PRC marketing opportunities for overseas funds

Announcement Highlight

On 24 April 2018, the State Administration of Foreign Exchange ("SAFE") China’s foreign exchange regulator, announced on its website that it will increase the quota for the Qualified Domestic Limited Partner ("QDLP") pilot scheme to US$5 billion, enabling global asset managers to more effectively market overseas funds to Chinese investors.

Overview of the QDLP pilot scheme

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. The typical operational framework of a QDLP follows a master­feeder structure. The foreign asset manager first sets up a PRC onshore fund management company, which will act as the onshore manager of a new feeder fund. The new management company then establishes a new PRC fund, which will act as a feeder into a master fund managed by the foreign asset manager. The feeder fund is then able to raise funds from qualified investors in China, which are then invested into the overseas master fund.

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 program in 2013, six large­scale hedge fund companies were each awarded a quota of US$50 million for the program; this figure was increased to US$100 million in 2015. As of September 2015, the Shanghai program 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 open­ended structure ­ UCITS or hedge funds. However, a handful of these structures have been created to feed into closed­ended private equity or real estate funds.

The recent increase in QDLP quota is very welcome, and 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:

Manager Registration

In previous versions of the shanghai QDLP pilot program, the foreign managers establishing local feeder structures did not have to be registered with the Asset Management Association of China ("AMAC") (which only started to regulate private fund managers from 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 changed. The activities performed by the foreign manager, such as promotion and marketing activities 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 AMAC as a private fund manager (which as is often described by the media “licensed by AMAC”), and comply with their rules and regulations so as to ensure they are performing duties such as product risk assessment and investor risk management in accordance with AMAC’S standards in addition to those of the relevant local regulators.

Fund Vehicle

Historically, QDLP feeder funds have been established using a partnership model, with few opting to employ a contractual fund structure. Now, the prevailing market practice in China is to use a contractual fund structure if the underlying asset is more liquid. This structure allows the manager to bypass certain tax issues and difficulties with subscriptions and redemptions that would exist with a PRC corporate entity. Under the current QDLP policies, the private fund manager can be set up in the form of either a contractual fund or a limited partnership, subject to the liquidity profiles of the underlying investments.

Service Providers

QDLP feeder funds must appoint a qualified commercial bank or qualified securities firm, duly registered with the AMAC, to act as custodian/depositary and to operate the foreign exchange transactions within the quota approved by the relevant authority. It is also common practice (especially for open­ended funds) for the feeder fund to appoint a fund administrator to provide net valuations, TA and related financial services.

Conclusion

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 very welcome development ­ a 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 program is an important opportunity for global asset managers to familiarise themselves with the Chinese market, and to test their investment strategies in China. In the past, a number of QDLP managers have built a strong track record with Chinese investors through participation in this program, paving the way to further growth of their businesses in China.