On December 24, 2010, three government agencies in Shanghai issued “Implementing Measures Concerning Carrying Out Pilot Program for Foreign Invested Equity Investment Enterprises in Shanghai” (the “Measures”). These Measures are expected to have a significant impact on foreign private equity (“PE”) investment in China.


Generally speaking, in China, foreign investment is subject to government approval by the Ministry of Commerce (the “MOFCOM”) at the central or local levels (depending on the size or nature of the investment), even if the foreign investment accounts for a very small percentage of the total capital of a company. When a Chinese PE fund has foreign GPs or foreign limited partners (“LPs”), it becomes a foreign invested equity investment enterprise (“FPE”), which is subject to MOFCOM approval. In addition, a person seeking to make an investment in China must do so in Chinese local currency, RMB. If such RMB is converted from a foreign currency, such conversion is subject to approval from the State Administration of Foreign Exchange (“SAFE”) or its local branch. In the past, SAFE granted approval subject only to the receipt of MOFCOM approval. However, due to the recent appreciation of RMB, SAFE has tightened up its approval process.  

The Measures

FPEs and FGPs

Pursuant to the Measures, foreign investors are allowed to participate in (i) FPEs, which are essentially private equity funds with foreign investment, and (ii) foreign invested equity investment management enterprises, which are essentially GPs (in the context of PE funds) with foreign investment (“FGPs”). A FPE’s main business is to invest in private Chinese companies, while a FGP’s is to establish a FPE and/or to manage its PE investment activities.

Pilot FPEs and Pilot FGPs

The Measures provide a framework for Pilot FPEs and Pilot FGPs, which are entitled to preferential treatment as follows:

  • an approved Pilot FPE may utilize custodian banks to deal with foreign exchange issues, implying that a Pilot FPE would not need to obtain SAFE approval of foreign exchange conversions; and
  • an approved Pilot FGP can invest foreign currency into a PE fund it has formed in an aggregate amount up to 5% of the total committed capital of the fund, without changing the nature of the PE fund from a domestic Chinese fund to an FPE. Accordingly, if all LPs are Chinese domestic investors and the GP is a foreign entity, the GP’s minority equity interest up to 5% will not change the PE fund from a domestic PE fund to an FPE (the “5% Rule”). However, as discussed below, the 5% Rule may be subject to modification.

According to the Measures, to apply for the establishment of a Pilot FPE, a foreign investor must:

  1. own assets of not less than US$500 million or manage assets of not less than US$1 billion in the fiscal year preceding the application;
  2. have a good corporate governance structure and internal control system, and have not been disciplined by judicial or other supervisory authorities within the prior two years;
  3. have (directly or through its affiliates) more than five years of experience with related investments; and
  4. meet certain other specified qualifications, including the requirement that the GP have more than three years of a good track record of directly or indirectly investing in Chinese domestic companies.

According to the Measures, offshore sovereign wealth funds, pension funds, endowment funds, charitable funds, funds of funds, insurance companies, banks and securities companies are primarily considered qualified for the Pilot FPEs.  

Recent Developments

Subsequent to the issuance of the Measures, Shanghai has announced the approval for three Pilot FPEs, which are to be established by Carlyle Group, Blackstone and DT Capital. In addition, Shanghai is contemplating issuing more approvals of Pilot FPEs.

However, on February 25, 2011, the MOFCOM issued a Notice Concerning Management of Foreign Investment, which specifically provided that a foreign invested partnership with investment as its main business, such as an FPE, shall be considered a foreign investor and its investment will therefore be subject to relevant foreign investment regulations.

Therefore, the implementation and interpretation of the 5% Rule is uncertain. Further clarifications are expected.

“Subsequent to the issuance of the Measures, Shanghai has announced the approval for three Pilot FPEs, which are to be established by Carlyle Group, Blackstone and DT Capital.”

In addition, news reports indicate that both Beijing and Shanghai have been allocated a foreign exchange conversion quota in a total amount equal US$3 billion. However, there is so far no official document supporting such quota.