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Shanghai or Shenzhen? Considerations in the Choice of Location for QFLP Funds

2018.11.27 XIE, Qing (Natasha)、QIN, Tianyu

Among the numerous cities in mainland China, both Shanghai and Shenzhen stand out as forerunners in the opening up of financial markets. Both cities have introduced pilot programs aiming to encourage foreign fund managers to establish a local presence, including Qualified Foreign Limited Partnership (QFLP) pilot programs focusing on inbound private equity investment, and Qualified Domestic Limited Partnership (QDLP) and Qualified Domestic Investment Enterprise (QDIE) pilot programs directed towards outbound investment in different asset classes. While the two cities introduced their respective programs at around the same time and would appear to offer closely competing opportunities, there are actually marked differences between the two cities in terms of the design and implementation of these policies.


In this Bulletin, we provide some useful information on the relative advantages of Shanghai and Shenzhen for our clients to take into account when deciding where to apply for their QFLP pilot qualification. 


I. Eligibility/Qualifications of Applicants


The Implementation Measures for the Launch of the Foreign-Invested Equity Investment Enterprises Pilot issued by Shanghai in 2010 (“Shanghai Measures”) stipulates that a QFLP fund manager shall have at least one investor, and that the business scope of such investor or its affiliates shall be related to equity investment or equity investment management. 


The Shenzhen Measures for the Foreign-Invested Equity Investment Enterprise Pilot Program issued by Shenzhen, amended on September 22, 2017 (“Shenzhen Measures”) provide details of the requirements on the foreign investors and domestic investors respectively. A foreign investor shall meet at least one of the following requirements: (i) In the year before application, its own assets shall be no less than USD 100 million; (ii) In the year before application, the assets under management (AUM) shall be no less than USD 200 million; (iii) The foreign investor shall hold an asset management license issued by a foreign financial regulatory authority. A domestic investor is required to be either a licensed financial institution, a subsidiary that is directly controlled by a licensed financial institution, or a large enterprise that has been introduced by and has the support of the Shenzhen Municipal Government, and meets certain profitability requirements. 


In contrast to the Shenzhen Measures, the Shanghai Measures do not set any specific threshold for a shareholder of the QFLP fund manager. However, in practice, it has been primarily globally renowned asset management institutions or asset specialists that have been welcomed to set up as QFLP fund managers in Shanghai. 


Shenzhen seems to be more open to those fund managers with small to medium sized AUM, and particularly to Hong Kong-licensed institutions. It has been not uncommon for foreign fund managers to set up joint ventures with local licensed financial institutions or enterprise groups to establish QFLP pilot projects in Shenzhen. 

In summary, the varying qualification requirements reflect the different positioning of the two cities with respect to the QFLP pilot program. 


II. Entity Incorporation and Fund-raising


Both Shanghai and Shenzhen rules draw a distinction between a foreign-invested equity investment enterprise (i.e., a QFLP fund) and a foreign-invested equity investment management enterprise (i.e., a QFLP fund manager). A QFLP fund manager may raise and launch a QFLP fund, or be entrusted to manage an enterprise whose business is equity investment. Both Shanghai and Shenzhen require that QFLP funds and QFLP fund managers should be based in their respective cities.


The Shenzhen Measures require that a QFLP fund shall “raise funds from domestic and foreign investors” privately, and shall complete the registration with the Asset Management Association of China (AMAC) and launch its first RMB private fund within 12 months after obtaining the pilot qualification. In addition, if the general partner and some of the limited partners of the QFLP fund are controlled by the same entity, the total capital contributions made by the controlling entity through the partners shall not exceed 50%. Overall, it would appear that in Shenzhen, the QFLP fund is positioned as an RMB fund mainly raised from third party investors.


In contrast with Shenzhen, for a QFLP fund established in Shanghai, all of its fundraising can be conducted outside of China with no need to absorb any domestic funds. Moreover, where the QFLP fund is a partnership, the general partner and the limited partners may all be foreign entities. In such circumstances, since the funds are not raised within China, such funds do not constitute a private fund as defined under the Interim Measures for the Supervision and Administration of Private Investment Fund (“Interim Measures”). Unless the Interim Measures are otherwise amended to include the investment and management activities of such purely offshore fundraising fund, there is currently no requirement for the fund manager of such QFLP funds to register as a private fund manager with the AMAC nor to file the funds with the AMAC. Please note that the above interpretation does not exempt a QFLP fund manager intending to launch an RMB fund in China from the need to comply with the Interim Measures, which require that prior to conducting any fund-raising in China, a fund manager shall register with the AMAC as a private fund manager and shall file such QFLP fund with the AMAC before making investments.


III. Our Observations


Based on our observations of the QFLP pilot regulations and the actual practices of the two cities, we believe that, in terms of determining where to establish a local base for QFLP fund managers, Shanghai offers certain structural advantages over Shenzhen. 


Firstly, under the Shanghai pilot program, an applicant may use US dollar funds to make investments through the QFLP fund in China at the initial stage and depending on its own situation, form an RMB fund through onshore fundraising at a later stage. 


Specifically, the Shanghai Measures permit a foreign fund manager to make investment in China only with funds raised outside China and allow the QFLP fund manager to decide whether and when to raise RMB funds. In terms of its commercial planning, a QFLP fund manager may prefer not to raise RMB funds in China until it is able to meet the requirement of having a track record of investments with large, domestic institutional investors, such as banks and insurance institutions.


Secondly, under the Shanghai scheme, a foreign fund manager that has already incorporated both private securities investment management and QDLP management entities in Shanghai may leverage these onshore resources for its participation in the QFLP pilot program, and through the optimization and integration of overall resources, may thereby minimize costs. 


These are two significant advantages of the Shanghai QFLP pilot and should be taken into consideration in the choice of location for a QFLP pilot.


It is apparent that for many foreign fund managers, it has not been viable to attempt to raise RMB funds within China without some prior experience in the Chinese market. A more realistic option is to use US dollar funds raised offshore to invest in China at initial stage, and to thereby establish an observable investment track record in China and gain credibility among large institutional investors to facilitate RMB fundraising at a later stage. The QFLP policy of Shanghai is probably the most appropriate to address this need. By contrast, the Shenzhen Measures, which do require that RMB funds should be raised from the outset, do not offer the same degree of flexibility. 


While there may initially appear to be few substantial differences in the QFLP pilot schemes of Shanghai and Shenzhen in aspects such as the framework of the pilot schemes, their application procedures, the requirements on qualified investors and senior management personnel, or the convenience of settlement of foreign exchange, our comparison indicates that in practice there are actually some significant variations between the two cities’ policy initiatives that should be taken into account by foreign fund managers who intend to invest in China. In order for our clients to make the most of the opportunities available to them in China, we recommend they pay close attention to the implementation of policy, and thereby select an approach that is most suitable to their own requirements.


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