By King & Wood’s Securities Group
Following the promulgation of the Notice on Further Regulating the Administration of Development and Filing of Equity Investment Enterprises in Pilot Areas (the "Pilot Rules") by the National Development and Reform Commission (the "NDRC") on 31 January 2011 and positive feedback from the six pilot areas, the NDRC is now determined to apply its administration and filing system to equity investment enterprises ("EIEs") across the nation.
On November 23, 2011, the NDRC promulgated its first set of nationwide rules on the administration of equity investment enterprises, the Notice on Promoting Regular Development of Equity Investment Enterprises (the "Notice"). The main objective of the Notice is to standardize the establishment and operation of private equity funds. This Notice evolved from the Pilot Rules and has addressed five major topics. Together with the Notice, the NDRC also issued a set of forms for filing and guidance for EIEs’ constitutional documents (i.e. guidance on articles of association/partnership agreement of EIEs, guidance on the fund raising prospectus, etc.).
Establishing a Nationwide Filing System
While the Pilot Rules only applied the filing requirement to EIEs with a capital amount of RMB 500 million or above, the Notice has removed this threshold and subjects all equity investment enterprises to filing. Existing EIEs are required to file within three months of the promulgation of the Notice (i.e. November 23, 2011) and newly-established EIEs should file within one month of completing their registration with the Administration for Industry and Commerce, unless:
- the EIE has registered as a venture capital enterprise pursuant to the Interim Management Measures on Venture Capital Enterprises; or
- the EIE is funded and established by a single entity or natural person, or by two or more investors that are wholly-owned subsidiaries of the same entity.
The filing authority is divided into two levels depending on the scale of the EIE:
- for capital equal to or more than RMB 500 million or its equivalent in foreign currency (including paid-in capital and committed capital), filing should be made with the NDRC, which takes up to 40 working days; and
- for capital less than RMB 500 million or its equivalent in foreign currency, filing should be made with an authority appointed by the provincial government (we believe that such filing authority will usually be the provincial counterpart of the NDRC), which takes up to 20 working days.
The Notice itself does not impose substantial sanctions for failure to follow the filing requirements (the only sanction provided in the Notice is that the NDRC will publicly announce non-compliant EIEs). However, we understand that, in practice, negative consequences may include being prohibited from investment by social security funds and possibly underlying pressure and constraints from the government during its operation and for establishment of new funds in the future.
Regulating the Establishment, Fund Raising, and Investment Operations of EIEs
The Notice provides that EIEs may take the form of a limited liability company, a company limited by shares or a partnership by following the PRC Company Law or PRC Partnership Law. The capital of an EIE may be committed capital to be paid in installments during the operation of an EIE according to its articles of association or partnership agreement.
Fund raising of EIEs is restricted to private placement to qualified investors capable of risk assessment and tolerance. Solicitation to unspecific investors via public channels, i.e. through media, seminars, text messages, etc., and promising a fixed return is forbidden. EIEs investment is limited to equity of non-publicly-traded companies and unused cash should either be deposited in banks or be used to purchase investment products of fixed income such as treasury bonds.
Improving the Risk Control System
For risk control purposes, the Notice prohibits an EIE from providing a guaranty to companies other than those it invests in and provides that affiliated parties must refrain from voting for an EIE’s investment in affiliated enterprises. The Notice further provides that assets of EIEs should be entrusted to an independent custodian institute, unless all investors agree to a waiver of such entrustment. Where the entrusted management institute of an EIE is a foreign invested company, assets of such EIEs must be entrusted to a custodian institute with independent legal status in the PRC.
Clarifying Basic Duties of an Entrusted Management Institute
The Notice requires that, where EIEs adopt the form of entrusted management, the entrusted management institute should prepare and implement the investment plan, manage invested enterprises, provide such enterprises with value-added services, disclose to the EIE relevant operational information, and prepare accounting statements and reports to EIEs. If the entrusted management institute acts against the interests of investors (i.e. using the EIEs’ assets for the benefit of a third party), investor may request the entrusted management institute to resign.
Establishing EIEs’ Information Disclosure System
The Notice requires EIEs provide investment operation information to investors as well as submit annual business reports and audited finance reports to the filing authority within four months of the end of each accounting year and report to the filing authority any of the following significant events during its operation within 10 working days from its occurrence:
- amendments to the articles of association, partnership agreement or entrusted management agreement of the EIE or entrusted management institute;
- increase or decrease of the capital or external financing of the EIE or entrusted management institute;
- division or merger of the EIE or its entrusted management institute;
- alteration of custodian institutes or entrusted management institutes including senior management changes or other material changes; or
- dissolution or bankruptcy of the EIE, or the EIE’s assets having entered into receivership.
(Written By Jiang Qian)