On December 24, 2010, three government agencies in Shanghai issued the Implementing Measures Concerning Carrying Out Pilot Program for Foreign Invested Equity Investment Enterprises in Shanghai (Measures).


Pursuant to the Measures, foreign investors are allowed to participate (i) in a foreign invested equity investment enterprise, which is basically a private equity (PE) fund with foreign investment (FPE) and (ii) a foreign invested equity investment management enterprise, which is basically a GP6 (in the context of PE funds) with foreign investment (FGP). FPE’s main business is to make equity investment in non-listed PRC companies, while FGP is to establish the FPE and/or to manage the PE investment activities. FPE can take the form of a partnership, while FGP can be formed as a partnership or a corporation. The main government agency with authority to approve the establishment of FPE and FGP is the Shanghai Municipal Financial Services Office.

Pilot FPE and FGP Program

Although the Measures provide a regulatory structure for FPE and FGP, currently the approval for FPE and FGP is to be issued on a trial basis. The approved FPE and FGP will be pilot FPE and FGP, which are required to have other qualifications.

According to Article 19 of the Measures, offshore sovereign wealth funds, pension funds, endowment funds, charitable funds, funds of funds (FOF), insurance companies, banks, and securities companies are primarily considered as qualified foreign LPs (as defined in footnote 6 below) for pilot FPE.

According to Article 20, to apply for the establishment an FPE, the foreign LP must:

  1. own assets of not less than US$500 million or manage assets of not less than US$1 billion in the last fiscal year prior to 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 (or through its affiliates) more than five years of experience of related investment; and
  4. meet other qualifications.

Article 21 requires the executive partner of the pilot FPE (or its affiliate) to have more than three years of a good track record of directly or indirectly investing in Chinese domestic companies.

Current PRC Foreign Exchange Control

In 2008, the State Administration of Foreign Exchange (SAFE) issued Decree 1427, which prohibits foreign invested enterprises from converting foreign exchange into RMB for the purpose of PE investment. Decree 142 restricts foreign investment from engaging in PE investment in two ways:

  1. Foreign LPs cannot establish a wholly foreign owned enterprise (WFOE) or joint ventures in China to engage in PE investment. Prior to the issuance of PRC regulations permitting foreign LPs to form limited partnerships in 2008, WFOE and joint ventures used to be popular PE investment vehicles. Although foreign LPs are now allowed to form limited partnerships in China, given that limited partnership related laws and regulations are new in China, there are a lot of uncertainties. Specifically, it is not clear whether foreign invested limited partnerships can convert foreign exchange for the purpose of equity investment.
  2. Foreign GPs cannot make investments into the PE funds. It is a common market practice in the PE funds that the GP typically holds minority shares in the PE fund in order to provide incentives for the GP to maximize profit for the PE fund. However, such practice creates a problem in China if the GP is a foreign entity. Under the PRC regulations, if the GP is a foreign entity and all LPs are Chinese investors, even 1% of shareholding by the GP would make the PE fund a foreign invested entity and thus all investment by the PE fund would be subject to foreign investment restrictions8. To avoid the restrictions, foreign GPs tend to establish a WFOE and hold the minority shares through the WFOE, so that the PE fund is not treated as a foreign entity. However, Decree 142 makes this impossible.  

Measures Open a Window for Foreign LPs and GPs in China

Before the issuance of the Measures, both foreign LPs and GPs were waiting for a breakthrough of the current foreign exchange control policy. In 2010, it was reported in the media that Shanghai and Beijing had submitted the qualified foreign limited partnership (QFLP) plans to the State Council for approval. QFLP’s core purpose is to allow PE funds to convert foreign exchange they received from their foreign LP and/or GP up to an assigned quota amount without prior approval from SAFE.

The Measures are commonly viewed as a limited trial for the QFLP, although there is no provision in the Measures directly allowing the foreign exchange conversion. To facilitate the future implementation of QFLP, the Measures have the following highlights.

  1. The measures allow FPEs to engage in PE investment as its main business. Decree 142 requires foreign invested enterprise to convert foreign exchange for the purpose of doing business within the approved business scope. It seems that under the Measures, if a FPE has the wording of “PE investment” in its business scope, it might be approved to convert foreign exchange for PE investment in China. This is one of the key points of the Measure.
  2. Article 24 of the Measures provides that approved pilot FGPs can use foreign exchange to invest up to 5% of the total committed capital into the PE fund it has formed without changing the corporate nature of the PE fund. This means that if all LPs are Chinese domestic investors and the GP is a foreign entity, the GP’s minority shareholding up to 5% will not change the PE fund from a domestic company to a foreign invested company. Such PE fund’s investment will not be subject to foreign investment restrictions as discussed above. This is another key part of the Measures.
  3. Article 25 of the Measures provides that approved pilot FPEs may go through their custodian banks to deal with foreign exchange issues, which implies that a FPE would not need to go to local SAFE for approval of the foreign exchange conversion.

Future Development

News reports indicate that Beijing and Shanghai have each been allocated with foreign exchange conversion quotas in a total amount of US$3 billion, and the Beijing version of the Measures will also be published soon. With these special regulations in Beijing and Shanghai, it is reasonable to expect that more foreign LPs and GPs will be attracted to Shanghai and Beijing.

Provisions of the Measures are not clear about the foreign exchange settlement, which leaves room for government agencies to “play” during the implementation of the Measures. Given the recent appreciation of RMB, the Chinese government is fully conscious of the need to control the flow of “hot money” into China. The implementation of the Measures and other QFLP related policies, which may loosen the foreign exchange control, remains uncertain. By the time of the release of this article, there has not been any pilot FPE or FGP approved. Further implementing rules, especially with regard to the foreign exchange issues, are expected.