An Analysis of the Draft Private Fund Measures from the Perspective of Foreign-invested Fund Managers
2024.01.12 XIE, Qing (Natasha)、ZHANG, Chi (Austin)、Joyce ZHANG
Recently, the China Securities Regulatory Commission (CSRC) solicited public comments on the Measures for the Supervision and Administration of Private Investment Funds (Draft for Comments) (the “Draft” or the “Measures”), which attracted attention from market participants. Certain provisions of the Measures may cause concern and raise questions; therefore, it is desirable to bring these to the attention of the regulatory authorities when finalizing the Measures after the public solicitation for comments. We summarize below certain key issues that may be of concern to foreign-invested institutions.
Article 7 PFMs … shall meet the following conditions on an ongoing basis: … (2) have good financial status, the minimum paid-up monetary capital shall be suitable for the scale of assets under management (AUM), and the initial paid-up monetary capital shall be no less than RMB 10 million; … (6) have information technology systems and security facilities that meet the relevant requirements….
It is worth noting that:
1. PFMs shall meet the requirement of having good financial status on an ongoing basis. The Draft sets the threshold of RMB 10 million for PFM’s initial paid-up capital, which means the regulator may set a higher paid-up capital threshold based on a PFM’s actual financial status post registration.
2. The Draft sets forth the requirements of having information technology systems and security facilities for the first time. We understand that information technology systems can be outsourced, i.e., PFMs are not required to establish their information technology systems by themselves. However, the detailed requirements for security facilities remain to be clarified.
Article 12 PFMs shall perform their discretionary management duties, and shall not directly or indirectly delegate their investment management duties to others.
Article 12 of the Draft requires PFMs to perform their discretionary management duties, which in substance prohibits PFMs from engaging in “channel business”.
Article 13 PFMs shall adhere to the principle of dedicated operations and engage in the following businesses in accordance with the law: … (2) provide securities investment advisory services for asset management products (AMP) as stipulated by Article 42(2) of the Measures; ….
Article 14 Where a PFM provides securities investment advisory services for AMPs as stipulated by Article 42(2) of the Measures, it shall meet the following conditions on an ongoing basis: ….
Article 15 Where a PFM provides securities investment advisory services for AMPs as stipulated by Article 42(2) of the Measures, it shall sign an investment advisory service contract with the AMPs and fulfill the following duties: … (2) fairly treat the private funds under its management and the products for which it provides investment advisory services; (3) establish mechanisms to prevent conflicts of interest and interest tunneling among the private funds under its management, AMPs for which it provides investment advisory services and the investments by its proprietary funds; (4) formulate clear decision-making processes for investment recommendations, and record and maintain materials relating to investment recommendations; ….
1. Article 13 of the Draft permits PFMs to provide advisory services for securities investments, but it is unclear whether they are permitted to do so for private equity investments.
2. Article 13 of the Draft permits PFMs to provide securities investment advisory services for AMPs as stipulated by Article 42(2) of the Draft, namely, AMPs offered and managed by securities companies and their subsidiaries, fund management companies and their subsidiaries, futures companies and their subsidiaries, commercial banks and their wealth management subsidiaries (Bank WMS), insurance companies, insurance asset management companies, financial asset investment companies, trust companies, finance companies and other institutions as stipulated by the CSRC. However, whether PFMs are permitted to provide securities investment advisory services for bank wealth management products, Bank WMS products, insurance asset management products, and trust plans, is still subject to the specific provisions of the National Financial Regulatory Administration (NFRA) on whether these products are permitted to engage PFMs as investment advisors.
3. Notably, PFMs are only permitted to provide securities investment advisory services for AMPs and not for private funds.
4. PFMs are explicitly required to perform duties in the course of the provision of advisory services, including but not limited to fairly treat the private funds under their management and products for which they provide investment advisory services; establish mechanisms to prevent conflicts of interest and interest tunneling among the private funds under their management, the products for which they provide investment advisory services and the investments by their proprietary funds; formulate clear decision-making processes for investment recommendations; and record and maintain materials relating to investment recommendations.
Article 16 A PFM that uses its proprietary funds to invest in private funds under its management or its affiliates’ management shall enjoy equal rights and interests and bear equal risks as other investors holding the same fund units.
Except for the circumstances specified in the preceding paragraph, a PFM shall prudently use its proprietary funds to carry out other investment activities. Where it is necessary to use its proprietary funds to carry out investment activities, a PFM shall formulate and implement proprietary funds utilization management policies, specify segregation arrangements in respect of personnel, finance, accounts, systems, and businesses, effectively prevent horizontal competition and conflict of interests, and report information in accordance with the relevant provisions.
Where the controlling shareholder, general partner, de facto controller, senior management personnel, and investment management personnel of a PFM use their proprietary funds to invest, they shall comply with the provisions of this article, and the relevant personnel shall not engage in investment activities with their proprietary funds by taking advantage of their positions or operations of the PFM.
The current provisions have only set restrictions on PFMs using their proprietary funds to carry out investment activities. It is unclear why the controlling shareholder, general partner, de facto controller, senior management personnel, and investment management personnel of PFMs using their proprietary funds to invest should abide by such restrictions, which seems illogical and unnecessary, and we suggest removing this restriction.
Article 18 Where the shareholders or partners of a PFM, or their controlling shareholder or de facto controller hold majority equity shares of or control two or more PFMs, they shall have sufficient reasons and necessity, have a concise and clear shareholding structure, disclose the division of businesses of each PFM in a comprehensive, timely, and accurate manner, properly conduct business segregation, and prevent horizontal competition. Additionally, they shall establish and improve unified compliance and risk control management policies, strengthen the examination, supervision, and monitoring of each PFM under their control, and prevent conflicts of interest and interest tunneling.
The reason and necessity must be justified for one entity to control two or more PFMs, in addition to the requirements for business segregation and the prevention of horizontal competition, all of which in our view are reasonable requirements and are already set forth in the current provisions. It seems the requirement of establishing unified compliance and risk control management policies for all PFMs under common control to be unnecessary, and we suggest that the CSRC remove this requirement or provide further clarification thereof.
Article 19 PFMs shall not set up branch offices. ….
It is unclear whether this article aims to prevent PFMs from setting up branches in different jurisdictions. Given that it is not uncommon in practice that a PFM’s registered address differs from its actual business address, we would suggest the Measures allow the PFM to register its actual business office as a branch office in accordance with the requirements of State Administration for Market Regulation in this scenario.
Article 35 In the event of any change of the following information of private funds, a PFM shall, within 10 working days from the date of such change, go through the filing formalities of such change with the AMAC: … (3) the investment manager, fund management team, or key persons; ….
The Draft, for the first time, requires PFMs to file the change of the investment manager, fund management team, or key persons of private funds with the AMAC within 10 working days from the date of such change.
Article 37 Where a PFM accepts the entrustment of a single investor to launch a private fund, the PFM and the fund investor may reach special agreements in the fund contract concerning the investment decision-making mechanism, custody matters, information disclosure, and the audit of the private fund.
Such sole investor shall be limited to the investor stipulated in Article 42(1)(4)(5)(6) of the Measures, and the paid-up capital of such private fund shall be no less than RMB 100 million.
According to this article, only investors stipulated in Article 42(1)(4)(5)(6) of the Measures are eligible to be the sole investor of a private fund: (a) financial institutions regulated by the financial regulatory authorities of the State Council; (b) pension funds such as social security funds, basic pension insurance funds and enterprise annuities, and social welfare funds such as charity funds; (c) qualified foreign investors; and (d) government funds or funds raising money from qualified government funds. This will have a substantial impact on QDLP funds, as it is common for QDLP funds to have a single AMP or trust plan as the sole investor. Considering the special nature of QDLP funds, we suggest that QDLP funds be exempted from this article.
Article 38 Where a PFM invests 80% or more of the private fund assets in a single target, all of the following conditions shall be met: … (2) The paid-up capital of the private fund shall be no less than RMB 20 million, and the paid-up contribution of each natural person investor (if any) shall be no less than RMB 10 million; (3) The single target to be invested shall have no affiliation with the PFM or its shareholders, de facto controllers, partners, or practitioners, unless otherwise agreed unanimously by all investors; ….
The Draft raises the threshold of the paid-up capital of private funds investing in a single target to RMB 20 million, of which the paid-up contribution of each natural person investor shall be no less than RMB 10 million. Article 38(3) stipulates that the single target to be invested shall have no affiliation with the PFM or its shareholders, de facto controllers, partners, or practitioners, unless otherwise agreed unanimously by all investors. This implies that QDLP fund managers need to obtain the unanimous consent of all investors concerning investments in the offshore funds managed by their overseas shareholders or affiliates.
Article 41 The paid-up contribution of each investor of a private securities investment fund or a parent fund shall be no less than RMB 1 million, and the paid-up contribution of each investor of a private equity investment fund (PE fund) shall be no less than RMB 3 million. The paid-up contribution of each investor investing in any of the following private funds shall be no less than RMB 5 million: (1) private funds with underlying real estate; (2) private funds that invest primarily in a single target, offshore assets or over-the-counter derivatives; ….
The Draft sets forth different paid-up contribution thresholds for investors of different types of private funds respectively, namely, 1) RMB 1 million for investors of private securities investment funds and parent funds; 2) RMB 3 million for investors of PE funds; 3) RMB 5 million for investors of private funds with underlying real estate and private funds that invest primarily in a single target, offshore assets or over-the-counter derivatives; and 4) RMB 10 million for natural person investors of private funds that invest primarily in a single target. According to the above, investors of QDLP funds that invest primarily in offshore master funds should contribute no less than RMB 5 million. This places an additional burden on QDLP fund managers who face the challenge of limited onshore distribution channels. Since investors of QDLP funds are usually AMPs offered by financial institutions and are recognized as qualified investors, it is recommended that the investors of QDLP funds should not be looked through in the application of the threshold of RMB 5 million; for QDLP funds raising funds from non-AMP investors, it is recommended that the threshold for such non-AMP investors should be the same as that of PE funds, i.e., RMB 3 million. It is suggested that the CSRC clarify that the threshold of RMB 10 million only applies to natural person investors who directly invest in the private funds underlying a single target and should not apply to natural person investors who invest in such private funds through other AMPs.
Article 42 … For investors that are AMPs or registered PFMs or filed private funds, the requirement of calculating the number of investors on a consolidated basis can be exempted. In this case, the PFMs or the fund distribution agencies shall effectively verify the ultimate investors of the private funds and the ultimate source of funds.
For the first time, the Draft sets forth the effective verification requirements for ultimate investors and ultimate source of funds. This means private funds invested by other private funds or AMPs can be exempted from being looked through when calculating the number of investors, but they cannot be exempted from the verification requirements for the ultimate investors and the ultimate source of funds. Considering that the licensed financial institutions who offer AMPs should have fulfilled the obligation of verifying the ultimate investors and the ultimate source of funds in accordance with the law and that from the commercial perspective, AMP managers may not be willing to disclose to PFMs the identity of their clients and the source of funds, the new requirements not only add an uncalled-for burden to PFMs but are also not in line with the practice. In this regard, we would recommend the exemption of such verification requirements for AMP investors.
Article 43(2) Fundraising or raising funds refers to such activities as opening private fund trading accounts for investors, promoting private funds, handling the subscription and redemption of private fund units, providing inquiry services for information on private fund trading accounts and other activities.
Article 2(3) of the Administrative Measures for Fundraising Activities of Private Investment Funds stipulates that fundraising activities include promoting private funds, offering fund units (interests), handling the subscription/purchase and redemption of fund units (interests), and other activities, without explicit reference to the provision of inquiry services for information on private fund trading accounts. We also note that the definition of fundraising of private funds in the Draft is substantially same as that of public funds stipulated in the Measures for Supervision and Administration of Publicly-Offered Securities Investment Fund Distribution Agencies.
Article 44 PFMs shall not engage, directly or indirectly, any of the following entities to raise funds: … (2) private fund distribution agencies that are affiliated with the PFM or the PFM’s shareholders, partners, de facto controllers, or practitioners; ….
The Draft prohibits PFMs from engaging affiliated fund distribution agencies for fund raising. We do not see the necessity of this prohibition, therefore recommend its removal.
Article 27(2) …. The fund contract shall, based on the primary investment direction and the type of assets to be invested, classify the private fund as a PE fund, a private securities investment fund, a parent fund, or other type of fund as prescribed by the CSRC.
Article 28(3) Parent funds refer to private funds that primarily invest in PE fund units, private securities investment fund units, the shares of AMPs as stipulated in Article 42(2) of the Measures, or other investment targets that meet the relevant requirements of the CSRC, of which the detailed provisions will be separately formulated by the CSRC.
Article 34 …. (3) The paid-up capital of a parent fund shall be no less than RMB 50 million, ....
Article 54 A private fund may invest in an AMP or another private fund, provided that the AMP or the private fund to be invested shall not invest in any other AMPs or private funds, except for public funds, unless otherwise provided by the laws, administrative regulations or the State. The calculation of levels of nesting shall not apply to parent funds, of which the detailed provisions will be separately formulated by the CSRC.
The Draft classifies private funds into PE funds, private securities investment funds, parent funds, and other types of funds prescribed by the CSRC, with no reference to “other classes” or “asset allocation classes”. The parent funds refer to private funds that primarily invest in PE fund units, private securities investment fund units, the shares of AMPs, or other investment targets that meet the relevant requirements of the CSRC and the paid-up capital of a parent fund shall be no less than RMB 50 million. Consistent with the Regulations on the Supervision and Administration of Private Investment Funds, the Draft stipulates that the calculation of levels of nesting shall not apply to parent funds. However, there needs to be further clarification by the CSRC on the specific rules of parent funds such as the requirements on investment portfolios and investment ratio in subsidiary funds, etc.
Notably, PE funds, even if they are not parent funds, may invest in partnerships and other PE funds. However, non-parent private securities investment funds may not invest in units of other private securities investment funds or other securities-type AMPs.
Article 64 PFMs, custodians of private funds, private fund distribution agencies and other private fund service providers shall make and properly maintain the records of investment decision-making, transactions, investor due diligence, investor suitability management, and other pertinent information of private funds for a period of no less than 20 years as of the date of completion of the liquidation of the private funds.
In view of the inconsistencies in the current provisions concerning the retention period of relevant materials, the Draft stipulates in a uniform manner that the retention period of records on investment decision-making, transactions, investor due diligence, investor suitability management, and other pertinent materials shall be no less than 20 years as of the date of completion of the liquidation of the private fund.
Article 77 Except for the circumstances stipulated in Article 76 of the Measures, PFMs, custodians of private funds, private fund service providers, and their practitioners who violate the provisions of the Measures shall be ordered to make rectifications, be given warnings or notices of criticism, and receive a fine of up to RMB 100,000; where financial security is involved and any harmful consequence has been caused, a fine of up to RMB 200,000 shall be imposed; the person-in-charge and other directly accountable personnel shall be given warnings or notices of criticism, and receive a fine of up to RMB 100,000; where financial security is involved and any harmful consequence has been caused, a fine of up to RMB 200,000 shall be imposed.
The shareholders, partners, and de facto controllers of PFMs, custodians of private funds, and private fund service providers who violate the provisions of the Measures shall be penalized in accordance with the provisions of the preceding paragraph.
The Draft raises the maximum penalty amount from RMB 30,000 to RMB 100,000 and RMB 200,000 respectively. Meanwhile, the objects of the penalties are expanded to the shareholders, partners, and de facto controllers of PFMs, the custodians of private funds and private fund service providers.
Article 79 The grace period shall commence as of the implementation date of the Measures. During the grace period, newly registered PFMs and newly filed private funds shall comply with the provisions of the Measures. If the existing PFMs/private funds that have already registered/filed with the AMAC prior to the grace period fail to meet the requirements set out in the Measures, they shall make rectifications according to the following requirements:
(1) Except for the requirements set out in Article 7(1)(2)(4) of the Measures, the existing PFMs shall make rectifications within one year in accordance with the provisions of the Measures.
(2) Before the rectifications have been made, the existing funds shall not conduct new investments, expand their fundraising size, or admit new investors, nor shall they extend the term of the funds, and the funds shall be liquidated upon the expiration of the fund contract; where the existing funds fail to meet the requirements set out in Article 54 (multi-level nesting) of the Measures, the rectifications shall be made within two years.
The AMAC will publicize the PFMs and the private funds that fail to make rectifications upon expiration of the grace period and will adopt self-disciplinary measures and sanctions thereto depending on the severity of the circumstances.
The existing PFMs are exempted from making rectifications if they fail to meet the relevant requirements in terms of their company name or business scope, or their paid-up capital is less than RMB 10 million, or their senior management personnel have no shareholdings, while PFMs that fail to meet other requirements set out in the Measures shall make rectifications within one year as of the implementation date of the Measures.
With respect to the private funds with multi levels of nesting, the PFMs shall make rectifications within two years as of the implementation date of the Measures.
Article 80 Where a PFM carries out private fund business activities overseas, the securities regulatory authority of the PFM’s domicile country or region should have a signed memorandum of understanding on securities regulatory cooperation with the CSRC or other organs recognized by the CSRC, and the PFM shall comply with the relevant provisions of the state on foreign exchange administration and cross-border investment.
Article 80 of the Draft sets out the general requirements that PFMs must adhere to when carrying out private fund business activities overseas. This acknowledges the market practice that one manager, or together with its affiliates, may launch both domestic RMB funds and offshore USD funds. At present, the CSRC has signed memorandums of understanding with the relevant regulatory authorities of major jurisdictions where funds are launched, including Hong Kong, Singapore, Cayman, Luxembourg, and Ireland. It is subject to further clarification by the foreign exchange regulator and other pertinent authorities (if applicable) whether and how PFMs launching and managing funds directly or indirectly offshore or providing relevant services to offshore funds would be in line with the provisions of foreign exchange administration and cross-border investment. From the CSRC departmental rule’s perspective, at least, the Measures do not impose additional restrictions on such activities.