China’s updated Private Fund Regulations were implemented on September 1, 2023, with the goal of establishing more transparent administrative guidelines to discourage misconduct among private fund managers. These strengthened regulatory measures are expected to contribute to financial stability within China and promote the sustainable development of the nation’s real economy. Nonetheless, the situation remains uncertain for foreign investors.
On July 9, 2023, China introduced the “Regulations on the Oversight and Management of Privately-Offered Investment Funds” (referred to as the “Private Fund Regulations”), with the aim of enhancing investor protection and encouraging innovation within the nation’s private fund industry.
Effective from September 1, these regulations are designed to govern a sector valued at RMB 21 trillion (US$2.9 trillion) in 2023. This overview highlights the key provisions of the Private Fund Regulations and their potential implications.
What prompted the introduction of the Private Fund Regulations?
The private fund sector has played a valuable role in supporting China’s economy, fostering innovation, and addressing individual wealth management needs. Premier Li Qiang’s initiative to harness the significant potential of private funds, previously an underregulated area, aims to stimulate growth and diversify funding sources.
Prior to the Private Fund Regulations, the “Interim Measures for the Supervision and Administration of Private Investment Funds,” issued by the China Securities Regulatory Commission (CSRC) in 2014, served as the primary framework for overseeing the private funds market. However, given its lower legislative status as a departmental regulation compared to the state-level Private Fund Regulations, and the industry’s rapid evolution over the past decade, it became clear that the Interim Measures were no longer adequate. The Private Fund Regulations were introduced to establish a more robust legislative framework in China for effective management of private funds and to guide the industry towards high-quality development.
The updated Private Fund Regulations introduce stricter requirements for private fund managers, their shareholders, and controlling entities. The primary goal is to enhance financial stability by managing sources of risk and promoting the efficient operation of private funds to support the real economy. Additionally, these regulations set clear boundaries, strengthen oversight, and implement tailored supervision, particularly for venture capital funds.
Navigating China’s Private Fund Regulations: Key Highlights
The Private Fund Regulations consist of 62 provisions organized into seven chapters, offering broad applicability to various forms of private investment funds, including contract-based, company-based, and partnership-based structures. These regulations cover a spectrum of aspects, including the roles and responsibilities of fund managers and custodians, fundraising procedures, risk assessment, venture capital supervision, overall regulatory oversight, management practices, and service agency requirements. In contrast to existing regulations, the Private Fund Regulations emphasize clear administrative measures aimed at preventing violations by private fund managers. Here are the key points to consider:
Investor Protection and Industry Standards Enhancement
The Private Fund Regulations prioritize the protection of investor rights, the maintenance of market integrity, and the promotion of fair industry practices. Participants in privately offered funds, such as fund managers, custodians, and service providers, are required to adhere to principles of voluntariness, fairness, and integrity (Article 3). This underscores the need for compliance with investment-level regulations by fund managers. Additionally, the regulations impose stricter requirements on employees, prohibiting actions that could harm investors or disrupt financial order (Article 6). Fund managers are also obligated to establish a system for managing affiliated transactions, ensuring transparency in information disclosure and sound decision-making (Article 10). This measure is designed to promote transparent affiliated transactions and ensure compliance with disclosure norms.
To safeguard investor interests and protect their investments, the Private Fund Regulations emphasize the separation of privately offered fund assets from those of managers and custodians. Except where required by law, debts associated with privately offered fund assets are the sole responsibility of the fund property itself (Article 16). This provision shields investors from the financial positions of managers and custodians, providing an additional layer of protection for their investments.
Tailored Supervision and Administration
Recognizing the diverse nature of privately offered funds, the Private Fund Regulations introduce a customized approach to regulatory oversight. The China Securities Regulatory Commission (CSRC) will implement differentiated supervision based on factors such as business models, assets under management, compliance status, and risk management. This approach includes categorized supervision for various types of private funds, including private equity, venture capital, and securities investment funds (Article 6, Article 33). By tailoring supervision to specific attributes of different privately offered fund categories, such as venture capital, equity, and securities investment, this strategy ensures more effective regulation and oversight.
Requirements for Fund Managers and Custodians
Chapter 2 of the Private Fund Regulations sets forth stringent requirements for privately offered fund managers and custodians. Fund managers must have legal establishment as either corporations or partnerships and must undergo verification by registration and record-filing authorities. Individuals or entities seeking roles such as shareholders, actual controllers, or general partners of fund managers must meet specific qualifications, including demonstrating sound financial standing and adhering to mandates prescribed by the securities regulatory body.
In addition, fund managers are obligated to appoint experienced executives with relevant expertise in investment management, risk oversight, and compliance. This commitment to seasoned leadership aims to prioritize investor interests and promote strong governance within fund management. Fundraising activities are limited to qualified investors who meet predetermined asset or income criteria.
Monitoring and Enforcement
To ensure market stability and protect investor interests, the Private Fund Regulations establish a comprehensive monitoring mechanism for privately offered funds (Article 23). This system enables centralized oversight of fund operations and investor holdings. The State Council’s securities regulatory authority will supervise this monitoring process and take necessary actions to enforce compliance with the provisions outlined in the Private Fund Regulations. The regulatory authority possesses the power to suspend operations, replace directors and senior executives, and mandate third-party audits if fund managers engage in activities detrimental to fund operations and investor interests, as detailed in the new rules (Article 34).
Various violations, including improper use of fund property, non-public information disclosure, and non-compliance with regulations, may result in fines, warnings, or suspension of business operations.
Foreign-Invested Fund Managers and Cross-Border Fundraising
Of notable importance, the Private Fund Regulations specify that administrative guidelines for foreign-invested private fund managers will be separately formulated by the China Securities Regulatory Commission (CSRC) and relevant State Council departments, aligning with foreign investment rules (Article 61). This implies the potential for new regulations tailored to foreign-invested private fund managers.
Articles 61(2) and (3) stipulate that foreign institutions generally cannot directly raise funds from domestic investors to establish private funds unless specific exceptions are specified by the State. Private fund managers engaging in fund activities overseas must comply with relevant State regulations.
While the scope of these exceptions remains unclear, it is widely assumed that they may encompass rules related to programs allowing foreign asset managers to secure capital from domestic Chinese investors for overseas investments, such as QDII (Qualified Domestic Institutional Investors), QDLP (Qualified Domestic Limited Partners), and QDIE (Qualified Domestic Investment Enterprise).
However, global asset managers must exercise caution when considering fundraising from domestic Chinese investors through cross-border models to ensure they do not inadvertently engage in regulated activities within China.
An open question remains as to whether the prohibition on domestic investor fundraising extends to foreign entities and vehicles associated with these investors. The release of the Private Fund Regulations may necessitate further interpretation by China’s regulatory authorities.
The Rapid Expansion of China’s Private Fund Market
As of May 2023, approximately 22,000 private investment managers had completed registration with the Asset Management Association of China (AMAC), overseeing a total of approximately RMB 21 trillion (equivalent to US$2.9 trillion) distributed across 153,000 funds. The growth of China’s private fund industry has been driven by significant capital market reforms, most notably the expansion of onshore stock markets, which have experienced remarkable growth over the past decade, exceeding a total value of US$10 trillion.
Nonetheless, this year has witnessed a higher rate of license revocations for Chinese private funds compared to 2022. Data from AMAC indicates that between January and July, there were a total of 2,035 private fund deregistrations—a twofold increase from the same period the previous year. These revocations encompass issues such as incorrect or incomplete information disclosure and extended periods without actively managing fund products. Many industry experts view the revocation of licenses from poorly managed funds as a positive development for the healthy progression of China’s capital market.
Furthermore, the introduction of the Private Fund Regulations coincides with China’s economy facing growing downward pressures, including factors such as weakening global demand, escalating geopolitical risks, and an uneven economic recovery across various sectors. The anticipated outcome of increased regulatory control is expected to provide enhanced protection for fund holders and mitigate potential risks that could disrupt the nation’s financial system.
What Do the Private Fund Regulations Mean for the Public and Foreign Investors in China?
Broadly speaking, the Private Fund Regulations have received positive feedback from industry participants. Many see these regulations as a formal recognition of the growing importance of the private fund industry in driving economic and technological progress. This recognition elevates the status of a sector that previously operated in a relatively undefined and partially unregulated environment. Furthermore, the Private Fund Regulations are expected to contribute to financial stability in China by effectively addressing potential sources of risk and optimizing the operations of private funds, thereby supporting the growth of the real economy.
However, the Private Fund Regulations may present some uncertainties for foreign investors. While most of the existing framework applicable to foreign-invested onshore fund managers is expected to remain in place and may be incorporated into future regulations, there are still unknowns regarding any potential additional requirements that foreign-invested fund managers could face under the forthcoming special rules. We will closely monitor these developments and provide updates as they unfold.