Many international private equity investors have expressed intense interest in forming or investing in RMB funds. The lack of a national framework in China to regulate private equity funds in general, and foreign-invested private equity funds in particular, has made the process challenging for fund sponsors and LPs; it has also created opportunities for the more entrepreneurial local governments, such as cities like Beijing, Shanghai and Tianjin, to formulate their own local regulations and establish themselves as the “fund centers” of China. For example, in February 2010, the Shanghai Administration of Industry & Commerce registered the Carlyle-Fosun partnership, and earlier this year the Shanghai Financial Services Office issued The Implementation Measures of Pilot Projects on Foreign Equity Investment; other cities such as Beijing are working on their own versions of similar rules.
Since January 2011, China’s National Development and Reform Commission (the NDRC) appears to emerge as the national regulator of funds established in China. On 31 January 2011, the NDRC issued the Circular on Further Regulating the Development, and the Administration on Filings, of Equity Investment Enterprises in Pilot Areas (the Circular), which came into effect on its issuance date. In addition to promulgating certain filing requirements, the Circular outlines certain ‘best practice’ principles on the organization, fund raising, investment practices, risk management and disclosure of “equity investment enterprises” (which term includes private equity funds and funds of funds). Then, on 21 March 2011, the NDRC issued 11 guidelines (the Guidelines) to implement the filing requirements set forth in the Circular.
Under the Circular and the Guidelines, any fund or fund of funds organized in any of the six “pilot locations” – Beijing, Tianjin, Shanghai, Jiangsu Province, Zhejiang Province and Hubei Province (the Pilot Locations) – must file with the NDRC, unless (i) it is a venture capital enterprise that makes filings in accordance with applicable laws, (ii) its fund size is less than RMB500 million or its foreign exchange equivalent, (iii) its fund size exceeds RMB500 million but not more than RMB100 million (or its foreign exchange equivalent) has been contributed, or (iv) all its capital is contributed by one institutional or individual investor, or by two or more investors that are wholly owned subsidiaries of the same institutional investor. The filing process can take up to 40 business days. The NDRC will release on its website names of the funds that have completed their filings.
These Guidelines include certain procedural details and forms, and recommend provisions and content for private placement memoranda, articles of association and partnership agreements for both the funds and the fund managers, legal opinions to accompany any application, and so forth. The Guidelines also interpret certain provisions and clarify some ambiguities under the Circular.
Historically, filings by funds with the NDRC were voluntary and there was no specific time frame on the NDRC’s review. However, such filing is a condition to raising capital from the China national pension fund. As so many funds have submitted their applications with the NDRC, as a practical matter, only a few select funds with strong government support could be filed after a lengthy review process. Therefore, foreign invested funds and funds with foreign or foreign invested managers have long awaited a new regulation to open the door for them, and some may consider this Circular as their answer.
“Domestic” or Not
The Circular does not make a distinction between purely domestic funds, foreign invested funds, or funds with only domestic investors but a foreign or foreign-invested fund manager. As a result, the market has speculated that the Circular's general applicability to all funds in the six Pilot Locations may mean that foreign invested funds (perhaps even in the form of Sino-foreign partnerships) may be organized in China (at least in the six Pilot Locations). Some foreign fund managers further hope that foreign invested funds, once so filed with the NDRC, are qualified to raise capital from China's national pension fund.
Even if foreign invested funds may be formed in China, the NDRC has not clarified whether a foreign invested fund, or a fund with a foreign or foreign invested manager, would enjoy the status of a “domestic” fund when it invests in portfolio companies. The Circular touches on this hot topic with only one sentence – it provides that investments by a “foreign invested equity investment enterprise” shall be subject to the approval process in accordance with the relevant regulations. Therefore, it would appear that a foreign invested fund cannot enjoy the “domestic” status when it invests in portfolio companies and, as such, cannot avoid the approval process related to foreign investments in China. However, it remains unclear if a “foreign invested equity investment enterprise” only refers to funds with foreign investors (e.g., a Sino-foreign partnership), or if the NDRC uses this term in a loose way to include funds with foreign or foreign invested managers with only domestic investors.
Regulation on Fund-Raising and Disclosure Strengthened
The Circular strengthens regulation on fund-raising. For example, it is prohibited to make a public offering of fund units through the Internet or agents, or to guarantee a fixed return to the investors while raising the fund.
Other than disclosure to the investors, the Circular also calls for disclosure of audited annual financial statements, annual business report and material changes (for example, mergers and acquisitions, liquidation, etc.) to the NDRC. Private funds generally would not want to make their financial statements or reports to investors available to the public. While the Circular is silent as to whether information provided to the NDRC will be made available to the public, based on past experience, that seems unlikely.
Minimum Capital Commitment Recommended
The Circular provides that a fund may raise capital only from investors who can identify and take the risks associated with such investments, but does not set a minimum capital commitment by each investor. Under the Guidelines, the NDRC recommends a minimum capital commitment of RMB10 million per investor. Although the Guidelines only recommend rather than mandate such minimum amount, it remains to be seen how the NDRC would handle applications of funds with investors who fail to satisfy such minimum amount.
Other Points to Note
The Guidelines reiterate restrictions on state-owned enterprises, listed companies, or public service units or social communities from becoming general partners of funds or fund managers. The Guidelines further provide that for the purposes of the Guidelines, “state-owned enterprises” refer to enterprises in which the aggregate state-owned shareholding is at least 50% – this definition seems to suggest that it is possible for enterprises with minority stakes held by the state to become general partners in funds.
The Guidelines expressly prohibit any investor from investing in a fund as a nominee. They also recommend that partnership agreements of funds not contain any provisions under which limited partners will, directly or indirectly, participate or otherwise be involved in the management and decision-making of such fund.
Regarding disclosure, other than the disclosures to investors and the NDRC as required under the Circular, the Guidelines encourage proper disclosure to the public on a voluntary basis, provided that such disclosure neither involves any trade secret nor contains any information on the fund-raising.
As the Circular and the Guidelines are implemented, and as the NDRC promulgates more rules and regulations regarding RMB funds, Orrick will continue to monitor developments and provide further updates.