PRC Funds: Shanghai Issues Long-awaited Qualified Foreign Limited Partner Rules
The development of foreign sponsored RMB-denominated funds (“RMB Funds”) has taken a step forward in Shanghai with progress to address two of the main hurdles that foreign fund sponsors (“Management Enterprises”) currently faces by providing (1) a clear avenue for converting foreign currency into RMB for investment into RMB Funds and (2) indication that foreign sponsored RMB Funds may be classified as domestic partnerships. Until now, Management Enterprises have been unable to invest into and establish RMB Funds without partnering with a domestic joint-venture partner because of difficulties in converting foreign currency into RMB for investment purposes. Additionally, until now, any RMB Fund that has any level of foreign participation would be treated as a foreign-invested partnership and not a domestic partnership.
To provide requirements and procedures for a Management Enterprises’ conversion of foreign currency to RMB for investment in RMB Funds, the Shanghai Financial Office (“Shanghai FO”), the Shanghai Municipal Commission of Commerce (“Shanghai MOC”) and the Shanghai Administration for Industry and Commerce (“Shanghai AIC”)jointly issued the Implementation Measures on the Pilot Program of Foreign Invested Equity Investment Enterprises in Shanghai (《关于本市开展外商投资股权投资企业试点工作的实施办法》) on 24 December 2010 (and made available to the public on 11 January 2011), which will come into effect on 23 January 2011 (the “Implementation Measures”, also known as the “Qualified Foreign Limited Partner Rules” or “QFLP Rules”).
The Implementation Measures also provide guidelines for the pilot program applying to PRC funds with investment from foreign investors (“Foreign Equity Investment Enterprises”). The Implementation Measures provide guidelines on how a Foreign Equity Investment Enterprise can participate in the pilot program. However, given the Implementation Measures’ silence on the ability for a Foreign Equity Investment Enterprise to be treated as a domestic partnership instead of a foreign-invested partnership, the Implementation Measures are less significant for Foreign Equity Investment Enterprises than for Management Enterprises because this is similar to the status quo situation for Foreign Equity Investment Enterprises.
- The Implementation Measures will apply to Management Enterprises, a type of foreign invested enterprise (a “FIE”), and Foreign Equity Investment Enterprises that have obtained the pilot qualification. Such Measures will (a) allow a Management Enterprise with pilot qualification to convert foreign currency into RMB that can be contributed as capital to RMB Funds that are sponsored and established by such an Enterprise (see paragraph headed “Investment by Management Enterprises in RMB Funds” below) and (b) will allow a Foreign Equity Investment Enterprise to use foreign currency capital commitments from foreign investors to make investments in the PRC (see fourth bullet in the paragraph headed “Foreign Equity Investment Enterprises” below). The permitted scope of business and other details of Management Enterprises and Foreign Equity Investment Enterprises are set out in the paragraphs headed “Management Enterprises” and “Foreign Equity Investment Enterprises” below, respectively.
- The Shanghai Municipal People’s Government will form a joint commission (the “Joint Commission”) to be responsible for approving the pilot qualification of Management Enterprises and Foreign Equity Investment Enterprises. The Joint Commission will consist of members from various government authorities including the Shanghai FO, the Shanghai MOC, the Shanghai AIC, and the State Administration of Foreign Exchange Shanghai Branch.
- The applicant for the pilot qualification (or any of its affiliates) needs to demonstrate that it has at least three years of experience investing in enterprises in the PRC.
- After obtaining the pilot qualification and then registering with the Shanghai AIC, a Management Enterprise or a Foreign Equity Investment Enterprise must file its constitutional documents with the Shanghai FO within 10 working days after such registration. Further, such enterprise must report material events to the relevant authorities every six months. Such material events include, among others, (a) investments made by the Management Enterprise or portfolio investments made by the Foreign Equity Investment Enterprise or; (b) any amendment to the articles of association or partnership agreement, as applicable, of the Management Enterprise or partnership agreement of the Equity Investment Enterprise ; (c) any change of senior management personnel; (d) any removal or appointment of the investment advisor engaged by the Foreign Equity Investment Enterprise; (e) any increase or reduction of registered capital or capital commitment; (f) any merger or division; and (g) any dissolution, liquidation or bankruptcy.
- The foreign investors of a Foreign Equity Investment Enterprise applying for the pilot qualification must be institutional investors recognised by the Joint Commission (including sovereign funds, pension funds, charity funds, fund of funds, insurance companies, commercial banks and securities companies) and must (a) have proprietary assets of no less than US$500 million or have assets under management of no less than US$1 billion for the financial year immediately preceding the application; and (b) have sound corporate governance and a complete internal control system and not been penalised by any court or relevant regulatory authority in the last two years. In addition, such foreign investors or any of their affiliates must have at least five years of investment experience.
- Before applying for the pilot qualification, a Foreign Equity Investment Enterprise is required to enter into a custody agreement with a qualified bank to open a custody account to hold its funds.
- A Management Enterprise may be in a form of a partnership or a limited liability company and must have a minimum capital commitment or registered capital of US$2 million which must be paid in cash.
- A Management Enterprise must include the words “equity investment fund management” in its name.
- A Management Enterprise is permitted to, among others, (a) sponsor and establish an RMB Fund; (b) provide investment management and related services to RMB Funds; and (c) provide equity investment consulting services.
- The Implementation Measures set out higher qualification requirements for the establishment of Management Enterprises than those requirements provided under the Measures on the Pilot Program of Foreign Invested Equity Investment Management Enterprises in Pudong New Area (《上海市浦东新区设立外商投资股权投资管理企业试行办法》) (the “Pudong Measures”) which the Implementation Measures are expected to replace. For instance, both measures require a Management Enterprise to have at least two senior management personnel of the Management Enterprise with the a certain period of experience in equity investment business or equity investment management business, but the Implementation Measures are stricter in that such individuals must (a) have at least five years (as opposed to two years under the Pudong Measures) of experience in equity investment business or equity investment management business; and in addition (b) have experience in equity investment in the PRC or have worked for financial institutions in the PRC; and (c) have not violated the relevant regulations during the last five years. It is currently not clear how the Implementation Measures will apply to Management Enterprises already established pursuant to the Pudong Measures.
- A Management Enterprise will be established upon registration with the Shanghai AIC. If the Management Enterprise is in the form of a company, the establishment will require the prior approval of the Shanghai MOC. The opinion of the Shanghai FO will be consulted regardless of the form of the Management Enterprise.
Investment by Management Enterprises in RMB Funds
- A Management Enterprise that has obtained the pilot qualification is permitted to convert its foreign currency into RMB for investment in an RMB Fund; provided that the amount so converted does not exceed 5% of the aggregate capital commitments of the RMB Fund. Such investment would not change the nature of the RMB Fund. This seems to imply that the RMB Fund formed by such Management Enterprise as general partner may be treated as a domestic partnership as opposed to a foreign-invested partnership; provided there are no foreign limited partners. Domestic partnerships adopting this structure are generally expected to be less regulated and encounter less investment restrictions than foreign-invested partnerships as far as portfolio investments are concerned.
- The Implementation Measures, however, do not provide any details relating to the actual formation and registration of a partnership sponsored and established by a Management Enterprise.
Equity Investment Enterprises
- A Foreign Equity Investment Enterprise may be in the form of a partnership and must have minimum aggregate capital commitments of US$15 million, which must be contributed in cash. The minimum capital commitment for each limited partner is US$1 million, but there is no requirement for a minimum capital commitment of the general partner. There is no provision in the Implementation Measures dealing with the establishment of Foreign Equity Investment Enterprises in the form of companies.
- A Foreign Equity Investment Enterprise must include the words “equity investment fund” in its name.
- A Foreign Equity Investment Enterprise is permitted to (a) subject to applicable PRC laws, use its proprietary funds to make portfolio investments, including, among others, formation of new enterprises, investment in existing enterprises, and acquisition of equity interest in existing enterprises; (b) provide management consulting services to its portfolio enterprises; and (c) conduct other businesses permitted by Shanghai AIC.
- Foreign Equity Investment Enterprises may use their foreign currency for portfolio investment in the PRC.
- Foreign Equity Investment Enterprises are prohibited from, among others, (a) investing in sectors that fall within the prohibited category for foreign investors; (b) trading in shares and enterprise bonds on secondary markets (except for shares held after the listing of portfolio companies); (c) engaging in financial derivative transactions; (d) directly or indirectly investing in non-proprietary real property; (e) misappropriating non-proprietary funds for investment; and (f) providing loans or security to a third party.
- A Foreign Equity Investment Enterprise will be established upon registration with Shanghai AIC. Shanghai AIC will consult the opinion of the Shanghai FO before completing the registration.
- The Implementation Measures require the prior approval of the Shanghai MOC if an FIE intends to invest in a PRC Fund in the form of a company. Such approval is not expressly required under the Implementation Measures in respect of FIEs’ investments in PRC Funds in the form of partnerships.
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