Melody Yang and YuYing Wang discuss the impact to global asset managers who are raising funds from Chinese investors or establishing private funds onshore.
On 9 July 2023, the State Council signed the State Council Order No. 762 and published the Regulations on the Supervision and Administration of Private Investment Funds (the “Regulations on Private Funds”), which will come into effect on 1 September 2023.
Unlike the Securities Investment Fund Law of the People’s Republic of China, which technically only applies to public funds and private securities investment funds, the Regulations on Private Funds, as the first administrative regulation (being a law of very high hierarchy) in the private fund industry, will become an overarching document for various private funds (including private equity and venture capital funds), and shall have profound significance for recognising the legal status of different types of private funds in China’s fund industry.
The major regulatory principles and requirements of the Regulations on Private Funds have been reflected in the rules published in recent years, and they have been generally recognised and expected by the industry. However, some of the provisions may have the following impacts on global asset managers who are raising funds from Chinese investors or establishing private funds onshore:
1. At the fund managers level:
1.1 Special Regulations on Foreign Private Investment Fund Managers
Article 61(1) of the Regulations on Private Funds stipulates that the supervisory measures for foreign-invested private fund managers shall be formulated by the securities regulatory authority of the State Council in conjunction with relevant authorities of the State Council in accordance with foreign investment laws, administrative regulations, and such Regulations on Private Funds.
At present, regulatory authorities have completely lifted the restrictions on the proportion of foreign investment in private fund managers sector. The special regulations on foreign private fund managers mainly refer to the Questions and Answers regarding Private Fund Registration and Recordation (X) issued in 2016 by the Asset Management Association of China (AMAC) for foreign private securities investment fund managers and the relevant regulations under Article 14 of the Measures for the Private Fund Registration and Recordation (the “Registration and Recordation Measures”) issued this year.
According to these regulations, the controlling shareholders and actual controllers of foreign private securities investment fund managers should be overseas financial licensed institutions. If the fund engages in securities and futures trading onshore, the manager (including WFOE PFMs) shall make investment decisions independently, and shall not place trading orders through an overseas institution or system, except as otherwise specified by the China Securities Regulatory Commission (CSRC). Except for these, there are no specific regulations or self-disciplinary rules that specifically apply to the registration and special regulations of foreign private fund managers.
Based on the relevant provisions of Article 61, we understand that, in the future, the CSRC may collaborate with authorities related to foreign investment (such as the Ministry of Commerce, the State Administration of Foreign Exchange, and the State Administration for Market Regulation) to issue separate regulations applicable to foreign private fund managers, so as to effectively achieve the coordination of regulatory rules across multiple authorities.
Not only do these provisions apply to the common WFOE PFM structure, it is also possible that there would be a national unification of legislation on Qualified Domestic Limited Partners or Qualified Domestic Investment Enterprises (QDLP/QDIE), and/or Qualified Foreign Limited Partners (QFLP).
1.2 Cross-border fundraising
Articles 61(2) and (3) of the Regulations on Private Funds stipulate that overseas institutions shall not raise funds directly from domestic investors to establish private funds, unless otherwise prescribed by the State. Private fund managers carrying out private fund business activities overseas shall comply with relevant State regulations.
The aforementioned regulations respond to the long-standing concerns in the market regarding cross-border fundraising by asset management institutions. On one hand, they clarify the principle that overseas institutions are not allowed to raise funds directly from domestic investors, and at the same time retain flexibility by allowing special domestic investors who are currently approved by regulatory authorities or allowed by specific laws and regulations to carry out overseas fund investments to continue to participate in related businesses.
The latter mainly includes Chinese sovereign wealth funds (such as CIC, SAFE and NSSF), Qualified Domestic Institutional Investors (QDII/RQDII), QDLP/QDIE, etc. However, regarding the meaning of non-eligible “Domestic Investors” who are restricted from investing in overseas funds, the Regulations on Private Funds did not provide an interpretation. Therefore, whether the current practice of overseas asset management institutions raising funds from high-net-worth Chinese investors who have legitimate foreign currency in their overseas bank accounts will be completely banned, still remains to be clarified.
1.3 Continuous Compliance
Article 13 of the Regulations on Private Funds stipulates that private fund managers shall continuously meet the following requirements:
- good financial condition, with operating capital which is suitable for the type of business and the size of assets under management;
- the legal representative, executive partner, or appointed representative, or senior management responsible for investment management shall hold a certain ratio of the equity or property shares of private fund managers in accordance with the regulations of the CSRC, unless otherwise stipulated by the State;
- other requirements stipulated by the CSRC.
The aforementioned regulation is consistent with Article 8 of the Registration and Recordation Measures, which prescribes the financial status, paid-in capital, and executive shareholding ratio requirements for private fund managers. It emphasises on continuous regulation on private fund managers.
Please note that, unlike the Registration and Recordation Measures, which prescribed the identical paid-in capital requirements for general managers (i.e., except otherwise specified by the private fund managers specializing in managing venture capital funds, other private fund managers’ paid-in capital shall be not less than CNY 10 million monetary capital or its equivalent value), this part requires managers to “possess operating capital which is suitable for both the type of business and the size of assets under management”.
This represents that private fund managers may not only need to satisfy the capital adequacy requirements upon the initial AMAC registration, but may also need to continue to comply with such requirements in their future daily operations, for example, meeting the potential capital reserve requirements. As for how to monitor the compliance on an ongoing basis, and whether the amounts and ratio of operating capital requirements are based on the manager’s business type and the managed scale of assets, remain to be further refined by subsequent regulatory rules.
1.4 Fund distribution
Article 17 of the Regulations on Private Funds stipulates that private fund managers shall raise funds on their own and shall not entrust others to raise funds, except as otherwise prescribed by the securities regulatory institution of the State Council.
Based on current AMAC rules, managers may engage institutions which acquired both the fund sale business qualification and member registration with AMAC to raise funds. In practice, we noticed that many asset management institutions which have just entered the Chinese market have engaged securities companies and other fund sales licensed institutions to raise funds in setting up their PFM funds and QDLP/QDIE funds for investment in securities.
In the public fund sales rules issued by the CSRC in 2020, it was explicitly stipulated that part of the rules equally apply to the sale of private funds, and independent fund sales institutions (referring to institutions specialized in fund sales business compared to financial institutions such as securities companies and futures companies) can only sell public and private securities funds on behalf of others, and cannot sell private equity funds. Therefore, for private equity funds, it is usually the responsibility of their manager to raise funds on their own.
Certainly, feeding investors’ funds into private funds through investment platforms (known in China as “wrapper products”) that are established by third-party asset management institutions is another viable option. We understand the current structure of fund consignment sales will not fundamentally change due to the implementation of the Regulations on Private Funds.
1.5 Investment Advisor
Article 27 of the Regulations on Private Funds stipulates that the fund manager may entrust the fund investment advisor specified in the Securities Investment Fund Law to provide securities investment advisory services. The Securities Investment Fund Law does not clearly state the rules in relation to the competency requirements for fund investment advisors, but has merely stated that the fund’s investment advisory institutions and their practitioners should not promise or guarantee the investment return.
According to the relevant provisions of the CSRC’s implementation rules of the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions issued by PBOC, CSRC and other authorities (“Super Guidance”) and the self-disciplinary rules of the AMAC, institutions providing investment advisory services for private securities investment funds include
- securities and futures operating institutions that can engage in asset management business (such as securities companies, futures companies, public fund companies and their subordinate asset management institutions), and
- private securities fund managers who meet the “3+3+1” condition, namely,
- they are members who have been registered with the AMAC for at least one year and have no record of major violations of laws and regulations, and
- there are at least three investment management personnel who have continuously perform traceable securities and futures investment management services for at least three years and have no adverse employment records.
We understand that the introduction of the Regulations on Private Funds does not affect the current regulatory status of private fund investment advisors.
2. At the fund level: Exemption of prohibition of multi-layered investments
Article 25(1) of the Regulations on Private Funds stipulates that the investment layer of private funds should comply with the regulations set out by the financial regulatory department of the State Council. However, private funds that meet the requirements set out by the CSRC and invest their majority of fund assets in other private funds are not deemed as one investment layer.
Such regulations, on one hand, confirms that private funds should be applicable to the provisions regarding the prohibition of exceeding two layers of investment of private investment products in the Super Guidance, which states that “An asset management product may further invest in a layer of asset management product, but the latter may not further invest in an asset management product other than a publicly offered securities investment fund.”
On the other hand, on the basis of the existing rules which exempt venture capital funds and government-funded investment industrial investment funds from accepting investments from asset management products and other private funds, where such funds are not considered as a layer of asset management product, this further exempts those fund of funds (“FoF”) which meet the regulatory conditions specified by the CSRC from being considered as one investment layer.
Please note that the specific conditions that such FoF which could be exempted from being deemed as one investment layer needs to meet, and how should FoF be defined (such as whether there is a minimum ratio requirement for the capital invested in other private funds to the entire investment scale of the FoF), would have to be clarified by subsequent regulatory rules.
3. Heightened legal responsibilities
Chapter 5 of the Regulations on Private Funds stipulates the responsibilities, rules and measures of the CSRC for supervising and managing the business activities of private funds. In the meanwhile, chapter 6 of the Regulations on Private Funds stipulates the specific legal responsibilities corresponding to the violations under such regulations.
Among the rules, due to the heightened legal responsibilities targeted on private fund managers, individuals that are directly responsible for violations, and responsible officers, the cost of illegal activities in this aspect has significantly increased.
For example, for the front running behaviours of private fund managers and their personnel who disclose non-public information obtained due to their convenience of position, use such information to engage in or explicitly or implicitly cause others to engage in related trading activities, according to the rules of Interim Measures for the Supervision and Administration of Private Investment Funds issued in 2014, the maximum amount of fine was only CNY 30,000, which is difficult to have punitive effect. In practice, although there have been cases where regulatory authorities have referred to similar provisions of public funds for punishments, the legal basis for application is relatively indirect.
The newly published Regulations on Private Funds align the rules in relation to applicable penalty level for front running in the context of public funds. Private fund managers and their related personnel may be required to have their illegal gains confiscated and face fines ranging from 1 to 5 times of the illegal gains due to such violations.
We will continue to monitor the implementation status of the Regulations on Private Funds in practical operations and the introduction of relevant detailed rules and share them with you in a timely manner.
This article was contributed by Melody Yang, Partner, and YuYing Wang, Managing Associate, at Simmons & Simmons in Beijing.