31 July 2012
This update describes two recent PRC legal developments: the amendments proposed to be made to the Securities Investment Funds Law and the possible introduction of a qualified domestic limited partner (QDLP) scheme in Shanghai.
Regulation of Private Investment Funds
The Standing Committee of the PRC National People's Congress is undertaking a public consultation process with respect to various amendments to the Securities Investment Funds Law.
The amendments seek to bring private investment funds under the supervision of China Securities Regulatory Commission (CSRC) and, represent a comprehensive effort to regulate the public/private fund industry and fund managers in China.
The major changes which are relevant to private investment funds are summarised below:
1. Scope of the Law
Public or private funds that make investments in securities will be subject to the Securities Investment Funds Law. Securities includes shares (both listed and non-listed), bonds, and other forms of securities and derivatives as determined by the CSRC. As a result, a private investment fund that makes investments in or holds securities, whether listed shares or non-listed shares in companies limited by shares, will be subject to the Securities Investment Funds Law.
2. Safe Harbour for Private Placements
The amendments include an exemption for marketing a private investment fund, i.e., a fund whose interests are offered via a private placement to less than 200 qualified investors who meet qualification requirements which are to be separately promulgated by the CSRC. Such qualification requirements are expected to include minimum income/asset level requirements, minimum subscription amounts and an evaluation of the investor's ability to understand, and bear, the risks involved.
3. Registration Requirement
The amendments include an obligation on private fund managers to register with the CSRC or, if the capital being sought for, or the number of investors being sought, are below a certain threshold, with a fund industry association. Without such registration or filing, the fund or fund manager is prohibited from using the terms "fund", "fund management" or other similar names in its name. The CSRC will have the right to restrict a private fund manager that fails to register with the CSRC or file with a fund industry association, or a fund under management by such private fund manager, from opening a securities account or undertaking securities trading activities.
4. Filing Requirement
Upon completion of fund raising by a private investment fund, the investment manager is required to file the prescribed details thereof with the CSRC or a fund industry association, as the case may be.
5. Custodian Requirement
The assets of a private investment fund must be held by an independent custodian unless otherwise provided for in the constitutive documents of the fund.
6. Management of Public Funds by Private Fund Managers
Subject to approval of the CSRC, a private fund manager may also manage public funds if its shareholders or senior management personnel meets certain requirements.
The amendments contain regulations for providers of various fund services in respect of publicly offered funds such as custodians, distributors, administrators and registrars, including a requirement for them to register with the CSRC. The amendments also contain fairly strict requirements on legal and accounting professionals providing services to funds.
The amendments, if adopted, will be a milestone for the legal development of the private investment fund industry in China and will be the first national law governing the formation and operation of private investment funds.
However, the amendments also present a number of issues that need to be addressed, some of which may require cooperation and coordination among different government agencies.The amendments seek to create a registration framework and procedure for private investment funds and fund managers, which differ from current NDRC registration requirements applicable to private investment fund managers.
Consideration may also need to be given to current practices of private fund industry when analyzing the impact of the amendments. Therefore, it remains to be seen what changes may appear in the final form of the amendments as it is understood various industry participants and service providers, including ourselves, have provided comments on the amendments.
Editorial note: After the consultation period ended on 5 August 2012, various PE/VC associations submitted a response on 13 August 2012 seeking to exclude PE/VC funds from the scope of the proposed law.
China may soon permit hedge fund managers to raise capital from PRC investors to invest in offshore securities markets.
According to industry participants, a new pilot scheme, Qualified Domestic Limited Partner (QDLP), is in the making and is set to start soon in Shanghai. The timing for the formal establishment of the QDLP program is uncertain, however, the Shanghai Municipal Office of Financial Services first spoke about the launch of a trial programme in March 2012. Under the QDLP scheme, an offshore hedge fund manager (or a PRC domestic institution), once approved, will be permitted to register in Shanghai, raise capital from qualified Chinese investors, convert such RMB into foreign currency under a quota granted to it and then invest in offshore securities markets, using different strategies, including long/short.
At present, Chinese investors' access to offshore securities market is still limited as a result of PRC's foreign exchange controls. Under the qualified domestic institutional investor (QDII) program, qualified PRC financial institutions may set up a QDII fund, convert RMB capital raised by such QDII fund from PRC investors into foreign currency and invest in offshore securities, with more limited investment strategies. Such QDII funds often are managed by the PRC financial institutions' offshore subsidiaries. An offshore asset manager (including a hedge fund manager) may only be able to serve as investment advisor to provide investment advice to such QDII funds.
The QDLP scheme, however, will permit qualified hedge fund managers to raise capital in China and manage its investments in offshore securities directly from China. The scheme has not been officially announced, but it was reported that hedge funds have already been lining up to apply for licenses in Shanghai. Similar to Shanghai's QFLP program (for private equity funds), the QDLP scheme is expected to start slowly and cautiously, and only the world's largest hedge funds may be allowed to participate, at least initially. It was reported a cap of USD5 billion has been set as the aggregate amount the approved hedge fund managers will be permitted to raise in China and invest offshore, collectively.
The PRC investors in this scheme are expected to be qualified high net worth individuals and institutions, similar to investors in private equity funds, with higher qualifications than investors in mutual funds or funds under the current QDII program.
This QDLP scheme is another step to open up China's capital account and further develop the country's capital market. It will allow offshore hedge fund managers access to capital in China, while providing qualified PRC investors access to offshore alternative investment managers and investment strategies.
A formal announcement of the QDLP scheme may be expected to be released later this year.
For inquiries related to this Legal Update, please contact Phill Smith, Yong Ren or your usual contacts with our firm.