To the perennial regret of foreign investment funds and managers, market entry for foreign companies and individuals in this sector has always been restricted. Official guidelines in China limit foreign ownership in such securities investment funds to no more than 49%.
Things changed on June 30, 2016 with the issuance of a new document from the Asset Management Association of China (AMAC). The document, officially titled the Tenth FAQ on Relevant Questions Regarding the Registration and Filing of Private Funds (the FAQ). The FAQ, approved by the China Securities Regulatory Commission (CSRC) presents an intriguing change in the official position on foreign investment in the sector. According to the FAQ “eligible” Wholly Foreign Owned Enterprises (WFOE) may register with AMAC as private securities fund managers and may carry out business activities as private securities fund managers, including by trading securities via the secondary market.
This is a big break from previous regulations and represents follow through by China on promises made to Foreign governments at official forums indicating China would open up this kind of investment.
Still, a lot hinges on that word “eligible.” According to the FAQ an eligible WFOE will Exist as a company incorporated within the territory of the PRC, and its foreign shareholder shall be a foreign financial institution licensed and/or approved by the financial regulatory authorities in its home jurisdiction, and such securities regulatory authorities shall have signed a memorandum of understanding on securities regulation cooperation (“MOU”) with the CSRC or other institutions recognized by the CSRC.
There’s always a catch.
This breaks down to require the securities authorities of a foreign investor to agree to cooperation with CSRC on securities regulation cooperation before any investors from that jurisdiction would be eligible to offer these services in China. As of right now, there’s not much information on what kind of regulations or what extent of cooperation the CSRC would demand from a foreign jurisdiction as part of one of these MOUs.
In practice, many foreign financial institutions wish to use the special purpose vehicles (“SPVs”) incorporated in Cayman Islands, Virgin Islands or Bermuda as a WFOE’s shareholder in consideration of tax issues. However, as currently there is no MOU between those areas and China’s CSRC, those SPVs do not meet the requirements for WFOE’s shareholder prescribed by the FAQs. Of course, no one would be surprised to find these offshore locations are eager to conclude such and MOU to attract this very particular set of investment funds.
Additionally, the WFOE and its foreign shareholder have not been subject to any material penalty by a regulatory authority or judicial organ in the past three years;
Because different regulators have different regulatory standards we recommend the target WOFE and its foreign shareholder should have no regulatory or judicial penalty or investigation over the past 3 years. This does also apply to foreign government agencies and judicial decisions. Still, this is relatively easy to comply with.
Finally, its foreign de facto controller (if any) shall meet the requirements set forth in items 2 and 3 above.
In addition to the requirements set forth in the new FAQ WFOEs must also comply with all other standard industry regulations in China, including the Law on Securities Investment Funds, the Interim Measures for the Supervision and Administration of Private Investment Funds, the Trial Measures for Registration of the Private Investment Funds Managers and the Filing of Funds and other laws and regulations.
Keep in mind the WFOE will be required to comply with all regulations of the China State Administration of Foreign Exchange, and the investment decisions made by the fund must be made “independently” without any influence of any foreign institution. What this means in practice, and how it would be proven remain to be seen. Not many foreign funds would want to leave their China operation totally without guidance. In fact part of the appeal of global funds is the ability to offer a coordinated global investment approach. This may be hindered if investment decisions made in China must be made entirely independently, and if enforced, this could hurt the appeal of establishing such China investment fund in the first place.
It is important to note finally that there will be no registration differences between private securities investment WFOEs, Joint Ventures, or entirely domestic funds. The CSRC has expressed its intention to fairly regulation foreign investment funds in accordance with existing regulations. This is good news for savvy fund managers seeking to get into the China market. It may also be a good move for the industry in China as it may lead to new investments and a changing and competitive marketplace.