In recent years, China’s private fund industry has grown at a rapid pace. At the end of July 2020, there were 24,500 private fund managers registered with the Asset Management Association of China (AMAC), and more than 88,000 private funds managing funds totalling RMB14.96 trillion (US$2.26 trillion).
Of those, the top private funds with at least RMB5 billion under management only accounted for 1.3% of the total, but nevertheless had 57.66% of the assets in the entire industry under their management. The private securities fund industry is currently seeing a trend away from freewheeling competition to increasing consolidation around the giants, leaving a narrowing space for the existence of small and medium-sized private funds.
While the private fund industry has been growing rapidly, the downward pressure on the real economy has been increasing, and various forms of illegal acts have gradually come to the fore. With a view to prodding the private fund industry into returning to the essence of private funds and investment, achieving a virtuous cycle of the inferior giving way to the superior in the industry, and promoting the compliant and sustainable development of the industry, regulators have recently issued a number of significant documents.
Of the more important are the Instructions for the Recordal of Private Investment Funds, issued on 23 December 2019, and, more recently, the Several Provisions for Strengthening the Oversight of Private Investment Funds (Draft for Comment).
The new instructions continue, in the form of the negative list, to further refine the external boundaries of private funds from the perspective of “does not fall within the scope of private funds”, and specify that the following five circumstances do not fall within the scope of private fund recordal:
(1) engagement in financial institution credit (deposit) business in a disguised manner, or direct investment in credit assets of financial institutions;
(2) engagement in recurring, for-profit private lending activities, including but not limited to engaging in the foregoing activities by such means as entrusted loans, trust loans, etc.;
(3) engagement, in a disguised manner, by a private investment fund in loan (deposit taking) activities by way of setting unconditional rigid repurchase arrangements where fund returns are divorced from the business performance of, or returns from, the investment targets;
(4) investment in factoring assets, financial leasing assets, pawn assets and other assets, equity, or the right to benefit therefrom, of or from business referred to in the Answers to Questions on the Registration and Recordal of Private Funds; (7) that conflict with private investment funds; and
(5) engagement, indirectly or in a disguised manner, in the foregoing activities by investing in partnerships, companies and asset management products (including private investment funds), etc.
These provisions have a direct impact on the product design and financing work of private funds.
Offerings by third parties
There are two ways of offering private funds – sale through an intermediary, and direct sale. Recently, the China Securities Regulatory Commission (CSRC) issued the Measures for the Oversight of Publicly Offered Securities Investment Fund Sales Institutions and complementary rules, which were implemented on 1 October 2020.
Article 9 states: “An independent fund sales institution is an institution that exclusively engages in the business of selling public funds and private securities investment funds. An independent fund sales institution may not engage in other business, unless otherwise provided by the CSRC.”
Chapter 6 of the measures contains a standalone provision that specifies that chapters 3 and 4 of the measures apply mutatis mutandis (once the necessary changes have been made) to fund sales institutions that lawfully engage in private fund sales business, in addition to public fund sales business, unless otherwise provided in laws or regulations, or by the CSRC. Accordingly, the newly issued measures apply to the sale of private funds, but if a law, regulation, or the CSRC specifies special provisions for the sale of private funds, such special provisions are to be complied with.
And, pursuant to the Administrative Measures for the Offering of Private Investment Funds, issued in 2016, a private fund may be sold directly by the private fund manager, or alternatively sold on its behalf by a third party. The only requirements in respect of such a sales agent are as follows:
Having the fund sales business qualifications specified by the CSRC; being a member of the AMAC; and the private funds regulated by the private fund offering measures covering every type of private fund offering, not just those in the securities field. Accordingly, whether independent sales institutions will, in future, be able to sell such products as private equity funds on an agency basis requires further clarification by the regulators.
Prohibitive offering provisions
The provisions stringently adhere to the bottom line that private funds are to be privately offered to qualified investors, and beef up the negative list governing the professional acts of private fund managers. More specifically, article 6 sets out the 10 prohibitive requirements that may not, directly or indirectly, characterize a private fund manager, private fund sales institution and their employees in the course of the offering of a private fund.
The provisions strictly prohibit the use of fund property to engage in non-private fund investment activities such as lending (deposit taking), provision of security, debt investment carried out in the guise of equity investment, etc.. They also strictly prohibit investments in quasi-credit assets or the rights to benefit from them, and prohibit the engagement in investing that gives rise to unlimited liability, and in projects in which the state prohibits or restricts investment. The above-mentioned are more straightforward and clear as compared to the provisions of the new instructions, and are in keeping with the policy objective of promoting the return of private funds to their investment roots.
In short, the design of fund products and the associated financing work is regulated through the improvement of the fund recordal system work, and the improvement of prohibited acts, and the investment negative list. On this basis, it is possible to strengthen the management of risks that accompany fund raising.
On the one hand, through the prohibition of debt financing, the development of equity investment funds is encouraged, but on the other hand, the issuance of vague restrictive regulations on the sale of private equity funds through third parties will require the strengthening of the management of risks associated with fund raising by sifting through the policies with a fine-toothed comb.
Hu Xiaobo is a partner at DOCVIT Law Firm
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