A private investment (PI) fund is an investment fund established with funds raised from investors in a non-public manner. In a contract-based PI fund, the fund contract serves as the legal medium specifying the rights and obligations of the investors, fund manager and fund custodian. Such a fund has clear advantages over PI funds organized in the form of a limited partnership or company, in terms of the number of qualified investors, operational convenience, taxation, etc. With the increasing popularity of contract-based PI funds, fund investors, publicity and promotion, and investment in third parties have become the focus of regulatory authorities regarding the compliant operation of such funds.
Recognition of investors
The Interim Measures for the Oversight of Private Investment Funds specify that qualified investors of PI funds are entities or persons that have the appropriate risk identification and bearing capacities, that invest not less than RMB1 million (US$150,000) in a single PI fund, and satisfy the following criteria: (1) being an entity with net assets of not less than RMB10 million; or (2) being an individual with financial assets of not less than RMB3 million, or who has had an average annual income of not less than RMB500,000 during the most recent three years.
The Law on Securities Investment Funds limits the number of qualified investors in a single contract-based PI fund to 200. Additionally, the interim measures creatively establish the penetration principle, namely, where funds collected from multiple investors are directly or indirectly invested in a PI fund by a means not involving a legal person, such as by a partnership, by way of contract, etc., a penetrating verification of whether the ultimate investors are qualified investors is to be conducted, and they are also to be counted when counting the number of investors.
However, the interim measures also exempt four types of investor from the qualified investor recognition conditions, namely: (1) social welfare funds, such as social insurance funds; (2) lawfully established investment plans filed with the fund industry association; (3) PI fund managers, and their employees, that invest in the PI funds under their management; and (4) other investors specified by the China Securities Regulatory Commission. The investors in (1), (2) and (4) are exempted from the penetrating verification of the ultimate investor recognition conditions and the number of investors.
Publicity and promotion
The fundamental difference between privately offered and publicly offered is whether there is a public offering. Accordingly, the methods of publicizing and promoting PI funds are an important criterion for distinguishing publicly offered and privately offered, and are also the red line dividing a lawful raising of funds from an illegal one. The interim measures specify that a PI fund manager or PI fund seller may not raise funds from entities or individuals other than qualified investors, nor publicize or promote the fund to non-specific targets through such mass media as newspapers, periodicals, radio, television and the internet, or by such means as forums, symposiums, workshops or bulletin boards, leaflets, mobile short message, WeChat, blogs or e-mail.
The authors understand that the core idea of this provision is the prohibition against publicizing and promoting a PI fund to non-specific targets, but if the targets of a promotion can be specified, the above-mentioned promotion method may not be completely unusable. The Administrative Measures for Offerings of Private Investment Funds (for Trial Implementation) (Draft for Comment) will likewise prohibit promotion media that are, in nature, public or without the capacity of selecting recipients. Once the official version of the administrative measures is issued, together with the interim measures, it will become the compliance guideline for methods of publicizing and promoting PI funds.
Investment in third parties
Article 2 of the interim measures specifies that the property of a PI fund is to be invested in investment targets that include the trading of stocks, equity, bonds, futures, options, fund units and other targets specified in the investment contract. However, it is the opinion of the authors that this does not signify that PI funds can directly extend loans. The General Rules for Loans specify that a lender must have its loan business approved by the People’s Bank of China and possess a legal person permit of a financial institution, or a business permit of a financial institution. Accordingly, if the manager of a contract-based PI fund has not secured approvals, it may not extend loans as a lender. If it determines to carry out loan-type investments, it must do so by entrusting a commercial bank to extend such loans, failing which it will face compliance risks.
Equity investment is one of the main types of investment for PI funds, however the medium for a contract-based PI fund is the fund contract, rather than a legal entity, and accordingly, when investing in the equity of an unlisted company, there may be obstacles to business registration. In general practice, it is common for the fund manager to register as a shareholder on behalf of the PI fund at the business registration stage. For PI funds, the Law on Securities Investment Funds is the higher-level law, and where this law is silent, the Trust Law applies. Accordingly, the authors argue that there is a certain legal basis for a fund manager, based on its “trust relationship” with the fund investors, to represent a PI fund in registering as a shareholder in an investee company.
Additionally, the answers in the Answers of National Equities Exchange and Quotations to Questions on Institutional Business (1), concerning contract-based PI funds not being required to carry out share restoration when investing in the equity of an enterprise proposing to list, and concerning directly registering the shares under the product when carrying out initial share registration, provide operational guidelines for changing the registration of a shareholder from the fund manager to the fund product when the company is listing on the New Third Board.
In conclusion, from the recently publicized administrative measures, and the controls placed on the establishment of PI fund managers in cities such as Beijing and Shanghai, one can see the determination of the regulators in erecting a compliant PI fund regime. Stricter regulatory oversight is the inevitable trend and conforming to key compliance points will be crucial for PI fund institutions if they do not wish to be eliminated by the market.g