The PRC is progressively introducing a series of measures to ease restrictions on foreign investment
|Inside China, written by FenXun Partners’ Xusheng Yang and Sue Liu, is an insight into aspects of the China market that often elude the naked eye.|
Yang is a specialist in China’s financial markets and institutions, having started his career at the China Securities Regulatory Commission and then co-founding FenXun in 2009. Liu’s practice focuses primarily on the asset management industry, and has previously worked as an associate at Skadden Arps Slate Meagher & Flom in New York.
China plans to further open its domestic market amidst brewing Sino-US trade conflicts and the financial services sector is receiving encouraging signals. On April 10, President Xi delivered a keynote speech at the opening ceremony of the Boao Forum for Asia Annual Conference 2018, confirming, among other things, that the country will further open up its financial market. On April 11, Gang Yi, governor of the People's Bank of China (PBOC), announced that a number of financial service sectors will see foreign investment restrictions relaxed within the year. These statements appear to be more than rhetoric. Commercial banks, securities companies, futures companies, fund management companies, trust companies and financing companies may all see reduced foreign investment restrictions in the coming months.
The investment fund management sector is a relatively young and fast growing financial services segment in China. According to the Asset Management Association of China (AMAC), a self-regulatory trade organisation authorised by the China Securities Regulatory Commission (CSRC), by the end of February 2018, aggregate asset under management (AUM) in publicly-offered funds reached RMB12.64 trillion (approximately $2 trillion) and AUM reached RMB12.01 trillion with respect to privately-offered funds. With the government pushing financial reform and curbing shadow banking, the funds sector expects to enjoy continued growth and expansion. International fund managers are actively seeking opportunities in the China market. In the past decade, a fair number of foreign asset managers have developed onshore investment and research capacities, but the development of distribution capability and onshore products has been more challenging.
The fund management sector is regulated by multiple regulatory agencies. Conducting investment advisory service and fundraising activities in China requires some form of onshore establishment and legal presence. In this regard, compared to their Chinese counterparts, foreign asset managers face market entry barriers in terms of foreign investment restrictions. In addition, some foreign asset managers, having achieved market recognition in offshore jurisdictions, may find it difficult to use their competitive advantages in the Chinese market. Both inbound investment and outbound investment (ODI) are subject to cross-border investment and capital exchange restrictions. Utilisation of existing investor relations, fundraising and deal sourcing capacities cultivated in offshore jurisdictions, whether by investing offshore client assets into the Chinese market or investing Chinese client assets into offshore jurisdictions, may be subject to tight regulatory control. In recent years, China has significantly relaxed inbound investment restrictions, making it easier for international fund managers to set up onshore subsidiaries and for foreign funds to make investments into Chinese portfolio companies and the secondary market. Since December 2017, both central and various local governments have indicated an intention to reopen channels for outbound investment by funds raised in China.
The fund management sector can be divided into the public funds segment and the private funds segment, which are separately regulated. However, the regulatory terminology is somewhat misleading. The term fund management company usually refers to a management company of publically-offered funds. The establishment and operation of fund management companies are subject to heightened regulatory scrutiny and supervision compared to management companies of privately-offered funds. Private fund management companies are further subdivided by the products they offer, eg private-offered securities investment funds and privately-offered equity investment funds.
Private fund management companies are not subject to the same level of regulation, including foreign investment restrictions
Predictably, public fund management companies are subject to higher entry barrier. China permits foreign investment into fund management companies following its accession to the WTO in December 2001. Pursuant to China's accession commitment, the initial foreign ownership cap was set at 33%, and raised to 49% in 2004. The first foreign invested fund management company, China Merchants Fund, was established in 2002 as a joint venture among China Merchants Securities, ING Asset Management and three other Chinese companies, with China Merchants Securities holding a 40% interest, and ING holding a 30% interest. As of February 2018, there were 45 foreign-invested fund management companies among the 116 fund management companies (exclusive of 15 securities companies and subsidiaries of securities companies and insurance companies that have been approved to conduct fund management business) in the China market. Since 2017, as a part of the overall reform and opening agenda of the financial market, Chinese regulators have indicated that foreign ownership cap in fund management companies would be raised to 51%, allowing foreign investors to hold majority interests in fund management companies. A time line was provided in Governor Yi's speech at the Boao Forum. It is envisioned that the foreign ownership cap will be raised to 51% in the first half of 2018 and completely removed after three years.
Private fund management companies, on the other hand, are not subject to the same level of regulation, including foreign investment restrictions. Since mid-2016, when the foreign ownership cap of 49% on private securities fund management companies was removed (private equity investment fund managers were not subject to foreign ownership cap at the time), foreign investors have been able to can form and register with the AMAC as wholly-foreign owned enterprises (WFOEs) to act as private fund management companies and raise private funds from Chinese investors for investment in China.
There is encouraging news for international fund managers seeking to raise onshore funds for offshore investment as well. For a Chinese investment fund (whether or not it is managed by a foreign-invested manager) to invest into offshore markets, approval will need to be obtained under specialised programmes. Between 2013 and 2015, outbound investment in all shapes and forms flourished. Central and local governments took a positive view towards ODI activities and enacted various regulatory programmes to create ODI channels within the overall capital control regime. However, since the securities market crash in 2015 and the ensued capital outflow pressure, most, if not all of these specialised programmes went into hiatus. In December 2017, however, some of these specialised programs saw opportunities of revival and expansion.
Specialised programs for funds outbound investment include the Qualified Domestic Institutional Investor (QDII) programme, the Qualified Domestic Limited Partner (QDLP) programme and the Qualified Domestic Investment Enterprise (QDIE) programme. These programmes combine regulatory review with foreign exchange quotas and are narrowly scoped. The qualification requirements and operation restrictions vary significantly. Fund managers interested in offshore investment need to carefully review the features of these programs to find a good fit.
The QDII programme
The CSRC initially promulgated the QDII programme in April 2006 – it went through rounds of revisions over the years. It allows qualified financial institutions, such as commercial banks, securities companies, fund management companies, insurance companies and trust companies, to invest proprietary and client money into offshore securities. A fund management company qualified under the programme may establish a publically-offered fund, raise money from qualified Chinese institutional and individual investors and invest into securities issued in offshore jurisdictions. Under the corresponding regulations promulgated by the State Administration of Foreign Exchange (Safe), each QDII also receives a foreign exchange quota, which caps the amount of foreign currency that a QDII can exchange under the exchange control regime for offshore investments. As of March 2018, there were a total of 132 QDIIs, which have received an aggregate foreign exchange quota of $89.99 billion. The QDII qualification is reviewed and approved by the regulatory bodies having authorities over the institutions (such as the CSRC, and the soon to be combined China Banking Regulatory Commission and China Insurance Regulatory Commission). There are currently 32 fund management companies qualified as QDIIs, holding an aggregate quota of $28.5 billion, each ranging from $100 million to $3.5 billion. Most of these fund management companies obtained QDII qualifications and were assigned exchange quotas in 2014 and 2015.
Safe announced that it will coordinate with other regulators to review and push forward a reform of the QDII programme
Since 2016, however, the QDII exchange quota has been granted just once in the amount of $1.885 billion. Following President Xi and governor Yi's statements, Safe issued a statement announcing that it will coordinate with other regulators to review and push forward a reform of the QDII programme. This is widely viewed as a positive massage for reviving and increasing quotas available under the programme.
A foreign fund manager can assess the QDII programme in two ways. The first is to act as an offshore investment advisor to a QDII fund. In order to act in this capacity, a potential advisor should, among other things, (i) have been established in a jurisdiction that has entered into a memorandum of understanding with the CSRC and have been approved by applicable regulatory authorities in its home jurisdiction to conduct investment management business; (ii) have conducted investment management business for more than five years; and (iii) have in the most recent fiscal year securities assets under management of not less than $10 billion. Alternatively, a foreign fund manager may form a joint venture fund management company in China with one or more Chinese partners, qualify the fund management company as a QDII and obtain an exchange quota. Such a foreign-invested fund management company should, among other things, (i) have net assets of no less than RMB200 million; (ii) have conducted securities investment fund management business for more than two years; and (iii) have in the last fiscal quarter AUMs of no less than RMB20 billion.
The QDLP and the QDIE programmes
These two programmes are geared towards privately offered funds. They are implemented at municipal level in a handful of cities in China and vary from place to place. They would normally require both the applicant fund manager and fund to be local entities established in the same city. The QDLP programme is intended for private raised securities investment fund investing in offshore secondary market, while its QDIE
counterpart does not make a distinction between investments into secondary market securities or private equities. The programmes are evolving and may become available in more cities. Among the existing programmes, the most widely utilised are the QDLP programme implemented in Shanghai and the QDIE one in Shenzhen.
The QDLP programme currently in operation in Shanghai is the first of such programmes. It was implemented in April 2012, with a total foreign exchange quota of $5 billion. In September 2013, a first batch of $300 million quotas were granted to six qualified QDLPs, each receiving a quota of $50 million. The municipal regulators are cautious and selective in their approach and handpicked onshore affiliates of some of the largest offshore hedge fund managers. Two more batches were granted in 2015 to nine asset managers each receiving a $100 million quota. Then, after a more than two-year hiatus, it was reported that another six fund managers qualified and each received a $50 million quota in February 2018.
The qualification requirements under the Shanghai QDLP programme include, among other things, that (i) the controlling shareholder of the applicant private fund management company conducts fund management business for privately offered funds investing in offshore secondary market and has been approved to conduct investment management by relevant regulatory authorities in its home jurisdiction; (ii) the private fund management company has registered capital of at least $2 million; (iii) the applicant fund has a minimum commitment of RMB100 million; and (iv) each fund investor, whether an entity or an individual, should commit a minimum of RMB5 million to the fund. Qualified QDLP funds can be invested into offshore secondary market, including through offshore hedge funds. This programme, combined with the removal of foreign ownership cap in a private securities fund management company, allows an international hedge fund manager to establish a wholly-owned subsidiary in Shanghai to act as a fund manager, raise onshore renminbi in an onshore feeder fund, and feed the investment into an offshore hedge fund.
The QDIE programme was introduced in Shenzhen in December 2014 and has a total quota of $2 billion. It is reported that in 2015, 41 applicants were approved under the QDIE programme, each receiving a $30 million quota. Then in late 2017, news surfaced that the QDIE programme has started to accept new applications following a two-year suspension. The key element of distinction between the QDLP and the QDIE programmes lies in the fund's scope of investment. Under the Shenzhen QDIE programme, a QDIE fund can invest into offshore secondary market securities or private equities. It is reported that domestic fund managers seeking opportunities in offshore venture capital or private equity investments are most interested in the QDIE programme.
In tune with the openness in global relations promoted at the Boao Forum this year, Chinese regulators will likely act to further ease control and restrictions on the financial market within the year. All may look forward to improvement in access to the China's funds market.