China's WFOE Private Securities Fund Management Framework
A Further Step Towards Liberalising China's Asset Management Sector
China's government is progressively loosening up relevant regulations to permit foreign-owned enterprises to access China's capital markets.
In June 2016, the China Securities Regulatory Commission (CSRC) and the Asset Management Association of China (AMAC) released FAQs providing for wholly foreign-owned enterprises (WFOEs) and Sino-foreign joint ventures to apply for registration as private securities investment fund managers, and engage in private securities fund management business in China. In January 2017, a wholly owned subsidiary of Fidelity International became the first global asset manager to register as a private securities investment fund manager, enabling it to launch private securities investment funds in China, accept investment from qualified Chinese investors, and invest the proceeds in China's capital markets.
For the global asset management industry, this is a meaningful and welcome step forward in the incremental opening of China's asset management industry to foreign participation.
Prior to the FAQs, foreign managers wanting to enter China's domestic securities fund market could only do so by taking a minority shareholding in a joint venture with a qualified Chinese partner. A large number of these ventures were unsuccessful, not least because the joint venture structure did not facilitate efficient resolution of disagreements. For many asset managers, a wholly-owned subsidiary is the only desirable vehicle for establishing a foothold in a foreign market.
The first sign of relaxing these restrictions came in September 2015 when the CSRC, as part of its continued policy discussions on enhancing market access, invited qualified WFOEs and Sino-foreign joint ventures to apply for a business license to engage in private securities investment management business in China. However it wasn't until the FAQs were released that fund managers were permitted to register with the AMAC, enabling them to launch investment funds under their own names and operate on a level playing field with local private funds.
Implications for parties
The new rules could prove to be a win-win development for all stakeholders.
From China's perspective, attracting the more prominent asset managers to the domestic market could help meet the growing asset management needs of institutional as well as high net-worth individual investors. It is also expected that foreign managers can introduce more advanced business models, investment theories, strategies and methods and risk control systems to the private funds sector, thus raising market standards and enhancing the competitiveness of China's asset management industry.
For foreign fund managers, particularly the global players, participating in the world's second largest market could be critical to their growth strategy and global positioning. A number of key players have already established WFOEs in China, and are well placed to apply for AMAC registration. According to statistics published by the AMAC, an aggregate amount of RMB 2.8 trillion (USD 406 billion) has been contributed to private securities investment funds as at February 2017.
Key features of the rules
The regulatory framework covering private securities investment funds in China is a patchwork of laws, rules and measures. In removing foreign investment restrictions from the private securities fund management sector, the CSRC has had to establish certain ground rules concerning the registration of WFOEs and Sino-foreign joint ventures as private securities investment fund managers, and clarify, through AMAC, the qualification requirements and registration procedures.
Notable considerations for interested foreign fund managers include:
It is important to understand the difference between a "securities investment fund" and an "equity investment fund" as those terms are used in the China fund industry. A 'securities investment fund' generally refers to a fund investing in securities traded in the secondary market, whereas an 'equity investment fund' refers to a fund investing in securities of private companies and privately offered public company securities. In contrast to securities investment funds, private equity investment fund management is not a restricted industry for foreign investment purposes, and numerous WFOEs have already registered with the AMAC as private equity investment fund managers.
Securities investment funds are further classified into two categories, namely, publicly offered funds and privately offered funds. Management of public securities investment funds (comparable to mutual funds) is a restricted industry for foreign investment, and, unless otherwise excepted, foreign investors may not have controlling interests in public securities fund management companies.
Key qualification requirements
The FAQs require WFOEs or Sino-foreign joint ventures registering with the AMAC as private securities investment fund managers to meet the following requirements:
- the registrant is a company established in China
- the registrant's overseas shareholders are financial institutions approved or licensed by the securities regulators in their respective domicile jurisdictions and which have entered into MOUs for securities regulatory cooperation with the CSRC or an institution recognised by the CSRC
- neither the registrant nor its overseas shareholders have been subject to material penalties imposed by regulatory or judicial bodies
"Overseas shareholders" refers to overseas persons or entities having de facto control over the registrant. The term 'de facto control person' has been subject to different interpretations, but includes persons or entities having control over a registrant without being a shareholder of, or holding a controlling interest in, the registrant.
A WFOE or Sino-foreign joint venture registrant is also required to have the same qualifications that apply to domestic private fund management entities, such as its senior management (including the legal representative/executive partner, manager, deputy manager, compliance/risk control officer etc) having appropriate investment fund business qualifications and experience.
Key operational requirements
A private securities investment fund managed by a WFOE or a Sino-foreign joint venture, is subject to operational requirements specific to this type of fund as well as those that are generally applicable to the industry, including:
- interests in the fund may only be privately offered to no more than 200 qualified investors
- the fund may only invest in China's capital market, without incurring cross-border currency exchange
- investment decisions on fund investments should be made independently, and trading instructions may not be issued by offshore entities or systems
- at least one fund must be launched within six months following the registration of the fund manager
A 'qualified investor' refers to an investor who (a) is capable of understanding and bearing relevant investment risks, (b) invests at least RMB 1 million in a private fund, and; (c) is an entity whose NAV is not less than RMB 10 million or an individual who has financial assets of no less than RBM 3 million or average annual income in the most recent three years of no less than RMB 500,000.
Additional operational requirements that relate to investment decision-making and post-registration fund offering are likely to mean that registrants need to line up investment and other professionals to conduct post-registration fund raising and to make post-formation investment decisions at the time of submitting an application to register. The burden on registrants to commit substantial capital and effort at this initial stage may explain why there has not been a surge of applications from foreign fund managers, despite clear interest in the initiative.
Allowing WFOEs to register as private securities fund managers represents a significant shift in China's approach towards foreign participation in the investment fund management industry. It also indicates the possibility of further liberalisation of market entry restrictions in the fund management sector, which we expect will be followed with great interest by the industry.