The Shanghai government is reportedly taking an initiative, called “Qualified Domestic Limited Partner” (QDLP), to allow foreign asset managers to set up wholly owned subsidiaries in China to raise RMB funds through private placement for investment in international capital markets. Despite the uncertainty of the fate of this QDLP program in the absence of approval by central-level authorities, the general trend of allowing funds raised in China to be invested in international capital markets, perhaps under foreign asset managers’ sole management, is unlikely to change.
Under the current regulatory regime in China, if a foreign fund manager wants to raise capital in China for investment in international capital markets, it may only do so pursuant to the regulations pertaining to Qualified Domestic Institutional Investors (QDII). Under the QDII regime, securities investment fund management companies and securities companies organized in China may apply to the China Securities Regulatory Commission (CSRC) for QDII status. Once qualified, a QDII can raise RMB funds in China, including through public placement; the QDII is then free to convert the RMB funds so raised into foreign currency for investment in international capital markets, subject to a quota pre-approved by the State Administration of Foreign Exchange (SAFE). Foreign ownership is capped at 49% for a securities investment fund management company, and 33⅓% for a securities company.
The Shanghai government is reportedly taking an initiative, called “Qualified Domestic Limited Partner” (QDLP), whose key feature is to do away with the cap on foreign ownership. Instead, it would allow foreign asset managers, hedge funds in particular, to set up wholly owned subsidiaries in China to raise RMB funds through private placement for investment in overseas capital markets. Like QDII, it is contemplated that foreign asset managers that have obtained the QDLP qualification would be able to convert the RMB capital raised into foreign currency for investment in overseas markets, subject to a foreign exchange quota to be granted by SAFE.
The QDLP initiative came on the heels of the implementation in recent years by the Shanghai government of its “Qualified Foreign Limited Partner” (QFLP) program that was aimed at encouraging foreign private equity fund managers to set up private equity funds in Shanghai for fund-raising and investment in China. One of the key attractions of the QFLP program was the possible “domestic” treatment of the funds formed there-under, which would help such funds bypass China’s foreign investment regulations when they make investments, if certain conditions are met.
The QDLP program is viewed as yet another endeavor by the Shanghai government to build the city into a RMB financial center after its launch of the QFLP program only a few years ago. It seems that the QDLP initiative is, in spirit, consistent with the lofty goal set by the State Council and the National Development and Reform Commission (NDRC) to make Shanghai an international financial center and, in particular, a RMB financial products transaction center, during the 12th five-year plan period. However, questions remain as to whether the Shanghai government may have gotten ahead of itself in its aggressive pushing of the QDLP program now and the QFLP program earlier. The blessing of certain specific central-level authorities is required for the successful launch and implementation of a program such as QDLP. This may particularly be the case in light of the recent decision of the NDRC that directly undermined the “domestic” treatment feature in the QFLP program. Now, it seems that the Shanghai government might have to struggle to win the support from the CSRC for the launch of the QDLP program. A recently proposed amendment to the Securities Investment Funds Law (currently being reviewed by the Standing Committee of the National People’s Congress, which is the last step before official promulgation) now makes it clear that funds raised through private placement for securities investment, which would cover the funds contemplated by the proposed QDLP regime, would be subject to the Securities Investment Funds Law, the enforcement agency of which is the CSRC. This proposed amendment seems to suddenly take the wind out of the sails of the Shanghai government’s QDLP push, and casts doubt on the viability of the QDLP program.
Despite what appears to be a setback to the QDLP program, the consensus seems to be that the general direction of allowing funds raised in China to invest in international capital markets, perhaps under foreign asset managers’ sole management, will not change. This is consistent with the trend of continuous reform of China’s own capital markets to be more open to the inflow of international investment, e.g., by relaxing the control over transactions of foreign exchange capital account items. The challenge is for the CSRC, NDRC, SAFE and often aggressive local governments to work out a proper regulatory framework and to allocate their powers and authorities among themselves that would well balance conflicting goals and interests. Foreign asset managers should stay ready to embrace the opportunities to satisfy the desire of RMB Investors to diversify their investment and to tap their appetite for investment in international capital markets. Those already having a joint venture QDII in China may also need to take a hard look at their existing joint venture arrangements to assess whether there are any covenants or obligations (e.g., non-compete) that might impair their ability to go on their own to create RMB funds in China for investment in international capital markets.