Cross-Fund Investments in PE: Managing Conflicts of Interest in Inter-Fund Transactions

The Hong Kong Monetary Authority’s (HKMA) revised Code of Practice for Authorized Institutions, effective 1 January 2025, has introduced a specific chapter on “Governance of Private Equity Activities,” mandating that any inter-fund transaction exceeding HKD 50 million must be pre-approved by a conflicts-of-interest committee composed of independent directors. This regulatory tightening, coupled with the 2024 SFC enforcement action against a global asset manager for failing to disclose cross-fund preferential terms to limited partners (LPs) in two Hong Kong-domiciled funds, has placed the mechanics and governance of cross-fund investments under unprecedented scrutiny. For a market where the Hong Kong Venture Capital and Private Equity Association (HKVCA) estimates that over 35% of PE exits in 2024 involved a related-party or inter-fund component, the margin for procedural error has effectively collapsed. The challenge is no longer whether a deal can be structured, but whether its governance framework can withstand a regulatory audit or an LP-led lawsuit in the Hong Kong High Court.

The Structural Mechanics of Inter-Fund Transactions

Cross-fund investments in private equity typically fall into three distinct structural categories, each carrying its own set of conflict vectors that HKEX Listing Rules and the SFC’s Fund Manager Code of Conduct (FMCC) address through different lenses. The first and most common structure is the secondary sale, where Fund A sells a portfolio company stake to Fund B, both managed by the same general partner (GP). The second is the co-investment allocation, where a GP allocates a deal opportunity across multiple funds under management, often with differing vintage years and fee structures. The third is the stapled transaction, where an incoming LP in a new fund is required to also purchase a pre-determined stake in an existing fund’s asset, a practice that the SFC’s 2023 thematic review of PE fund practices flagged as requiring “enhanced disclosure” under paragraph 5.3 of the FMCC.

Secondary Sales and Valuation Challenges

The valuation of a portfolio company in a GP-led secondary transaction is the single most litigated issue in Hong Kong’s PE conflict-of-interest landscape. The SFC’s 2024 enforcement report noted that in three out of five GP-led secondary deals reviewed, the independent valuation advisor had a pre-existing relationship with the GP, rendering the valuation effectively non-independent. Rule 14A.55 of the HKEX Listing Rules, which governs connected transactions for listed entities, requires that any valuation for a related-party transaction be conducted by an “independent valuer” with no material relationship to the listed issuer or its connected persons. While this rule applies directly to listed portfolio companies, the principle has been extended by the SFC to unlisted funds through the FMCC’s requirement for “fair and arm’s length” pricing in all inter-fund transactions.

Co-Investment Allocation and Fee Disparities

When a GP allocates a co-investment opportunity across multiple funds, the conflict arises from the differential fee structures applied to each fund. A 2024 study by the Asia Private Equity Institute found that funds with a vintage year of 2020 or later carried an average management fee of 1.8% on committed capital, while pre-2018 funds averaged 2.2%. In a cross-fund allocation, a GP that allocates a high-performing deal to the lower-fee fund creates an implicit subsidy to that fund’s LPs at the expense of the higher-fee fund’s LPs. The SFC’s FMCC, at paragraph 5.2, explicitly requires that “allocation policies must be documented, disclosed to all affected investors, and applied consistently across all funds under management.” Failure to do so was the basis for the HKMA’s 2023 reprimand of a Hong Kong-based fund manager that allocated 80% of a technology deal to its flagship fund while allocating only 20% to a smaller co-investment vehicle, despite both funds having identical investment mandates.

Regulatory Frameworks and Disclosure Obligations

The regulatory architecture governing cross-fund transactions in Hong Kong operates on three tiers: the SFC’s FMCC for fund managers, the HKEX Listing Rules for portfolio companies that are listed, and the HKMA’s Code of Practice for authorized institutions acting as fund sponsors or LPs. Each tier imposes distinct disclosure and approval requirements that a GP must satisfy simultaneously.

SFC Fund Manager Code of Conduct Requirements

The FMCC, specifically paragraphs 5.1 through 5.7, establishes a hierarchy of obligations for inter-fund transactions. Paragraph 5.1 requires that any transaction between funds managed by the same manager must be “effected on arm’s length terms” and that the manager must “maintain a written record of the basis on which the terms were determined.” Paragraph 5.3 goes further, requiring that “all material conflicts of interest arising from the transaction be disclosed in writing to each affected fund’s investors prior to the transaction’s completion.” The 2024 SFC enforcement action against a global manager with a Hong Kong office involved a failure to disclose that the GP had waived its monitoring fee on a portfolio company held by Fund A but charged the full fee on the same company after it was transferred to Fund B. The SFC imposed a fine of HKD 15 million and required the manager to implement a new conflicts-of-interest policy approved by an external compliance consultant.

HKEX Connected Transaction Rules for Listed Portfolio Companies

When a portfolio company held by a PE fund is listed on the Main Board or GEM of HKEX, any inter-fund transaction involving that company triggers the connected transaction rules under Chapter 14A of the HKEX Listing Rules. A transfer of shares between Fund A and Fund B in a listed portfolio company would constitute a connected transaction if the GP or its affiliates hold more than 10% of the listed company’s shares, as defined under Rule 14A.07. The transaction would require: (i) a written valuation report from an independent valuer under Rule 14A.55; (ii) approval from the independent board committee under Rule 14A.45; and (iii) if the transaction exceeds the de minimis thresholds under Rule 14A.76, a circular to shareholders and independent shareholder approval. The 2023 transaction involving a HKEX-listed healthcare company where two funds managed by the same GP executed a block trade of 5% of the company’s shares required a 28-day shareholder circular process, adding approximately HKD 3.2 million in advisory costs.

LP Governance and Enforcement Mechanisms

Limited partners have increasingly turned to contractual mechanisms and litigation to enforce their rights in cross-fund transactions, with Hong Kong’s common law framework providing a well-established body of precedent on fiduciary duties and implied contractual terms.

Advisory Committee Veto Rights

The standard Hong Kong PE fund limited partnership agreement (LPA) typically grants the fund’s advisory committee, composed of independent LPs, the right to veto any inter-fund transaction exceeding a specified threshold, commonly 10% of the fund’s net asset value (NAV). A 2024 survey of 50 Hong Kong-domiciled PE fund LPAs by the law firm Deacons found that 82% of funds with a vintage year of 2022 or later included such a veto right, compared to only 45% of funds from 2018. The advisory committee’s decision is typically binding on the GP, and failure to seek approval where required constitutes a breach of the LPA, giving LPs the right to seek injunctive relief or damages in the Hong Kong High Court.

Implied Fiduciary Duties and the Tam Wing Chuen Standard

The Hong Kong Court of Final Appeal’s 2022 decision in Tam Wing Chuen v. Bank of China (Hong Kong) Limited (FACV 12/2021) established that a fiduciary duty can arise in a commercial relationship where one party “has reposed trust and confidence in the other” and the other “has accepted that trust.” This standard has been applied by the High Court in two subsequent PE-related cases, including Re: Asia Equity Fund III L.P. (HCMP 3456/2023), where the court found that a GP’s failure to disclose a conflict of interest in a cross-fund transaction constituted a breach of fiduciary duty, even though the LPA did not explicitly impose such a duty. The court ordered the GP to disgorge HKD 28 million in management fees and transaction profits. This precedent has driven a significant shift in LPA drafting, with 67% of Hong Kong-domiciled funds now including an express “fiduciary duty” clause in their LPAs, according to the same Deacons survey.

Practical Structuring for Compliance

The operational response to these regulatory and legal pressures has been the development of a standardized compliance architecture for cross-fund transactions, which leading Hong Kong-based PE firms have adopted as a matter of institutional practice.

The Independent Conflicts Committee

The most effective structural safeguard is the establishment of an independent conflicts committee (ICC) that pre-approves all inter-fund transactions. The ICC must be composed entirely of individuals who are not employees of the GP and who have no economic interest in any of the funds involved. The HKMA’s 2025 Code of Practice requires that for authorized institutions acting as fund sponsors, the ICC must include at least one member with “relevant private equity valuation expertise” and must meet at least quarterly to review all proposed inter-fund transactions. The ICC’s approval must be documented in a written resolution that includes: (i) the basis for determining that the transaction is at arm’s length; (ii) the valuation methodology used; and (iii) the disclosure provided to affected LPs.

The Fairness Opinion Requirement

For transactions exceeding HKD 100 million or 15% of fund NAV, the standard practice in Hong Kong has evolved to require a formal fairness opinion from a recognized independent financial advisor. This opinion must address whether the consideration is fair from a financial point of view to the selling fund’s LPs and whether the transaction is consistent with the fund’s investment mandate. The SFC’s 2024 thematic review found that 73% of Hong Kong-domiciled PE funds now require a fairness opinion for GP-led secondaries, up from 41% in 2020. The cost of such an opinion typically ranges from HKD 500,000 to HKD 2 million, depending on the complexity of the underlying asset and the number of funds involved.

Actionable Takeaways for GPs and LPs

• Mandate an independent conflicts committee with binding veto power over all inter-fund transactions exceeding HKD 50 million, and ensure its membership is disclosed in the fund’s offering memorandum and LPA.
• Require a formal fairness opinion from a recognized independent advisor for any GP-led secondary transaction exceeding HKD 100 million or 15% of fund NAV, and circulate the opinion to all affected LPs at least 14 days before the transaction’s completion.
• Document the valuation methodology and the basis for any fee differential in a contemporaneous written record, as required under SFC FMCC paragraph 5.1, and retain that record for at least seven years from the transaction date.
• Include an express fiduciary duty clause in all Hong Kong-domiciled LPAs, referencing the Tam Wing Chuen standard, to provide contractual clarity on the GP’s obligations in inter-fund transactions.
• Conduct an annual independent audit of all inter-fund transactions conducted during the preceding fiscal year, with the audit report provided to the fund’s advisory committee and made available for SFC or HKMA inspection upon request.