The Implementing Measures for the Pilot Program of Foreign-Invested Equity Investment Enterprises (the "Shanghai Measures") promulgated by the Shanghai government in early 2011 mark an important change in China's policy towards foreign funded private equity investment in China. The Shanghai Measures conditionally permit foreign investors to convert foreign currency for investment in and with RMB denominated private equity funds ("RMB Funds") in Shanghai. Furthermore, RMB funds with limited participation of foreign investment may be treated as a domestic fund, excluding them from restrictions applying to foreign funds. Since the Shanghai Measures were enacted, similar RMB Funds have been launched in Beijing, while other areas of China are expected to follow soon.

The Shanghai Measures introduce two vehicles that enable foreign investors to establish or invest in RMB Funds in Shanghai under certain conditions. These vehicles may apply to a joint committee, consisting of Shanghai governmental agencies, for "pilot recognition". Pilot recognition allows foreign investors to convert foreign currency into RMB for equity investment. There was no prior legal basis for such currency exchange before the Shanghai Measures.

The new vehicles are:

Management Enterprise

The foreign invested equity investment management enterprise ("Management Enterprise"), a limited liability company or partnership, acts as general partner of an RMB Fund. A Management Enterprise must have, amongst others, a capital exceeding USD2 million and at least 5 years of relevant experience to apply for pilot recognition. The Shanghai Measures provide that a Management Enterprise with pilot recognition is able to contribute converted foreign capital to an RMB Fund. As long as this contribution does not exceed 5% of the RMB Funds' total capital and it concerns a fund with only domestic investors (i.e. domestic limited partners), the fund will be treated as a domestic fund, excluding it from certain foreign investment restrictions.

Investment Enterprise

The foreign invested equity investment enterprise ("Investment Enterprise"), a partnership, is an RMB Fund. The committed capital of the Investment Enterprise must be no less than USD 15 million, while each limited partner's capital contribution must be no less than USD1 million. To apply for pilot recognition the foreign investors in an Investment Enterprise (i.e. the limited partners) must be institutional investors recognised by the joint committee, such as sovereign wealth funds and securities companies. Each limited partner needs to have, amongst others, self-owned assets worth not less than USD500 million or managed assets worth not less than USD1 million in the financial year preceding the application.

The Shanghai Measures have opened up China's private equity market to foreign investors. Media recently reported that the first group of foreign investors, including the major buyout funds Blackstone Group and Carlyle Group, has obtained qualification recognition in Shanghai. Following Shanghai's lead, Beijing has allowed Goldman Sachs and Morgan Stanley to launch similar RMB Funds in Beijing, while Tianjin is also expected to start a similar program.

The rules governing private equity investment promulgated by different local governments have further developed China's private equity industry, but have also led to an incoherent legal framework in China. The National Development and Reform Commission ("NDRC"), however, recently promulgated the Circular on Further Improving Administration of Developing and Filing of Equity Enterprises in Pilot Areas, followed by Guidelines providing further clarification on the Circular on 21 March 2011. NDRC's legislation for the first time codified general operational, disclosure and filing requirements for RMB Funds in different areas of China.

The new rules on RMB Funds offer foreign investors easier access to domestic investments and domestic investors. Despite these opportunities, regulatory restrictions remain. Further reform will be necessary if foreign investors are to be operating on a level playing field with domestic investors.