Since the outbreak of the global financial crisis, the typical model of China's capital market—that both fundraising and exit of private equity (PE) funds/venture capital (VC) are effected overseas—has begun to attract skepticism. In contrast, Chinese currency PE funds have been growing in past months. Chinese authorities have released a series of policies, meanwhile, to promote the development of equity investment.

At the end of 2008, the General Office of the State Council released “Several Opinions on Providing Financing Support for Economic Development,” which is significant for the growth of China's equity investment industry. Yet, until recently, foreign-funded equity investment, such as VC and PE funds, have only been allowed to form as "venture investment enterprises" or "venture investment management enterprises" (collectively, "Venture Investment Enterprises"); Venture Investment Enterprises were only allowed to take the form of limited liability companies.

Early in March 2009, China's Ministry of Commerce (MOFCOM) issued the circular, “Notice on Delegating the Examination and Approval Authority of Foreign Funded Investment Companies” (the "Circular"). The Circular delegates approval authority of foreign-invested Venture Investment Enterprises with registered capital of no more than $100 million (including the expansion of investment scale by no more than $100 million), to provincial-level departments of MOFCOM. The Circular also provides that equity investment of a substantial amount may seek approval from a local government, rather than from the central government, by dividing the investment into phases of no more than $100 million.

Upon issuance of the Circular, several foreign PE firms formed foreign-domestic investment companies after obtaining approvals from provincial-level local governments. Moreover, in competition to become China's "PE fund center" and attract international PE firms, the local governments of Beijing, Tianjin, Shenzhen and Chongqing have promised policies and laws to support the development of equity investment.

As part of the city's plan to become an international financial center by 2020, the Shanghai municipal government has been busy luring equity investors. In August 2008, four governmental divisions of Shanghai Municipality jointly issued the “Notice on Business Registration and Other Issues of Equity Investment Enterprises” (the "Notice"). The Notice extends tax breaks to equity investment enterprises and offers a 40 percent rebate on personal property taxes to investment firm senior executives. It further extends a 20 percent rebate to mid-level managers. Until recently, such benefits were offered only to domestic PE firms.

Pudong, Shanghai's largest district, is the most eager to attract equity investors with favorable policies. On June 10, Pudong's local government issued “Trial Measures Regarding the Establishment of Foreign-funded Equity Investment Management Enterprises” (the "Trial Measures"). The Trial Measures allow, for the first time in China, foreign-funded equity investment companies to register as equity investment management enterprises. However, the scope of "foreign-funded equity investment enterprises" is unclear. In China, there is no concrete definition of the same in the regulatory documents. It is popular belief that foreign-invested Venture Investment Enterprises, established under the Rules on Administration of Foreign-invested Venture Capital Enterprises, should be considered as foreign-funded equity investment enterprises. However, it is unclear whether consulting companies set up by global PEs to carry out fund management business should be included as well.

In order to control financial risk, it is stipulated in the Trial Measures that a foreign-funded equity investment management enterprise (FEIME) be incorporated as a limited company with registered capital of no less than $2 million. At least one of the FEIME's investors (or its affiliated entities) should be legally engaged in equity investment or equity investment management. In addition, a FEIME should have at least two executives with two or more years of experience in a senior managerial position in either equity investment or equity investment management.

The Trial Measures stipulate that FEIMEs are included under specific incentive and preferential tax policies offered to domestic equity investors as set forth in Shanghai Municipality's Notice of August 2008. The following incentives are available to FEIMEs:

Startup award

If the registered capital of a FEIME amounts to ¥500 million, it will be granted a lump-sum award of ¥5 million. ¥10 million and ¥15 million will be awarded to a FEIME if its registered capital reaches ¥3 billion and ¥5 billion, respectively.

Fiscal revenue refund

If a FEIME invests in a state-owned enterprise, high-tech enterprise, middle- or small-scale enterprise in Pudong, then half of the financial revenue generated from such investment and allocated to the Pudong government will be refunded to the investing FEIME.

Incentives for management

In addition to the property tax rebates extended under the 2008 Notice, senior executives of a FEIME will be offered a 20 percent rebate for their paid individual income taxes, while mid-level managers will be offered a 20 percent rebate for paid individual income taxes. In addition, a housing allowance of up to ¥200,000 will be offered to executives if a FEIME's trust fund reaches ¥1 billion.

Rent subsidy

If a FEIME is located in a specific area assigned by the Pudong government, a rental subsidy (¥500 per square meter per year) will be provided to it. Alternatively, an allowance equal to 1.5 percent of the purchase price of the office will be offered to the FEIME if it chooses to purchase an office in the area.

With the launch of the Trial Measures, all foreign-funded VC and PE companies already established in Pudong are allowed be re-registered as FEIMEs and are thus ineligible for certain tax incentives granted to equity investment management enterprises.

The Pudong government hopes that the Trial Measures will attract more foreign equity investment capital to China's domestic markets. The Trial Measures will expire on June 30, 2010. It is anticipated that a permanent regulation with respect to foreign-funded equity investment will be promulgated before then.


Local governments have been promising preferential policies to lure PEs and VCs. However, major obstacles which impede the establishment of onshore PE and VC still exist. The first major obstacle is the foreign exchanges settlement issue on capital conversion. In the current environment, capital injected to a foreign-invested PE firm cannot be converted directly to RMB directly until the equity, investing project is approved by the Ministry of the Commerce or until the stock investment plan is approved by China's Security Regulatory Commission. Secondly, there remain strict limitations for overseas funds to invest in certain "Investment Prohibited Industries" or "Investment Restricted Industries" in China.

Moreover, Global PE firms are facing increased competition from domestic funds. Local firms have better contacts and are quick to strike deals. Domestic funds are less concerned with currency controls, taxation and exit strategies.

Despite the economic recession, it is estimated that PEs in China will rebound strongly next year. The long-awaited NASDAQ-style middle-small enterprise public offering board commenced in July 2009, which is good news for both foreign-funded and domestic PEs. The opening of this board offers a new channel for the funds of the existing foreign PE firms. It is reported that the Pudong government is in discussions with the central government in an attempt to further allow and encourage expanded overseas fund investment, such as foreign exchange control. It remains to be seen whether Pudong can lead the next wave of finance market growth by creating a more preferential and flexible environment. Blackstone Group, the world’s biggest private equity firm, recently unveiled plans to launch a ¥5 billion fund in partnership with the Shanghai government, Reuters reported. Other firms are following suit.