In the last decade, there has been a dramatic increase in the total assets under management (AUM) of local fund management companies in the PRC — from RMB 260 billion (approximately USD41 billion) as of December 2003 to RMB 2.2 trillion (approximately USD 345 billion) as of December 2011, complemented by the boom in qualified foreign institutional investors (QFII), with a total investment quota of USD28.5 billion granted as at the end of July 2012.
In response to industry demand, Chinese central legislators recently published two sets of regulations — Circular on Certain Issues Regarding The Implementation of Administrative Measures on Domestic Securities Investment by Qualified Foreign Institutional Investors (关于实施《合格境外机构投资 者境内证券投资管理办法》有关问题的规定) (the QFII Circular) issued on 27 July 2012 and the Proposed Amended Securities Investment Fund Law (证券投资基金 法（修订草案）) (Proposed Fund Law) issued on 6 July 2012. These regulations have the general effect of enhancing the current regulatory regime governing foreign and domestic investors, respectively. There have been similar initiatives at the provincial level as well — it is widely expected that the Shanghai municipal government will shortly launch a qualified domestic limited partner (QDLP) program that will allow foreign asset managers to form RMBdenominated private funds for investment in overseas markets. In addition, on 27 August 2012, the Shanghai Securities Exchange (SSE) announced that it was considering drafting rules to allow so-called “sunshine” private trust funds (hitherto the PRC’s answer to hedge funds) to trade interests in the funds on the SSE.
Since 2002, the QFII program has allowed foreign investors to buy and sell RMB-denominated shares listed on the Shanghai and Shenzhen stock exchanges. The QFII Circular effectively relaxed a number of key aspects of the existing QFII regime.
Minimum AUM: As had been widely anticipated by the industry, the financial threshold requirements for QFII applicants have been significantly eased — the minimum AUM requirements for all categories of QFII applicants (i.e., asset managers, commercial banks, securities firms and other financial institutions) have been lowered. As an example, the minimum AUM requirement for QFII asset manager applicants is now only USD500 million instead of USD5 billion, which is a significant reduction and opens the gates to many more potential applicants. QFII applicants are also now required to submit audited reports of only the preceding one year instead of the preceding three years.
Segregated Accounts: QFIIs may now establish segregated accounts for each client’s investments. Previously, only “open-ended China A funds” managed by QFIIs were permitted to maintain separate accounts of their own. This development will afford segregation and protection of different clients’ assets and help mitigate risk of comingled assets. This will clearly be attractive to more sophisticated clients of QFII applicants. QFIIs may also maintain multiple trading accounts with different brokers, whereas previously each QFII was limited to working with only one broker with respect to each stock exchange.
Investments: QFIIs are permitted to invest in the interbank bond market as well as stock index futures in China, and the maximum aggregated shareholding of QFIIs in any one PRC-listed company has been increased from 20% to 30%.
Proposed Fund Law
Separate efforts are also being made to improve the regulatory environment for domestic participants. On 6 July 2012, the National People’s Congress published the Proposed Fund Law for public consultation.
One of the most significant amendments proposed by the legislature is to extend the existing Law on Securities Investment Funds to the private fund industry (which is currently not covered by the domestic regulatory framework). The Proposed Fund Law introduces a registration system for private fund managers and private funds. Private funds may only be offered to qualified investors who have a specified minimum threshold level of income or asset holdings (details of which are to be determined by the China Securities Regulatory Commission) and who are able to understand and bear the potential risks that may arise from an investment in a private fund.
The Proposed Fund Law also introduces a new fund structure to public funds — the board of administration form (which is more akin to a mutual fund corporation structure) — in addition to the traditional contract-form public fund (which is more akin to a unit trust). The board of administration-form public funds may delegate certain powers and duties to the board of administration (which is established through a holders’ general meeting).
Certain regulations and restrictions on fund management companies have been extended to their shareholders and de facto controllers. As the Proposed Fund Law does not distinguish between joint venture fund management companies (between foreign and domestic parties) and purely domestic fund management companies, foreign shareholders of joint venture fund management companies will, presumably, also be subject to such enhanced supervision.
Noting the lack of a national regulation that governs the distribution of offshore private funds in the PRC, the Shanghai municipal government has taken the initiative to invite qualified foreign asset managers to establish private RMB-denominated funds in Shanghai.
While there is uncertainty as to the actual rules applicable to the establishment and operation of such structures (the detailed QDLP rules are yet to be published and be publicly available), the industry seems to expect that the program will set high financial asset net worth and minimum investment threshold amounts for the high net worth domestic individuals and institutional investors who will be permitted to invest in such funds. Additionally, there will likely be qualification requirements applicable to the foreign asset managers permitted to establish such RMB-denominated funds.
Given the lack of publicly available direction in this area, interested potential QDLP participants are now engaging directly in discussions with the Shanghai municipal government or local industry participants in a bid to determine a leading edge.
Listing of Sunshine Private Trust Funds on the SSE
Another initiative that has recently come under the spotlight is the SSE’s announcement to consider a plan to list so-called “sunshine” private trust funds on the SSE in order to facilitate trading in such funds by retail investors. While the relevant rules in this regard are yet to be released and implemented, the initiative is believed to be a move to attract more retail investors to support the growth of the sunshine private trust funds industry and also provide a greater variety of investment options for domestic investors.
Sunshine private trust funds, a domestic PRC hybrid between a private hedge fund and a public mutual fund, are popular investments with financial institutions and high net worth individuals in China because, in order to comply with certain fund formation, fund raising and regular information disclosure requirements and other regulations, sunshine private trust funds operate in a more transparent way than traditional private hedge funds. Also, sunshine private trust funds are exempted from certain of the investment restrictions and limitations imposed on public mutual funds, which gives more flexibility in the operation of such sunshine private trust funds.
These new regulations and proposals appear to indicate a trend among the PRC regulators towards a more efficient and transparent investment funds regulatory regime in the PRC, which should attract both domestic and foreign participants. It is expected that the QFII application process will be further simplified and that an increased number of QFII licenses will be more easily granted/obtained in the near future.
The Proposed Fund Law, although still subject to further changes by the National People’s Congress, has generally been welcomed by industry participants. Notwithstanding the current silence of the Proposed Fund Law on how foreign fund managers may raise and market private funds in China, the QDLP program, although initiated only in Shanghai, will (if it is successfully launched) provide a new channel for foreign asset managers to attract RMB-denominated subscriptions.