China Law Insight : China Business and Intellectual Property Lawyers & Attorneys : King & Wood Law Firm : IP, Arbitration, Litigation, Securities, Foreign Investment

According to Circular Hui Zong Fa [2008] 142 (“Circular 142”), unless otherwise provided for under law, the capital of a foreign invested enterprise (“FIE”) shall not be used for equity investment. If an FIE intends to act as a GP of a RMB PE fund, it will find it difficult to satisfy the GP’s RMB commitment (often 1% of the total commitment of the fund) because the FIE cannot convert its capital into RMB. This further effectively blocks the means by which an FIE is able to act as an LP because it is much more difficult for it to satisfy the LP’s RMB commitment, which is typically substantially higher than a GP’s commitment.

The Trial Plan is intended to establish a Qualified Foreign Limited Partner (“QFLP”) mechanism by adopting the approach similar to the QFII (Qualified Foreign Institutional Investor) system, and allows foreign funded GPs and LPs to convert foreign exchange capital into RMB. The aggregate quota for foreign exchange convertible into RMB shall not exceed 50% of the size of the fund, and the quota for a GP shall not exceed 5% of the fund size.

It is unclear if foreign funded GPs and LPs refers to foreign investors only or both foreign investors and FIEs, which are Chinese entities partly or wholly owned by foreign investors. Also, as is known by veterans of the Chinese PE industry, a domestic partnership’s partners shall all be Chinese individuals or Chinese entities, which may include FIEs. This allows indirect foreign investment (with difficulties arising from foreign exchange conversion). On the other hand, a foreign invested partnership may directly accommodate a foreign GP or LP. Therefore, either a domestic partnership and a foreign invested partnership both allow the participation of foreign investment. However, it is unclear if the Trial Plan will apply to both domestic partnerships and foreign invested partnerships.

Though not crystal clear, a domestic partnership with indirect foreign investment is likely to be treated equally as other pure domestic funds in terms of portfolio investment, but a foreign invested partnership will be treated as a foreign investor and subject to industrial restrictions and cumbersome approvals. If the Trial Plan does apply to domestic partnerships, that will be a real breakthrough and Pudong will be better positioned to attract RMB PE funds than its competitors in China. Further details will be publicized in April.
 

Prior to the promulgation of the Pilot Measures, the Shanghai Financial Services Office, in conjunction with the Shanghai Administration for Industry and Commerce, State Taxation Bureau of Shanghai Municipality and Local Taxation Bureau of Shanghai Municipality, issued a notice on industrial and commercial registration of equity investment enterprises in Shanghai (Hu Jin Rong Ban Tong [2008] No. 3) ("Notice") on August 11, 2008. The Notice specifies the basic conditions for equity investment management enterprises. But in practice, the examination and approval authorities or the registration authorities generally only apply the provisions regarding equity investment management enterprises in the Notice to domestic enterprises and not foreign enterprises.

I. Mandatory Requirements for Establishment of Foreign-invested Equity Investment Management Enterprises

According to the Pilot Measures, foreign-invested equity investment management enterprises refer to Sino-foreign equity or contractual joint ventures, or wholly-foreign owned enterprises, which are incorporated in Pudong New Area by foreign companies, enterprises, other economic organizations or individuals, and mainly engage in equity investment management upon entrustment of equity investment enterprises.

Meanwhile, the equity holders and senior management personnel of the foreign-invested equity investment management enterprises shall satisfy certain legal requirements, including: (1) a foreign-invested equity investment management enterprises shall have at least one investor (equity holder), and the business scope of the investor or its affiliates shall include equity investment or equity investment management; (2) when applying for incorporation, the foreign-invested equity investment management enterprise shall have more than two senior managers with over two years experience in equity investment or equity investment management and they shall have over two years experience in senior management positions.

According to the Pilot Measures, a foreign-invested equity investment management enterprise shall be incorporated as a limited liability company with a registered capital of USD 2,000,000 or more.
 

An established foreign-invested enterprise that meets the forgoing conditions may apply for conversion into a foreign-invested equity investment management enterprise.

II. Preferential Treatment for Foreign-invested Equity Investment Management Enterprises

The Shanghai Pudong New Area Financial Services Office and Finance Bureau published the Circular on Issuance of Opinions on Promoting Development of Equity Investment Enterprises and Equity Investment Management Enterprises in Pudong New Area ("Opinions") on December 15, 2008, and Implementing Rules on Promoting Development of Equity Investment Enterprises and Equity Investment Management Enterprises in Pudong New Area ( "Implementing Rules") in March 2009. The Opinions and Implementing Rules set forth preferential and supporting policies for equity investment enterprises and equity investment management enterprises. These policies include:

(a) "For an equity investment management enterprise incorporated as a company, its chairman, vice chairman, general manager and deputy general manager shall receive 40% of their respective paid annual income tax as a subsidy, and the core staff acting as investment manager or project manager shall receive 20% of their respective paid annual income tax as a subsidy;
(b) For an equity investment management enterprise incorporated as a company managing a capital of RMB 1,000,000,000 or more, its chairman, vice chairman, general manager and deputy general manager shall each receive housing or lease subsidy of RMB 200,000 in a lump sum.
(c) An equity investment management enterprise, which is entrusted by an equity investment enterprise incorporated as a partnership to conduct equity investment management business, may receive an award in a lump sum based on the funds actually raised by the equity investment enterprise in the current year: an award of RMB5 million where RMB1 billion is raised; an award of RMB10 million where RMB3 billion is raised, or an award of RMB15 million where RMB5 billion is raised. The amount of the award shall be increased for enterprises which provide substantial contribution to the development of Pudong financial industry."

III. Approval Authority and Procedures for Establishment of Foreign-invested Equity Investment Management Enterprises

The establishment of foreign-invested equity investment management enterprises, either by incorporation or conversion, requires the approval from Shanghai Pudong New Area Economic Commission (the "Pudong Economic Commission"). According to Pudong Economic Commission, the preparation of documents and approval procedure for the application for establishment of foreign-invested equity investment management enterprises is similar to that required for establishment of general foreign-invested enterprises.

Upon accepting the application, Pudong Economic Commission will also consult with Pudong Finance Office regarding the application materials. Pudong Finance Office will then examine and appraise the qualification of the equity holders and senior management personnel of the foreign-invested equity investment management enterprises. Before approving an application, Pudong Economic Commission will verify whether the said equity holders and senior management personnel are qualified according to the Pilot Measures.

The promulgation of the Pilot Measures has given the green light for incorporation of equity investment management companies by foreign equity investment entities in Pudong New Area. However, the Pilot Measures, which have not established detailed rules for their implementation, need to be refined by relevant authorities in the future.