Private investment funds have grown rapidly in China. But rulemaking for the industry has been muddled
China's asset management industry, virtually non-existent 20 years ago, has since achieved explosive growth. In a report jointly published by Boston Consulting Group and China Everbright Bank, the assets under management by asset management enterprises in China had reached RMB93 trillion (approx $14 trillion) as of the end of 2015, and is expected to grow to RMB 149trillion by 2020. While the business of asset managers expanded by leaps and bounds in every direction, regulators had to play catch-up.
Private investment funds, an important player in the industry had remained largely unregulated until late 2011. In less than five years, the regulation of private funds has experienced significant changes. Overall, this sector has become subject to increased regulatory scrutiny and supervision.
A background
The regulation of traditional players in the asset management industry has always been fragmented. The securities companies and fund management companies (for publically offer funds) are regulated by the China Securities Regulatory Commission (CSRC), commercial banks and trust companies are regulated by the China Banking Regulatory Commission, and insurance companies are regulated by the China Insurance Regulatory Commission. Over the years, an abundance of rules, measures, notices and interpretations, has been produced by these regulatory agencies to set out, usually in a piecemeal fashion, the rules of engagement for both investments in asset management products and provision of asset management products and services.
Since 2012, significant steps were taken by the regulators to loosen restrictions and allow regulated financial institutions to act as sponsors, advisors and placement agents of various types of collective asset management products.
On the other hand, private investment funds, which could not fit squarely in to the then established regulatory framework, became a subject of turf war between regulators. In November 2011, the National Reform and Development Commission (NDRC) issued a notice setting out a number of rules with respect to the qualification, offering, operation and regulatory filing obligations of private investment funds. The notice was also taken as an assertion of the NDRC's authority to regulate private funds.
The NDRC's role, however, was short-lived. On December 28 2012, the Securities Investment Fund Law of China (the Fund Law) was amended by the Standing Committee of the National People's Congress, which amendment became effective on June 1 2013. Among other things, the amendment specifically added privately offered funds into its reign, and placed the same under the purview of the CSRC and an unspecified securities investment fund trade association.
To further clarify the regulatory agenda for private funds, the State Commission Office for Public Sector Reform issued a notice on June 27 2013 to allocate to the CSRC the authority to regulate and supervise private funds, and to the NDRC the authority of policymaking. Thereafter, the CSRC went on to authorise the Asset Management Association of China, a CSRC-backed industry association established on June 6 2012 (AMAC), to carried self-regulatory functions sanctioned by the fund law.
Regulations of private funds
When the dust settles, the CSRC has emerged as the main regulatory authority of private funds, and the AMAC the authorised self-regulatory body. In these capacities, the CSRC and AMAC promulgated various rules and measures to configure a regulatory programme for private funds. This article discusses a few components of this regulatory program, including corrections and adjustments made to it.
Registration and filings
The AMAC first started to process registrations and filings on February 7 2014, in accordance with the provisions of the Measures for the Registration of Private Fund Managers and Filing of Private Funds (Trial) it had promulgated on January 17 2014.
For the first two years, registration of fund managers was carried out in a straightforward manner based on submission of necessary application materials. The information to be provided in these materials was quite basic. The AMAC, in a spirit of encouraging registration, indicated that no substantive review of the application materials would be conducted.
It welcomed, into its open arms, well established fund managers, as well as newly formed enterprises. By the end of 2015, however, it became apparent that the registration process had no effect on curbing fraudulent or illegal activities in the industry. In some cases, registration with the AMAC had even been touted as some kind of official certification. In response, the AMAC temporarily halted registration of fund managers.
On February 5 2016, the AMAC issued the Announcement on Further Regulating of Registration Matters of Private Fund Managers, in which new requirements were imposed, among other things, to weed out inactive registered managers and raise the bar for registration. In doing so, the AMAC placed private funds and fund managers under a level supervision almost comparable to that of traditional financial institutions.
In the announcement, the AMAC demanded registered managers to initiate operations in a lawful manner and complete filings for its funds on a timely basis. It declared that a manager's registration would be cancelled if, following the issuance of the announcement, a newly-registered manager fails to complete filings for its first fund within six months of registration, a manager that had been registered for at least 12 months fails to complete filings for its first fund prior to May 1 2016, or a manager that had been registered for less than 12 months fails to complete filings for its first fund prior to August 1 2016.
In the same announcement, the AMAC required all applications for registration and updates on existing registration be accompanied by legal opinions issued by a Chinese law firm setting out, instead of legal opinions, conclusive and unreserved fact-finding reports re various aspects of a fund manager's business operation.
To produce an opinion letter in a form satisfactory to the AMAC, attorneys will not only be obliged to conduct comprehensive due diligence review of the applicant and try to interpret rules, principals and policies that are vague and incoherent, but also to take a leap of faith where a judgment call cannot be avoided.
It comes as no surprise that this requirement, although relatively clever from the AMAC's point of view, is hugely unpopular amongst legal professionals as it puts the lawyers in a position both as sniffer dogs and scapegoats.
Also related to registration of managers, the AMAC tightened up qualification requirements for senior management. At least two senior management personnel of a manager must now be qualified to conduct private fund business, which should include the legal representative/representative of the executive partner and the head of compliance/risk management.
Unless otherwise exempted, qualification may be obtained by passing a written exam administered by the AMAC. The first of such exams took place on April 23, in which 11,272 people took part. The qualification exam became, at the time, an entertainment news topic due to celebrities, who'd dabbled in the business, taking part therein.
Unlike the now stringent manager registration requirements, post-closing filings for funds remain a data collection exercise. A fund manager is required to provide basic information of the fund (such as name, size of capital, fund agreements) to the AMAC through online filing with in 20 days following the closing of the fund.
Offering restrictions
A combination of laws and rules dictate that private investment funds can only be offered privately to qualified investors. In addition to the provisions of the Securities Law of China, the Fund Law and the Interim Measures for the Supervision and Administration of Private Investment Funds, promulgated by the CSRC on 21 August 2014 (the CSRC Measures), the AMAC has issued the Measures for the Administration of Private Investment Fund Offering Activities, promulgated on April 15 2016 and to become effective on July 15 2016, to provide more detailed guidance in this regard.
The notion of private offering is long established, but regulations differ, and sometimes overlap, across different types of issuers. From a private fund's perspective, private offering should encompass at least the following components: Firstly, the fund can be offered to no more than 200 investors, all of whom should be qualified investors. Secondly, marketing efforts may not be directed at non-specific persons through mass media (such as newspapers, radio, TV and the internet), promotional meetings or seminars, or other forms of communication (such as billboards, flyers, text messages, wechat, weibo, blogs or emails). Finally, fund managers and placement agents should pre-identify specific investors for marketing, which identification could be done through the completion of a written questionnaire.
The AMAC has even provided a form questionnaire, which contains questions relating to the identification, employment status, financial situations, investment knowledge and investment goals, and risk preference of prospective investors. Judging by its content, the form questionnaire can also be used to establish qualified investor status.
The CSRC Measures set down the qualifications of qualified investors in the context of private fund offering. A qualified investor for private funds should be able to identify and bear relevant risks; must invest at least RMB1 million in the fund; and meets the following: (1) is an institutional investor having net asset of at least RMB10 million, or (2) is an individual investor having financial assets (including bank deposits, stocks, bonds, mutual fund units, assets management plan interests, bank wealth-management products, trust interests, insurance products, futures interests) of RMB3 million or more, or whose average annual income during the preceding three years is not less than RMB500,000. The CSRC Measures also acknowledge the following as de facto qualified investors: social security funds, pension funds (such as enterprise annuity funds), and charitable funds, legally established investment schemes that have completed filing with the AMAC, fund managers and their employees investing in funds under their management, and other investors confirmed by the CSRC.
Disclosure requirements
Inside China |
Inside China, written by FenXun Partners’ Xusheng Yang and Sue Liu, is an insight into aspects of the China market that often elude the naked eye. Yang is a specialist in China’s financial markets and institutions, having started his career at the China Securities Regulatory Commission and then co-founding FenXun in 2009. Liu’s practice focuses primarily on the asset management industry, and has previously worked as an associate at Skadden Arps Slate Meagher & Flom in New York. |
On February 4 2016, the AMAC issued the Measures on the Administration of Private Investment Fund Information Disclosure, which require fund managers and custodians to disclose a broad range of information to fund investors through an online private fund information disclosure and backup platform designated by the AMAC. These measures also include requirements on information to be provided in the offering materials to prospective investors at the offering stage and periodical disclosure requirements to investors throughout the life of the fund.
The information to be disclosed through the online platform include: the fund agreement, the offering memorandum and other promotional materials, substantive provisions of rights and obligations of the placement/sales agreement, status of the fund's investments, status of the fund's assets and liabilities, status of distributions of the fund's investment income, fund's expenses and performance allocation arrangements, potential conflicts of interest, significant disputes concerning fund management business, fund assets and custodian business, and other information as determined by the CSRC or the AMAC.
Notably, disclosures made on the platform, as distinguished from basic information submitted to the AMAC for manager registration or fund filings (which can be accessed by the general public at the AMAC's website); the AMAC, the parties making disclosure, and the recipient investors are required to keep the confidential information so disclosed confidential.
The disclosure platform is still under construction and has been in a test run since the beginning of this month. Subject to the results of the test run, the system is expected to become fully functional within the year. We understand that many fund managers have reservations against providing confidential information in a digital format to a third-party operated online system. Data security concerns aside, the scope of information required for disclosure under these measures does not exceed what fund managers routinely provide to their investors or prospective investors and the disclosure requirements are not regarded as exceedingly burdensome.
Looking forward
As reiterated time and again by the CSRC and the AMAC, the ultimate goal of regulation is investor protection. Amidst the myriad of conditions and requirements that have been implemented so far, although far from comprehensive, a regulatory program towards this end has taken shape. What's woefully lacking are, perhaps, negative reinforcement mechanisms. From the Fund Law, to the CSRC Measures, and to the AMAC rules, most of the violations conducted by private fund managers would only be subject to administrative actions such as blacklisting, condemnation, revocation of qualification, and fines not in excess of RMB 30,000.
Such penalties seem miserably inadequate where damages to investors could easily run into millions of dollars. On top of that, although violations appear to be rampant at times, administrative actions and penalties taken against such violations are quite rare.
For instance, as of February 2 2016, the AMAC has handled 236 alleged offering violations but only two sanction notices against such violations can be found on the AMAC's website.
Given the inherent nature of the conflict of interest between fund managers and fund investors, one would hope that regulators could, on the one hand, improve the rules and regulations, and on the other, boost enforcement efforts.