments to the Code on Unit Trusts and Mutual Funds” (SFC, 2023) and the overarching principles of the SFC’s “Code of Conduct for Persons Licensed by or Registered with the SFC” (Cap. 571, subsidiary legislation) require that all material fees be disclosed to investors in a manner that is not misleading. For buyout firms operating in Hong Kong, Singapore, or the Cayman Islands, the controversy is no longer theoretical: undisclosed monitoring, advisory, and transaction fees represent a material litigation and regulatory risk that directly impacts fund performance and GP-LP trust.

The Anatomy of Ancillary Fees: Monitoring, Advisory, and Transaction Charges

The core of the controversy lies in the distinction between fees earned for genuine value-add services and those that represent a disguised profit extraction from the portfolio company. A standard PE fund’s management fee (typically 1.5% to 2.0% of committed capital) is designed to cover the GP’s operating costs. Ancillary fees, however, are charged on top of this, often directly to the portfolio company, creating a dual-revenue stream for the GP that can significantly reduce net returns to LPs.

Monitoring Fees: The Most Contested Line Item

Monitoring fees, also known as supervision or management fees, are charged by the GP to its portfolio companies for ongoing strategic and operational oversight. The standard structure is an annual fee calculated as a percentage of the portfolio company’s earnings before interest, taxes, depreciation, and amortization (EBITDA), typically ranging from 1.0% to 3.0% of EBITDA. For a mid-market company with HKD 200 million in EBITDA, this represents an annual charge of HKD 2 million to HKD 6 million directly to the company’s profit and loss statement.

The controversy arises from the double-dipping concern. In a standard LBO structure, the GP’s management fee is already intended to cover the cost of monitoring portfolio companies. When a GP charges both a management fee to the fund and a monitoring fee to the portfolio company, the total fee burden on the investment can exceed 3.0% of invested capital annually, eroding the internal rate of return (IRR) by 100 to 200 basis points over a five-year hold period, according to a 2024 study by the Institutional Limited Partners Association (ILPA). The Delaware ruling in Frozen Food Express (2024) explicitly found that the GP’s failure to disclose the full extent of these fees to LPs constituted a breach of fiduciary duty, with the court awarding damages of USD 4.2 million to the LP.

In Hong Kong, the SFC’s “Code of Conduct” (2023) requires that any fee charged to a portfolio company that is controlled by the fund must be disclosed in the fund’s offering document. If the fund is structured as a Cayman Islands exempted limited partnership, the partnership agreement must clearly specify whether the GP is entitled to retain such fees or whether they must be offset against the management fee. The standard market practice in Hong Kong, as observed in funds advised by Deacons and Simmons & Simmons, is now to include a 100% offset provision: every dollar of monitoring fee received by the GP is deducted from the management fee charged to the fund.

Advisory Fees: The Scope Creep Problem

Advisory fees represent a broader category of charges for services such as strategic planning, M&A advisory, and operational improvements. Unlike monitoring fees, which are typically recurring, advisory fees are often transaction-specific or project-based. The controversy here is the scope creep: GPs may charge advisory fees for services that are already covered by the management fee or that are part of the GP’s core fiduciary duty.

A specific example is the “board advisory fee” charged by some GPs for placing a partner on the portfolio company’s board of directors. This fee, which can range from HKD 500,000 to HKD 2 million per annum per board seat, is particularly contentious because it creates a direct conflict of interest: the GP’s representative on the board is simultaneously an agent of the fund (the owner) and a service provider to the company (the owned entity). The SFC’s “Code on Unit Trusts and Mutual Funds” (Cap. 571, section 4.2) mandates that any transaction between a fund and a connected party must be conducted on arm’s-length terms and fully disclosed. A board advisory fee paid to the GP’s nominee would fall squarely under this requirement.

In 2023, the US Securities and Exchange Commission (SEC) fined a major PE firm USD 12 million for failing to disclose that its advisory fees were being used to pay for the GP’s own travel, entertainment, and marketing expenses, rather than for genuine advisory services to the portfolio company. While the SEC does not have direct jurisdiction in Hong Kong, the SFC has increasingly adopted a similar enforcement posture. The SFC’s 2022 enforcement action against a Hong Kong-based asset manager for misappropriating fund assets (SFC, 2022) demonstrates that the regulator will pursue cases where fees are charged without a corresponding service being rendered.

Transaction and Break-Up Fees: The Hidden Cost of Failed Deals

Transaction fees, including arrangement fees, success fees, and break-up fees, are charged by the GP to the portfolio company in connection with a specific acquisition, divestiture, or financing. The standard structure is a one-time fee of 1.0% to 2.0% of the transaction value. Break-up fees, which are paid if a deal fails to close, are particularly controversial because they are paid by the portfolio company to the GP for a deal that never happened.

The controversy is twofold. First, these fees can be substantial: for a HKD 1 billion acquisition, a 1.5% transaction fee equals HKD 15 million. Second, they are often charged in addition to the GP’s management fee and any monitoring fee, creating a triple fee layer on a single investment. The ILPA’s 2024 “Principles for Responsible Fee Disclosure” (ILPA, 2024) recommends that all transaction fees be subject to a 100% offset against the management fee, and that any break-up fees be fully rebated to LPs.

In practice, Hong Kong-based funds have adopted varying approaches. Some funds, particularly those managed by global firms with strong LP relationships, have moved to a “zero additional fee” model, where the GP waives all transaction fees. Others continue to charge them but provide a detailed quarterly report to LPs, itemizing each fee and the service provided. The key regulatory reference point in Hong Kong is the SFC’s “Frequently Asked Questions on the Code on Unit Trusts and Mutual Funds” (SFC, 2023), which states that any fee that is not disclosed in the fund’s constitutive documents is deemed to be prohibited.

Disclosure Standards: What the Regulators and LPs Now Demand

The regulatory landscape has shifted from a principle of “disclosure if material” to a de facto standard of “disclosure unless explicitly exempted.” This shift is driven by both regulatory action and LP pressure, with the largest institutional investors—such as the Hong Kong Monetary Authority (HKMA), the California Public Employees’ Retirement System (CalPERS), and the Canada Pension Plan Investment Board (CPPIB)—now demanding granular fee reporting as a condition of investment.

The SFC’s Position: A Principles-Based but Strict Regime

The SFC does not have a specific code for PE funds, but its general regulatory framework applies. The “Code of Conduct for Persons Licensed by or Registered with the SFC” (Cap. 571, subsidiary legislation) requires that all fees be “fair and not excessive” (paragraph 5.1) and that any conflict of interest be “disclosed in writing to the client” (paragraph 8.1). For a PE fund, the “client” is the fund itself, and by extension, the LPs.

The SFC’s 2023 consultation on the “Code on Unit Trusts and Mutual Funds” introduced a new requirement for all authorized funds to disclose “all fees and charges payable by the fund, including any fees payable to the manager or its connected persons” (SFC, 2023, paragraph 4.3). While this code applies primarily to retail funds, the SFC has indicated that it expects the same standard of disclosure from PE funds that are marketed to professional investors in Hong Kong.

The practical implication is that any PE fund that has a Hong Kong-licensed manager or that is marketed to Hong Kong-based LPs must include a comprehensive fee schedule in its private placement memorandum (PPM). This schedule must list each type of fee, the calculation method, the expected amount, and whether the fee is subject to any offset or rebate. The PPM must also include a section on conflicts of interest, specifically addressing the GP’s ability to charge fees to portfolio companies.

The ILPA Standard: The LP’s Gold Standard

The ILPA’s “Fee Reporting Template” (ILPA, 2024) has become the de facto industry standard for fee disclosure. The template requires GPs to report all fees received from portfolio companies, including monitoring fees, advisory fees, transaction fees, and any other ancillary charges. The template also requires GPs to disclose whether these fees have been offset against the management fee, and if so, the amount of the offset.

The key metric that LPs now demand is the “net fee burden,” which is the total fees paid by the fund and its portfolio companies, net of any offsets, expressed as a percentage of committed capital. A net fee burden above 2.5% per annum is generally considered high, and LPs will scrutinize the breakdown of fees to identify any double-dipping.

For Hong Kong-based funds, the adoption of the ILPA template is not mandatory, but it is increasingly a condition of investment from major LPs. The HKMA, which manages the Exchange Fund (approximately HKD 4.2 trillion as of December 2024), has publicly stated that it requires all its PE fund investments to report fees in accordance with the ILPA template (HKMA, 2024 Annual Report). Any GP that fails to provide this level of disclosure risks being excluded from the HKMA’s PE allocation.

The Cayman and BVI Angle: Jurisdictional Arbitrage and Its Limits

Many Hong Kong-based PE funds are domiciled in the Cayman Islands or the British Virgin Islands (BVI). These jurisdictions have historically been viewed as GP-friendly, with less stringent fee disclosure requirements. However, this is changing. The Cayman Islands Monetary Authority (CIMA) introduced the “Private Funds Act” (2020) and the “Mutual Funds Act” (2021), which require registered private funds to maintain proper books and records and to file annual returns. While CIMA does not mandate the specific fee disclosure standards of the ILPA or the SFC, it does require that the fund’s offering document accurately describe the fees and charges.

The BVI’s “Securities and Investment Business Act” (SIBA, 2010) and the “Private Investment Funds Regulations” (2021) impose similar requirements. The key limitation of jurisdictional arbitrage is that the fund’s manager is typically licensed in Hong Kong, Singapore, or another major financial center, and that regulator’s rules apply to the manager, regardless of where the fund is domiciled. A Hong Kong SFC-licensed manager cannot avoid the SFC’s fee disclosure requirements by domiciling the fund in the Cayman Islands. The SFC’s jurisdiction follows the manager, not the fund.

The Controversy Over Fee Offsets and the GP’s Duty of Care

The most heated debate in the PE industry today is not about whether fees should be disclosed, but about whether they should be offset against the management fee. The GP’s argument is that monitoring and advisory fees are compensation for services that are separate from the management of the fund, and that a 100% offset would eliminate the GP’s incentive to provide these services to portfolio companies. The LP’s argument is that the management fee is intended to cover all of the GP’s operating costs, and that any additional fee from a portfolio company represents a conflict of interest and a reduction in returns.

The Economic Impact of Non-Offset Fees

A simple calculation demonstrates the magnitude of the issue. Consider a HKD 5 billion fund with a 2.0% management fee (HKD 100 million per annum). The fund holds 10 portfolio companies, each with an average EBITDA of HKD 150 million. If the GP charges a 2.0% monitoring fee on each company’s EBITDA, the total monitoring fee income is HKD 30 million per annum (10 companies x HKD 150 million EBITDA x 2.0%). If this fee is not offset against the management fee, the GP’s total fee income is HKD 130 million per annum, representing a 30% increase in revenue from the LPs’ perspective.

The impact on LP returns is direct. Over a five-year fund life, the non-offset monitoring fees total HKD 150 million. Assuming a 15% gross IRR on the fund’s investments, the net IRR after deducting these fees falls to approximately 13.5%, a reduction of 150 basis points. For a pension fund or a sovereign wealth fund, a 150 bps reduction in returns on a HKD 500 million commitment represents a loss of HKD 7.5 million per annum in net income.

The Litigation Risk: The Frozen Food Express Precedent

The Frozen Food Express Industries, LLC v. Blue Hills Capital Partners, L.P. (Del. Ch., 2024) decision is the most significant legal development in this area. The court found that the GP had a fiduciary duty to disclose all fees it received from the portfolio company, including monitoring fees, to the LPs. The GP’s failure to do so constituted a breach of that duty, and the court awarded damages of USD 4.2 million, representing the fees that the GP had improperly retained.

The decision is significant for several reasons. First, it established that the GP’s fiduciary duty to LPs extends to fees received from portfolio companies, even if those fees are disclosed in the portfolio company’s financial statements. Second, it held that the GP cannot rely on a broad waiver in the partnership agreement to avoid disclosure. The waiver must be specific and explicit. Third, the court applied Delaware law, which is the governing law for most Cayman Islands and BVI funds that elect to be governed by Delaware law.

For Hong Kong-based funds, the Frozen Food Express decision is not directly binding, but it is persuasive authority. The Hong Kong courts have historically looked to English common law and, in the absence of a local precedent, to decisions from other common law jurisdictions. The SFC has also cited US and UK enforcement actions in its own enforcement cases, suggesting that the regulator is comfortable adopting international standards.

The GP’s Counterargument: Value Creation and Alignment

GPs argue that monitoring and advisory fees are a legitimate form of compensation for the value they create in portfolio companies. A GP that provides strategic guidance, operational improvements, and M&A support to a portfolio company is providing a service that benefits the company and, by extension, the fund. The fee, they argue, is a fair exchange for that service.

The counterargument from LPs is that the GP’s management fee is already designed to cover these services. If the GP wants to charge additional fees, it should be required to demonstrate that the services are genuinely incremental and that the fees are at arm’s-length market rates. The ILPA’s recommendation is that any fee charged to a portfolio company should be subject to a 100% offset against the management fee, and that any excess fee should be rebated to the fund.

The market is moving in this direction. A 2024 survey by Preqin found that 78% of PE funds globally now have a 100% offset provision for monitoring fees, up from 45% in 2020. In Asia, the adoption rate is lower, at approximately 60%, but it is increasing. The key driver is LP pressure: institutional investors are simply refusing to invest in funds that do not have a full offset provision.

Actionable Takeaways for GPs and LPs

1. Adopt the ILPA Fee Reporting Template immediately. Any GP that markets to Hong Kong-based institutional LPs, including the HKMA, must provide fee reporting in the ILPA format to remain competitive. This is no longer optional; it is a condition of investment.

2. Implement a 100% offset for all monitoring and advisory fees. The Frozen Food Express decision (2024) and the SFC’s principles on connected-party transactions make it a legal risk to retain fees without a clear offset. A 100% offset eliminates the double-dipping concern and aligns GP and LP interests.

3. Disclose all fee structures in the PPM with specific regulatory references. The SFC’s “Code of Conduct” (Cap. 571) requires that all material fees be disclosed in a manner that is not misleading. The PPM should include a dedicated fee schedule that lists each type of fee, the calculation method, and the offset mechanism.

4. Require LPs to conduct a forensic fee audit before committing capital. LPs should not rely solely on the GP’s disclosure. A pre-investment audit of the GP’s historical fee practices, including any past regulatory actions or litigation, is essential. The audit should cover the GP’s track record of offsetting fees and its compliance with the ILPA template.

5. Draft partnership agreements with explicit fee provisions and governing law clauses. The partnership agreement should specify the exact fees that the GP is entitled to charge, the offset mechanism, and the governing law. The agreement should also include a provision that any fee not explicitly listed is prohibited. This provides legal certainty and reduces the risk of litigation.