CSRC issued new rules of private funds in China

On 11 September 2020, China's securities regulator, the China Securities Regulatory Commission (CSRC), issued a consultation paper of the Several Provisions on Strengthening the Regulation of Private Investment Funds (in Chinese 《关于加强私募投资基金监管的若干规定（征求意见稿）》) (the Draft Provisions) to seek opinions from the fund industry.

On 8 January 2021, CSRC published its announcement to officially issue the Several Provisions on Strengthening the Regulation of Private Investment Fundsin Chinese 《关于加强私募投资基金监管的若干规定》), (the Official Provisions) which became retrospectively effective from 30 December 2020.

The Official Provisions now become the first regulation issued directly from the CSRC, not AMAC, targeting at private fund managers ever since the introduction of the Interim Measures for the Supervision and Administration of Privately Investment Funds (in Chinese 《私募投资基金监督管理暂行办法》) (Interim Measures) back in 2014.

1. Background

The Official Provisions consist of 14 articles in total. According to the CSRC, the Official Provisions are formulated with the purposes of reinforcing the country’s supervision of private funds, cracking down violations emerging in the past couple of years (such as public offering in a disguised form, failure to comply with qualified investors identification and onboarding requirements, failure in manager registration and/or product filing, tunnelling within affiliated managers, illegal capital pooling, conflict of interest, fund raising for the purpose of financing the manager’s non-fund related projects, embezzlement, illegal capital raising and etc.), and protecting the legal rights and interests of investors, with much enhanced enforcement tools. Please see a word-for-word translation for the background of the Official Provisions published by CSRC at the bottom of this article.

Before the release of the Official Provisions, most regulatory rules for private funds were scattered across various industry self-discipline rules, notices, Q&As from AMAC. Despite the fact that those regulatory rules were complied with by most fund managers, the lack of the same legal status with official laws and regulations created some obstacles in enforcement.

We understand that the intention of CSRC is to reiterate and clarify some key points in the existing industry self-discipline rules by making them the formal ministerial regulations, with stronger enforcement actions empowered with CSRC.

Compared to the Draft Provisions, we have seen the industry’s voice has been heard and regulators taking a sophisticated and practical approach to regulate risks whilst enhancing the growth and improving the efficiency of the market.

2. Highlights

We have highlighted the following changes brought about by the Official Provisions, which are not currently required under the existing AMAC rules.

2.1 New requirements on PFM’s corporate name and business scope
The second paragraph of Article 3 of the Official Provisions stipulates, “the private fund manager shall indicate the words ‘Private Fund’, ‘Private Fund Management’ and other words of similar meaning in its name and business scope…”.

Compared to the Draft Provisions, the Official Provisions no longer require the existing PFMs to make rectifications if their names and business scopes do not meet the preceding requirements.

New requirements regarding discrepancies between registered address and actual office space

The Draft Provisions once required the registered address of a private fund manager and the location of its principal office space to be located in the same provincial administrative region (or municipal as the case may be). This had invited heated discussions in the market, as in practice, many fund managers choose to separate their registered addresses and their principal office spaces in different places, due to various factors, such as local tax incentives, conditions to receive local government’s funding, and HR arrangements.

The market is now reassured to see that the Official Provisions have removed such requirement.

2.2 Recognising QFIIs as the exempt investors (i.e. deemed qualified investors)
The industry is also very pleased to see that for the first time QFII/RQFIIs have been recognised as exempt investors (also known as deemed qualified investors). As background, a full set of client onboarding procedures, including primarily, identification, suitability test (consisting of investor basic information check, investor classification, product rating and investor risk rating), signing risk disclosure letter, confirmation of qualified investor status, contract signing, cooling-off period, return interview would apply when onboarding a qualified investor whilst certain types of investor can skip some of the procedures.

Before the Official Provisions, QFII/RQFIIs were deemed as Professional Investors but non-exempt investors, whilst they are now categorised as exempt investors. This effectively means that the QFII/RQFII investors are able to benefit from a much streamlined client onboarding procedures, which facilitate their investments into the PFM funds under the reformed QFII rules. (If helpful you may find more details on the cross border programmes such as QFII/RQFII via link 1 and link 2.)

2.3 Restrictions on lending activities
The Official Provisions also impose some restrictions on private funds’ investment activities, in particular, lending activities.

Specifically, Article 4 and Article 8 of the Official Provisions prohibit a PFM from using fund assets to engage in the relevant activities, which include, among others, borrowing and lending, guarantees, and pledges. As an exemption of the restrictions described, the Official Provisions allow a private fund to provide loans or guarantees to its portfolio companies for a term of less than one year, but further stipulate that the maturity date of such loan or guarantee shall be no later than the exit date of corresponding equity investment. The assets of the fund utilised to make such loan arrangement shall be limited to 20% of the total contributed capital of the fund.

Apparently, the rules above are intended to regulate equity funds whilst questions arise as to whether there would be a line drawn between pure lending activities and activities of managing a private credit fund.

A silver lining is that the Official Provisions have explicitly added an exception under both Articles 4 and 8 (as compared to only in Article 8 in the Draft Provisions), indicating that a private fund might be able to apply private credit strategies in the future if separately stipulated by CSRC. We understand regulators are looking into the space of private credit funds and considering the best way to regulate them. This move is also in line with the regulators’ objective to open up China’s non-performing loan market, among others, to foreign investors and possibly managers.

2.4 Preventing conflicts of interest
Article 11 of the Official Provisions further regulates the conflict of interest concerning PFMs. It requires the manager that is using the fund asset to transact with any related parties to (1) establish a regime to prevent conflicts of interest; (2) seek consent or approval from all the investors or through the relevant decision making mechanism as pre-agreed by the investors in the constituent documents of the fund; (3) report to investors after making a conflicted investment.

Notably, the first two points of requirements of Article 11 have been reflected in the Instructions for Fund Filing issued by AMAC.

We understand the intention of this rule is to follow the best practice in the private equity industry which requires the approval of the limited partner advisory committee for any action that could or could potentially constitute a conflict of interest. Compared to the Draft Provisions, the Official Provisions no longer require a reporting to AMAC each time after the deal is done, which has increased the enforceability of this clause.

Background (published by CSRC in light of the issuance of the Official Provisions)
In order to further strengthen the supervision of private investment funds, crack down on all kinds of illegal acts, strictly control the incremental risk of private investment funds, steadily resolve the existing risk, enhance the standardised development of the industry, and protect the legitimate rights and interests of investors and related parties, the CSRC recently issued Several Provisions on Strengthening the Supervision of Private Investment Funds (hereinafter referred to as Provisions).

Since 2013, when private investment funds have been incorporated into the supervision of the CSRC, the private investment fund industry has achieved rapid development, playing an important role in promoting social capital financing, increasing the proportion of direct financing, promoting scientific and technological innovation, optimising the structure of capital market investors and serving the development of the real economy in many aspects. Under the situation of economic downturn and pressure from internal and external, private investment funds have shown significant growth against the trend. By the end of 2020, there are 24,600 registered managers, 96,800 private investment funds filed, with a management scale of 15.97 trillion RMB. As of the third quarter of 2020, the cumulative investment of private equity funds and venture capital funds in the equity of domestic unlisted and unlisted enterprises, the equity of the NEEQs (新三板企业) and the number of refinancing projects reached 132,000, forming equity capital of 7.88 trillion RMB for the real economy.

Private investment fund industry is in the rapid development, but also accompanied by a variety of chaos, including public or disguised public fund-raising, circumventing the requirements of qualified investors, failing to fulfil the obligations of registration and filing, complex group operations, capital pool operations, transferring of benefits, self-financing and self-assurance, and even the emergence of embezzlement, misappropriation of fund assets, illegal fund-raising and other serious violations of the interests of investors, industry risks gradually emerge. In recent years, the typical risk events represented by the Fuxing group, Jincheng group (in Chinese阜兴系、金诚系)etc. have had significant negative impacts on the reputation and benign ecology of the industry. According to the relevant requirements on strengthening financial supervision, after repeated research, a comprehensive summary of the characteristics of the occurrence of risk events in the field of private investment funds and disposal experience, and by reaffirming and refining the bottom-line requirements of private investment fund regulation, the private investment industry will truly return to the origin of private investment, promoting the virtuous cycle of the elimination of the fittest and the standardised and sustainable development of the industry.

The draft provisions were opened for public consultation from September 11 to October 10, 2020, while CSRC also considered written consultation and conducted seminars to fully listened to the views of all parties. During the consultation process, local governments, private investment fund managers, custodians, law firms, industry associations, investors gave extensive attention. In general, all parties believe that the introduction of the Provisions is very necessary, in particular, the prevention and resolution of industry risks, regulation of the healthy development of the industry, optimisation of the promotion of benign development of ecological significance. The parties have all agreed with the Provisions’ general idea, the overall framework and the main content and urged them to be introduced as soon as possible and strengthen law enforcement efforts to combat. At the same time, the parties also put forward specific proposals for changes. CSRC carefully studied the views one by one, most of which have been absorbed into the final version.

There are a total of 14 articles in the Provisions, which form ten prohibitive requirements for private investment fund managers and practitioners and others. The main content is as follows: First, to regulate the name of private investment fund managers, the scope of business, and the implementation of the old and new delineation. Second is to optimise the supervision of group private investment fund managers, to achieve the best and limit the bad. Third, reiterate that private investment funds should be non-public solicitated from qualified investors. Fourth is to clarify the investment requirements of private investment fund property. Fifth is to strengthen the private investment fund managers and practitioners and other subjects to regulate the requirements and conducts of related transactions. Sixth is to clarify the legal liability and transition arrangements.

The release of the Provisions is one of the important measures to implement the requirements for the prevention and mitigation of risks in the private investment fund industry, which will further guide the private investment fund industry to establish a sense of bottom line and compliance, and also has positive significance for optimising the ecology of the private investment fund industry.

In the next step, the CSRC will further improve the legal and regulatory system of private investment funds in accordance with the overall requirements of building a system, non-intervention and zero tolerance, and consolidate the institutional basis for strengthening the regulation of private investment funds. At the same time, the CSRC will increase policy support, coordinate the strengthening of private investment fund supervision and promote the standardised and sustainable development of the industry, and further plays an important role in improving the proportion of direct financing, supporting entrepreneurship and innovation, serving the real economy and wealth management of residents.

If you would like any more information on the contents of this insight, please get in contact with Melody Yang.