1. Overview

On April 23, 2012, China’s National Development and Reform Commission (“NDRC”) issued a Reply on Relevant Issues Relating to Foreign-Invested Equity Investment Enterprises(8) (the “Reply”) in response to the Shanghai Development and Reform Commission’s inquiry to clarify the “national status” of an RMB fund managed by the Blackstone Group as its general partner (“GP”). The Reply affirms that an equity investment enterprise in the form of limited partnership in which all the limited partners (“LP”) are domestic investors, and which is managed by a foreign-invested management company as its GP, shall still be deemed as “foreign” and therefore be subject to the laws and regulations on foreign investment. The investment projects of such RMB funds shall therefore be subject to The Catalogue for the Guidance of Foreign Investment (“Catalogue”),(9) a basic regulation specifying industry restrictions for foreign investment.

  1. Background

At the end of 2010, with the goal of encouraging foreign private equity fund managers to establish private funds in Shanghai, the Shanghai Financial Services Office and several other authorities jointly issued Implementing Measures for the Launch of Pilot Foreign- Invested Equity Investment Enterprises in the Municipality.(10) These measures marked the beginning of the long-awaited Qualified Foreign Limited Partner (“QFLP”) system in Shanghai. The QFLP system permits offshore investors to channel their offshore capital to domestic RMB funds, converting offshore capital to RMB for equity investment in China.

In fact, the QFLP system was launched as a means to get around the restrictions on foreign exchange transactions under Circular 142 of the State Administration of Foreign Exchange (“SAFE”).(11) Circular 142 specifies that RMB converted from the paid-up capital in foreign currency of a foreign-invested enterprise cannot be used for equity investment in China unless otherwise provided. The restrictions of Circular 142 mean that equity investment in China by foreign-invested enterprises or funds structured in the form of a partnership must be approved by a local SAFE branch on a case-by-case basis.

One of the breakthroughs of the QFLP system was that qualified pilot enterprises(12) were allowed to directly convert their paid-up capital in foreign currency to RMB through designated banks for equity investment in China. Another breakthrough of the QFLP system was that when a qualified pilot foreign-invested equity investment management enterprise used foreign currency to make capital contributions to the equity investment enterprises promoted by it, and its capital contribution did not exceed 5% of the total capital commitment amount, such foreign currency capital contribution did not change the “national nature” of the equity investment enterprises. In other words, a RMB fund promoted by a qualified foreign GP would be treated as a pure RMB fund if all of the LPs are PRC investors and the GP’s capital commitment to the RMB fund does not exceed 5%. The “national treatment” was seen as the biggest incentive for foreign fund managers to raise RMB funds in China, because many major industries are currently still closed to foreign investment, such as media, banks, telecommunications, and certain mining industries. The “national treatment” of these foreign-invested equity investment enterprises was considered to be a means of bypassing the restrictions and onerous approval procedures otherwise imposed on foreign investment.

  1. Implications

The end-result of the NDRC’s Reply is that the QFLP system introduced in Shanghai seems to have come to an end. The Reply suggests that the purpose of the QFLP system was to learn from the advanced experience of foreign fund managers, rather than to allow foreign investors to circumvent foreign investment restrictions. The NDRC’s view that funds with a foreign-sourced GP and Chinese LPs should be treated as foreign funds means that such funds are subject to the Catalogue and the aforementioned foreign exchange restrictions. Accordingly, unless new regulations are issued, the QFLP system is not as attractive to foreign investors as originally had been hoped when the pilot program was first introduced.