Investment Funds 2024

Last Updated February 08, 2024

China

Law and Practice

Authors



King & Wood Mallesons has its key office in Beijing and has an extensive global network of 30 international offices. The investment funds legal team of King & Wood Mallesons is equipped with in-depth local experience and has been a consistent industry leader in the establishment, investment and exiting of domestic and overseas funds. The firm’s lawyers and experts have proficiency in laws, policies and regulations, both at home and abroad, and are capable of advising clients on various private equity funds, on drafting investment plans and on designing investment structures. King & Wood Mallesons also has lawyers who focus on tax, intellectual property, labour, real estate and insurance law, enabling them 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 approval 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 may be considered the Chinese equivalent of retail funds.

According to the latest statistics published by the Asset Management Association of China (AMAC), as of 31 June 2023, the assets under management of 10,980 public funds reached CNY27.69 trillion.

Private Funds

Private funds can only be marketed to Qualified Investors by way of a private placement. Private funds may be considered the Chinese equivalent of wholesale funds or alternative investment funds.

According to the AMAC, as of 31 June 2023 there were 22,113 private fund managers registered with it, and the assets under management of 152,298 private funds that filed with the AMAC stood at CNY20.80 trillion.

Funds Market in 2023

Due to China’s continuing economic downturn in 2023, the growth of funds that invest in listed securities (including public funds and private securities investment funds) remains slow. From January 2023 to September 2023, public funds increased from CNY27.25 trillion to CNY27.48 trillion – an increase of only CNY0.23 trillion. This was higher than in 2022 (an increase of only CNY0.157 trillion) but considerably lower than in 2021 (an increase of CNY4.97 trillion). From January 2023 to September 2023, the number of private securities investment funds increased from 94,264 to 97,964. At the same time, private securities investment funds increased from CNY5.61 trillion to CNY5.89 trillion – an increase of only CNY0.276 trillion.

Growth in the private equity funds industry has slowed down. By September 2023, the size of private equity funds had increased to CNY14.34 trillion, which represented an increase of 2.61% compared to the beginning of 2023; however, the increase in 2022 was 6.63%. Additionally, the number of private equity funds increased to 53,737, which represented an increase of 6.17% compared to the beginning of 2023, though in 2022 this increase was 12.25%.

Further, the polarised situation of the fundraising market has become more pronounced. Money has been gradually concentrated into top-tier private equity fund managers, who have unfortunately also slowed down their fundraising pace compared to 2022. For those less successful fund managers, 2023 was a more difficult year than 2022, and perhaps even their most difficult year yet.

Most 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’s Company Law does not support the concept of a “management share” as is available in some other jurisdictions and that gives the holder of a management share similar power 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 needing to go 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 must withhold income tax for individual investors.

Private Equity Funds

Limited partnership

In the PRC, most private equity funds are structured as limited partnerships, for the following reasons.

  • The PRC’s Partnership Law is flexible, and a limited partnership fund can accommodate most of the international practice of private equity funds.
  • 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 will be formed as a limited partnership, instead of as 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 state-owned enterprises (SOEs) may use the form of a limited company. The PRC’s Partnership Law provides that an SOE shall not act as the general partner; but, in practice, an SOE under the 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

Most private fund managers are structured as limited companies, though some may be structured as limited partnerships.

Establishing a Legal Entity and Registering It With the AMAC as a Private Fund Manager

The form of a legal entity as a limited company or limited partnership must first be established. The name of such entity must include “private fund”, “private fund management” or “venture capital investment”, and the business scope of such entity must include “private funds management”, “private securities investment funds management”, “private equity funds management” or “venture capital funds management” and other words reflecting the characteristics of the private equity fund it intends to manage.

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 such establishment. The entity should apply to the AMAC for registration as a private fund manager within 12 months from the date of establishment, except in cases where registration needs to be deferred due to changes in policies of the relevant state departments, etc. To register the legal entity with the AMAC as a fund manager, a legal opinion must be issued by a qualified PRC law firm on whether the applicant has fulfilled the AMAC’s requirements regarding the applicant’s:

  • name;
  • business scope;
  • number of employees;
  • capital contributions; and
  • relevant investment experience of its officers, etc.

It usually takes three to four months to complete registration with the AMAC, but there is no guarantee of this timeframe. The AMAC reserves much discretion and an applicant satisfying all the written requirements may still fail to complete registration due to inconsistency with the AMAC’s internal principles or otherwise. 

Establishing 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 such establishment.

Fundraising

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

Fund-Filing With the AMAC

After the first closing and first instalment of the capital contribution, the fund is filed with the AMAC by the fund manager, and the process may take one to two months.

Regarding the debt of private funds, investors shall generally 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 essentially no 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 must include basic information on:

  • the fund and the manager;
  • custody arrangements (if any):
  • investment of the fund;
  • distribution of proceeds; and
  • performance fee arrangements, etc.

The content of these should 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 must 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 must be submitted to the 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 the AMAC’s rules, such events would normally 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 failure to fulfil disclosure requirements

The 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, the AMAC may 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.

The authors see increasingly 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 would normally invest in 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 take 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, who is often a subsidiary of the fund manager. 

For contractual funds, parties to the fund contract 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 an internal fund management team without a separate fund manager.

Private funds can only be invested in by Qualified Investors.

Qualified Investors are those institutions and individuals who invest an amount of not less than CNY1 million in a single private fund, and accord with the following standards:

  • with respect to institutions, their net assets must be no less than CNY10 million; or
  • with respect to individuals, their financial assets (such as bank deposits, stocks and bonds) must be no less than CNY3 million, or their personal average annual income in the last three years must be no less than CNY500,000. 

Where an investor has no legal personality (such as partnerships and contracts), such investor shall be looked through to verify whether those investors holding interests in such investor are Qualified Investors, with the exemptions applicable to certain investors, including:

  • social welfare funds;
  • private funds;
  • bank asset management products;
  • Qualified Foreign Institutional Investors (QFIIs) and Renminbi Qualified Foreign Institutional Investors (RQFIIs) approved by the CSRC; and
  • private fund managers and their employees who invest in the private funds under their management.

These shall be regarded as Qualified Investors and are not subject to the above “look-through” rules. QFIIs and RQFIIs refer to foreign institutional investors that have been approved by the 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, the AMAC is a self-disciplinary organisation, but the authors tend to believe it is also the de facto regulator of the private funds industry. 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 provide a general regulatory regime for the private funds industry. The AMAC subsequently 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 outline the latest regulatory framework regarding private funds. In June 2022, the AMAC promulgated the new List of Requirements for Private Fund Manager Registration, the Key Points of Private Equity Fund Filing and the Key Points of Private Securities Investment Fund Filing, stipulating the latest regulations regarding fund manager registration and the filing of private funds.

In February 2023, the AMAC promulgated the Measures for Registration and Filing of Private Investment Funds (effective on 1 May 2023), further summarising, revising and highlighting regulations regarding fund manager registration and the filing of private funds.

In July 2023, the State Council issued the Regulation on Supervision and Administration of Private Investment Funds (effective on 1 September 2023 (the “Regulation”)). The Regulation essentially follows and emphasises the pre-existing rules, but the authority of the Regulation is higher than those rules issued by the CSRC and AMAC. In September 2023, the AMAC released a series of detailed new rules regarding the filing of private funds (see 4.1 Recent Developments and Proposals for Reform).

Under the preceding regulations, private funds are not permitted to directly or indirectly make investments that are prohibited or restricted by the government, or that are inconsistent with national industrial policies, environmental protection policies or land administration policies, with the exception of investments in listed securities. Investing in loans (including disguised loans) and providing guarantees are also prohibited by the 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 may not invest in credit assets such as factoring assets, financial leasing assets or pawn assets, nor 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 China to Chinese private funds/fund managers, 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, it seems unlikely that a Chinese fund would engage a non-local custodian or administrator.

Only fund managers that have been duly registered with the 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 should be sought before conducting such activities. 

See 2.1.2 Common Process for Setting Up Investment Funds.

Under PRC law, there is no clear definition of pre-marketing. With reference to the EU’s definition, pre-marketing activities may be understood as including provision of information on investment strategies or investment ideas on behalf of a private fund manager to qualified investors, and testing investors’ interest in a private fund before the commencement of fundraising, but without providing such information as contained in the fund marketing documents (see 2.1.4 Disclosure Requirements).

For the provision of information on investment strategies or investment ideas, the Measures for the Administration of the Fundraising of Private Investment Funds (the “Fundraising Measures”) expressly allow private fund managers to market their investment strategies through legitimate and public means, indicating a relaxed attitude towards regulating such activities.

PRC law is silent on the testing of investors’ interest in a private fund, but before such testing it is advisable to complete the following:

  • determination of specified investors; and
  • suitability matching (see 2.3.10 Investor Protection Rules).

In general, the marketing of private funds is regulated by:

  • the Securities Investment Fund Law;
  • 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 During 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 must not disseminate information to non-specific targets via public communications media (such as newspapers, radio stations, TV or the internet) or through lectures, seminars, analysis meetings, bulletins, leaflets, short messages, blogs, emails or other means. However, marketing through an official website or the internet with a mechanism that is only accessible to specific targets is not considered a public offering.

Restrictions on Content of the Presentation

Certain content is strictly forbidden to be used when marketing, including:

  • direct or indirect promises to investors that there will be no losses of the investors’ funds, or that 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. 

Under PRC law, authorisation or notification is not required by the national regulator for marketing private funds.

Private fund managers who have marketed and closed a private fund must perform the following duties:

  • fund filing with the AMAC (see 2.1.2 Common Process for Setting Up Investment Funds);
  • information disclosure (see 2.1.4 Disclosure Requirements); and
  • periodic reporting obligation (see 2.1.4 Disclosure Requirements).

Special Protection for General Investors

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

General investors can be further classified into five types (C1 to C5), based 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 may 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 a private fund must receive fair treatment. 

Regulatory Reporting Requirements

As well as submitting periodic reports to the AMAC (see 2.1.4 Disclosure Requirements), private fund managers must also disclose fund operation information to investors, and must submit information disclosure reports to an AMAC online system for records. While private securities investment fund managers should 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. As mentioned in 2.1.4 Disclosure Requirements, when certain events occur, private fund managers are required to report to the AMAC within ten business days and make a disclosure to investors. In accordance with the AMAC’s rule, significant matters specifically include:

  • change of the fund manager and the custodian;
  • major changes to the fund contract;
  • change of type of private fund;
  • change of fund service institutions; 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.

The AMAC accepts telephone enquiries as well as email enquiries regarding the relevant regulations and compliance requirements. Face-to-face meetings are 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 that are inconsistent with national industrial policies, environmental protection policies or land administration policies, except for 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 must mainly invest in unlisted equity; investing in loans and other fixed-income investments has generally been banned by the AMAC, which holds the general view that any investment looking for fixed income cannot 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 that are inconsistent with national industrial policies, environmental protection policies or land administration policies, except for an investment in listed securities.

Investing in loans (including disguised loans) and offering guarantees is also prohibited by the 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, except for a real estate pilot fund, which may provide loans or guarantees to portfolio companies without limitations on the period. In addition, private funds may not invest in credit assets such as factoring assets, financial leasing assets or pawn assets, nor make investments that have unlimited liability.

Asset Protection

In general, unless otherwise agreed in the funds contracts of certain funds satisfying AMAC criteria, private funds may have fund custodians. Where there is no custodian, the funds contract should 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 investor protection, where private funds conduct related-party transactions (ie, transactions that 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 these subjects), effective risk-control mechanisms such as disclosure arrangements and special decision-making procedures for related-party transactions must 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, except for a real estate pilot fund, which may provide loans or guarantees to portfolio companies without limitations on the period. Despite the foregoing, the expiry date of the term of borrowing or guarantee must be no later than the end of the investment, and the amount of borrowing or guarantee must not exceed 20% of the total assets of the private fund, except for more lenient restrictions for a real estate pilot fund.

Valuation of fund assets

The 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 must not conduct related-party transactions that may cause loss of fund assets or violate the interests of investors. Private fund managers should 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 must acquire pre-approvals from investors through the agreement mechanism, and must 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 these rules are subject to strict administrative measures by 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 must 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 must be limited, and the total assets of a private product must not exceed 200% of its net assets, which means the borrowing must not exceed 100% of the capital. For graded products (products with preferred unit holders receiving distributions prior to other unit holders), the total assets must not exceed 140% of the net assets.

The Guiding Opinions do not directly apply to private funds, and the 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. Additionally, 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 to 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

A limited company fund itself is subject to enterprise income tax (EIT) at the rate of 25%.

Income tax also applies to investors, depending on the investor type:

  • limited company investors 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, uncertainty exists regarding the eligibility of the dividends paid by a portfolio company 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

As with limited partnership funds, contractual funds are also tax-transparent. 

  • Similar to the practice of investment trust companies in China for the IIT of individual investors regarding 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, except for 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;
  • 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.

For those 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 should be similar to a trust.

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

Public funds can be operated as open-ended or closed-ended. After the first open-ended public fund was approved in 2001, open-ended public funds have developed rapidly and have become the most popular form of public fund. As of September 2023, there were 9,885 open-ended public funds; whereas the number of closed-ended public funds was 1,336.

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-ended public funds. 

Based on the list of public fund managers publicised by the 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 doing the following.

  • Establishing a new public fund management company.
  • Obtaining a public fund manager licence for an existing asset management institution, such as for:
    1. asset management subsidiaries of securities companies;
    2. insurance asset management companies;
    3. wealth management subsidiaries of commercial banks; or
    4. private securities investment fund managers.

In May 2022, the CSRC released Measures for Supervision and Administration of Public Securities Investment Fund Managers (effective on 20 June 2022) and supplementing rules, which impose stricter requirements for setting up a public fund manager (such as a higher requirement regarding financial status of the major shareholders of a newly established public fund manager).

Setting up a new public fund management company

To set up a public fund management company, approval of the CSRC must first be obtained after satisfying various strict requirements. High-standard requirements also apply to the company’s 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 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 must 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 must 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 asset management subsidiaries of securities companies and insurance asset management companies, wealth management subsidiaries of commercial banks, or private securities investment fund managers) can also apply for the public fund manager licence from the CSRC.

In general, an applicant must 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
  • the number of employees who have obtained the qualification for fund practice must not be less than 30 in principle.

Other requirements include a minimum scale of assets under management, construction of information systems, and so on.

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 must 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 must be registered with the CSRC before being marketed to the general public. In general, a public fund to be marketed should have a specific investment direction, and the name must 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 must not exceed three months from the date of offering. Upon the expiry of the fundraising period, the manager must 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.

Regarding 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 must disclose fund information to investors and publicise fund operation information via newspapers and websites recognised by the CSRC.

Specifically, the following information must be disclosed:

  • 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 regarding income are strictly prohibited.

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

Based on their investment scope (as further explained in 3.3.1 Regulatory Regime), public funds can be classified as:

  • share investment funds;
  • bond funds;
  • money market funds;
  • hybrid funds; and
  • funds of funds.

Except for low-risk money market funds (which are the most popular for 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.

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

The Appropriateness Measures also apply to public funds. As previously mentioned, investors are split into general investors and professional investors, and general investors can be further classified into five types (C1 to C5), based on their risk tolerances. Fundraisers may 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 accordingly promulgated 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 must be invested in stocks;
  • for bond funds, 80% or more of the assets must be invested in bonds;
  • for money market funds, all assets must be invested in money market instruments; and
  • for funds of funds, 80% or more of the assets must 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 must 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 China to Chinese public funds/fund managers, under Shanghai-Hong Kong Stock Connect (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 must comply with the relevant provisions under PRC law and Hong Kong law.

In general, the Hong Kong service provider must 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 must 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 seems 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 must be established and operated in compliance with Hong Kong law, and must be approved to have a public offering and be regulated by the SFC. Also, the Hong Kong fund manager must be registered in Hong Kong and licensed to conduct asset management.

In addition, a prospective Hong Kong fund manager must 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.

Under PRC law, there is no clear definition of pre-marketing. With reference to the EU’s definition, pre-marketing activities may be understood as including provision of information on investment strategies or investment ideas on behalf of a public fund manager to investors, and testing investors’ interest in a public fund before the commencement of fundraising, but without providing such information as contained in the fund marketing documents (see 3.3.6 Rules Concerning Marketing of Retail Funds).

Currently, PRC law is silent on pre-marketing activities, but it is advisable to conduct the risk assessment and suitability-matching procedure (see 3.2.3 Restrictions on Investors) before testing investors’ interest.

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 may be marketed to the general public.

Fundraising Information Disclosures

The above regulations provide detailed requirements on the information that must be disclosed for fundraising of public funds. For example, the marketing document of a public fund must 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; and
  • risk warnings.

Risk Assessment and Matching Investors With Suitable Funds

Under the Appropriateness Measures, fundraisers may not actively conduct marketing of a public fund to general investors whose tolerance is lower than the risk rating 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 may conduct marketing towards the general public.

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

Public fund managers who have marketed and closed a public fund must perform the following duties:

  • information disclosure (see 3.1.4 Disclosure Requirements);
  • conducting separate management and separate accounting for different fund assets;
  • distributing earnings to fund unit-holders promptly;
  • convening fund unit-holders’ general meetings according to the fund contract; and
  • conducting accounting for the fund and preparing the financial accounting reports, the half-yearly and annual fund reports for the fund, etc.

Statutory Reporting Requirements

Public funds are subject to stricter reporting requirements than private funds. Public fund managers must publicise quarterly reports, semi-annual reports and annual reports of public funds. In addition, fund managers must 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 meetings are generally not available.

Restrictions on the Types of Investments for Public Funds

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

Asset Protection

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, may serve as the custodian of a public fund.

Other Specific Operational Requirements

Liquidity risk control

Fund managers of open-ended public funds are required to establish and improve an internal liquidity risk-control system, including:

  • a sophisticated management mechanism;
  • a standardised business operations process;
  • an independent and strict supervision system; and
  • flexible emergency response plans.

Specific restrictions include that total investment in liquidity-restricted assets must not exceed 15% of the net asset value of an open-ended public fund.

In addition, in 2020 the CSRC issued guidelines for the side pocket mechanism of public funds, for liquidity risk-management purposes; a special account must 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 as discussed in 3.5 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 must determine the fair value of net assets in a timely manner, accurately and 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-ended public fund must not exceed 140% of its net assets, which means the borrowing must not exceed 40% of the capital, and the total assets of a closed-ended public fund must 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 0.1% 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.

Issuance of Regulation on Supervision and Administration of Private Investment Funds

As discussed in 2.3.1 Regulatory Regime, in July 2023 the State Council issued the Regulation on Supervision and Administration of Private Investment Funds (effective on 1 September 2023 (the “Regulation”)). The Regulation essentially follows and emphasises the pre-existing rules, but its impact is significant. The Regulation is the first administrative regulation for the private investment fund industry in China. Before the issuance of the Regulation, private investment funds were mainly governed by rules/regulations issued by the CSRC and AMAC.

Under PRC law, the authority of administrative regulations (ie, regulations issued by the State Council) is higher than those regulations/rules issued by the CSRC and AMAC. According to the PRC’s Civil Code, any activities under the Civil Code that violate the mandatory provisions of laws (ie, laws adopted by the National People’s Congress of the PRC) and administrative regulations shall be null and void. Therefore, the Regulation may be invoked as a direct basis for determining the validity of activities under the PRC’s Civil Code, whereas those rules/regulations issued by the CSRC and AMAC cannot. Besides, the Regulation provides for stricter penalties and therefore increases the cost of non-compliance in the private investment funds sector.

A Series of New Detailed Rules Issued by the AMAC Regarding Private Investment Funds

In February 2023, the AMAC promulgated the Measures for Registration and Filing of Private Investment Funds (effective on 1 May 2023 (the “Measures”)), further summarising, revising and highlighting regulations regarding fund manager registration and the filing of private funds. The Measures impose stricter requirements regarding the registration of private fund managers, such as:

  • minimum paid-up capital of CNY10 million;
  • shareholding requirements for senior management; and
  • qualification requirements for the actual controller and senior management, etc.

Private fund managers are subject to increasingly stringent regulations. Additionally, the Measures add a new minimum requirement for the size of the initial paid-up capital of private investment funds.

Further, in September 2023 the AMAC released a series of detailed new guidelines regarding the filing of private funds (collectively, the “Filing Guidelines”):

  • Guideline No 1 on Filing of Private Investment Fund – Private Equity and Venture Capital Funds;
  • Guideline No 2 on Filing of Private Investment Funds – Private Equity and Venture Capital Funds; and
  • Guideline No 3 on Filing of Private Investment Funds – Change of Manager for Private Investment Funds.

Since the date of implementation of the Filing Guidelines No 1 and No 2, the Instructions for the Filing of Private Investment Funds, Key Points of Filing of Private Investment Funds and related materials were abolished. The Guidelines No 1 and No 2 basically follow the pre-existing rules and formalise certain verbal instructions by the AMAC, but also revise some rules, such as relaxation of restrictions on subsequent closings.

The Pilot Programme for Real Estate Funds

On 28 November 2022, the CSRC proposed carrying out a new pilot programme that enables eligible private fund managers to set up real estate private funds, which previously was hard to complete in terms of fund filing with the AMAC. The programme aims to stabilise the debt-ridden and distressed real estate sector and to bolster the growth of real estate enterprises; the more detailed rules of the programme remain to be seen.

On 20 February 2023, in order to implement the CSRC’s proposal to carry out the pilot programme for real estate funds and to regulate private investment funds to engage in the business of real estate investment, the AMAC issued the Guidelines for Filing of Real Estate Private Investment Funds Pilot (for Trial Implementation) (the “Real Estate Pilot Guidelines”). The Real Estate Pilot Guidelines came into effect on 1 March 2023, and have broadened financing channels for the real estate industry and enriched the various types of private equity funds. Under the premise of improving the qualifications of fund managers and investors, the Real Estate Pilot Guidelines have achieved a breakthrough in relaxing regulatory restrictions on investment activities of real estate pilot funds – including the restrictions on scope of investment, borrowings and guarantees, graded arrangements, etc. This has improved the flexibility for investment activities of such funds.

King & Wood Mallesons

17th Floor, One ICC, Shanghai ICC
999 Middle Huai Hai Road, Xuhui District
Shanghai 200031
People’s Republic of China

+86 21 2412 6037

+86 21 2412 6150

duhonghui@cn.kwm.com www.kwm.com
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Trends and Developments


Authors



Grandall Law Firm (Grandall) is a leading law firm specialising in capital markets, investment funds and finance in China, and was founded in June 1998 through the merger of three prominent Chinese law firms. Grandall currently boasts over 680 partners and over 5,000 individuals, consisting of practising attorneys, paralegals, administrative assistants, and other support personnel in 36 locations in China, the United States and Europe. More than 90% of partners hold a doctorate or master’s degree, along with other senior qualifications. Many are renowned experts and academics in specific legal areas and fields. Grandall has a long history of being placed on various legal lists such as Chambers and Partners, IFLR 1000, Legal Band, Legal 500, Asialaw Profiles, China Business Law Journal and ALB.

Introduction

Benefiting from China’s nearly four decades of reform and opening up, the private investment funds industry has flourished in the last decade, while many problems have also simultaneously emerged. In recent years, regulators have adopted more stringent regulatory measures and have set higher entry thresholds for the private investment funds industry.

Market Overview

As of October 2023, there were 22,000 registered private investment fund managers in Mainland China, with over 150,000 funds and assets under management, amounting to CNY21 trillion (equivalent to USD2.94 trillion). Private investment funds have been important in serving the real economy, promoting direct financing and supporting scientific and technological innovation in Mainland China. However, the tide of explosive economic growth in Mainland China has been ebbing ever since 2023. Particularly under the impact of anti-globalisation, difficulties in fundraising and exiting, and problems owing to the unregulated operations of private investment funds, have all stood out.

Regulatory Development

The year 2023 has been a milestone for the development of China’s regulatory policies on private investment funds. Issued by the Asset Management Association of China (AMAC), the self-regulatory organisation of China’s private investment funds industry, the Measures for Registration and Filing of Private Investment Funds (the “Filing Measures”) and their supporting guidelines came into effect on 1 May 2023.

The Filing Measures provide detailed requirements with respect to the registration and change of private investment fund managers and the filing of private investment funds. The Filing Measures have also integrated and optimised the related rules and requirements scattered throughout current self-regulatory measures, miscellaneous notices or practical cases, from where a form of “measures, guidelines and guiding cases” has been gradually taking shape, which would make the private investment funds industry more scientific and standardised.

On 9 July 2023, China’s State Council officially issued the Regulations on the Supervision and Administration of Private Investment Funds (the “Regulations”), which came into effect on 1 September 2023. As the first administrative regulation issued for the private investment funds industry, it fills the legislative gap in this industry at the administrative regulation level. Therefore, with the Regulations being “guiding principles”, a systematic legal regulation framework has been gradually forming, including a multi-level and multi-dimensional regulatory framework of laws, administrative regulations, department rules and AMAC self-regulatory rules.

On 8 December 2023, the China Securities Regulatory Commission (CSRC) published the Measures for the Supervision and Administration of Private Investment Funds (Exposure Draft) (the “Exposure Draft”), which, when in effect, will replace the current Interim Measures for the Supervision and Administration of Private Investment Funds (the “2014 Interim Measures”) implemented in August 2014, and the Several Provisions on Strengthening the Regulation of Privately Offered Investment Funds (the “2020 Provisions”) implemented in December 2020.

Overall, the year 2023 has seen nearly all previous regulations being updated in the private investment funds industry, which reflects the regulator’s focus on the balance between safety and development, and the strengthening of supervision – while delivering differentiated treatments for different types of private investment fund managers and funds, supporting those that are well-developed and restricting those that are non-compliant.

Venture Capital (VC) Funds

In China, VC funds mainly invest in the equity of unlisted companies, which differ from private equity funds in terms of investment scope, investment strategy, use of financing leverage, term of existence, etc. The Regulations and the Filing Measures further emphasise the differentiated management strategy for VC funds, as follows.

Different requirements for initial capital contribution

In principle, the Filing Measures require that the scale of the initial paid-in contribution shall not be less than CNY10 million for private equity funds. However, the requirement for initial paid-in contribution of VC funds cannot be less than CNY5 million, but it should be agreed in the fund contract that the minimum contribution threshold of CNY10 million be completed within six months of the VC fund’s filing.

Venture capital funds cannot be indebted

According to the Regulations, VC funds cannot use financing leverage.

Exemption from the multi-layer investment restriction of VC funds

Since the issuance of the Guiding Opinions on Regulating Asset Management Business of Financial Institutions by the CSRC and other regulatory authorities in 2018, it has been legally confirmed that an asset-management product is only permitted to be invested into one additional layer of another asset-management product, which means that the nested investment structure of asset-management products cannot exceed two layers.

However, according to a Notice issued in 2019 with Circular No [2019] 1638 by the National Development and Reform Commission (NDRC) and other governmental authorities, VC funds meeting certain conditions cannot be regarded as one-layer asset-management products, so as to be exempted from such two-layer restriction. The conditions are as follows:

  • it is compliant with relevant regulations and completing the filing of the VC fund;
  • its investment is in line with national macro-management policies;
  • its investment scope is limited to equity in unlisted companies;
  • its operation is not involved in debt financing (except that its legal issuance of bonds is designed to improve its investment capability);
  • its term of existence is not less than seven years;
  • there is no structured arrangement of the fund shares, except for government-launched VC guide funds as a priority; and
  • the words “venture capital” are included in the name of such fund, or the “venture capital” strategy is reflected in the fund contract and PPM.

VC funds can only invest in equity of unlisted companies

The 2014 Interim Measures set up a strict limitation on investment of VC funds: they are only allowed to invest in equity of unlisted start-ups. The Regulations further state that the investment scope of VC funds is limited to equity in unlisted companies, but is not restricted to start-ups. In addition, one of the guidelines issued with the aforementioned Filing Measures, the Private Investment Fund Filing Guideline No 2 – Private Equity and Venture Capital Funds, also encourages VC funds to invest in early-stage enterprises, small and medium-sized enterprises (SMEs) and high-tech enterprises.

Secondary Funds (“S Funds”)

Along with the rapid development and cyclical adjustment of the private equity funds market, S funds have become one channel for alleviating the exit problems in recent years; and the secondary market, which is mainly based on the transfer of private equity fund shares, has ushered in related development opportunities in China. However, the previous policies have not synchronised with the market tempo; thus, S fund transactions have faced problems and challenges in the absence of regulations.

For example, generally for the secondary share transfer of state-owned shares, investors usually comply with the rules of state-owned property transactions. However, the capital contribution by state-owned enterprises to limited liability partnership enterprises cannot be registered as state-owned property rights, and different understandings exist among local state-owned assets supervision and administration commissions and among equity exchanges on whether limited liability partnerships should comply with rules of state-owned property transactions. Therefore, it is has not yet been possible to standardise the implementation of such standards and criteria.

In 2020, the executive meeting of the State Council decided to “carry out a pilot project of transferring shares of equity investment and VC investment in regional equity markets”. In December 2020 and November 2021, Beijing and Shanghai, respectively, took the lead in carrying out the pilot project of transferring shares of S funds, and issued relevant local supporting regulations. In 2023, Guangdong Province and Jiangsu Province also launched their pilot projects for transferring shares of S funds.

In August 2023, the State Council issued the Opinions on Further Optimising the Foreign Investment Environment and Increasing Efforts to Attract Foreign Investment, which emphasised the support for qualified foreign limited partners (QFLPs) to make related domestic investments directly, and the policy of no withholding tax on profits obtained from domestic reinvestment by foreign investors. With the support of the above policy, foreign investment institutions have also gradually participated in establishing S funds and related transactions.

The authors are pleased to see regulators continuing to expand the scope of pilot projects in the future, or promoting the corresponding experience nationwide, and introducing more supportive policies to enliven the S funds market.

Concentration of Business Operators

Since the amendment of the Anti-Monopoly Law came into effect on 1 August 2022, anti-monopoly enforcement efforts have been significantly enhanced, and penalties have been gradually increased for illegal concentration of business operators. Against this backdrop, the authors also note that in the private equity funds market there has also been a significant increase in the compliance awareness of market participants, with a gradual increase in the declaration of concentration of business operators in establishment and investment segments of private equity funds. This is becoming the norm, particularly for mainstream RMB funds.

The concentration of business operators stipulated in the Anti-Monopoly Law requires that both “control” and “turnover” criteria be met. “Control” refers to a business operator’s taking control of or ability to exert decisive influence over other business operators. “Turnover” refers to the overall turnover of the group of companies to which the business operator belongs. For private equity funds, it is not difficult to satisfy both criteria at the same time.

In practice, scenarios such as common dual-GP structure, LPs appointing investment decision-making committee members while enjoying veto power over investment decisions, or minority investments enjoying veto power over specific major matters of invested companies may constitute a change of control within the scope of the Anti-Monopoly Law. Provided that the turnover criterion is met at the same time, this would be considered a concentration of business operators and would need to be declared. Due to the special characteristics of the private equity funds market, most declarations are made using the simplified procedure, which also largely improves convenience in making declarations on such a concentration.

The consequences of failing to declare in accordance with the law may be unbearable – from the perspective of legal risk, a business operator who so fails to declare may be subject to fines. They may also be required to stop performing the act of such concentration and to revert to the pre-concentration status; from a business perspective, this may have an adverse impact on the fund managers’ reputation and compliance records. Moreover, it may also affect subsequent transactions and listing of target companies. Therefore, increasingly more fund managers have begun to carefully consider the making of declarations of concentration of business operators.

With China’s anti-monopoly enforcement increasing in recent years, there have been precedents of penalties for private equity funds not declaring concentration in accordance with the law. The risk of failure to declare concentration, historically or in the present, has increased significantly. For fund managers, it is even more necessary to continue keeping an eye on concentration issues during the launch process and the investment transactions of private equity funds, to avoid possible anti-monopoly compliance risks.

Exiting of Funds

In recent years, as many private equity funds established in the early stage of China’s investment funds industry have entered the exit and liquidation period, how private equity funds can be successfully exited and liquidated has become a key concern for fund managers. From the perspective of investment, private equity funds can adopt various strategies to dispose of their investment portfolios, including but not limited to:

  • initial public offerings (IPOs);
  • mergers and acquisitions (M&A); and
  • the sale of fund shares in the secondary market (S strategies), etc.

However, due to the impact of many factors such as economic environment and the change of capital market policies, it may not be easy to exit from the investment side, and fund managers have begun to pay attention to the methods and possibilities of the gradual exiting of funds.

From the perspective of investment funds, there are several ways in which private equity funds can exit. The main options include the following.

Fund liquidation

The occurrence of a statutory cause of dissolution under the Company Law or the Partnership Law, or an agreed cause of dissolution written in the fund contract, will result in the dissolution of the private equity fund and the liquidation process. For both company-type funds and, more commonly, partnership-type funds, the liquidation of the funds entails the simultaneous fulfilment of the filing, reporting and deregistration processes required by the AMAC and various regulatory authorities (such as the company registry and taxation department), owing to the dual legal identities of both the private fund and the company/partnership entity.

In-kind distributions

The purpose of investors when investing in private equity funds is to obtain cash returns rather than hold and dispose of the investment portfolios at their own discretion. In the domestic RMB funds market, investors usually think that it is the fund manager’s obligation to achieve cash distributions. Additionally, the current company registry system and the securities registration and settlement system cannot fully match such in-kind distributions. Therefore, the distribution of private equity funds is usually based on the principle of cash distribution, with in-kind distribution as an exception. Fund managers may decide to make in-kind distribution only when such distribution is more in the interests of all limited partners or when the cash distribution cannot be realised.

In recent years, as the CSRC has begun pilot projects for the in-kind distribution of shares by private equity funds to investors, there is clearer policy support for such distribution. This is beneficial for the differentiated needs of investors, and further optimises the environment regarding the exiting of private equity funds and VC funds.

Fund status deregistration

In addition to the regular fund liquidation procedure, the Private Investment Fund Filing Guideline No 2 – Private Equity and Venture Capital Funds issued by the AMAC in September 2023 allows a filed company-type or partnership-type private equity fund to terminate the entrustment relationship between fund manager and investors after mutual agreement, and to transform into a non-fund-type company or partnership.

It provides another option for fund managers: the filed private equity fund can deregister as a fund but remain as a company/partnership; meanwhile, it should delete the word “fund” from its registered business scope and name, so as to avoid the need to fulfil the fund liquidation procedure required by the AMAC, and continue to operate in the form of a company or partnership of ordinary nature. It is foreseeable that this will become one of the exit options for private equity funds in the future.

Outlook

Overall, since 2010, China’s private investment funds industry has been developing rapidly, with the number of fund managers, the scale of private investment funds under management and the number of practitioners all increasing significantly. Mainstream investors have also gradually changed from individual investors to institutional investors, such as financial institutions, state-owned enterprises and listed companies. Fund managers, investors and regulators have a deeper understanding of the private investment funds market, and pay more attention to the compliance of fund managers and the protection of investors’ rights.

Ten years have passed in a flash. China’s private investment funds industry has travelled a road from “moderate regulation” and “moderately strict regulation” to today’s “strengthened regulation”, with regulatory differentiation for various types of funds. As competition in this industry intensifies and regulation tightens, China’s private investment funds industry is transforming from high-speed development to high-quality development. In the context of recent macroeconomic tightening, it is expected that China’s investment equity funds industry will move forward for a period of time against the backdrop of a downward trend in the fundraising and exit environment, and will look towards ushering in a new phase of high-quality development.

Grandall Law Firm

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968 West Beijing Road
Shanghai
PRC 200041

+86 21 5234 1668

+86 21 5234 1670

zoujing@grandall.com.cn www.grandall.com.cn
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Law and Practice

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King & Wood Mallesons has its key office in Beijing and has an extensive global network of 30 international offices. The investment funds legal team of King & Wood Mallesons is equipped with in-depth local experience and has been a consistent industry leader in the establishment, investment and exiting of domestic and overseas funds. The firm’s lawyers and experts have proficiency in laws, policies and regulations, both at home and abroad, and are capable of advising clients on various private equity funds, on drafting investment plans and on designing investment structures. King & Wood Mallesons also has lawyers who focus on tax, intellectual property, labour, real estate and insurance law, enabling them to offer professional one-stop support in investment funds projects at any time.

Trends and Development

Authors



Grandall Law Firm (Grandall) is a leading law firm specialising in capital markets, investment funds and finance in China, and was founded in June 1998 through the merger of three prominent Chinese law firms. Grandall currently boasts over 680 partners and over 5,000 individuals, consisting of practising attorneys, paralegals, administrative assistants, and other support personnel in 36 locations in China, the United States and Europe. More than 90% of partners hold a doctorate or master’s degree, along with other senior qualifications. Many are renowned experts and academics in specific legal areas and fields. Grandall has a long history of being placed on various legal lists such as Chambers and Partners, IFLR 1000, Legal Band, Legal 500, Asialaw Profiles, China Business Law Journal and ALB.

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