Author: Melody Yang, Partner of Simmons & Simmons
2018 has seen a new chapter in the asset management industry in China. The announcement on 11 April 2018 by Yi Gang, the Governor of the People’s Bank of China, has marked the commencement of a larger series of reforms in the asset management sector in the nation with different measures, with the aim of opening up China’s financial services to foreign investors. With this optimistic outlook of the Chinese fund industry, it can be foreseen that more asset managers overseas will be ready to enter the Chinese market. Meanwhile, global asset managers may also market overseas funds to Chinese investors in view of the welcoming policies. This article aims to give a survey of the opening-up of the financial services sector in China to foreign investors, with a focus on the registration of the private fund managers in China and the Qualified Domestic Limited Partner pilot scheme, both of which would be of paramount importance for asset managers around the globe to pay attention to, in response to their entry to the Chinese market.
1. Opening-up of Chinese Financial Services Sector to Foreign Investors
As mentioned above, a number of measures were announced by the Governor of the People’s Bank of China, with the aim of opening up the financial services industry in China. Relevant governmental authorities are in the process of legislating new rules or have already done so in order to implement those measures by the year-end of 2018. In short, the measures include:
1.1 cancelling the restrictions on foreign ownership in banks and financial asset management companies;
1.2 increasing the limit of foreign shareholding in securities, mutual fund management, futures and life insurance companies to 51% (with the limit to be removed in three years’ time);
1.3 removing the requirement to have at least one domestic securities company as a shareholder of Sino-foreign securities joint ventures;
1.4 quadrupling the daily quota for mainland-Hong Kong stock connect programs;
1.5 allowing foreign investors to establish and operate the insurance agency and insurance assessment businesses;
1.6 expanding the business scope of foreign-invested insurance brokerage to match their Chinese counterparts;
1.7 encouraging foreign investment in various financial sectors such as trust, financial leasing, auto finance and consumer finance;
1.8 removing the limit of foreign ownership in newly established financial asset investment companies and wealth management companies sponsored by commercial banks;
1.9 substantially increasing the business scope of foreign-invested banks;
1.10 removing the business scope restrictions for Sino-foreign securities joint venture;
1.11 cancelling the requirement for foreign companies to first operate a representative office for two years before establishing a foreign-invested insurance company; and
1.12 the Shanghai-London Stock Connect scheme.
All these measures serve as clear signals as to the intention of Chinese authorities to encourage more foreign investors into China, drawing further capital into the nation. It is worth noting in particular that the limit of foreign shareholding in securities, mutual fund management, futures and life insurance companies is to be lifted to 51%, which suggests a majority control, with a view of any limit to be eventually removed. This would encourage foreign asset managers to locate their investment into funds in China. To start with such an investment, these managers may first consider establishing a private fund manager in China.
2. Registration of Private Fund Managers
In 2016, the Asset Management Association of China (the “AMAC”) unveiled new rules allowing wholly foreign-owned enterprises (the “WFOEs”) to engage in private securities investment fund management businesses.
Under the private fund manager programme, a foreign asset manager is allowed to establish a WFOE or a joint venture which serves as a private fund manager. Then the private fund manager can raise an open-ended fund targeted at PRC qualified investors, i.e., a private securities investment fund as defined under Chinese rules, structured as a contractual type fund. The manager and the custodian are the de facto co-trustees of the private fund.
A private securities investment fund can invest in securities issued in China, including the stocks of companies limited by shares issued publicly in China, bonds, fund units and other securities and derivatives recognized by the China Securities Regulatory Commission (the “CSRC”).
However, private securities investment funds may not invest in securities issued outside of China except that, in the future, they may be allowed to participate in the sale and purchase of specified foreign stocks through stock connect programs and QDII qualification and quota.
Asset managers overseas may first choose to establish a private fund manager in China to facilitate their investment in private securities investment funds in China. In terms of registration, a company applying for private fund manager registration shall firstly be registered with the AMAC, which is the de facto private fund regulator. Specifically, a private fund manager who wishes to launch a private securities investment fund needs to register with the Department of International Affairs of the AMAC. Private securities investment fund in China includes hedge funds and other types of open-ended funds (such as those adopting long-only strategies).
During the registration stage, the AMAC needs to make sure that an applicant has established various internal control policies and, through the PRC legal opinion, the fund manager has met the requirements set out below, among others.
|Verification item||Compliance requirements|
|Registered and Paid-in Capital||The applicant must ensure that it has enough capital to operate according to its own operational requirements. Although there are no mandatory regulations on the applicant’s registered or paid-in capital, if the paid-in capital of the registered PFM is less than RMB 1 million, or if the ratio of paid-in capital to registered capital does not reach 25%, the AMAC will disclose this information in a public notice. In practice, the AMAC now suggests RMB 2.5 million should be the minimum level in terms of capitalisation of the PFM manager (kindly note that the capitalisation requirement changes from time to time).|
|Company name and business scope||The name and business scope of the applicant shall include “investment management” or “asset management”. The AMAC shall not register an applicant whose name and/or business scope does not conform to the abovementioned requirements.|
|Requirements for senior managers||The legal representative and other senior management personnel (including a legal representative, general manager, deputy general manager and the person responsible for compliance/risk control) must all obtain the fund qualification certificate either through examinations or other approved methods.|
|Negative Characteristics||The applicant and the applicant's senior management personnel must not exhibit any negative characteristics, such as: (1) being labelled as an abnormal or illegal company in the National Enterprise Credit Information Publicity System; (2) being subjected to criminal sanctions; or (3) being subjected to penalties or other administrative measures taken by the Financial Supervision Department.|
It takes 20 working days for the AMAC to complete the registration if all the documents and information is in order. In practice, it is usually a bit longer as the AMAC may ask questions and request additional information based on the first round of submission.
2.2 Launching a fund
After a successful registration with the AMAC, a private fund manager would consider launching a fund in China. The prevailing market practice in China is to use a contractual fund structure if this is a private security investment fund. This structure allows the manager to bypass certain tax issues and difficulties with subscriptions and redemptions that would exist with a PRC corporate entity.
A registered private fund manager may launch its own private fund products and shall, in any event, launch its first private fund within six months from the date of registration with the AMAC. Otherwise, the AMAC may revoke the registration.
In the past, with respect to a private fund manager, it was not allowed to have an ultimate controller who was an individual. In other words, only those very institutionalised asset managers were allowed to come. The restriction is now lifted as long as the direct parent company of the applicant is a licensed financial institution in a jurisdiction which has entered a Memorandum of Understanding (the “MOU”) with the Chinese authority. In practice, the AMAC may reserve certain discretion when looking at the history of operation, record of compliance and others. Therefore, usually, a pre-meeting with the AMAC is helpful to find out their view about the structure.
3. Qualified Domestic Limited Partner (“QDLP”) Pilot Scheme
The Qualified Domestic Limited Partnership (the “QDLP”) is a pilot programme developed by Chinese local authorities (i.e. Shanghai and Tianjin). It allows foreign asset managers to raise RMB from wealthy and institutional investors in China for overseas investment. It is a programme common in Shanghai and which also exists in Tianjin. Under the QDLP program, foreign asset managers can establish an investment entity in China as a general partner. They can also set up a Qualified Domestic Investment Fund (RMB Fund Enterprise, featuring as a feeder fund) to feed into the master fund managed by an overseas management group. This pilot programme requires the RMB Fund Enterprise to appoint a qualified commercial bank as a custodian bank, which will operate the business of RMB and foreign exchange settlement within the quota approved by the authority.
As more foreign asset managers may want to have a stake in securities companies in China following the opening-up of the asset management industry, their local presence in China would gradually be established over time. This would mean a boost in their popularity and goodwill in China, which may, in turn, attract Chinese investors into overseas funds from those foreign asset managers. This is where the QDLP programme becomes relevant. On 24 April 2018, the State Administration of Foreign Exchange (the “SAFE”), China’s foreign exchange regulator, announced on its website that it will increase the quota for the QDLP pilot scheme to US$5 billion. This will enable global asset managers to more effectively market overseas funds to Chinese investors.
3.1 Overview of the QDLP pilot scheme
It may be helpful to first give a general survey of what the QDLP programme is about. The QDLP scheme was first launched in Shanghai in 2012 to provide global asset managers access to high net worth and institutional investors in China by facilitating RMB investments into overseas funds.
Since its inception, the scheme has been restricted by the limited foreign currency quota issued by the Shanghai local government. In the first test-run of the Shanghai programme in 2013, six large-scale hedge fund companies were each awarded a quota of US$50 million for the programme. This figure was increased to US$100 million in 2015. As of September 2015, the Shanghai programme awarded combined foreign currency quotas of approximately US$1.2 billion to 15 asset management companies, after which the scheme was temporarily suspended as a result of SAFE’s policy of increased control of capital outflows.
For those asset management companies who have obtained quota, most of them have raised capital for the benefit of an overseas master fund adopting an open-ended structure - UCITS or hedge funds. However, a handful of these structures have been created to feed into closed-ended private equity or real estate funds.
The increase in QDLP quota in 2018 as mentioned above is much welcomed, and it means that the QDLP scheme is now set to become a mainstream reality for a new group of foreign asset managers. Some of the features of the current iteration of the QDLP scheme are described below.
3.2 Basic Structure
The typical operational framework of a QDLP fund follows a master-feeder structure, with a new Chinese feeder fund flowing into an overseas master. To achieve this, the foreign asset manager first sets up a PRC onshore fund management company. This new management company then establishes a new PRC fund, which will act as a feeder into the overseas master fund (managed by the same foreign asset manager). The feeder fund is then able to raise funds from qualified investors in China for investment into the overseas master.
In addition to other “softer” requirements, such as being able to understand and bear the risks associated with investing in a private fund, a qualified investor, whether corporate or individual, should meet certain asset thresholds or be expressly exempted from those asset thresholds by the regulators (e.g. being a pension fund).
3.3 Manager Registration
In previous versions of the Shanghai QDLP pilot programme, foreign managers establishing local feeder structures did not have to be registered with the AMAC, which has only started to regulate private fund managers since 2014. Rather, foreign managers were required only to seek approval from the relevant local regulators in order to gain the foreign currency quota. This has now been changed. The activities which will be performed by the foreign managers in China, such as promotion and marketing and portfolio management of the feeder, will fall within the scope of “private fund” activities under the relevant CSRC Regulations. Accordingly, foreign managers must now be registered with the AMAC as a private fund manager, which is often described by the media as “licensed by the AMAC”, and to comply with their rules and regulations. This is intended to ensure that the foreign managers carry product risk assessment and investor risk management in accordance with the standards of the AMAC in addition to those of the relevant local regulators.
3.4 Fund Vehicle
Historically, QDLP feeder funds have been established in China with a partnership model, with few opting to employ a contractual fund structure. Now, as mentioned above, the prevailing market practice in China is to use a contractual fund structure if the underlying assets are more liquid. This structure allows the manager to bypass certain tax issues and difficulties with subscriptions and redemptions that would otherwise exist. Under the current QDLP policies, the fund can be set up as either a contractual fund or a limited partnership, the choice of which would mostly be dependent upon the liquidity profiles of the underlying investments.
3.5 Service Providers
QDLP feeder funds must appoint a qualified commercial bank or qualified securities firm, duly registered with the AMAC, to act as a custodian/depositary and to operate the foreign exchange transactions within the quota approved by the relevant authority. It is also a common practice, especially for open-ended funds, for the feeder fund to appoint a fund administrator to provide net valuations, transfer agency services and related financial services.
3.6 Summary of QDLP programmes
The opening-up of the asset management industry in China should be welcomed as an attraction of foreign investment into the nation. The interaction between global and local foreign asset managers would provide bilateral advantages. As foreign asset managers establish their local presence in China, they will, in turn, build up their image locally. This is where the QDLP programme comes into play when foreign asset managers can market their funds to Chinese investors. Whilst the QDLP programme remains a pilot, and the number of participating institutions and size of investments will be relatively small, the increased QDLP quota is a much-welcomed development and another sign of China’s increased openness in the financial services sector. Aside from the benefits for foreign investment managers in terms of raising additional capital, the programme is an important opportunity for global asset managers to familiarise themselves with the Chinese market and to test their investment strategies in China. Over the years, a number of QDLP managers have built a strong track record with Chinese investors through participation in this program, paving the way to further the growth of their businesses in China.
Simmons & Simmons PRC funds team is currently working closely with a number of global asset managers in various cross-border programmes, including but not limited to PFM WFOE (private fund regime), QDLP feeder fund regime, QFII/RQFII ((RMB) qualified foreign institutional investors), QDIIs (qualified domestic institutional investors), MRF (mutual fund recognition regime), stock connect programmes, in order to gain funding from Chinese investors and/or widening their investment universe to include relevant products available in China.
Melody Yang, a partner based in our Beijing office, has been appointed as a member of the QDLP “Expert Review Committee” of the Shanghai Financial Services Office (i.e. regulator in Shanghai in charge of local pilot programmes such as QDLP) and Advisory Board of International Partners’ Committee of the AMAC (i.e. China’s private fund regulator) and is heavily involved in shaping those programmes’ development and direction.
Simmons & Simmons is registered in China as a foreign law firm. We are permitted by Chinese regulations to provide information on the impact of the Chinese legal environment and also to provide a range of other services. We are not admitted to practise in China and cannot, and do not purport to, provide Chinese legal services. We are, however, able to co-ordinate with local counsel to issue a formal legal opinion should this be required.