The past ten years have been a decade of vigorous development in the investment fund sector in China, and domestic private equity/venture capital (PE/VC) firms and renminbi-denominated funds have witnessed dramatic developments. By the end of August 2023, a total of 21,948 private fund managers (PFMs) managing 152,961 private investment funds (PIFs) had been registered with the Asset Management Association of China (AMAC), the self-regulatory organisation of the fund industry in China, with total assets under management of CNY20.82 trillion.

Due to the geopolitical volatilities and disruptions caused by the COVID-19 pandemic, the PE/VC market has had ups and downs in the past three years. Five main trends in domestic PE/VC markets have emerged in recent years:

• Firstly, state-guided funds (SGFs) and government-guided funds (GGFs) are the major source of capital for PE/VC funds.
• Secondly, fundraising periods have become relatively longer. For example, around 2016 a PE/VC fund took, on average, approximately three months to complete its first closing (in fact, a few PE/VC funds completed their first closing within one month) and took an additional three to nine months to reach its final closing. However, in the past three years, it has been quite common for PE/VC funds’ first closing to take six to 12 months, and for the final closing to take an additional 12 months.
• Thirdly, compared to the market practice in recent years, fund structures have become more complicated to accommodate fundraising needs. PE/VC funds have commonly utilised a parallel fund structure, multi-parallel fund structure, connecting fund structure, umbrella fund structure and combinations of these structures.
• Fourthly, it is obvious that only certain “top-quartile performance” funds have successfully launched with smooth fundraising. Many PE/VC firms at “middle waist” are still under great pressure in their fundraising activities.
• Fifthly, there are fewer new PE/VC firms coming to the market compared to previous years. Due to the internal and external environment, there has been a significant decrease in the generation of new market players in China’s PE/VC market.

It is a primary trend that the investment fund practice will continue to maintain its Blue Ocean status. However, laws and regulations governing the investment fund sector have been strengthened – particularly the Regulations on the Supervision and Administration of Private Investment Funds published on 9 July 2023, which came into effect on 1 September 2023 (the “New PIF Regulations”) – which will cause the PE/VC industry to develop in a more standardised and robust way.  Meanwhile, with the “first generation” PE/VC funds set up around 2010 entering their exit period, it is a significant task to arrange an orderly liquidation of such funds. The value of secondary funds and secondary transactions to the liquidity and continuity of the PE/VC market will become more notable. Additionally, the investment fund sector will enter a new era of cross-border capital allocation, with the liberalisation of qualified foreign institutional investor (QFII), qualified foreign limited partnership (QFLP), qualified domestic limited partnership (QDLP), qualified domestic investment entity (QDIE) and qualified domestic institutional investor (QDII) policies and quotas, and the growing importance of allocating capital to the Chinese market.

The categories of PIFs in the Asset Management Business Electronic Registration System (AMBERS) include the following:

• Private securities investment fund – this is a private investment fund that primarily invests in stocks of public companies, bonds, futures, options, fund units and other securities and derivatives, as provided by the China Securities Regulatory Commission.
• Fund of private securities investment fund – this is a private investment fund that primarily invests in private securities investment funds, trust plans, brokerage asset management plans, special fund accounts and other asset management plans.
• Venture capital fund – this is a private investment fund that primarily makes equity investments in unlisted growth enterprises at various stages of business.
• Fund of venture capital fund – this is a private investment fund that primarily invests in venture capital funds, trust plans, brokerage asset management plans, special fund accounts and other asset management plans.
• Private equity investment fund – this is a private investment fund that invests in shares issued privately by unlisted companies or by listed companies (including private placement, bulk trading, and transfer by agreement of listed companies), convertible bonds, etc.
• Fund of private equity investment fund – this is a private investment fund that primarily invests in private equity investment funds, trust plans, brokerage asset management plans, special fund accounts and other asset management plans.
• Private alternative funds – this is a private investment fund that primarily invests in assets other than securities, derivatives of securities, and equities.
• Fund of private alternative funds – this is a private investment fund that primarily invests in private alternative funds, trust plans, brokerage asset management plans, special fund accounts and other asset management plans.
• Private asset allocation fund – this is a private fund that primarily makes cross-category asset allocation investments in securities, equities, etc, as funds of funds, where more than 80% of the fund assets will be invested in private funds and public funds that have been filed with the AMAC or other asset management products established in accordance with the applicable laws.

There are three main legal forms adopted by PIFs in the Chinese market – limited partnership, limited company and contractual type fund. In August 2006, the Standing Committee of the National People’s Congress adopted the newly amended Law on Partnership Enterprises and introduced the concept of “limited partnership”, after which, limited partnerships quickly emerged as the primary form of PE/VC funds in the market. The legal form of limited company is widely used by SGFs and GGFs, as the sponsors of SGFs and GGFs are almost all state-owned enterprises (SOEs) and SOEs are expressly prohibited from acting as the general partner (GP) under the Law on Partnership Enterprises. In August 2014, the China Securities Regulatory Commission (CSRC) promulgated the Interim Measures for the Supervision and Administration of Private Investment Funds (the “PIF Interim Measures”), which established the registration system of PFMs and record-filing system of PIFs. In addition, the legal form of the contractual type fund was first officially recognised under the PIF Interim Measures. The contractual type fund is the most popular form for private securities investment funds, and comparatively for a small group of PE/VC funds, due to its loose relationship with other parties.

Limited partnerships and limited companies are required to be registered with the local Administration of Regulation (AMR). For entities to be operated and managed in the long term, efficiency is the key factor when determining PE/VC funds’ location. However, most GGFs may designate the location of the PE/VC funds they invest in, typically choosing the location of such GGFs.

PFMs must file the record of the PIFs under their management with AMAC within 20 business days upon completion of fundraising. Before the completion of record-filing with AMAC, the PIFs may not make any investments. When filing a PIF, AMAC will examine whether the PFM’s fundraising procedures are in compliance with relevant rules issued by AMAC through the paperwork and information submitted by the PFM, including whether the PFM has adopted suitable measures to make sure that the interests in such PIF are offered to qualified investors. It usually takes one to two weeks to complete the filing procedure. 

As AMAC has promulgated several regulations regarding information disclosure by PFMs and PIFs, PE/VC funds must comply with these disclosure requirements.  Under the Regulatory Measures of Information Disclosure for Private Investment Funds and the No 2 Guideline for Information Disclosure for PE/VC Funds, PFMs are required to periodically, or at such time as a material change occurs, update both their own registration information with AMAC and the information filed for the PIFs under their management via an online system. In addition, PFMs are also required to disclose to investors the information in relation to PIFs under their management, according to fund documents. Of course, some investors may have their own requests on information disclosure, such as SGFs, GGFs and insurance companies, which PIFs will usually make an effort to satisfy for fundraising purposes. Only basic information relating to PFMs and PIFs (such as registered name, stake holders, partners, registered capital, controlling person, chief compliance officer, etc) is publicly available.

As with the regulatory regime, there is no specific set of tax rules applicable to alternative funds. General tax rules are followed for private funds, and the tax position of private funds established in China is mainly determined by their legal form. 

Limited Partnerships

For PIFs in the form of a limited partnership, the layer of partnership is look-through from a tax perspective. Corporate limited partners (LPs) are taxed at the LP level at a rate of 25% on taxable gains from a PRC corporate income tax perspective. Individual LPs are taxed at the layer of partnership at 5–35% on taxable gains from a PRC individual income tax perspective. Specifically, individual LPs are taxed at a reduced tax rate of 20% for dividend and interest income. For various reasons, the taxation of individual LPs in limited partnership in China is far from mature, and thus uncertainties arise from time to time.

Limited Companies

For PIFs in the form of limited companies, their tax position is almost the same as corporate LPs in a limited partnership, that is, 25% corporate income tax charged on taxable income.

Contractual Type Funds

For contractual type funds, investors are responsible for filing and settling their income tax liability from their side, that is, 25% corporate income tax for corporate investors and 20% individual income tax for individual investors.

Tax Incentives for PIFs

In the meantime, there are some tax incentives available for PIFs. For example, the individual LPs of a qualified limited partnership may enjoy a reduced 20% individual income tax rate on investment gains. Qualified corporate PIFs may enjoy a reduced corporate income tax burden in accordance with their individual shareholder.

For contractual PIFs, the total proceeds are subject to value added tax at a rate of 3%, and the profit is taxed at the level of LPs on their side.

QFLPs and Offshore Funds

QFLPs and offshore funds have more complicated PRC tax implications as a result of transactions being cross border. Basically, QFLPs and offshore funds are charged 10% PRC withholding income tax upon disposal of PRC investments. Where a QFLP is considered as having a permanent establishment in China, the applicable tax rate would rise to 25%.

The Registration and Filing of Private Investment Funds issued by AMAC in December 2019 (the “2019 PIF Registration Notice”) further embodies the terms under the Asset Management Guidance regarding the operation of PIFs, restating that PIFs’ primary business may not cover borrowing or lending activities. According to the 2019 PIF Registration Notice, any PIF conducting private lending activities as its regular business or setting up valuation adjustment mechanisms to engage in disguised loan activities (which separate the PIF’s income from the profits from the invested companies), will not be permitted for PIF registration. The CSRC’s rules provide that all PIFs are prohibited from providing loans or guarantees to other persons or entities, except in the following instance – a PIF may provide a loan or guarantee with a term of no more than one year to its portfolio ‎company in accordance with relevant contracts for the purpose of making an equity investment‎ in such portfolio company, provided that: (i) the maturity date of such loan or guarantee may not be later than the exit date of the equity investment in such portfolio company; and (ii) the balance of the loan or guarantee may not exceed 20% of the contributed capital of the said PIF. The New PIF Regulations reiterate these compliance requirements.

As PIFs are only allowed to conduct private equity investments, they are not permitted to invest in non-traditional assets, such as digital assets, credit and other loan portfolios, cannabis/cannabis-related investments and litigation funding, under the PRC laws.

It is common for PIFs to use special purpose vehicles (SPVs) to make their investments where:

• there are multiple co-investment parties and such SPVs can be used as a platform for pooling the funds of co-investment parties; or
• the PIF intends to exit its investment in a portfolio company through trade sale and the equity interest in such SPVs, rather than equity interests in the portfolio company, can be transferred or disposed of directly.        

A PIF must be managed by a PFM pursuant to PRC laws. An investment manager’s business activities in China are subject to registration with the relevant administrative authorities for market regulation as a partnership (including a limited partnership) or a corporation. Before an investment manager undertakes any fundraising activities for a PIF, such investment manager is required to be registered with AMAC as a PFM. A PFM registered with AMAC is allowed to explore and conduct its business throughout China.

So far, no substance requirement has been imposed on PIFs under PRC laws.

Contractual type funds are required to engage a custodian, while other types of funds have flexibility to engage a custodian. However, if no custodian can be engaged, a PIF is not permitted to set up an SPV to make its investment and is not permitted to increase its fund size after registration with AMAC. A custodian must be a domestic financial institution with a custodian qualification, which could be either a commercial bank or a security company. There are no compulsory requirements regarding the administrator, money-laundering reporting officer or compliance officer under PRC laws.

As the New PIF Regulations took effect on 1 September 2023, it is anticipated that the updated rules on PIFs will be further promulgated by the relevant administrative authorities and AMAC at a later stage.

Most promoters or sponsors of alternative funds in the Chinese market are domestic institutions or individuals. There also appears to be a growing trend for foreign sponsors to establish or intend to establish PFMs either independently or by co-operating with domestic institutions. 

Two main legal forms are generally adopted by PFMs in the Chinese market – limited partnership and limited company. As there are fewer tax planning methods for private securities investment funds, the form of limited partnership is widely used by private securities investment fund managers.

PIFs in China are required to comply with various operational and compliance requirements. Before engaging in any fundraising activity, PFMs established in China (including PFMs with direct or indirect foreign shareholders) must register with AMAC in accordance with the regulations formulated by AMAC. After the completion of fundraising, a PFM must register the PIFs managed by them with AMAC under the PFM’s name.

PIF Interim Measures

The PIF Interim Measures promulgated in August 2014, which established the system of registration of PFMs and record-filing of PIFs, defined qualified investors, and specified non-public fundraising and disclosure requirements for PFMs. According to these rules, PFMs must apply for PFM registration with AMAC before initiating any substantial business operations. This registration requires the PFM:

• to engage qualified legal counsel to conduct due diligence on the PFM to confirm its compliance in all aspects with applicable laws and regulations, to issue a legal opinion thereon; and
• to submit any other materials requested by AMAC. 

To qualify for PFM registration, PFMs must employ professionals with AMAC-recognised qualifications for certain positions, including investor relations manager, risk and compliance officer, etc.

The Three Types of PFM

When applying for registration with AMAC, a PFM is only allowed to choose one of three business types:

• Type 1: private equity fund manager;
• Type 2: private securities investment fund manager; or
• Type 3: fund manager to manage other types of private funds.

A fund manager that manages PE/VC funds (including a QFLP fund manager if required to be registered as a PFM) must be registered as a Type 1 PFM, and then the PIFs it manages must have their records filed with AMAC under such fund manager’s name, after completing the first round of fundraising but prior to such PIFs undertaking any investment. A fund manager that manages securities investment funds must be registered as a Type 2 PFM, while a QDLP fund manager must be registered as a Type 3 PFM.

Denial of Registration

In November 2017, AMAC clearly defined for the first time the circumstances under which PFMs will be denied registration in Q&As Related to the Registration and Filing of Private Investment Funds (“Q&A No 14”). These include illegal fundraising, making a false statement, engagement in conflicting business, being listed as enterprises that have taken part in serious illegal or dishonest acts, or that have discredited senior executives. In December 2018, AMAC restated the circumstances under which PFMs will be denied registration via a PFM Registration Notice, in which AMAC also listed the main requirements for PFM registration. Basic information about registered PFMs is publicised by AMAC on its official website.

Circulars and Measures Affecting Registration

In 2020, AMAC promulgated the Circular on Issues Concerning Facilitating Application for Registration of PFMs in February and the Circular on the Issuing List of Application Materials for Record-Filing of PIFs in March, listing the materials necessary for the registration of PFMs and the record-filing of PIFs, which represents AMAC’s effort to enhance service efficiency and improve the chances of compliance in related applications. In February 2023, AMAC issued new Private Investment Fund Registration and Filing Measures and these updated self-regulation rules established the principle of “favour top students and reject underachievers” in the PFM registration process. These new measures took effect on 1 May 2023, raising the bar and conditions for the registration of a PFM. The List of Application Materials for Record-Filing of PIFs was renewed in April 2023.

For PFMs, there are no specific tax rules. PFMs in the form of a limited company are subject to corporate income tax at a rate of 25% and PFMs in the form of a limited partnership are subject to taxation at LP levels. Qualified corporate PFMs in certain areas (eg, Hainan Province) may enjoy a reduced 15% corporate income tax rate. 

There is generally no exemption or other rules to ensure that alternative funds with a manager in China do not have a permanent establishment or other taxable presence in China. If offshore funds have been identified as having a permanent establishment in China, PRC corporate income tax at a rate of 25% will be charged unless there is applicable tax treaty protection.

The current PRC tax regime does not have any specific rules on carried interest. This means that carried interest is taxed as normal profit. One interesting note is that sometimes certain tax authorities charge 6% VAT instead of income tax on carried interest but this only happens occasionally, depending on the discretionary judgement of the relevant tax authorities.

PFMs are allowed to outsource or delegate some of their investment functions or business operations to other persons. There is no specific regulatory requirement or restriction on such outsourcing or delegation under PRC laws. However, a PFM must exercise due care in selecting appropriate and qualified agents to undertake certain of its functions and there are some implications regarding such delegated agents. For example, only qualified agents, such as qualified custodians, qualified financial institutions and independent holders of a retail licence can be engaged for certain functions and operations in PIFs, thereby safeguarding the assets and the marketing and distribution interests of the fund.

To qualify as a PFM registered with AMAC, an investment manager must have economic substance, including but not limited to: (i) having at least five full-time qualified staff members; and (ii) having an independent office site. However, there is no requirement regarding the local director, employee or local general partner under PRC laws. 

When a PFM applies for AMAC registration, it must disclose its controlling person. After completion of AMAC registration, such controlling person will be disclosed to the public on AMAC’s website. Pursuant to relevant guidelines issued by AMAC, the controlling person refers to the controlling shareholder (the shareholder who has the power to designate the majority of directors of the PFM or the shareholders who are in agreement on concerted action) and the natural person, legal person or other organisation that can control the activities of the PFM. The “look-through” rule will apply to track the ultimate natural person, SOE, collective enterprise, listed company or overseas institution under the supervision of foreign financial regulatory authorities, for the purpose of identifying whether any of them is a controlling person.

When a change-of-control event occurs, a private fund manager must complete the relevant procedures required for such change with AMAC‎ within 30 business days from the date of such change and submit a legal opinion on such change to AMAC. The controlling shareholder and/or the actual controlling person after such change must satisfy all the relevant requirements under the applicable laws and rules issued by AMAC. In the event that any change of actual control of a private fund manager occurs, the assets ‎under its management may be no less than CNY30 million ‎consecutively in the 12 months ‎prior to the date of such change.

As the New PIF Regulations only took effect on 1 September 2023, it is anticipated that the updated rules may be further promulgated by the relevant administrative authorities and AMAC at a later stage.       

The primary investors in alternative funds in the Chinese market include institutional investors and individual investors. The following types of investors have recently been active in the market:

• SGFs and GGFs;
• listed companies (including SOEs);
• non-listed corporate investors (including SOEs);
• insurance companies;
• financial institutions managing asset management products (such as a trust plan);
• social security funds;
• charity funds;
• campus funds;
• family offices and family funds; and
• high net worth individuals.

Among such investors, social security funds and insurance firms are the most challenging, since there is a relatively high bar for PIFs accepting such investors.

In addition, SGFs, GGFs and insurance companies may have certain specific requests on the fund terms of PIFs and information disclosure, due to their respective risk tolerance and internal policies, which PFMs will usually make efforts to satisfy for fundraising purposes. For example, the European-style distribution waterfall might be preferred by SGFs and GGFs when they invest in a PIF in the form of a limited partnership, to ensure that all the invested capital of the investors and the agreed preferred return will be returned in full to be distributed to the investors prior to any generation and distribution of carried interests to general partners.

Side letters are permitted and commonly used in the fundraising process, and there is no special approval or disclosure requirement in the Chinese market.  Institutional investors, in particular, will usually request to have a side letter to satisfy their own specific requests on commercial terms and compliance matters, such as:

• a most-favoured nation (MFN) clause;
• an information right and confidentiality request;
• an advisory committee member seat;
• reduction on the management fee or carried interest;
• co-investment preferences and arrangements;
• an LP interest transfer right to affiliate; and
• other special compliance requirements and tax provisions.

Under PRC law, PFMs or their qualified agents may only offer PIF interests to investors classified as “qualified investors”, which is determined based on the supporting materials and risk-tolerance questionnaires that the investors provide. A “qualified investor” refers to any investor who satisfies each of the following requirements:

• the investor’s identified risk and tolerance ability matches the PIF product in which the investor intends to invest;
• the investor makes a commitment to the PIF product in an amount of no less than CNY1 million; and
• if the investor is an entity, such investor has net assets in an amount of no less than CNY10 million; or
• if the investor is a natural person, such investor has individual financial assets in an amount of no less than CNY3 million (including bank deposits, securities, bonds, trusts, etc), or has an average individual annual income in an amount of no less than CNY500,000 in each of the past three years.

An exception to the above requirements is where an investor is a “deemed qualified investor”. Deemed qualified investors may be any of the following:

• social security funds, enterprise annuity schemes and other pension funds, charitable funds and other commonwealth funds;
• PIFs registered with AMAC;
• financial products supervised by financial regulatory authorities;
• a PIF’s fund manager and/or its employees; and
• other investors prescribed by the CSRC and AMAC.

In this regard, if the PIF intends to admit any PRC investors, the investors to be admitted must either be “deemed qualified investors” or satisfy the “qualified investor” requirements as described above, and such PRC investors must also provide the relevant supporting materials to prove their qualification and status accordingly.

There are specific rules and restrictions on fundraising activities in the Chinese market. 

Fundraising Practitioner Qualifications

Persons who intend to undertake fundraising activities are required to have AMAC-recognised PIF professional qualifications.

Qualified Investor Verification Procedure

The PFM and/or its agent is generally required to collect from prospective investors supporting materials and risk-tolerance questionnaires to determine whether such investors satisfy the “qualified investor” requirements or “deemed qualified investor” status before they undertake marketing or advertising of PIF interests to such investors. In addition, the number of investors in a single PIF must not exceed 200 persons, pursuant to PRC regulations.

Marketing Method

After completing qualified investor verification procedures, a PFM and/or its agent may only offer PIF interests and circulate offering documents and fund contracts to qualified investors on a non-public basis. Any kind of public offering – such as placements through published materials; outdoor advertisements; posters; newspaper, radio, TV or internet promotional materials; and such other public media or speeches, seminars and similar meetings – is expressly prohibited. 

Marketing Materials

AMAC Rules provide certain key words which cannot be used in the offering document, such as “estimated return” and “expected yield”. Meanwhile, specific information is required to be disclosed in the offering document under PRC laws, such as the registration number of the fund manager, the custodian engaged for the PIF, etc.

No Guarantees

Investment managers and alternative funds are prohibited to directly or indirectly promise investors a fixed return or no loss in any situation.

Record-Filing

After the investors execute the fund contracts and the closing of a PIF is announced, the PFM must submit the record-filing of such PIF to AMAC under the PFM’s name, before the PFM undertakes any investment on behalf of such PIF.

Placement agents are commonly used in the fundraising process in the Chinese market. There are two kinds of placement agents – financial institutions holding the licence to distribute the interest of PIFs and agents without qualifications. For financial institutions holding the relevant licence, such institutions can undertake offering activities directly; for agents without qualifications, such agents can only refer potential investors to, and connect such investors with, the relevant PFMs, and all fundraising activities must be undertaken by the PFM itself.

For taxation at investor level, refer to 2.5 Tax Regime for Funds.

Whether an alternative fund established in China may generally qualify for benefits under double tax treaties depends on the legal form of the funds, tax rules in the jurisdiction in which the funds may invest, and the applicable double tax treaty. Generally speaking, as a large percentage of PRC PIFs conduct overseas investment through offshore SPVs, tax treaty benefits, if triggered, may not be relevant to the PRC tax regime.

China is a member of the CRS compliance regime and information exchange is carried out every year. However, there are very few reported tax avoidance matters through such exchange mechanism. How this actually functions in China remains to be seen.

There is no specific anti-money laundering (AML) requirement imposed on PIFs or PFMs under PRC laws, as AML requirements are mostly conducted by financial institutions such as commercial banks and security companies. The know your customer (KYC) process is usually completed by PFMs during the verification procedure to identify “qualified investors” based on the supporting materials and questionnaires provided by such investors.

There are three pillar laws under China’s data law legal framework, namely, the Cybersecurity Law (CSL), the Data Security Law (DSL), and the Personal Information Protection Law (PIPL). The PIPL and the DSL are more relevant and respectively stipulate compliance requirements, including cross-border data transfer restrictions, on personal information and more sensitive information (aka, “Important Data”). Both the PIPL and the DSL set forth extra-territorial effects that apply to managers and funds dealing with China-based investors. Notably, local investors need to enter into data transfer agreements with overseas recipients and seek approval from regulators when exporting personal information or Important Data. 

In addition, in the event that sensitive data may constitute state secrets or otherwise endanger national security, managers and funds need to act cautiously and avoid requiring and/or exporting such data. The Anti-Espionage Law will apply if funds and managers do require or export such sensitive data and there will be administrative penalties or even criminal liabilities arising from such violations.

As the New PIF Regulations only took effect on 1 September 2023, it is anticipated that the updated rules may be further promulgated by the relevant administrative authorities and AMAC at a later stage.