Author: | Published: 1 Jan 2000
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The People's Republic of China has been re-regulating its securities and other investment funds to modernize its financial asset management industry. The PRC enacted national securities investment fund (mutual fund) legislation in late 1997, with a view to establishing a nationally regulated mutual fund industry that would be professionally organized and managed, and that would facilitate greater institutional investor ownership levels in the Chinese securities markets. On November 5 1997 the State Council of the PRC (the Cabinet) approved the Provisional Rules for the Administration of Securities Investment Funds (PFR). Moreover, the regulatory authorities have indicated that new legislation governing Sino-foreign investment funds and management companies is forthcoming. Furthermore, the authorities have also begun drafting regulations to govern similarly structured industrial and venture capital investment funds.


Capital market context for re-regulated securities investment funds

The nationally regulated mutual funds were established for a number of purposes. For instance, the PRC had over 32 million shareholders on the Shanghai Securities Exchange (SSE) and the Shenzhen Stock Exchange (SZE) at the end of 1997 . The vast majority of these shareholders were individuals who view shares as short-term instruments to make speculative profits, a feature that increases their volatility and reinforces this perception. For instance, the 1997 China Securities and Futures Statistical Yearbook reported that the turnover rate on the SSE and SZE were 591% and 902% respectively compared to Taiwan's 243%, London's 58.3%, New York's 52%, and Tokyo's 27% at the end of 1996. Hence, there was a need to introduce institutional investors to the stock exchanges of the PRC in order to reduce the volatility of these markets, in particular the A-Share markets in which domestic investors are allowed to invest. Moreover, the PRC regulatory authorities wanted to increase market liquidity by transferring more of the Rmb5,000 billion ($600 billion) in bank savings accounts into stock market investments. While the stock markets in the PRC have become relatively large in size, there was a need to increase their liquidity so that more PRC enterprises could raise funds through the stock market. For instance, the market capitalization of the SSE and the SZE were $110.9 billion and $100.0 billion respectively at the end of 1997 according to the China Securities Bulletin. Moreover, the 1997 China Securities and Futures Statistical Yearbook reported that the annual trading value for the exchanges in the PRC was $257 billion, compared to $3,347 billion for New York, $865 billion for Tokyo and $838 billion for London at the end of 1996.

History of the mutual fund industry

The mutual fund industry was established in 1991 when banks and other financial institutions were permitted to set up mutual funds for equity and bond investments. The first Chinese investment fund was the Wuhan Securities Investment Fund, a fund with capital of Rmb10 million, which was established in the Wuhan Municipality in October 1991. The first listed closed-end investment fund was the Shandong Zi Bo Town and Township Enterprise Investment Fund to which People's Bank of China gave approval on November 3 1992 and which was listed on the Shanghai Stock Exchange (SSE) in August 1993. This fund had an investment fund of Rmb100 million and a maturity of eight years.

This market segment developed quickly with over 70 mutual funds, having raised nearly Rmb5 billion by the middle of 1993. The largest, the Shenzhen Tian Ji fund, has assets of almost Rmb600 million. Since these mutual funds were operated through lending institutions, there was a lack of professional investment management due to a lack of qualified managers. The various stock exchanges and trading centres regulated the operation of these funds listed on their exchanges in the absence of national regulations. The head office of the People's Bank of China (PBoC) had given official approval to only a few of these funds.

On May 19 1993 the PBoC issued an Emergency Notice, announcing the immediate cessation of non-PBoC approved investment funds and trust beneficiary bonds. The PBoC had become responsible for examining and approving all investment companies, a task that it often delegated to its local branches. The PBoC feared that in the absence of national regulations, these investment funds would further increase volatility on the domestic stock and bond markets. The ban on the approval of new funds was removed on December 1996.

The PRC had 75 investment funds and 47 fund-like certificates at the end of 1996, most of which were closed-end funds. The SSE and the SZE, the only two officially sanctioned stock exchanges in the PRC, had a total of 15 and 10 listed investment funds at the end of 1996; the balance of these funds traded on a number of regional trading centres (or over-the-counter markets) which operated in parallel and sometimes in tandem with the SSE and the SZE for a number of years. However, the Wuhan Securities Trading Centre, the largest regional trading centre was closed in early November 1998, marking the beginning of the consolidation of the regional trading centres in the PRC.

These older investment funds had total assets of Rmb9.03 billion and net assets of Rmb8.58 billion at the end of 1998. These older investment funds were generally less well regulated, subject to an uneven supervisory framework of stock exchange and regional trading centre rules and regulations. Investors for the most part viewed these funds as speculative short-term vehicles rather than long-term growth vehicles because the older funds had few or no restrictions on the scope of their investments. Many funds invested the corpus of their assets in real estate.

Formation of national regulations and mutual funds

In an attempt to better regulate the domestic mutual fund market and increase the importance of mutual funds as institutional investors in the capital markets of China, Chinese regulators formulated a three stage plan to re-regulate and enlarge the domestic mutual fund market. The first stage involved enacting national regulations for domestic mutual fund management companies; the second, enacting national regulations for the establishment of Sino-foreign investment management companies; and, the third, enacting regulations to deal with foreign mutual fund management companies.

First stage

The PBoC commenced work on the first stage as early as 1991 when it began drafting regulations to govern the domestic mutual fund industry. These regulations underwent several revisions before being enacted in late 1997. The delay in the enactment of the Securities Investment Fund Management Law had been attributable to several factors, including the continuing failure to enact underlying and comprehensive national securities legislation and jurisdictional battles between the PBoC and the China Securities Regulatory Committee (CSRC), a regulatory agency under the administrative purview of the then State Council Securities Commission, over the delineation of their regulatory purview over this industry.

Second stage

The PBoC commenced work on the second stage in July 1994 when it began to draft regulations, the Sino-Foreign Investment Fund Management Law, for the establishment and regulation of Sino-foreign joint venture investment funds and management companies. The investment funds would be invested in the domestic markets, including the A-shares of listed companies and government bonds. The need for a Sino-foreign investment fund management companies initially arose when the CSRC announced plans to permit foreigners to trade in A-shares as part of an attempt to bolster, at the time, the falling A-share markets. A government circular released in January 1997 provided the general outline of this proposed legislation as it was envisaged then. The joint venture investment management company must have a minimum of Rmb30 million in registered capital and a minimum of 25% foreign ownership. The foreign partners of the underlying joint venture investment fund management company must have more than 10 years of fund management experience and have at least the equivalent of $10 billion under management, of which no less than $2.5 billion has been acquired through a public offering. The foreign joint venture partner must have also established a representative organization in the PRC for two years or more. Given the regulatory dynamics that exist in the PRC, and that of further WTO accession negotiations, this outline will likely change when it is eventually enacted.

Foreign investment management companies have shown considerable interest in becoming joint venture partners in the mutual fund industry in China, despite the prospect that only one or two foreign investment firms would probably be allowed to establish joint venture investment funds in the initial period. Despite delays in releasing this legislation, a number of Chinese and foreign firms have announced proposed Sino-foreign joint venture funds and management companies including AIG with China International Trust and Investment Corporation, Kleinwort Benson with Guotai Securities and Manulife with Sinochem. Third stage The third stage of permitting foreign investment management companies to offer mutual fund products has no timetable. In all likelihood, the PRC regulatory authorities could come to this stage only when the domestic asset management companies and investment funds could survive against their better capitalized counterparts from abroad, with many more years of relevant asset management experience.

National mutual funds regulations

On November 5 1997 the State Council of the People's Republic of China approved the 57-article Provisional Rules for the Administration of Securities Investment Funds (Provisional Fund Rules or PFR). The State Council Securities Control Commission promulgated the PFR on November 14 1997. Under the PFR, the CSRC was appointed to administer, and implement this legislation. The CSRC on December 13 1997 issued a number of guidelines to implement the PFR and to govern the establishment and operation of the securities investment funds and fund management companies. The CSRC has subsequently issued other guidelines on the operation and the investment parameters of these investment funds.

Types of funds:

The PFR allows both open funds and closed funds, very much like international asset management practices and governing legislation and regulations. Under the PFR, an open fund is an investment fund where the total fund issuance and units of the fund are neither predetermined nor fixed, whereas a closed fund is an investment fund where the total fund issuance and units of the fund are both predetermined and fixed. In each case, the CSRC must examine and approve of the establishment of an investment fund.

closed-end funds may be listed and traded on the stock markets subject to CSRC and stock exchange approval. Open funds can only be traded in markets stipulated by the state. The SSE and SZE issued on March 16 1998 rules for the listing of mutual funds on their exchanges to strengthen the healthy development of the fund industry and to protect the legal rights of investors. For instance, the SSE listing rules specify a number of requirements for the listing of mutual funds, including CSRC approval; maturity not less than five years; minimum collected amount of Rmb200 million, with not fewer than 1,000 holders; and, to have qualified fund managers and trustees for the fund.

Investment fund promoters:

Under the PFR, promoters establish investment funds by making an application to the CSRC, accompanied by supporting documents. The PFR recognizes the role of a primary, or leading promoter, which organizes the other promoters in sponsoring an investment fund. Primary promoters must be a securities company, a trust and investment company or a fund management company. Moreover, the primary promoter must have more than three years' experience in securities investment and continuous profit. To ensure the participation of larger, successful financial institutions, the PFR requires that promoters have paid-up capital of at least Rmb300 million.

Investment fund management companies:

The fund management company is responsible for investing and managing the assets of an investment fund pursuant to the investment fund contract. The promoters of the investment fund concurrently establish the investment fund and the investment management company, which is owned by the promoters of the investment fund, with the primary promoter having the largest interest. The investment management company must have at least Rmb10 million in paid up capital, a feasible fund management plan, and qualified personnel for fund management. Although the fund management companies in the PRC are generally the subsidiaries of leading securities companies, and in some cases, investment and trust companies, the PFR envisage the time when an investment management company may become the primary promoter in establishing another investment fund.

Investment fund custodians:

The investment fund custodian is responsible for keeping safe the assets of the fund and for handling all movement of capital belonging to the fund. The custodian also oversees the fund manager, reporting to the CSRC instructions from the fund manager, which are illegal or against regulations. The PFR require that the custodian be a commercial bank, with a minimum paid-up capital of Rmb8 billion and with staff specialized in the fund custodial business.

Investment fund investment restrictions:

The PFR specifies a number of various investment restrictions and opportunities. For instance, the investment fund must make investments of at least 80% of the gross asset value of the fund in corporate equities and state and corporate bonds. Moreover, the fund must invest at least 20% in the net asset value of the fund in state bonds. Furthermore, the fund has specific limits for investments in the shares of listed and unlisted companies. For instance, the fund cannot invest more than 10% of its net assets in the shares of any listed company. Moreover, a fund manager in control of several funds cannot invest more than 10% of the funds in the shares of any company.

Investor restrictions:

The PFR regulates the ownership of investment funds. For instance, commercial banks and fund trustees cannot invest in investment funds, and, investment funds cannot invest in other investment funds. Moreover, promoters of an investment fund are restricted by the CSRC to subscribing to and holding a certain proportion of the fund. The CSRC set this proportion at 3% in the first tranche of investment funds that were issued in the period March to July 1998.


The CSRC is the primary regulator of these securities investment funds. Under article 5 of the PFR, the CSRC has regulatory oversight (examination and approval) of the establishment of the mutual funds. Moreover, under article 56, the CSRC has the authority to implement these procedures.


The PFR provides a number of administrative sanctions, which include fines and incarceration. For instance, income from a fund, or income derived by individuals from a fund that is established without CSRC authorization is considered illegal and is subject to confiscation, with individuals and the fund subject to a fines between one and 10 times the amount of illegal income. The CSRC has already taken action to sanction violations of the PFR. For instance, the CSRC in mid-April 1998 imposed fines upon and give reprimands to a number of institutional investors for making otherwise prohibited investments in the units of these investment funds, including fines levied against 15 institutional investors for illegally subscribing to the Jin Tai and the Kai Yuan funds when using false accounts designated for individuals in an attempt to circumvent the prohibition against institutions from subscribing to the investment funds.

First tranche of nationally regulated investment funds

The first tranche of nationally regulated investment funds were issued in 1998. These five closed-end funds, with maturities of 15 years, collected subscriptions worth Rmb2 billion each and Rmb10 billion collectively.

The Jin Tai Fund and the Kai Yuan Fund, the first two investment funds in the first tranche of nationally regulated investment funds permitted in 1998, were listed on the SSE and the SZE in April 1998 respectively. The Xing Hua fund, the third investment fund in the first tranche of investment funds permitted in 1998, issued its units to the public in April 1998 and listed on the SSE. The An Xin Fund, the fourth investment in the first tranche of investment funds permitted in 1998, was created on June 22 1998, and listed on the SSE on June 26 1998. The Yu Yang fund, the fifth and final investment fund of the first tranche of investment funds permitted in 1998 was established in July 1998. The Yu Yang fund listed on the SSE, the fourth in this first tranche to do so.

The CSRC selected the better securities firms to lead the creation of the investment funds and their underlying asset management companies. In part, the CSRC chose the securities firms which had a clean regulatory record so that individual investors could confidently invest in these investment funds. The CSRC gave permission to the top three Chinese securities firms to sponsor the first three investment funds. China Securities, also known as Huaxia Securities, a Beijing company, Shanghai Guotai Securities, a Shanghai company, and China Southern Securities, a Shenzhen company, were established by the central government in 1992. Securities firms with past trading violations were less likely to gain approval to establish investment funds. For instance, Shenyin & Wanguo Securities, J&A Securities and Haitong Securities, which were publicly rebuked in 1997 for stock market manipulation did not receive approval for the first round of investment funds in establishing fund management companies. Shenyin & Wanguo Securities, for instance, had to be content with a 20% interest in the investment management company for the An Xin Fund.

In most cases, the leading securities companies would take the largest equity stake in the securities investment fund management company, with lesser securities companies and trust and investment companies comprising the balance of ownership. For instance, the Xing Hua fund is managed by the China Fund Management Company, an investment management company with registered share capital of Rmb70 million. The China Fund Management Company is jointly owned by the China Securities Company, Beijing Securities Company, and the China Science and Technology International Trust & Investment Company, the trust and investment arm of the Chinese Academy of Sciences, with each having a 55%, 38% and 7% interest respectively. The major commercial banks in China served as the custodian of these securities investment funds. For instance, the Industrial and Commercial Bank of China (ICBC), the PRC's largest state-owned commercial bank, with assets that rank it in the top thirty banks in the world, was the custodian of the first, second and fourth funds, the China Construction Bank, the third fund and the Agricultural Bank, the fifth fund.

The first five investment funds were launched under relatively auspicious market circumstances and great investor enthusiasm, with each being heavily oversubscribed. For instance, the Kai Yuan and the Jin Tai Funds were oversubscribed by 42 and 40 times, and the Yu Yang Fund by 83 times.

Second tranche

The CSRC in July 1998 approved a plan for the creation of five new investment funds before the end of 1998. Like the earlier investment funds, each would manage Rmb2.0 billion. The CSRC chose, as it did earlier, to organize groups, with one or two leading securities firms and a number of trust and investment companies to invest in the underlying investment management company. Given weak stock market sentiment, only the Pu Hui Fund was launched in 1998 at the end of the year, and listed on the SZE. The CSRC approved four new funds and fund managers at the end of February 1999. The Tai He and the Tong Yi funds were launched in early April 1999 on the SSE and the SZE respectively, the seventh and eighth nationally regulated securities investment funds. The Jin Hong Fund and the Han Sheng Fund were issued on SZE and the SSE in late April 1999. These were all 15-year closed-end funds.

Third tranche

The CSRC approved five third tranche securities investment funds in a short period from June to August 1999. These funds were different from the earlier tranches in that they were 50% larger, with an intake of Rmb3.0 billion and that their prospectuses could advertise specific investment strategies other than one of maximizing gains. Moreover, the CSRC permitted a few of the more successful extant investment fund management companies to manage a few of these new investment funds, rather than create new management companies, as a reward for their superior performance.

The An Shun and Yu Long Funds, two 15-year closed-end funds and the eleventh and twelfth of the new nationally-regulated securities investment funds, were issued and listed on the SSE and SZE respectively in June 1999. The An Shun Fund was designed to invest 60% of its funds in high-growth companies, and 40% in high-dividend stocks and bonds. The Yu Long Fund would focus on long-term growth companies with undervalued shares. The next three funds were generally index-funds. The Xing He and the Pu Feng funds, two more 15-year closed-end funds, were issued and listed in July 1999 on the SSE and SZE respectively. Each of the two funds would invest 50% of their net assets in listed companies according to their weight in the weighted index of the exchange, with a remaining 30% in blue chip shares and a remaining 20% in bonds. The Tai Yuan Fund, the fifth third-batch fund, was issued on the SZE in August 1999. The Tai Yuan Fund would invest primarily in index-related SSE and SZE stocks which have good liquidity, stable dividends and capital growth potential.

Fourth tranche

The CSRC approved four fourth tranche securities investment funds in late September 1999. These funds are like the third tranche securities investment funds in that they have an intake of Rmb3 billion and have specific and different investment strategies. For instance, the Jin Xin Fund, which is sponsored by Guotai-Jun'an Securities and Zhejiang International Trust and Investment Corporation, and operated by the Guotai Fund Management Co., will invest in shares of restructured state owned enterprises. The Han Xing Fund and the Jing Fu Fund, operated by Dacheng Fund Management Company and the Fuguo Fund Management Company, will concentrate on high growth and value stocks. The Tong Sheng Fund, which was sponsored by the CITIC Securities and the Hubei Securities and managed by the Chang Seng Fund Management Company will do the same. However, the Tong Sheng Fund was different in that it was the first securities investment fund in which insurance companies in China were allowed to invest.

Insurance company investments

The PRC's insurance companies were required hitherto to invest only in bank deposits, government and financial bonds and other financial instruments approved by the Cabinet under the Insurance Law, which was promulgated on June 30 1995 and which came into force on October 1 1995. The CSRC and the China Insurance Regulatory Commission has allowed insurance companies to invest in selected corporate bonds since April 1999 and in late October 1999, new securities investment trusts on the primary market or extant securities investment trusts on the secondary market. These measures were taken not only to provide more institutional investor involvement in China's stock markets, but also to liberalize the investment powers of the insurance companies, the primary investments of which were government bonds. The premium income of the insurance companies have been growing by more than Rmb100 billion annually. Chinese insurance companies can invest up to 30% collectively and 10% individually in securities investment funds. Moreover, the Chinese insurance companies could invest no more than 15% of their assets in securities investment funds. Eleven Chinese insurance companies purchased 900 million units of the three billion units in the Tong Sheng Fund that was launched on the SZE on November 1 1999. The China Life Insurance Corporation and the Ping'an Insurance Corporation bought 300 million units each, and the China Reinsurance Corporation, 100 million units. The remaining 200 million units were purchased by the remaining eight insurance companies.

Further reform of securities investment trust funds

The CSRC announced plans in May 1999 to merge or close many of the smaller unregulated securities investment trust funds. The CSRC wants to resolve the issue of the older unregulated funds by June 2000. Moreover, the CSRC decided to permit approved fund management companies to issue new securities investment trust units to institutional investors, hitherto prohibited from making investments in these funds, to optimize the investment mix and enhance stability in these funds.

The SSE and SZE issued circulars in early October 1999 requiring that the more than 20 old investment funds listed on their exchanges start providing detailed financial disclosure such as monthly book and asset values and quarterly investment portfolios. The SSE required its listed old investment funds which invested in the industrial and real estate sectors to be audited by certified public accountants and appraised by certified asset assessors. Moreover, the CSRC formulated a plan to re-regulate these investment funds at a level with the new investment funds. First, the illiquid assets of the old funds, such as real estate, would be converted into shares and cash and other liquid assets such as government bonds. Second, management of the old funds would be transferred to CSRC approved professional fund management companies, and their assets under the custody of the PBoC-approved commercial banks. The CSRC in early November approved the capital increases and stock exchange listings for the first three transformed old investment funds. Dacheng Fund Management which received approval to issue a new securities investment fund in the fourth tranche, received approval to increase the number of units of two of its old investment funds, the Changyang Securities Investment Fund from 200 million to one billion units at Rmb1 each, and the Jubo Securities Investment Fund from 250 million units to one billion units at the same unit price. Moreover, the Boshi Fund Management received approval to increase the number of units in its Xiangzhen Securities Investment Fund from 200 million to 1.5 billion units at Rmb1 each. The new units were distributed like a rights issue, with extant unit holders given a right of first refusal on new units based pro rata on their existing units. For instance, the old unit holders of the Xiangzhen Securities Investment Fund were entitled to buy 6.5 units for each unit held. Any units not purchased by extant unit holders could be purchased by insurance companies approved to purchase securities investment funds on the primary and secondary markets, and in turn, the sponsors of these funds for the balance. The tenor of these closed-end funds was extended by five years to 2007.


The PRC has been experimenting with other types of investment funds raised from non-state and foreign sources. These types of funds are analogous in many respects to securities investment trusts in that investors pool funds collectively under the aegis of an investment management company to make investments in companies. However, these investment funds make direct investments in companies, with the expectation of assisting incumbent management in their daily operational management practices and even corporate governance.

The State Council gave high priority to the establishment of industrial investment and venture capital investment funds in 1998, assigning responsibility to various government bodies for drafting the legislative framework that would govern nationally these investment funds. The PRC wants to introduce more industrial investment funds to provide capital to non-listed companies in order to develop a new investment and financing mechanism in which the government would play a much less important role than was previously the case. Under this system, industrial fund management companies would be established to invest in the shares of unlisted companies and to transform their management practices. The industrial investment fund management companies could either be domestic concerns raising funds domestically, or Sino-foreign joint management companies that would raise industrial investment funds on both the domestic and international markets. For the PRC, the advantage of the Sino-foreign joint management companies and industrial investment funds is that the various institutional investors from the developed countries, such as mutual fund companies, insurance companies and pension plans would become involved in financing PRC industry. These industrial investment management companies would use their industrial investment funds, which would be entrusted to a commercial bank as custodian, to make direct investments in unlisted PRC companies and earn profits commensurate with their equity stake. The industrial investment funds would later be listed for trading on the stock markets. Major proponents of capital market reform in the PRC have stated that a first draft of an investment fund law would be available during the first half of 2000, with a view towards having a final investment fund law by the end of 2002.

The PRC plans to revamp and to increase the financing of its high-tech industry by channeling more private financing into venture capital firms. As currently envisaged, the PRC would establish risk investment consulting and management companies to assess and recommend to domestic and overseas investors investment portfolios of a number of high-tech investment projects. Moreover, a national legislative framework to govern the manner in which these companies solicit and invest venture capital funds is being drafted. Although specialists have been assigned to draft venture capital legislation, the most sanguine government officials have indicated that it would take at least two years before the government could promulgate national venture capital legislation. The creation of a second board in the PRC for the primary market distribution and secondary market trading of shares in high-tech companies is however viewed as a long-term goal of at least five to 10 years in large part because the market would require even more transparency and regulatory supervision than the established SSE and SZE have been capable of generating. Hence, in the interim, other measures such as fiscal and tax incentives including government grants for start-ups with promising ideas and better means by which these companies can obtain loan guarantees are being considered as important and effective measures that can be taken in the near future. Moreover, the CSRC and the stock exchanges have been encouraging promising high-tech companies to take advantage of listing on Hong Kong's Growth Enterprise Market (GEM). For instance, the CSRC on September 21 1999 promulgated Guidelines for Examination, Approval and Supervision of Enterprises in China Applying to List on the Hong Kong Growth Enterprise Market in order to facilitate the GEM-listing of prospective PRC enterprises. China Agrotech Holdings, a Fuzhou-based bio-chemical company, was one of two companies to list on GEM during its first day of operations on November 25 1999. Moreover, nearby hi-tech industry leader, Shenzhen has been selecting well-performing technology companies for GEM listing while the SZE, which claims that 15% of its listed companies are high technology companies, has begun preparations for its own second board. Industry sources suggest that Beijing wants to learn from Hong Kong's GEM before establishing its own Nasdaq, or at least some form of electronic communications network.

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