Investment Funds 2021

Last Updated February 09, 2021

China

Law and Practice

Authors



King & Wood Mallesons has its key office in Beijing and an extensive global network of 28 international offices. The investment funds legal team of King & Wood Mallesons is equipped with in-depth local experience and has been the consistent industry leader in the establishment, investment and exit of domestic and overseas funds. The firm’s lawyers and experts have expertise in laws, policies and regulations home and abroad, who are capable of advising clients on various private equity funds, assisting clients in drafting investment plans and designing investment structures. Meanwhile, King & Wood Mallesons also has lawyers who focus on legal service in relation to tax, intellectual property, labour, real estate and insurance, which enables King & Wood Mallesons to offer professional one-stop support in investment funds projects at any time.

In the People’s Republic of China (PRC), investment funds are generally divided into two categories: public funds and private funds.

Public Funds

Subject to approvals by the China Securities Regulatory Commission (CSRC), public funds may be marketed through public means, such as public media, towards the general public, including those who are not Qualified Investors (as further explained in 2.2.3 Restrictions on Investors). Public funds can be deemed as the Chinese equivalent of retail funds.

According to the latest statistics published by the Asset Management Association of China (AMAC), as of November 2020, the assets under management of 7,783 public funds reached RMB18.75 trillion.

Private Funds

In the PRC, private funds can only be marketed to Qualified Investors by way of a private placement. Private funds can be deemed as the Chinese equivalent of wholesale funds or alternative investment funds.

According to AMAC, as of November 2020, there were 24,611 private fund managers registered with AMAC, and the assets under management of 94,739 private funds that filed with AMAC stood at RMB15.91 trillion.

Funds Market in 2020

On the one hand, funds that invest in listed securities (including public funds and private securities investment funds) experienced a significant increase in size as a result of the booming stock market. Despite the impact of COVID-19, the amount of funds raised by public funds reached a record RMB3.16 trillion in 2020. The size of the private securities investment funds industry also increased from RMB2.56 trillion to RMB3.74 trillion, which mainly came as a result of the net asset value growth.

On the other hand, the growth in the private equity funds industry was relatively slow. As of November 2020, the size of private equity funds increased to RMB11 trillion, which represented an increase of 13.36% compared to 2019. Influenced by the enhanced regulations, the mainstream financial products (such as bank asset management products) can hardly invest into private equity funds. Other corporate investors intend to raise their own funds, instead of investing as a pure financial investor of private equity funds without synergy with their own business. It appears that state-owned enterprises (SOEs), government guiding funds and insurance companies are the major sources of institutional investors for private equity funds. 

It should be noted that while top-tier private equity fund managers continued to succeed in raising successor funds with a larger size, a substantial portion of other fund managers have had difficulties in fundraising.

In general, the majority of private funds in the PRC are structured as limited partnerships or contractual funds. Although funds can be formed as limited companies, in practice, limited company funds are relatively rare because they are generally less tax efficient, and the PRC Company Law does not support the concept of “management share” that is available in some other jurisdictions and gives the holder of a management share power similar to a general partner.

Private Securities Investment Funds

Private securities investment funds typically take the form of a contractual fund. The main competitive advantages that a contractual fund has over a limited partnership are as follows:

  • a contractual fund can have up to 200 investors, whereas a limited partnership only allows up to 50 partners;
  • a contractual fund is not a legal entity that needs to be registered with the enterprise registration authority, the Administration for Market Regulation (AMR), and therefore its subscription and redemption processes are more efficient, without going through the registration process; and
  • the fund manager of a contractual fund does not withhold the income tax for individual investors as a matter of general practice, whereas a limited partnership fund shall withhold income tax for individual investors.

Private Equity Funds

Limited partnership

The majority of private equity funds are structured as limited partnerships in the PRC. The reasons for using the limited partnership structure are as follows:

  • the PRC Partnership Law is flexible and a limited partnership fund can accommodate most of the international practice of private equity funds; and
  • in examining a company looking to launch an IPO, the CSRC generally treats a shareholder in the form of a contractual fund as problematic because it is hard to trace the beneficial owners behind the contractual fund. Therefore, a fund with a strategy of exiting from its portfolio companies by way of an IPO shall be formed as a limited partnership, instead of a contractual fund.

Contractual fund

Due to the difficulties of listing real estate companies or assets in China, a real estate fund’s exit strategy usually excludes an IPO or securitisation, and therefore it may be formed as a contractual fund.

Limited company

Some of the funds funded by SOEs may use the form of a limited company. The PRC Partnership Law provides that an SOE shall not act as the general partner, but, in practice, an SOE under the PRC Partnership Law is interpreted in a narrow way; eg, the subsidiary of an SOE may be exempted. However, some SOEs may still prefer a fund in the form of a limited company, where no SOE will need to act as the general partner. 

Fund Managers

The majority of private fund managers are structured as limited companies, while some of them may be structured as limited partnerships.

Establish a Legal Entity and Register It with AMAC as a Private Fund Manager

  • A legal entity in the form of a limited company or limited partnership shall be established first, and the name of such entity shall include “private fund”, “private fund management” or “venture capital investment”, and the business scope of such entity shall include “private funds management”, “private securities investment funds management”, “private equity funds management” or “venture capital funds management”. The timeline depends on the location where the entity is established, and may vary from one month to six months or even longer. Some local governments set high standards for accepting the establishment of such entities, which makes it extremely difficult to complete the establishment. 
  • To register the legal entity with AMAC as a fund manager, a legal opinion shall be issued by a qualified PRC law firm on whether the applicant has fulfilled AMAC’s requirements on the applicant’s name, business scope, number of employees, capital contributions and relevant investment experience of its officers, etc.

It usually takes 3-4 months to complete the registration with AMAC, but there is no guarantee that the registration can be completed within such period. AMAC reserves much discretion and an applicant satisfying all the written requirements may still fail to complete the registration due to inconsistency with AMAC’s internal principles or otherwise. 

Establish a Fund Vehicle

For private equity funds, the fund vehicle, usually in the form of a limited partnership with a business scope containing equity investment, may be established before the first closing of the fund, so that the fund vehicle may admit investors upon first closing. Again, the timeline depends on the location where the entity is established, and may vary from one month to six months or even longer. Some local governments set high standards for accepting the establishment of such fund vehicles, which makes it extremely difficult to complete the establishment.

Fundraising

The timeline for the fundraising process depends on various commercial factors, and shall be subject to various requirements regarding marketing of the fund, risk disclosure, verification of Qualified Investors, etc.

Fund Filing with AMAC

After the first closing and first instalment of the capital contribution, the fund shall be filed with AMAC by the fund manager, and the process may take up to 1-2 months.

In respect of the debt of private funds, investors generally shall be protected by limited liability as follows.

Limited Partnership Funds

Limited partners shall be liable for the debt of the limited partnership fund to the extent of their subscribed capital; ie, their capital commitment.

Contractual Funds

Though a contractual fund, as a legal form, is frequently used for setting up most private securities investment funds, and occasionally for private equity funds, there is hardly any explicit law dealing with contractual funds.   

According to the Securities Investment Fund Law, investors of public funds and private securities investment funds shall only be liable for the debt of the fund to the extent of their investments, which is read as applicable to a private securities investment fund in the form of a contractual fund. Also, the authors tend to believe such limited liability protection shall apply to investors of a private equity fund in the form of a contractual fund.

Limited Company Funds

For a fund in the form of a limited company, investors (ie, shareholders) are liable to the extent of their subscribed capital.

In the PRC, private funds are subject to ongoing disclosure obligations.

Fundraising Information Disclosure

Marketing documents such as the private placement memorandum shall include basic information on the fund and the manager, custody arrangements (if any), investment of the fund, distribution of proceeds, performance fee arrangement, etc, the content of which shall be substantially the same as the fund contracts. In addition, a risk disclosure document is required to be signed by investors as a filing document, which shall fully disclose various risks of the fund.

Fund Operation Information Disclosure

Periodic reporting obligation

The content and frequency of disclosure requirements differ according to the type of fund. For private securities investment funds, monthly reports shall be submitted to AMAC, disclosing information on the fund size, unit net value and investors. However, private equity funds are only required to report quarterly in respect of the net asset value, and key financial and investment information.

Disclosure requirement on specific events

When certain events occur, disclosures are required to be made to investors in a timely fashion. According to AMAC’s rules, such events normally would have a significant impact on investors’ interest, including change of investment scope of the fund, change of the fund manager or the custodian and significant related-party transactions.

Consequences of failing to fulfil disclosure requirements

AMAC conducts inspections on fund information disclosure from time to time and may take disciplinary actions against the responsible person, depending on the seriousness of the case.

If a private fund manager fails to submit periodic reports in a timely manner, AMAC can suspend the fund manager’s application for filing a new fund until such obligation is fulfilled.

In the PRC, private funds can only be marketed to Qualified Investors, which includes individual investors and institutional investors.

This firm sees more individual investors investing in private securities investment funds, and more institutional investors (ie, corporate investors, SOEs, government guiding funds, insurance companies, etc) investing in private equity funds. Institutional investors also have different preferences depending on their type. For example, insurance companies normally would invest in the funds established by top-tier fund managers, and corporate investors tend to invest in specific industrial funds for synergy with their own business.

Fund Managers

In the PRC, private fund managers are typically structured as limited companies, and some of them are in the form of limited partnerships.

Fund Structures

For limited partnership funds, fund managers usually also serve as general partners, but there is a trend of separation of the fund manager and the general partner, which is often a subsidiary of the fund manager. 

For contractual funds, the parties to the fund contract shall include investors, the fund manager and the custodian.

For limited company funds, a separate fund manager may or may not be one of the shareholders of the fund. Also, it is possible for a limited company to have its internal fund management team without a separate fund manager.

Private funds can only be invested in by “Qualified Investors”.

Qualified Investors refer to those institutions and individuals who invest in a single private fund an amount not less than RMB1 million and accord with the following standards:

  • with respect to institutions, their net assets shall be no less than RMB10 million; or
  • with respect to individuals, their financial assets (such as bank deposits, stocks and bonds) shall be no less than RMB3 million or their personal average annual income in the last three years shall be no less than RMB500,000. 

Where an investor has no legal personality (such as partnerships and contracts), such investor shall be looked through to verify if those investors holding interests in such investor are Qualified Investors respectively, with the exemptions applicable to certain investors, including bank asset management products, Qualified Foreign Institutional Investors (QFIIs) and Renminbi Qualified Foreign Institutional Investors (RQFIIs) approved by CSRC, which shall be regarded as Qualified Investors and are not subject to the above “look-through” rules. The aforesaid QFII and RQFII refer to foreign institutional investors that have been approved by CSRC to make securities and futures investments in the PRC with offshore funds, including overseas fund management companies, commercial banks, insurance companies and securities companies.

In general, the CSRC is the regulator of the listed securities and futures market, and also supervises and administers the private funds market. Under the supervision of the CSRC, AMAC is a self-disciplinary organisation, but the authors tend to believe it is also the de facto regulator of the private funds industry and it has issued a set of self-disciplinary rules on the registration of private fund managers, the filing of private funds, disclosure requirements, etc.

In 2014, the CSRC promulgated the Interim Measures for the Supervision and Administration of Private Investment Funds, which provides a general regulatory regime for the private funds industry. AMAC then released a series of detailed rules. In January 2021, the CSRC promulgated the Provisions on Strengthening the Supervision of Private Funds (the “Private Funds Provisions”), which outlines the latest regulatory framework regarding private funds.

Under the preceding regulations, private funds are not permitted to directly or indirectly make investments that are prohibited or restricted by the government, or inconsistent with national industrial policies, environmental protection policies or land administration policies, with the exemption of investment in listed securities. Investing in loans (including disguised loans) and providing guarantees are also prohibited by AMAC. However, for the purpose of equity investment, if the borrowing or guarantee period is less than one year, private equity funds may provide loans or guarantees to portfolio companies. In addition, private funds shall not invest in credit assets such as factoring assets, financial leasing assets or pawn assets, or make investments that have unlimited liability.

Generally, only local service providers are allowed to provide services in China to private funds. 

For non-local service providers providing services outside of China to Chinese private funds/fund managers, the PRC law is silent regarding the regulation of registration requirements, etc. Considering a Chinese fund is unlikely to have an offshore account or other offshore operations, etc, it appears unlikely that a Chinese fund would engage a non-local custodian or administrator.

Only fund managers that have been duly registered with AMAC are permitted to manage private funds in China. There are no regulatory requirements expressly applicable to non-local managers of private funds. A non-local manager’s marketing activities in China for their offshore funds are not clearly dealt with by PRC law, and professional advice shall be sought before conducting such activities. 

See 2.1.2 Common Process for Setting up Investment Funds.

In general, the marketing of private funds is regulated by the Securities Investment Fund Law, the Measures for the Administration of the Fundraising of Private Investment Funds (the “Fundraising Measures”), the Measures for the Administration of the Appropriateness of Securities and Futures Investors promulgated by the CSRC (the “Appropriateness Measures”) and the Private Funds Provisions.

Public Offering Should Be Avoided in the Course of Private Fund Marketing

In the PRC, approval is required for marketing to the general public.  According to the Securities Investment Fund Law, raising funds from non-specific targets or issuing securities to more than 200 specific targets accumulatively in the PRC will be regarded as a public offering and should be subject to the CSRC’s approval.

Private fund managers and placement agents shall not disseminate information to non-specific targets via public communication media such as newspapers, radio stations, TV or the internet, or through lectures, seminars, analysis meetings, bulletins, leaflets, short messages, blogs, emails or by other means. However, marketing through an official website or the internet with a mechanism that is only accessible to specific targets is not considered as a public offering.

Restrictions on Content of the Presentation

Certain contents are strictly forbidden to be used in the course of marketing, including:

  • direct or indirect promises to investors that there will be no losses of the investor’s funds or there will be a minimum income; or
  • using exaggerated words, such as “safe”, “promise”, “secure”, “avoidance of risks”, “guaranteed”, “high income” or “no risk”.

Private funds can only be marketed to Qualified Investors. 

Special Protection for General Investors

Qualified Investors that can invest in private funds are broadly split into general investors and professional investors.

General investors can be further classified into five types (C1-C5), varying on their risk tolerances. Special protections will be provided to general investors with respect to information disclosures, risk warnings, suitability matching, etc. For example, fundraisers shall not actively conduct marketing of a fund to general investors whose tolerance is lower than the risk level of the fund. Investors who belong to the lowest risk tolerance category are not allowed to invest in any fund with a risk rating above their risk tolerance. However, investors may invest in relatively riskier funds after accepting special risk warnings that are issued by fundraisers in writing.

Fair Treatment to Investors

Under the Private Funds Provisions, all investors of one private fund shall have fair treatment. 

Regulatory Reporting Requirements

With respect to regulatory reporting requirements, except for submitting periodic reports to AMAC (see 2.1.4 Disclosure Requirements), private fund managers shall also disclose fund operation information to investors, and submit information disclosure reports to an AMAC online system for records. While private securities investment fund managers are supposed to issue an information disclosure report to investors monthly, quarterly and annually, private equity fund managers are only required to submit semi-annual disclosure reports and an annual disclosure report. Again, as mentioned in 2.1.4 Disclosure Requirements, when certain events occur, private fund managers are required to report to AMAC within five business days and make a disclosure to investors. To be specific, in accordance with AMAC’s rule, significant matters include:

  • change of the fund manager and the custodian;
  • major changes to the fund contract;
  • large redemption of the fund;
  • major litigation, arbitration or disputes in relation to fund management, fund assets or fund custody services;
  • investment that accounts for more than 50% of the net asset value of the fund cannot be duly exited; and
  • other events that may have a significant impact on the continued operation of the fund, the interests of investors or the net asset value of the fund.

AMAC accepts telephone enquiries as well as email enquiries regarding the relevant regulations and compliance requirements. Face-to-face meeting is generally not available.

Restrictions on Investments in Private Funds

In general, private funds are not permitted to directly or indirectly make investments that are prohibited or restricted by the government, or inconsistent with national industrial policies, environmental protection policies or land administration policies, with the exception of an investment in listed securities. 

Private securities investment funds

For private securities investment funds, investment is limited to listed stocks, bonds, futures, options, other securities investment funds, and other assets recognised by the CSRC.

Private equity funds

Private equity funds shall mainly invest in unlisted equity; investing in loans and other fixed-income investments has generally been banned by AMAC, which holds the general view that any investment looking for fixed income shall not be the investment target of private funds. Specifically, private funds are not permitted to directly or indirectly make investments that are prohibited or restricted by the government, or inconsistent with national industrial policies, environmental protection policies or land administration policies, with the exception of investment in listed securities. Investing in loans (including disguised loans) and offering guarantees is also prohibited by AMAC. However, for the purpose of equity investment, if the borrowing or guarantee period is less than one year, private equity funds may provide loans or guarantees to portfolio companies. In addition, private funds shall not invest in credit assets such as factoring assets, financial leasing assets or pawn assets, or make investments that have unlimited liability.

Asset Protection

In general, unless otherwise agreed in the fund contracts of certain funds satisfying AMAC criteria, private funds shall have fund custodians. Where there is no custodian, the fund contract shall explicitly provide measures to protect fund assets and a dispute resolution mechanism. In practice, the majority of private funds have custodians.

In addition, in line with the investor protection, where private funds conduct related-party transactions (ie, transactions involve the private fund, the fund manager, investors, other private funds managed by the manager or under the same actual controller, or other related parties that have significant interests with the above subjects), effective risk control mechanisms such as disclosure arrangements and special decision-making procedures for related-party transactions shall be established.

Other Specific Requirements

Borrowing restrictions

According to the Private Fund Provisions, private funds are generally banned from providing loans or guarantees, but for the purpose of equity investment, if the borrowing or guarantee period is less than one year, private equity funds may provide loans or guarantees for portfolio companies. Despite the foregoing, the expiry date of the term of borrowing or guarantee shall not be later than the end of the investment, and the amount of borrowing or guarantee shall not exceed 20% of the total assets of the private fund.

Valuation of fund assets

AMAC has published fund valuation guidelines, which are not compulsory, and provides comprehensive guidance on the valuation of fund investment targets, including stocks, restricted shares, fixed-income instruments and unlisted equity. However, because it is not compulsory, most fund managers do not use the guidelines.

Restrictions on related-party transactions

According to the Private Fund Provisions, private fund managers shall not conduct related-party transactions that may cause loss of fund assets or violate the interests of investors. Private fund managers shall establish mechanisms regulating related-party transactions such as a pricing policy in relation to related-party transactions and a transaction approval system. Related-party transactions that involve fund assets shall acquire pre-approvals from investors through the agreement mechanism, and shall be fully disclosed to investors after the investment.

Prohibition on insider dealing and market abuse

Insider dealing, manipulating a securities and futures market and other market abuse conduct are forbidden under the Private Fund Provisions. Violations of the preceding rules are subject to strict administrative measures of the CSRC, and the violator shall be publicised through the capital market integrity information database. Also, criminal penalties may be imposed if the relevant conduct constitutes an offence under criminal laws.

In general, private funds in the PRC are permitted to borrow for making investments. For example, private equity funds may access M&A loans, in which commercial banks can provide loans of up to 60% of the transaction price, and the borrower shall provide sufficient security for the debt.

Restrictions on Borrowings

According to the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (the “Guiding Opinions”), the leverage ratio of an asset management product shall be limited, and the total assets of a private product shall not exceed 200% of its net assets, which means the borrowing shall not exceed 100% of the capital. For graded products (products with preferred unit holders receiving distributions prior to other unit holders), the total assets shall not exceed 140% of the net assets.

The Guiding Opinions does not directly apply to private funds, and AMAC has indicated that it would issue a detailed rule applicable to private funds in accordance with the Guiding Opinions. However, such a rule has not yet been published, and it is advisable to follow the restrictions of the Guiding Opinions.

In practice, it is not common for private equity funds to borrow to make investments. Also, fund contracts may also set restrictions such as prior approval on each borrowing.

Security for Borrowing

In the PRC, it is common for banks to take collaterals such as real property or marketable securities, or seek a guarantee from guarantors with capability of repayment. Sometimes, the fund manager or its affiliate may provide a bridge loan or warehousing to a fund without security. 

The applicable tax regime for private funds depends on the form of the fund and the type of income.

Limited Company Funds

On the one hand, a limited company fund itself is subject to enterprise income tax (EIT) at the rate of 25%.

On the other hand, income tax also applies to investors depending on the investor types:

  • for limited company investors, they are generally subject to a 25% EIT on their own profit, but dividends from the limited company fund may be exempted to avoid double taxation after the limited company fund has paid its EIT; and
  • for individual investors, a 20% individual income tax (IIT) shall apply. 

Limited Partnership Funds

Private funds structured as limited partnerships are tax transparent for income tax, and for investors of such funds, the tax treatments are as follows.

  • For individual investors, due to the absence of clear tax law, the practice varies between different locations of China. Ideally, a flat rate of 20% IIT shall apply, but in some locations, a progressive rate from 5% to 35% shall apply.
  • For a limited company investor, a 25% EIT applies to its profits. Though dividends received by a company from another company shall be exempted, there exists uncertainty regarding the eligibility of the dividends paid by portfolio companies indirectly through a limited partnership fund to its limited company investors, which can be interpreted as distribution from the limited partnership, instead of dividends from the portfolio company. The practice may vary between different locations of China.

Contractual Funds

Similar to limited partnership funds, contractual funds are also tax transparent. 

  • Similar to the practice of investment trust companies in China in respect of the IIT of individual investors of investment trusts under their management, the fund manager does not withhold the IIT for individual investors and each individual investor shall be responsible for their own tax declaration.
  • A limited company investor is subject to a 25% EIT on its profits, with the exemption of dividends received from another company. 

Preferential Tax Policy for Venture Capital Funds

An additional preferential tax policy may apply to venture capital funds investing in scientific and technological enterprises that meet certain requirements. 

  • For a venture capital fund structured as a limited company, where the fund has directly invested in an eligible scientific and technological enterprise for more than two years, it can have a tax credit at 70% of the investment amount against the EIT. If the amount of the granted tax credit is not fully used, that balance can be carried forward to the following tax year.
  • For a venture capital fund structured as a limited partnership, a similar policy applies to the investors of the fund. Namely, a limited company investor can claim a tax credit of 70% of the investment amount in the eligible scientific and technological enterprise against its income from the fund. An individual investor can have the same amount of tax credit against its income from the fund.

The law is unclear about the form of public funds; eg, a limited partnership, a trust or otherwise. 

Under the Securities Investment Fund Law, a public fund is not a legal entity, and the fund manager is entrusted to manage the assets of the public fund, and the assets of the fund are separate from the assets of the fund manager. In respect of the issues that the Securities Investment Fund Law does not provide for, the PRC Trust Law shall apply. Therefore, the authors tend to believe that the form of a public fund shall be similar to a trust.

Investors’ interests in a public fund are called fund units.

Public funds can be operated as open-ended or close-ended. After the first open-end public fund was approved in 2001, open-end public funds have developed rapidly and become the most popular form of public fund. As of November 2020, there were 6,655 open-end public funds, whereas the number of closed-end ones was 1,128.

As a public fund is not a legal entity, the subscription or redemption of fund units will not trigger the registration process with the AMR, which suits the operation of open-end public funds. 

Based on the list of public fund managers publicised by AMAC, public fund managers are all structured as limited companies in the PRC.

The common process for setting up a public fund in the PRC includes the following steps.

Setting up a Public Fund Manager

A public fund manager can be set up by way of (i) establishing a new public fund management company, or (ii) obtaining a public fund manager licence for an existing asset management institution (such as a securities company or an insurance asset management company).

Setting up a new public fund management company

To set up a public fund management company, the approval of the CSRC shall be obtained first after satisfying various strict requirements. High standard requirements also apply to its major shareholders in respect of their registered capital, net asset scales, etc.

After the submission of the application documents, the CSRC may require the applicant to supplement the documents before it accepts the application. Once the application documents are accepted, the CSRC shall decide whether to issue the approval within six months. In practice, it is hard to obtain approval from the CSRC, which determines whether to grant the approval on a discretionary basis. Therefore, the actual time for obtaining the approval is uncertain, depending on the background of the prospective shareholders of the fund manager, etc. 

Within 30 days of receipt of the CSRC’s approval, the applicant shall register the fund management company with the AMR. The new fund management company is established upon the issuance of a business licence by the AMR. 

After the establishment of the fund management company, the company shall prepare for operation by satisfying various requirements regarding its office, IT system, employees, etc, to be inspected by the CSRC. The preparation period may last as long as six months or so. The public fund management company may only start business operations after passing the inspection by the CSRC. 

Public fund manager licence for existing institutions

Subject to certain conditions, asset management institutions (such as securities companies and insurance asset management companies) can also apply for the public fund manager licence from the CSRC.

In general, an applicant shall fulfil the following conditions:

  • at least three years' management experience of securities assets with good performance;
  • sound corporate governance, with a sophisticated internal mechanism and effective risk control system;
  • good business performance and financial standing for the last three years;
  • no significant violation of the applicable laws and regulations; and
  • admitted as a member of AMAC.

Other requirements include a minimum scale of assets under management, construction of information systems and a number of staff members with fund practice qualifications.

After submission of the application documents, the CSRC may require the applicant to supplement the documents before it accepts the application. Once the application documents are accepted, the CSRC shall decide whether to issue the approval within 20 business days, which may be extended to 30 business days subject to the CSRC’s internal approval. For similar reasons, the actual time for obtaining the approval is uncertain.

After the application is approved, the applicant shall further prepare for public fund management business by satisfying various requirements, such as setting up a specific department for fund business and the establishment of a fund investment decision-making process, to be inspected by the CSRC. The preparation period may last as long as six months or so. The public fund management company may only start public fund management business after passing the inspection by the CSRC. 

Fund Registration with the CSRC

A licensed public fund manager may market and raise public funds subject to the relevant requirements. 

A prospective public fund shall be registered with the CSRC before being marketed to the general public. In general, a public fund to be marketed shall have a specific investment direction and the name shall indicate its type and features. The application documents for fund registration generally include an application report, a draft fund contract, a draft custody contract, a draft prospectus and a legal opinion issued by a PRC law firm. 

The CSRC may require the applicant to supplement the documents before it accepts the application for registration of a new public fund. Once the application documents are accepted, the CSRC shall decide whether the public fund can be registered for fundraising within six months. In practice, some public funds may complete registration within one month.   

Fundraising and Filing with the CSRC

The fundraising period shall not exceed three months from the date of offering. Upon the expiry of the fundraising period, the manager shall engage an accounting firm to conduct capital verification for the fund and file the public fund with the CSRC, which will grant a written confirmation within three business days.

In respect of the debt of public funds, investors are protected by limited liability and only bear the risks to the extent of their investment in the fund.

In general, public fund managers and custodians shall disclose fund information to investors and publicise fund operation information via newspapers and websites recognised by the CSRC.

To be specific, the information required to be disclosed is as follows:

  • the prospectus, the fund contract and the fund custody agreement;
  • the fundraising information;
  • the announcement on the listed fund units;
  • the net asset value of the fund and fund units;
  • the subscription and redemption prices;
  • the quarterly reports, semi-annual reports and annual fund reports;
  • interim reports;
  • the resolutions of the fund unit holders’ meeting;
  • major personnel changes of the fund custodian or manager;
  • legal proceedings or arbitration related to fund assets, the fund management or the fund custody; and
  • other information to be disclosed as required by the CSRC.

False records, misleading statements or material omissions, predictions of investment performance and promises on incomes are strictly prohibited.

Subject to fund marketing rules, including the Appropriateness Measures, public funds may be offered to the general public. 

Public funds can be classified as share investment funds, bond funds, money market funds, hybrid funds and funds of funds based on their investment scope (as further explained in 3.3.1 Retail Funds Regulatory Regime). Except for the low-risk money market funds, which are the most popular to both individual and institutional investors, institutional investors generally prefer bond funds, while individual investors generally prefer hybrid funds (ie, funds that can invest in shares, bonds or other funds) and share investment funds.

More recently, as a result of the booming stock market, both individual and institutional investors have increased their investment in share investment funds.

Based on the list of public fund managers publicised by AMAC, public fund managers are all structured as limited companies in the PRC.

The Appropriateness Measures also applies to public funds. As mentioned above, investors are split into general investors and professional investors, and general investors can be further classified into five types (C1-C5), varying on their risk tolerances. Fundraisers shall not market a fund to any investor whose risk tolerance is lower than the risk level of the fund without solicitation of the investor. Investors of the lowest risk tolerance category shall not be accepted to invest in any fund with a risk rating above their risk tolerance unless a special risk warning in writing has been provided.

The Securities Investment Fund Law is the basic law regarding the regulation of retail funds. The CSRC, as the regulator of the public fund industry, has promulgated accordingly a series of regulations in relation to the establishment of a fund management company, fund registration, and the operation and management of public funds.

A public fund may only invest in listed securities, futures and derivatives, depending on the type of the fund. Except for hybrid funds (ie, funds that can invest in shares, bonds, or other funds), the limitations on different types of public funds are as follows:

  • for share investment funds, 80% or more of the fund assets shall be invested in stocks;
  • for bond funds, 80% or more of the assets shall be invested in bonds;
  • for money market funds, all assets shall be invested in money market instruments; and
  • for funds of funds, 80% or more of the assets should be invested in other funds.

In addition, public funds are subject to certain restrictions with respect to the proportion of the investment. For example, for each public fund, the value of securities of a single company held by the fund shall not exceed 10% of the fund’s net asset value.

Generally, only local service providers are allowed to provide services in China to public funds.

For non-local service providers providing services outside of China to Chinese public funds/fund managers, under Shanghai-Hong Kong Stock Connect (ie, a cross-boundary investment scheme that connects the Shanghai Stock Exchange and the Hong Kong Stock Exchange), Chinese fund managers are permitted to engage Hong Kong entities to provide investment advisory services such as issuance of a research report on southbound trading (ie, domestic investors in China investing in securities listed in Hong Kong). A Hong Kong entity providing investment advisory services shall comply with the relevant provisions under the PRC law and Hong Kong laws.

In general, the Hong Kong service provider shall have obtained the licence on providing investment advice from the Hong Kong regulatory authority, the Securities and Futures Commission (SFC). Where a Chinese public fund manager is provided with such services, it shall file documents – including the service agreement, an undertaking letter issued by the Hong Kong service provider and relevant certificates – with the CSRC.

Except for the above, the law is silent regarding the registration requirements for other non-local service providers. Considering a Chinese public fund is unlikely to have an offshore account or other offshore operations, etc, it appears unlikely that a Chinese fund would engage a non-local custodian or administrator.

As mentioned in 3.1.2 Common Process for Setting up Investment Funds, only fund management companies and asset management institutions that have been approved by the CSRC are permitted to manage public funds in China. 

For non-local managers’ marketing activities in China for their offshore funds, according to the Interim Provisions on the Administration of Recognised Hong Kong Funds (the “Hong Kong Funds Provisions”), Hong Kong public funds – including unit trusts, mutual funds and other collective investment schemes – may be marketed to the general public in China after registration with the CSRC. The registration is subject to strict conditions regarding the fund and the fund manager. For example, the Hong Kong fund shall be established and operated in compliance with Hong Kong laws, and is approved to have a public offering and is regulated by the SFC; and the Hong Kong fund manager shall be registered in Hong Kong and licensed to conduct asset management.

In addition, a prospective Hong Kong fund manager shall engage a Chinese public fund manager or a custodian approved by the CSRC as its local representative.

See 3.1.2 Common Process for Setting up Investment Funds.

In the PRC, the rules applicable to the marketing of public funds include the Securities Investment Fund Law, the Measures for the Operation and Administration of Public Funds, the Measures for the Administration of Information Disclosure of Public Funds, and the Appropriateness Measures. The main rules that apply to the marketing of public funds are as follows.

Fund Registration with the CSRC

As discussed in 3.1.2 Common Process for Setting up Investment Funds, only public funds that have been registered with the CSRC can be marketed to the general public.

Fundraising Information Disclosures

The above regulations provide detailed requirements on the information that shall be disclosed with respect to fundraising of public funds. For example, the marketing document of a public fund shall include the following information:

  • basic information on the fund manager and the fund custodian;
  • a summary of the contents of the fund contract and the fund custody agreement;
  • the price, cost and duration of the fund units;
  • the proportions of the remuneration and other related expenses of the fund managers and fund custodians;
  • risk warnings, etc.

Risk Assessment and Matching Investors with Suitable Funds

Under the Appropriateness Measures, fundraisers shall not actively conduct marketing of a public fund to general investors whose tolerance is lower than the risk rate of the fund (see 3.2.3 Restrictions on Investors).

Upon registration of the public fund (see 3.1.2 Common Process for Setting up Investment Funds), public fund managers can conduct marketing towards the general public.

Statutory Reporting Requirements

Public funds are subject to stricter reporting requirements than private funds. Public fund managers shall publicise quarterly reports, semi-annual reports and annual reports of public funds. In addition, fund managers shall publicise the net asset value of the fund and the fund units at least once a week.

The CSRC accepts both telephone and email enquiries from the general public. Face-to-face meeting is generally not available.

Restrictions on the Types of Investment for Public Funds

Public funds shall only invest in listed securities, and investment scope is also restricted based on the type of public fund (see 3.3.1 Retail Funds Regulatory Regime).

Asset Protection

With respect to asset protection of public funds, each public fund must appoint a bank custodian to hold the fund assets. Commercial banks and other financial institutions, including securities companies that have been approved by the CSRC, can serve as the custodian of a public fund.

Other Specific Operational Requirements

Liquidity risk control

Fund managers of open-end public funds are required to establish and improve an internal liquidity risk control system, including a sophisticated management mechanism, a standardised business operation process, an independent and strict supervision system, and flexible emergency response plans. Specific restrictions include that total investment in liquidity-restricted assets shall not exceed 15% of the net asset value of an open-end public fund.

In addition, the CSRC issued guidelines for the side pocket mechanism of public funds in 2020, for liquidity risk management purposes; a special account shall be established for assets with high uncertainty in valuation.

Borrowing restrictions

While borrowing for making an investment is permitted, public funds are subject to certain borrowing restrictions to be discussed in 3.5 Retail Fund Finance.

Valuation and pricing of assets of public funds

The CSRC has published a guiding opinion on public valuation, the basic principle under which is that public fund managers shall determine the fair value of net assets in a timely manner and accurately in accordance with statutory accounting rules, using valuation techniques supported by sufficient available data and other information. Other pricing guidelines are also provided with respect to specific businesses. 

Public funds are permitted to make borrowings for making an investment. Under the Guiding Opinions, the total assets of an open-end public fund shall not exceed 140% of its net assets, which means the borrowing shall not exceed 40% of the capital, and the total assets of a closed-end public fund shall not exceed 200% of its net assets. 

In the PRC, public fund managers may conduct margin trading by borrowing funds from securities companies approved by the CSRC. The securities company will require the borrower to provide the security at a certain percentage of the margin (which may be in the form of securities), and assets bought on margin in the borrower’s account will also be a collateral for the margin trade.

The applicable taxes mainly include stamp duty, EIT and IIT.

Tax for Funds

A stamp duty of 1‰ of the share price shall apply to the selling of shares by public funds. Gains of trading price difference of shares and bonds, as well as dividends from shares and interest from bonds, are exempted from the EIT.

Tax for Investors

Individual investors of public funds are exempted from the IIT on gain of redemption price over the subscription price, and dividends paid by the fund. However, institutional investors are not exempted from the 25% EIT on the gain of redemption price over the subscription price.

In January 2021, the CSRC promulgated the Private Funds Provisions, which integrates certain self-discipline rules previously issued by AMAC. The key points of the Private Funds Provisions are as follows.

Standardise the Name, Business Scope and Business Operation of Private Fund Managers

The Private Funds Provisions provides that the name of a private fund manager shall include the words “private fund”, “private fund management” or “venture capital investment”, and the business scope of such entity shall include “private funds management”, “private securities investment funds management”, “private equity funds management” or “venture capital funds management”.

Private Funds Are Only Permitted to Provide Short-Term Loans or Guarantees for Portfolio Companies

As discussed in 2.4 Operational Requirements for Alternative Investment Funds, private funds are generally prohibited from investing in loans (including disguised loans) or offering guarantees, with the exception that, for the purpose of an equity investment, if the borrowing or guarantee period is less than one year, private funds may provide loans or guarantees for portfolio companies. Despite the foregoing, the expiry date of the term of borrowing or guarantee shall not be later than the end of the investment, and the amount of borrowing or guarantee shall not exceed 20% of the total assets of the private fund.

Unfair Treatment of Different Investors of the Same Private Fund Is Prohibited

The previous AMAC rule also required that fund managers are not permitted to treat different investors unfairly, under which, private fund managers are prohibited from setting up different investment units within one fund, often with separate accounting and distribution for each investment unit as if it is a standalone fund, which is similar to the mechanism of a segregated portfolio company of the Cayman Islands, but without the segregation of legal risks between different investment units. The Private Funds Provisions provides for a general principle that all investors of one private fund shall have fair treatment, appearing to offer a broader protection. 

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King & Wood Mallesons has its key office in Beijing and an extensive global network of 28 international offices. The investment funds legal team of King & Wood Mallesons is equipped with in-depth local experience and has been the consistent industry leader in the establishment, investment and exit of domestic and overseas funds. The firm’s lawyers and experts have expertise in laws, policies and regulations home and abroad, who are capable of advising clients on various private equity funds, assisting clients in drafting investment plans and designing investment structures. Meanwhile, King & Wood Mallesons also has lawyers who focus on legal service in relation to tax, intellectual property, labour, real estate and insurance, which enables King & Wood Mallesons to offer professional one-stop support in investment funds projects at any time.

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