The alternative investment funds industry in China is relatively new yet fast-growing compared to many more developed regions in the West, with less than 20 years of history. Under the Chinese financial regulatory regime, oversight of the asset management industry is allocated to different regulatory bodies based on the asset manager or sponsor’s type of business. For example, financial institutions in banking, insurance, securities, investment funds, futures and trusts each have their own respective regulator overseeing the business and operations of such financial institutions and the financial products (including alternative investment products) they issue or sponsor.
Our discussion on alternative investment funds will mainly focus on private investment funds. In the past ten years, China gradually established and enhanced its private investment fund legislation and regulatory regime, which facilitated a rapidly growing fund industry. To June 2021, there were more than 24,000 registered private fund managers and more than 10,000 private funds filed with the Asset Management Association of China (AMAC), a self-disciplinary industry body under the Chinese securities regulator (the China Securities Regulatory Commission (CSRC), with a total of CNY17.89 trillion in funds raised.
In accordance with the AMAC filing system, private investment funds can be classified into the following categories:
The most commonly used fund structures in China include contractual collective investment schemes, limited partnerships and companies (including limited liability companies and companies limited by shares).
Contractual Collective Investment Schemes (“Contractual Funds” or a “Contractual Fund”)
Most Private Securities Funds are established as Contractual Funds. The number of investors in a single Contractual Fund shall not exceed 200. Contractual Funds are not considered legal entities and forming a Contractual Fund does not require registration with the business administration bureau. Instead, rights and obligations of all parties of the fund will be provided in the fund agreement. A Contractual Fund formation will become effective upon filing with AMAC.
Most private equity funds and venture capital funds are established as limited partnerships in China. Funds established as limited partnerships can have up to 50investors in a single fund vehicle with a minimum of one general partner and one limited partner. The general partner bears unlimited liability and the limited partners assume liabilities and indebtedness of the limited partnership to the extent of their respective capital contributions.
Limited Liability Companies or Companies Limited by Shares
Private investment funds can be established in the form of limited liability companies or companies limited by shares. As China has a relatively advanced legal framework in the areas of company law and corporate governance, government funded or sponsored funds, or corporate funds under state-owned enterprises may prefer the corporate form as their chosen fund structure.
China has promulgated many laws and regulations covering the private investment fund industry, the most important of which are the following.
Partnership Law (2006)
The implementation of the Partnership Law is particularly significant because it provided a clear legal foundation for the use of limited partnerships for private investment funds.
Securities Investment Fund Law (2015)
The Securities Investment Fund Law, while mainly focusing on the regulation of mutual funds, includes a chapter on regulation of Private Securities Funds. It provides that investors in a private investment fund must be Qualified Investors (as defined below) and the number of investors in a single fund vehicle cannot exceed 200. The Securities Investment Fund Law provides that a private investment fund cannot engage in fundraising to any investors who are not Qualified Investors or to the general public, especially through public media such as newspapers, television, radio, and the internet or by way of general solicitation such as lectures, reports or seminars that are open to the public. It also provides that private investment funds can invest in publicly traded stocks, bonds, fund interests and other securities and derivatives as approved by the securities regulatory body of the State Council.
Interim Measures for the Supervision and Administration of Private Investment Funds (2014) (“Interim Measures”)
The Interim Measures are the primary regulation on private funds and fund managers in China issued by the CSRC. Specifically, the Interim Measures provide that the fund managers should file with AMAC upon completion of fundraising of a private fund. The Interim Measures further provide that a qualified investor is an entity or individual that is able to invest at least CNY1 million in investment interests of a fund and has the capacity for risk assessment and risk tolerance, and must meet the following net worth or income requirements: (i) if the investor is a legal entity, it should have net assets of at least CNY10 million; or (ii) if the investor is an individual, he or she should hold at least CNY3 million in financial assets, or have a personal average annual income of no less than CNY500,000 for the last three years (“Qualified Investor”). The Interim Measures also require that fund managers and fund sales agencies should not make guarantees that there will be no loss of investment capital or of minimum returns.
Guiding Opinion on Regulation of Asset Management Business of Financial Institutions (2018) (the "Guiding Opinion”)
Asset management products issued by different types of financial institutions such as commercial banks, insurance companies and securities firms are overseen by different financial regulators under different sets of rules and regulations. Therefore, the same type of fund products may be subject to different regulations issued by different regulatory authorities. The Guiding Opinion is aimed at consolidating the regulatory requirements of different financial regulators on the asset management products issued by different financial institutions (including their subsidiaries) to prevent opportunistic arbitrage due to policy differences. For the first time, the Guiding Opinion set forth requirements and restrictions on asset management business under all financial institutions such as limits on leverage ratios, a prohibition on multiple-layer structures and maturity mismatches, which significantly impacted the private fund industry.
Several Provisions on Strengthening the Regulation of Private Investment Funds (2021) (“Several Provisions”)
The Several Provisions upgraded regulations on private investment funds and their fund managers by specifying a number of new rules. The Several Provisions emphasised that use of “fund” or “fund management” or similar phrases shall not be used without satisfying the requisite registration and filing requirements with AMAC. The Several Provisions further provide that assets of private investment funds shall not be used for: (i) providing loans, guarantees, or debt financing disguised as equity financing (however, assets of private investment funds can be used for short-term bridge loans or guarantees for portfolio companies with a term of no more than one year); (ii) investing in factoring assets, financial leasing assets, mortgage financing assets and other credit assets, or equity interests or other interests lined to credit assets; (iii) investments with unlimited liability; or (iv) other activities that are prohibited by applicable laws, regulations or the CSRC.
Additionally, AMAC has established relatively well-developed self-disciplinary rules for regulation of the private fund industry from the fundraising stage to investments, and exit of funds’ investments.
Private investment funds in China are not allowed to originate loans, except that private investment funds can provide bridge loans or guarantees of a term of no more than one year to portfolio companies for the purpose of equity investment, provided that the total amount of such loans or guarantees shall not exceed 20% of the fund’s total capital commitment.
Currently, Chinese regulatory authorities are rather prudent in their regulation of the types of assets private investment funds are allowed to invest in. Many non-traditional investment targets such as cryptocurrency, credit assets, distressed assets and rights to profit-sharing are not eligible investment assets for private investment funds. The regulations expressly prohibit private investment funds from investing in factoring assets, financial leasing assets, mortgage financing assets, and other credit assets or equity interests or other interests lined to credit assets.
Once fundraising is completed, a private fund manager should submit the filing on behalf of the fund with AMAC within 20 working days. Upon full and complete submission of filing materials, certain credible and reputable fund managers can complete the filing within the next working day through a fast-track process. For the fund managers that do not enjoy fast-track submission, it will take approximately two weeks to complete the fund filing process.
To manage or to raise private investment funds domiciled in China, the fund manager must have a registered legal presence in China and obtain the requisite qualifications and registrations.
The legal framework does not require private investment funds to hire local employees or to have an actual place of business. The local substance requirements, such as employee qualifications and business premises, are aimed at private fund managers.
Other fund service providers to private investment funds in China, such as custodians, appraisers and fund interest registration agencies, must be established in China and have obtained the requisite qualifications. In general, private investment funds in China shall engage a custodian to safeguard fund assets. Qualified commercial banks and securities firms are permitted to provide custodian services to private investment funds. Other service providers, such as appraisers and registration agencies, are generally securities firms with the relevant qualifications.
Currently, service providers established outside of China or without the requisite qualifications are not allowed to provide services to private investment funds in China.
The following tax regimes apply to alternative funds in China.
In China, private equity funds are subject to different tax collection methods and tax rates depending on the fund’s organisational structure. Funds in the form of limited partnerships are pass-through entities, and thus investment proceeds derived from the fund are distributed to investors without being subject to enterprise income tax at the fund level. If an investor is an entity, the investor will fulfil its own tax filing obligations. If the investor is an individual, the fund will be obligated to withhold personal income tax on behalf of such individual at the rate of 20% or 5%-35% as determined by local tax authorities.
For Contractual Funds, because the fund itself is not a tax person under Chinese law, the fund or the investors of the fund are not subject to taxation at the fund level. Instead, investors will be responsible for submitting their own tax filings in relation to investment proceeds.
For a private investment fund in the form of a company, profits from investment proceeds of the fund will be subject to a 25% enterprise income tax. For investors that are legal entities, distribution of proceeds as dividends from the fund will not be subject to double taxation. However, for individual investors, distribution as dividends from the fund will be subject to 20% personal income tax.
If the investor of a private investment fund is not a Chinese tax resident, then proceeds distributed to such an investor will be subject to a 10% withholding tax at the fund level or will be subject to tax at a higher rate if the non-tax-resident investor is considered to have a permanent establishment in China through its investment in the private investment fund. Additionally, if such non-Chinese tax resident is an individual, then depending on different cases, the fund should withhold personal income tax from proceeds to be distributed to the investor at the rate of 20% or 5%–35% depending on different cases.
Transfer of financial products (including stock or other securities), interest income and other financial assets are subject to value-added tax.
Private investment funds in China do not necessarily qualify for benefits directly under double tax treaties. Non-tax resident investors shall apply for tax benefits under double tax treaties on a case-by-case basis.
It is not a common practice for private investment funds in China to set up subsidiaries or SPVs to make investments. Most private funds invest directly into target companies (or other assets). Depending on the transaction structure and tax planning goals, private investment funds may occasionally establish downstream SPVs for certain transactions.
Sponsors or promoters of private funds domiciled in China must establish a registered legal presence in China and register with AMAC as private investment fund managers. Foreign promoters or sponsors cannot engage in management of a private fund in China directly from an offshore entity. Additionally, foreign equity holders of the promoters/sponsors/managers of Private Securities Funds must satisfy certain regulatory requirements.
Investors in private investment funds in China are mainly Chinese institutional and individual investors. In accordance with regulations on Qualified Foreign Limited Partners (QFLP), approved private fund managers can sponsor and manage QFLP funds which are private investment funds invested by foreign investors. The origins of foreign investors are quite broad and may vary from fund to fund.
In terms of the type of private funds, secondary funds ("S funds") have become increasingly active recently. The main reason behind this trend is that private funds in China boomed during 2010–15, and as the term of these funds is becoming due, investors of these funds are under pressure to exit their investments therefore creating more demand in the market.
As China gradually loosens its foreign exchange control policies, foreign investors are seeing more opportunities to participate in Chinese domestic private funds. Meanwhile, domestic CNY private funds are increasingly active in cross-border or foreign investments in recent years.
Some private fund managers which used to manage a single type of assets are seeking to broaden the scope of assets and product types under management. Many fund managers started to deploy multiple investment and asset management strategies, including different investment stages and objectives and different product types.
Due to macro policy changes, investments in certain industries, such as real estate, education and gaming, have become increasingly restricted. However, industries such as technology, advanced manufacturing and clean energy will be more favoured by investment funds as government-encouraged industries.
Private fund managers and custodians bear the obligation to make disclosures to the investors in relation to the fund.
Mandatory disclosure requirements of the fund managers (and fund custodians) include:
During the fundraising period, the following information should be included in the fund promotional materials (such as the PPM):
During a private investment fund’s operation, the fund manager should provide periodic reports to investors. The fund manager should also report to investors promptly upon the occurrence of material changes of the fund or fund manager.
Information disclosure shall be made in accordance with provisions of the fund agreements. Fund managers should also make appropriate periodic filings and disclosures in connection with the fund and fund manager as required by AMAC through AMAC’s online filing system. However, disclosures made by private investment funds shall not be made to the public.
The Chinese regulatory authorities are considering implementing a private fund regulation that has higher legislative authority. The draft for public opinion of this upcoming regulation shows that it will impose heavier penalties for regulatory violations.
Because China has a relatively well-developed company law legal framework, fund managers usually use limited liability companies as the preferred legal form. We note that recently, due to tax planning and other business considerations, some private fund managers also choose limited partnerships as their legal form.
In accordance with the Interim Measures, private fund managers are subject to registration requirements before they can sponsor a private investment fund or engage in any fundraising activities. There are certain qualifications and substance requirements that a fund manager must satisfy in order to successfully obtain registration status with AMAC. Additionally, pursuant to the Announcement on Several Matters concerning Further Regulating the Registration of Private Investment Fund Managers (2016), a private fund manager applicant must engage a Chinese law firm to issue a legal opinion on whether the applicant is eligible for application of registration and whether the applicant satisfies all the application requirements. The legal opinion is one of the most important documents that AMAC will review to determine whether the applicant meets the registration requirements.
Restrictions and Limitations on Business Activities of a Fund Manager
Private fund managers must include the following language in their legal and business names: “private investment fund manager”, “private investment fund”, “venture capital investment”, and include words indicating the type of asset management business in the business scope such as “private investment fund management”, “private securities investment fund management” and “private equity investment fund management”. Private fund managers can only promote and market funds to specific Qualified Investors without engaging in a public offering or general solicitation. During their marketing and promotional activities, private fund managers cannot make statements to the effect of any promise of return or safety of investment capital to the investors. Each private fund manager can only manage a single type of private fund (see 2.1 Types of Alternative Funds). A private fund manager shall not engage in any business unrelated to or conflicting with private fund management such as lending, providing guarantees, or factoring. Additionally, a private fund manager shall not manage any fund that has not completed its filing with AMAC.
Private fund managers shall also establish effective internal control systems to prevent conflicts of interest and other unethical conduct.
See 3.7 Local Substance Requirements for substance requirements on private fund managers.
Wholly Foreign-Owned or Joint-Venture Private Fund Managers
The Questions and Answers on Registration and Filing of Private Investment Funds (Number 10) for the first time clarified the requirements for setting up a wholly-foreign owned private fund manager or a foreign-Sino joint venture private fund manager in China. The main requirements for setting up private fund managers with foreign equities include the following:
Private fund managers in the form of companies are subject to enterprise income tax and VAT. The enterprise income tax rate is 25% of the profit of the company (including management fees and any performance incentive fees) and VAT is taxed at 6% and is applicable to management fee revenue.
Private fund managers in the form of limited partnerships are considered tax pass-through entities and are not subject to enterprise income tax. Management fees and performance incentive fees received by the limited partnership manager will be distributed to the non-individual partners which will in turn make their own tax filings. For individual partners, the limited partnership manager will withhold individual income tax at the rate of 5%-35% based on the amount of proceeds received.
There are no clear rules on whether foreign investors investing passively in a private fund domiciled in China with no participation in the management and operation of the fund will be deemed to have a “permanent establishment” in China. Therefore, if such foreign investors are considered to have “permanent establishment” through their investment in a private fund in China, they may be subject to a tax rate higher than the 10% withholding tax by Chinese tax authorities. For fund management teams that manage both offshore funds and onshore China-domiciled funds, there could be potential questions as to whether the same management team’s presence in China will constitute “permanent establishment” of the offshore fund and fund manager. There are no well-established rules in China as to what constitutes an exemption to “permanent establishment”. However, in practice, offshore funds and fund managers should ensure that they do not have a permanent business presence in China, and that the investment decisions and operations of the offshore funds are carried out in an offshore jurisdiction to avoid being deemed to have “permanent establishment” in China.
There are no specific rules applying to taxation of carried interest. If a company is the receiving entity of the carried interest, the company is subject to 25% enterprise tax on its profits for the year. If a limited partnership is the entity receiving carried interest, because limited partnership is treated as a pass-through entity, carried interest will be taxed at the partner level of the limited partnership. For individuals receiving carried interest from a partnership entity, the partnership will withhold tax at the tax rate of 20% or 5%–35%, depending on whether the local tax authority deems the carried interest as proceeds derived from an equity transfer or from income of business operations.
The Chinese legal framework allows private fund managers to outsource some of the fund management and operation functions, such as the fund assets custodian, valuation and fund interest registration. The service providers should be institutions legally established in China with the requisite qualifications.
To register as a private fund manager in China, the applicant must satisfy the following requirements.
Currently, the Chinese legal framework does not allow foreign private fund managers to sponsor or manage private funds domiciled in China.
China has the following common types of investors:
Under the Chinese legal framework, private fund managers can promote and market funds to specific Qualified Investors without engaging in public offering or general solicitation. Please see the definition of “Qualified Investor” in 2.3 Regulatory Regime.
The following investors are deemed to be “qualified investors”:
Foreign investors investing in domestic CNY funds in China may be subject to higher investor subscription standards as local rules and regulations on QFLPs may vary.
Marketing and sales of private investment funds can only be made to specific Qualified Investors in private placement without engaging in public offering or general solicitation. The following conduct is strictly prohibited:
A Chinese individual or entity that is a Qualified Investor can invest in alternative funds in China that suit the investor’s risk tolerance.
Once a private fund manager obtains registration status with AMAC, it can engage in marketing and sales of fund interests in accordance with applicable laws and regulations without any additional filings.
If the fund manager engages a placement agency to conduct fund marketing and sales on its behalf, such placement agency must have the requisite fund sales qualifications.
In accordance with investor suitability requirements, the fund manager should obtain the following information from its investors:
To verify if an investor satisfies the Qualified Investor test, investors will provide certain information in relation to their legal status and qualifications, finances and assets. For investors in the form of limited partners and contractual arrangements, investors will be required to provide information as to their investors and interest holders unless an exception applies.
Investors are also required to provide information regarding their identity and source of funding to comply with anti-money laundering regulations.
With respect to CRS reporting obligations, investors are also required to provide certain information in relation to their tax residency.
If the private investment fund is established as a limited partnership or a Contractual Fund, an investor in the form of a company will be subject to 25% enterprise income tax on its overall annual profits. An individual investor investing in such a fund will be subject to 20% or 5%-35% tax (which will be withheld by the fund) as determined by local tax authorities for the proceeds derived from his or her investment in the fund.
If the private investment fund is established as a company, an investor in the form of a company will not be subject to enterprise income tax again for the proceeds distributed to the investor as dividends derived from its investment in the fund. An individual investor in such a fund will be subject to 20% individual income tax for proceeds distributed to the investor as dividends received from the fund.
In general, non-Chinese tax residents that are foreign entities will be subject to a 10% withholding tax for the proceeds derived from investment in private investment funds in China, or they will be subject to a higher tax rate if such investor is considered to have a permanent establishment in China through its investment in the private investment fund. Foreign individual investors will be subject to 20% or 5%–35% individual income tax as determined by local tax authorities which will be withheld by the fund.
Private investment fund managers are required to implement a CRS review process in connection with their investors.