Draft CSRC Private Investment Funds Measures for Public Consultation

On 8 December 2023, the China Securities Regulatory Commission (CSRC) issued the draft Measures for the Supervision and Administration of Private Investments Funds (the Draft CSRC Measures), which aim to replace the Interim Measures for the Supervision and Administration of Private Investments Funds issued in 2014.

This is the third time in 2023 that financial regulators in China issued new regulations concerning private investment funds (the Private Funds) and their managers (the PFMs) in China. Please refer to our previous publication, “A New Era for Private Investment Funds and their Managers in China”, dated 24 August, 2023, for discussions on the previous two rounds of legislative changes. 

The previous two rounds of regulatory changes (the Recent Regulatory Regime), were made by (a) the State Council (an authority senior to CSRC), which established a top level legal framework to oversee Private Funds and PFMs, and (b) the Asset Management Association of China (AMAC, a lower level association authorised by CSRC), which aimed to detail the respective filing and registration requirements for Private Funds and PFMs. Comparing to the Recent Regulatory Regime, these Draft CSRC Measures (once formally promulgated) may have a more significant impact on the operations of Private Funds and PFMs.

This article highlights some proposed changes that have attracted controversies and discussion in the market.

1. One of the most controversial points under the Draft CSRC Measures is the proposed requirements on rectification of non-compliance within a designated grace period. 

In contrast to the Recent Regulatory Regime, which only required PFMs established, and Private Funds filed after, its promulgation to comply with its requirements, the Draft CSRC Measures propose to require all PFMs and Private Funds (including those have already been established/filed prior to the formal issuance of the Draft CSRC Measures) to comply with the new requirements. These new requirements include:

(a) existing PFMs which are not already fully compliant, shall comply with the new requirements under the Draft CSRC Measures (unless the requirements only relate to names, business scope and paid-in capitals of PFMs, and senior management team’s shareholdings in PFMs) within one year from the formal issuance of the Draft CSRC Measures;

(b) Unless otherwise permitted, existing Private Funds which have breached the multi-layer investment restriction  shall rectify the non-compliance within two years from the formal issuance of the Draft CSRC Measures. Such multi-layer investment restriction means that, unless otherwise specified, a Private Fund is only permitted to invest into one additional layer of another Private Fund or an asset management product; and

(c) existing Private Funds which fail to rectify any non-compliance referred to in item 1(b) above shall not engage in a range of activities, including the making of new investments, increase of fundraising scale, introduction of new investors or extension of the term of the fund contracts, and the relevant Private Funds must be liquidated upon the expiry of the fund contract.

It is a common market view that the above grace period rectification requirements under items 1(b) and (c) will have a significant negative impact on existing non-compliant Private Funds, especially those that are raised for equity investments.

2. PFMs are proposed to be subject to continuous statutory qualification requirements, which include:

(a) their controlling shareholder(s), general partner(s), and actual controller(s) shall possess  experience in equivalent sectors such as investment and asset management; and

(b) they shall hire a number of senior management personnel and other practitioners (meaning those employees dedicated to fund investment and management business) who have the required professional qualifications.

The Draft CSRC Measures are however not clear on the above requirements. The market speculates that the Recent Regulatory Regime should be referred to. If this is the case,  a large number of existing PFMs will need to change their shareholding structures or their management teams, because no more grandfathering exemption is available under the Draft CSRC Measures (see item 1 above). 

For example, in terms of the requirement under item 2(a) above, the Recent Regulatory Regime has required that such “experience in equivalent sectors” is meant to impose a track record of at least 5 years. This requirement did not affect the PFMs established prior to the promulgation of the Recent Regulatory Regime (as mentioned under item 1 above). However, if the Draft CSRC Measures are formally issued, all existing PFMs established prior to the promulgation of the Draft CSRC Measures will be required to rectify within one year upon the formal issuance of the Draft CSRC Measures (see item 1(a) above), which will have a significant impact. 

3. In addition to the investment management of Private Funds, PFMs will also be allowed to provide securities investment consultancy services to designated financial institutions which offer asset management products. 

The Draft CSRC Measures however are not clear on how this will interact with the existing regime . In fact, some types of PFMs are already permitted to provide the same services but subject to different qualification requirements, or to provide the same services but to a different category of service recipients. The market is expecting CSRC to further clarify this when the Draft CSRC Measures are formally issued.

4. When PFMs use proprietary funds to make investments into Private Funds managed by themselves (or their affiliates), PFMs shall be treated equally with other investors/limited partners (LPs). It means that PFMs shall have the same rights and bear the same level of risk with respect to the fund units held. This requirement will equally apply to the controlling shareholders, general partners, actual controllers, senior management and investment personnel of PFMs when they contemplate investing their proprietary funds to the foregoing mentioned Private Funds. This requirement is considered by the market as a significant change, given that in practice, it is not uncommon for the general partners to receive preferential rights superior to those of the LPs contractually. 

5. The Draft CSRC Measures provide some requirements and prohibitions regarding the structure of Private Funds. They include:

(a) the concept of “fund of funds” is introduced as a specific category of the Private Funds, which will be subject to special treatment. For example, same as the Recent Regulatory Regime, fund of funds is expressly exempted from the multi-layer investment restriction (see item 1(b) above);

(b) A PFM is permitted to establish a Private Fund even if there is only one single investor/LP, but such single investor/LP can only be a “default investor” who must be either a designated financial institution, a designated pension and charity fund, or a qualified overseas investor. The paid-in asset scale of such Private Fund is also required to be no less than RMB100 million; and

(c) Strict qualification requirements are proposed to be imposed on Private Funds that intend to invest 80% or more of their assets into a single investment target. These qualifications include a requirement on the paid-in asset to be no less than RMB20 million; the fund assets must be under statutory custody by a qualified custody entity (e.g. a bank) (the Statutory Custody); the Private Funds cannot make related party investments unless agreed by all investors; and any additional fundraising can only be offered to existing investors. 

These structural requirements and restrictions aim to protect investors from high risk investment targets. However, this may also cause some practical difficulties. For example, a PFM may want to file an ordinary Private Fund which will have multiple investors/LPs (as opposed to a Private Fund having only single investor/LP who is a “default investor”). However, initially, such PFM can only raise funds from one investor/LP (who is not a “default investor”), but the PFM will stipulate in the fund contract the detailed subsequent fundraising plan allowing for new investors/LPs. Due to the restriction under item 5(b) above, it remains uncertain as to whether the PFM can successfully file this type of Private Fund with AMAC under the Draft CSRC Measures at a time when only one investor/LP (who is not a “default investor”) is available or whether such PFM has to wait until at least two investors/LPs are signed up before it can successfully file the Private Fund with AMAC.

6. Designated types of Private Funds are proposed to be subject to Statutory Custody. These Private Funds include those: (a) that are established via contractual arrangements, (b) that are invested by asset management products or other Private Funds; (c) which will invest into a single target, overseas assets or OTC derivatives which are deemed as risky assets; and (d) which will carry out leverage financing activities. 

7. The Draft CSRC Measures have also provided a positive list and a negative list of investment targets which are respectively permitted or not permitted to be invested in by Private Funds, the scope of both of which are generally in line with the Recent Regulatory Regime. The CSRC will also guide AMAC to establish separately an investment negative list in practice. A promising change is that a Private Fund for equity investments will be permitted to offer loans and guarantees to the invested corporations in an amount of up to 20% of the total paid-in amount of such Private Fund, with the remaining paid-in capital being invested in equities. 

8. “Qualified investors” will be defined, which adopts the definitions under the existing regime. They include (a) individual investors having financial assets (on family aggregated basis) of no less than RMB5 million, or individual investors having net financial assets (on family aggregated basis) of no less than RMB3 million, or individual investors having an average annual income in the last three year of RMB 400,000 or above, (b) institutional investors having net assets of no less than RMB10 million, and (c) default investors (who are designated financial institutions and the asset management products offered by them, PFMs, Private Funds, government backed funds/capitals, designated pension and charity funds, and qualified overseas investors). Practitioners of PFMs are no longer deemed as a “default investor”.

9. To what extent these Draft CSRC Measures will apply to the Private Funds raised by PFMs who are incorporated in the form of a qualified domestic limited partnership (QDLP)? A Private Fund managed by a QDLP PFM usually takes the form of a liaison fund that solely invests in the overseas corresponding fund for which to make the subsequent downstream investments into overseas underlying assets. Due to this specific structure, QDLP PFMs and the Private Funds under their management may not be able to satisfy all requirements proposed under the Draft CSRC Measures, e.g. the shareholders’ qualification requirements, relevant experience and track record requirements, and single investment target requirements and restrictions etc. The market has expected the CSRC to allow some flexibilities on compliance, but this needs to be further clarified by CSRC.