China

Author: | Published: 3 Oct 1999
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Procedures relating to the Administration of Securities Investment Funds (Procedures) were approved by the State Council in 1997. Fourteen funds have since been established under the Procedures, raising a total of Rmb32 billion ($3.9 billion).

The stated objectives of the Procedures include strengthening the administration of securities investment funds, protecting the legal rights and interests of investors and promoting the healthy and stable development of the securities market.

Historical overview

The Wuhan Securities Investment Fund, the first investment fund established in China in 1991, raised Rmb10 million.

In 1992 there was significant development and growth in Chinese investment funds. That year the People's Bank of China formally approved the establishment of the Zibo Shandong Town and Township Enterprise Investment Fund, the first standardized corporate closed-end investment fund, raising Rmb100 million.

From 1993 to early 1994, 73 additional investment funds were established, with an approximate total net asset value (NAV) of Rmb6 billion. An emergency notice was then issued prohibiting the establishment of non-PBOC approved funds. This prohibition was not lifted until late 1996. By October 1996 it was reported that China had 75 officially approved funds of which 22 were listed, 12 on the Shanghai Stock Exchange and 10 on the Shenzhen Stock Exchange. The majority of these domestic funds are closed-end and invest in a combination of securities, real estate and other investments. As of December 1996 these 75 funds reportedly had total assets of more than Rmb10 billion. The largest was the Tianjin fund with approximately Rmb580 million in assets under management. Compared with 1,473 funds authorized for sale in Hong Kong at the end of 1997 (with a total NAV of approximately HK$1,000 billion ($129 billion)), the potential for developing the investment funds industry in China is immense.

Historical problems

Before the introduction of the Procedures, there was a lack of unified legislation on the supervision and regulation of investment funds in China. Significant operational problems — inadequate supervision, failure to segregate the manager's assets and the fund's assets, and insufficient disclosure of information to investors — were commonplace. In addition, regulations governing custodians and managers varied in different municipalities which frustrated supervisory review and enforcement. The Procedures were introduced to help solve these problems. The China Securities Regulatory Commission (CSRC) is empowered to oversee the implementation of the Procedures.

The Procedures

Open-ended funds

Open-ended funds may be established if subscription proceeds exceed Rmb200 million within three months from the date of approval of the fund. Subscription proceeds cannot be invested until the minimum level of subscriptions have been reached. Subscription proceeds must be held in a commercial bank pending establishment of the fund. Where the minimum subscription threshold is not reached, all subscription monies must be returned to investors with interest within 30 days of the end of the three-month initial offer period.

Advantages of open-ended funds include liquidity, greater size (and therefore economies of scale) and transparency of price. However, the first 14 funds approved since the promulgation of the Procedures are all closed-end, which indicates that the CSRC is encouraging long-term investment schemes to lock up much needed capital and reduce volatility.

closed-end funds

closed-end funds must have a minimum life of five years and a minimum market capitalization of Rmb200 million. The initial offer period may not exceed three months from the date of approval of the fund. The fund may only proceed if at least 80% of the approved capital value is raised within three months.

A second tranche of shares may be issued and/or the life of a closed-end fund may be extended with CSRC approval. Such approval will only be granted if the performance of the fund exceeds the average rate of return of other funds in China, the trustee and manager have not committed any violations of law over the preceding three years, the shareholders' consent to such additional issue or extension and the issue or extension complies with such other conditions stipulated by the CSRC. The review/approval process is subjective. The CSRC has absolute discretion to control the establishment and increase in size of closed-end funds through its ability to impose whichever conditions it deems appropriate in the circumstances. Nevertheless, CSRC chairman Zhou Zhengqing re-affirmed in April 1999 that approved fund managers of important securities funds will be allowed to issue new units this year to further optimize diversification of investments.

Investment restrictions

The Procedures impose requirements on the composition of investment portfolios to diversify risk and obtain a balance of investment assets. Limitations on a fund's investment objectives include:

  • not less than 80% of the fund's gross asset value will be invested in shares and bonds;

  • not less than 20% of the fund's NAV will be invested in government bonds;

  • not more than 10% of the fund's NAV will be invested in securities of any one issuer;

  • the fund's manager may not collectively (on behalf of the fund and/or any other funds) hold more than 10% of the securities of any one issuer; and

  • the fund is prohibited from investing in other funds; borrowing; lending, pledging and margin trading; investing in real estate; investing in securities of companies in which the trustee or manager maintains a vested interest; and any other investments prohibited by the CSRC.

Disclosure

In March 1999 the CSRC announced guidelines on the disclosure of information relating to securities investment funds. According to the guidelines, the public release of any information on finances and accounting must be approved by certain institutions like certified accounting and legal firms, which must present their findings in written form and assume responsibility for the accuracy of the documents. No promotional statements can appear in the disclosure. Projections of fund performance, guarantees of profits or attempts to induce investors to purchase funds are prohibited.

Recent Examples of Fund Launches

Of the 14 funds that have been established under the Procedures the first 10 were each capitalized at Rmb2 billion through the issue of two billion units of Rmb1 par value. The remaining four funds each raised Rmb3 billion. All 14 funds are closed-end and have a fixed life of 15 years.

The establishment of Anshun and Yulong, China's 11th and 12th securities investment funds, heralded a departure from the structure of the previous funds. Anshun and Yulong, the first two performance-linked funds in China, were designed to rekindle investors' interest in the country's fund management industry. (The launch of these funds was met with a distinct lack of enthusiasm from retail investors. Anshun and Yulong were over-subscribed only 3.6 and 1.6 times respectively. In comparison, Yuyang, launched in July 1998, attracted 164 billion yuan in subscription monies (ie, 84 times over-subscribed)). Mainland stock analysts suggested that such a phenomenon was largely a result of the disappointing performance of the first 10 funds, coupled with the excessive premiums (a flat 2.5%) charged to investors. To address the declining interest in investment funds, Anshun and Yulong reduced their monthly management fees to 1.5% and included a performance bonus which becomes payable if the fund outperforms certain criteria. Another new feature in Anshun and Yulong is the shift in investment policy from blue chips to companies with "good potential". This shift may mark the beginning of the government's willingness to experiment further with the structure and investment philosophy of new funds.

The first index-weighted funds in China, Xinghe and Pufeng, were established in July 1999. Xinghe and Pufeng are listed in Shanghai and Shenzhen, respectively, and invest in stocks listed on the two exchanges in accordance with their index weightings.

foreign involvement

Foreign fund managers are not permitted to manage domestic investment funds. In an effort to open up the fund management industry and raise professional standards a draft national regulation, tentatively entitled Administrative Measures for Sino-foreign Joint Venture Funds (the JV Fund Regulations), is expected to be enacted in the near future. These regulations are expected to permit the formation of Chinese-foreign joint venture fund investment companies. According to CSRC chairman Zhou Zhengqing, a committee set up in May 1999 has started drafting the JV Fund Regulations. Press comment suggests that the Chinese government's conservative position on the introduction of foreign investment funds is based on concern about Asia's continuing regional financial crisis. The government's attitude is unlikely to change until the stock market stabilizes and becomes more liquid.

Representatives of the CSRC have indicated that the JV Fund Regulations will provide the framework for foreign investors to set up joint venture fund management companies with Chinese investors and will be somewhat reflective of Chinese laws and regulations governing foreign investment in China. The draft JV Fund Regulations are reported to require foreign joint venture partners to have at least 10 years' experience in the fund management industry and at least the equivalent of Rmb1 billion under management. Each joint venture fund company will be required to have a minimum registered capital of Rmb30 million and a minimum foreign participation of 25%.

Alternative fund structures

The Sino-Swiss Partnership Fund, the first joint venture industrial investment fund registered in China, was launched on December 11 1997. (Paul Weiss advised the Swiss government on the organization and establishment of this investment fund.) The fund, co-sponsored by the Chinese and Swiss governments, had an initial capital of Swfr31.25 million and was designed to support the development of Swiss-invested enterprises in China. The Swiss government holds 80% of the fund and China Development Bank holds the remainder. In line with the jointly drafted investment principles, the fund can provide various financial services in either renminbi or foreign currencies and non-financial services to enterprises by means of equity, bonds, loans and guarantees.

Industrial Investment Funds

As part of the formalization process of the investment funds industry in China, the State Development and Planning Commission is drafting the Administrative Measures Governing Trial Industrial Investment Funds and the Ministry of Science and Technology is making policies governing the framework of science and technology venture capital funds. An industrial investment fund directly invests in industry and supports unlisted enterprises in terms of capital. Toll highways and high-tech projects will hopefully be among the projects to be financed by the first batch of industrial investment funds.

Beijing was reportedly engaged in talks with ING Group last year to launch a Sino-foreign joint venture industrial investment fund to raise up to Rmb2 billion in a public offering. According to the China Daily, the direct investment fund would focus on high-technology enterprises and would be established only after the formulation of relevant international regulations on industrial investment funds.

The establishment of an industrial investment fund would not be eligible for listing until it had a performance track record over a certain period of years.

Conclusion

The reluctance of individual Chinese residents to invest in funds needs to be overcome before significant progress can be made in the development of this industry in China. Hopefully, with the introduction of regulated and therefore presumably safer investment vehicles, Chinese residents will be more willing to invest their savings in the equity market, thereby contributing much needed capital to the continued economic development of China. The enactment of an Investment Funds Law (which is also in the drafting stages) should also assist in the development of the investment funds industry in China.

The Procedures have established relatively clear and concise rules governing the establishment and operation of investment funds and, to a large extent, have provided a framework within which participants' rights are clearly defined, albeit under the overall supervisory/discretionary control of the CSRC. One question is whether the CSRC's overriding discretion is overly protective. There remain a number of grey areas which empower the CSRC to retain control of the development of the industry. With time, however, the CSRC's discretionary powers may be used to encourage innovative investment funds rather than to control the development of them in a paternalistic manner, which in the long-term could slow down the development of the investment funds industry in China.

Mr Philip Millward Mr Philip Millward, based in Hong Kong, advises fund managers on structuring investment funds and their subsequent investment activities.

Mr Gangliang Qiao Mr Gangliang Qiao, based in Beijing, focuses on securities, foreign currency issues and foreign direct investment in China.

Current Trends

domestic savings exceed Rmb5 billion

investors seeking longer-term investments

slow capital markets expansion

industrial investment funds can provide much needed capital support

diversification


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Philip Millward

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Qiao Gangliang

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