China opens up to foreign enterprises

The government is progressively loosening up relevant rules to allow foreign-owned enterprises to access China’s capital market, which has been tightly regulated until now

Inside China

Inside China, written by FenXun Partners’ Xusheng Yang and Sue Liu, is an insight into aspects of the Chinese 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 she has previously worked as an associate at Skadden Arps Slate Meagher & Flom in New York.

Much interest was raised following the announcement by Fidelity International that FIL Investment Management (Shanghai) Company Limited (FIL), its wholly-owned subsidiary in Shanghai, had, on January 3 2017, completed registration with the Asset Management Association of China (Amac), the industry self-regulatory body in charge of administering investment fund and fund manager registration, as a private securities investment fund manager. The significance of this event lies in the fact that FIL is the first wholly foreign-owned enterprise (WFOE) to have completed Amac registration as a private securities investment fund manager. By completing such a registration, FIL will be permitted to launch private securities investment funds in China, accept investments from qualified Chinese investors, and invest the proceeds in China's capital market. To the global asset management industry, this is a meaningful step forward in the incremental opening of China's asset management industry to foreign participants.

The successful registration by FIL as a private securities investment fund manager is a breakthrough from certain restrictions imposed by relevant foreign investment regulations. Securities investment fund management is a restricted industry for foreign investment. Pursuant to the 2015 version of the Catalogue for the Guidance of Foreign Investment Industries promulgated by the National Development and Reform Commission (NDRC) and the Ministry of Commerce (Mofcom), foreign investment in a securities investment fund management enterprise is subject to a Chinese party having control. In practice, such an investment is usually structured as a Sino-foreign joint venture company between a Chinese party and a foreign party, in which the foreign party owns up to 49% of the shares. So far, no noticeable attempt has been made to reconcile this regulatory discrepancy. The categorisation of securities investment fund management as a restricted industry is still present in the draft 2016 version of the Catalogue, which was released by the NDRC and Mofcom for public comment on December 6 2016.

A Sino-foreign joint venture is not a preferred form of organisation for foreign managers eyeing China's domestic securities fund market. At times, domestic partners could be invaluable for a newly established enterprise in a foreign jurisdiction. That said, divergence of interest will occur sooner or later but the joint venture structure is usually incapable of efficiently resolving conflicts. As a result, squabbles, holdups and deadlocks occur and the joint venture falls apart. For many asset managers, a wholly-owned subsidiary is the only desirable vehicle for establishing a foothold in a foreign market. Allowing WFOEs to qualify as private securities investment fund managers offers a programmatic path for foreign fund managers to gain access to the Chinese market.

In contrast to securities investment funds, private equity investment fund management is not a restricted industry and plenty of WFOEs have registered with Amac as private equity investment fund managers

The liberalisation of the private securities investment fund management sector to foreign investment unfolds against a backdrop of continued intergovernmental negotiations on market access. In June 2016, at a press conference hosted by the China Securities Regulatory Commission (CSRC), China's securities regulator that oversees the fund industry, it was stated that the initiative of welcoming qualified WFOEs and Sino-foreign joint ventures to engage in private securities investment management business is an achievement of the Seventh China-US Strategic and Economic Dialogue and the Seventh China-UK Economic and Financial Dialogue, which took place in June 2015 and September 2015 respectively. Fidelity International, founded in the US, and Aberdeen Asset Management, one of the UK's largest investment groups, were the immediate beneficiaries, and both obtained business licences to establish WFOEs in the Shanghai free trade zone to carry out investment management business in September 2015. However, obtaining such a business licence is only a half-step, as fund managers are generally required to register with Amac before launching investment funds. As such, the topic of market access into the fund management industry came up again during the June 2016 Eighth China-US Strategic and Economic Dialogue. Shortly thereafter, at the CSRC press conference referenced above, a policy statement was made to welcome qualified WFOEs and Sino-foreign joint ventures to apply for registration as private securities investment fund managers and to engage in private securities fund management business in China, including securities trading on the secondary market.

It is a win-win development for all sides. From the Chinese perspective, the most prominent asset managers could be attracted to the domestic market to provide products and services, meeting the growing asset management needs of institutional as well as high net worth individual investors. Foreign managers operating in the Chinese market are expected to introduce more advanced business models, investment theories, strategies and methods and risk control systems. All in all, it is expected to raise market standards and enhance the competitiveness of China's asset management industry in a global setting. From the perspective of the foreign fund managers, the second-largest economy is not a market they would normally want to stay out of. For the largest global players, China could be important in their growth strategy and global positioning. In addition to Fidelity International and Aberdeen Asset Management, other big names such as Vanguard, Bridgewater, JP Morgan, Allianz, Neuberger Berman and Mirae Asset Management have also established similar WFOEs in China, and will be in a good position to apply for Amac registration, and get ready to tap into the already sizable and fast growing private securities fund market. According to statistics published by Amac, as of February 28 2017, an aggregate amount of RMB2.8 trillion ($406 billion) had been contributed into private securities investment funds.

For an asset manager interested in evaluating the potential opportunities, it would be useful to understand some key terminologies under Chinese laws and regulations concerning the fund industry. First of all, the term 'securities investment fund' generally refers to a fund investing in securities traded in the secondary market. In comparison, its 'equity investment fund' counterpart refers to a fund investing in the 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 plenty of WFOEs had registered with Amac as private equity investment fund managers. As of February 28 2017, aggregate capital contributions made to private equity investment funds amounted to RMB8.55 trillion. Secondly, securities investment funds are classified into two categories, namely, publically 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. As of February 28 2017, the public funds sector had an aggregate net asset value of RMB8.8 trillion.

The regulatory framework covering private securities investment funds is a patchwork of laws, rules and measures. In removing foreign investment restrictions from the private securities fund management sector, the CSRC had laid down certain ground rules concerning WFOEs and Sino-foreign joint ventures registering as private securities investment fund managers, and instructed Amac to clarify the qualification requirements and registration procedures. There are some notable considerations for interested foreign fund managers to consider.

As set out in Q&As published by Amac on June 30 2016, a WFOE or Sino-foreign joint venture registering with Amac as a private securities investment fund manager should meet the following requirements:

(i) The registrant is a company established in China.

(ii) Overseas shareholders of the registrant are financial institutions approved or licensed by securities regulators of their respective domicile jurisdictions. These securities regulators will have entered into memoranda of understanding for securities regulatory cooperation with the CSRC or another institution recognised by the CSRC.

(iii) Neither the registrant nor its overseas shareholders have been subject to material penalties imposed by regulatory and judiciary bodies.

Clauses (ii) and (iii) apply 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 should include persons or entities having control over a registrant that are not shareholders of the registrant, or are not shareholders holding a controlling percentage of shares in the registrant.

In addition, a WFOE or Sino-foreign joint venture registrant should also have the qualifications that are applicable to domestic private fund management entities. For example, the registrant and its senior management (including the legal representative/executive partner (representative), manager, deputy manager, compliance/risk control office etc) will have obtained investment fund business qualifications.

A private securities investment fund, if managed by a WFOE or a Sino-foreign joint venture, would be subject to a combination of operational requirements that are either generally applicable to the industry or specifically applicable to such a fund, some of which include:

(i) The fund interests may only be privately offered to no more than 200 qualified investors.

(ii) The fund may only invest in China's capital market, without incurring cross-border currency exchange.

(iii) Investment decisions on fund investments should be made independently, and trading instructions may not be issued by offshore entities or systems.

Allowing WFOEs to qualify as private securities investment fund managers offers a programmatic path for foreign fund managers to gain access to the Chinese market

(iv) At least one fund must be launched within six months following the registration of the fund manager.

The term 'qualified investor' refers to an investor who (i) is capable of understanding and bearing relevant investment risks, (b) invests at least RMB1 million in a private fund, and; (c) if an entity, whose net asset value is not less than RMB10 million or, if an individual, who has financial assets of no less than RBM3 million or average annual income in the most recent three years of no less than RMB500,000. The term 'financial assets' refers to bank deposits, stocks, bonds, fund interests, asset management plans, commercial bank finance plans, trust plans, insurance products and futures interests etc.

Operational requirements relating to investment decision-making and post-registration fund offering could mean that the registrant needs to line up, at the time it submits an application to register, investment and other professionals to conduct post-registration fund raising and to make post-formation investment decisions. Such conditions would significantly increase the burden of a registrant to commit substantial capital and efforts at the time it prepares its registration application. Such a burden could be one of the reasons why, despite lively interest in the topic, we haven't yet seen foreign fund managers rushing in.

It's worth mentioning that qualifying as a private securities investment fund manager is not the only option to access the Chinese market and Chinese investors. As an alternative, the qualified domestic limited partnership program (QDLP program) in Shanghai allows foreign fund managers to establish wholly-owned or controlled onshore entities, which, in turn, can launch products onshore for securities investment in the overseas market. Quite a number of large asset managers, such as Man Group, UBS AM and BlackRock, have obtained quotas under the QDLP program. It operates in parallel to the new registration scheme discussed herein and the two are distinguishable in terms such as qualification requirements and geographic restrictions on fund investments.

Allowing WFOEs to register as private securities fund managers is a significant change to the foreign investment restrictions on securities investment fund management companies in China. The development signals a willingness of the Chinese government and regulators to open up the investment fund management industry to foreign participation. It also indicates a possibility of further liberalisation of market entry restrictions in the investment fund management industry. Needless to say, all eyes will be on the public securities investment fund management sector.

By Sue Liu, partner at FenXun Partners (Beijing)