On 31 January 2011, the National Development and Reform Commission (the NDRC) of China issued the Circular on Further Regulating the Development, and the Administration on Filings, of Equity Investment Enterprises in Pilot Areas (the Circular). The Circular sets forth certain "best practices" principles on organization, fund raising, investment practices, risk management and disclosure of "equity investment enterprises" (which includes private equity funds and funds of funds). In addition, the Circular mandates that funds organized in six pilot locations - Beijing, Tianjin, Shanghai, Jiangsu Province, Zhejiang Province and Hubei Province (the Pilot Locations) – file with the NDRC. The Circular came into effect on its issuance date.

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 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.

Filing Requirements

The Circular requires that any fund or fund of funds organized in the Pilot Locations 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, or (iii) 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.

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

With only one sentence, the Circular touches on the hot topic of 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 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.