2020.01.10 XIE, Qing (Natasha)、ZHANG, Chi、QIN,Tianyu
Following a year and a half of ongoing discussions and amendments, on December 23, 2019 the Asset Management Association of China (AMAC) released an updated version of the Guidance on Filing of Private Investment Funds (“Filing Guidance”), which provides a more detailed and comprehensive framework for regulation than the previous version of the Filing Guidance. We note that the regulation of private fund filing has been strengthened in some aspects but relaxed in others. While reiterating the importance of sticking with regulatory bottom lines, the Filing Guidance still focuses on key aspects of responding to market needs, which reflects the desire to maintain a moderate level of regulation. Some key provisions of the Filing Guidance are summarized as follows.
The Filing Guidance reiterates several key points in previous rules and regulations, such as the prohibition on ”fake private funds”, the prohibition on “pooling businesses” and the prohibition on “rigid payment”, and reformulates the regulatory rules in the following aspects:
(1)First, the Filing Guidance lists out items that do not possess the features of a “fund” and thus shall not be accepted for filing as a private fund. For example, items that have the following features are explicitly prohibited: (i) conducting credit lending (savings) businesses of financial institutions in a disguised form, or directly investing in credit assets of financial institutions; (ii) engaging in regular or operational private lending activities; and (iii) investing in assets of businesses that conflict with the private investment fund business.
(2)Second, the Filing Guidance reemphasizes that a private investment fund manager (“manager”) shall not engage in business that can create conflicts of interest with the private investment fund or entrust the fiduciary duties of the manager to others. For the first time it also expressly provides that a private investment fund shall have no more than one manager.
(3)Third, the Filing Guidance prohibits any rigid payment, guarantee of principal and returns in a disguised form, or any express or implicit indication of expected returns of a private investment fund that may cause investors to have an expectation for rigid payment. Specifically, the Filing Guidance prohibits a manager of a private securities investment fund from conducting the following activities that violate the principles of sharing interests and risks, and matching risks with returns: (i) adjusting returns or losses of the fund by offering capital enhancement or fee refunds; (ii) using the fund units subscribed with its proprietary capital to bear the losses first so as to provide risk compensation for the fund; and (iii) using structured share classes to conduct interest tunneling or engaging in illegal businesses such as “margin financing” in a disguised form.
The Filing Guidance underscores the duties of a custodian. A custodian shall not be exempted from their statutory duties through any contractual arrangement. In the event that a manager encounters any abnormality and is unable to perform their managerial duties, the custodian shall perform the duties of a custodian pursuant to laws, regulations and relevant contracts, as well as safeguard the legitimate rights and interests of investors. If a custodian, in the course of supervising the investment operation of a manager, finds out that the investment or settlement instructions of the manager violate laws, regulations, self-regulatory rules or relevant contracts, they shall refuse to execute such instructions, and shall report to the China Securities Regulatory Commission (CSRC) and the AMAC. Moreover, the Filing Guidance provides that a private investment fund, which indirectly invests in underlying assets through special purpose vehicles (SPVs) in the form of companies and partnerships, shall have a custodian, and the custodian shall maintain constant supervision of the capital flow of the private investment fund as well as the SPVs, identify the capital transfer route in advance, and secure and retain the capital transfer and investment certificates afterwards.
The Filing Guidance requires the fund contract and the risk disclosure letter of a private investment fund to stipulate the emergency disposal plans and dispute resolution mechanisms for safeguarding the fund assets, maintaining the fund operation or liquidating the fund in the event that the manager objectively loses their capacity to continue managing the private investment fund. Moreover, the responsibilities of the manager and relevant parties for a private investment fund shall not be exempted by the deregistration of such manager or other measures taken by the AMAC in accordance with laws, regulations or self-regulatory rules. In the event of deregistration, the deregistered manager and relevant parties shall, in accordance with the Securities Investment Fund Law, relevant self-regulatory rules of the AMAC and the fund contract, properly dispose the fund assets under management and protect the legitimate rights and interests of investors in accordance with the law.
The Filing Guidance reiterates that private investment funds shall only be raised from qualified investors, and also specifies that only a legally filed asset management product can be exempted from the look-through verification to confirm the ultimate investors are qualified investors and the aggregation of the total number of ultimate investors. The Filing Guidance also strictly prohibits a manager from establishing multiple private investment funds for a single financing project to circumvent the restriction on the maximum number of investors or any other regulatory restrictions in a disguised form.
Notably, the Filing Guidance provides that an investor shall not collect funds from others to purchase private investment funds. In addition, it enhances the verification obligation of a fundraising institution, namely, the fundraising institution of a private fund shall verify that the amount of investment made by the investor matches its funding capacity, and that the investor purchases the private investment fund for itself rather than on behalf of others.
The Filing Guidance stipulates the scope of information that a manager shall disclose to investors in the fundraising and promotional materials, such as the prospectus. It also specifies the disclosure obligation of a private equity investment fund in connection with its main intended investment projects.
The Filing Guidance provides that neither a PE/VC fund nor a private asset allocation fund shall open for subscription or redemption after completion of fund filing, except for dividend distribution, reduction of subscribed capital of investment projects, removal or replacement of defaulting investors, or transfer of fund units. A PE/VC fund or a private asset allocation fund that has completed the filing with the AMAC, upon satisfying certain conditions, may accept new investors or increase the subscribed capital contribution of existing investors, provided that the increased amount does not exceed three times the subscribed capital contribution amount at the time of filing.
Pursuant to the Filing Guidance, prior to the completion of fund filing, a private investment fund may, for the purpose of cash management, invest in bank current deposits, treasury bonds, central bank notes, money market funds or other cash management tools recognized by the CSRC. Allowing such temporary investments prior to fund filing is in response to increasing appeals from the market in this regard.
To suppress channel businesses, the Filing Guidance stipulates the general requirements for making portfolio investments. Namely, private investment funds are encouraged to make diversified portfolio investments and the fund contract of a private investment fund is recommended to specify the proportion of the total subscribed capital of the private investment fund that invests in a single asset management product or project. We note that the regulators take a more pragmatic approach in this regard by not proposing any fixed proportion.
In regard to related-party transactions conducted by private investment funds, the Filing Guidance requires a manager to specify in the fund contract the ex-ante and interim information disclosure arrangements and the special decision-making mechanism and recusal arrangements for related-party transactions. Apart from the restrictions on related-party transactions, the Filing Guidance proposed a few mechanisms to ensure compliance with the principles of protecting the rights and interests of investors and treating investors fairly.
(1)Prohibition on investment sub-fund
The Filing Guidance for the first time prohibits a manager from setting up investment units/sub-funds invested by different investors in different underlying assets within a private investment fund. This practice is deemed an evasion of the fund filing obligation and an unfair treatment of investors.
(2)Ad hoc dealing day
The Filing Guidance precludes any abuse of ad hoc dealing day mechanisms. It provides that if a fund contract stipulates an ad hoc dealing day mechanism, it shall also specify the triggering conditions of such ad hoc dealing day, and in principle, subscription/purchase shall not be continued by using the ad hoc dealing day mechanism.
The performance fee shall match the duration, distribution of returns and investment operation characteristics of a private securities investment fund; a single private securities investment fund may only adopt one performance fee accrual method to ensure fair treatment of investors. The payment ratio for performance fee shall not exceed 60% of the investment returns above the accrual basis for the performance fee. The interval between two consecutive instances of accruing the performance fee by a private investment fund shall not be less than three months. Managers are encouraged to adopt an interval of not less than six months.
(4)Several funds managed by the same manager
A manager shall treat different private investment fund assets under its management fairly, prevent any interest tunneling and conflict of interest between such funds effectively, and shall not transfer gains or losses between different funds. Prior to the completion of investment of 70% of the subscribed amount of an established private equity investment fund (including a reasonable reservation for payment of fund taxes), except with unanimous consent of all investors or approved under a decision-making mechanism recognized by all investors, the manager shall not establish a new fund with substantially same investment strategies, scope and phases as those of the aforesaid fund.
The Filing Guidance also specifies the requirements for private asset allocation funds. Namely, (i) a private asset allocation fund shall mainly adopt the investment method of fund-of-funds (FOF); (ii) more than 80% of the fund assets of a private asset allocation fund shall be invested in legally established or filed asset management products; (iii) investment of a private asset allocation fund in a single asset management product or project shall not exceed 20% of the total subscribed capital of the fund; and (iv) where a structured private asset allocation fund invests in a cross-category private investment fund, the leverage ratio shall not exceed the maximum leverage ratio prescribed for any private investment fund it has invested.
We note that the Filing Guidance specifically provides that the relevant requirements for private investment funds investing in debts, rights to receive proceeds, non-performing loans assets or other special investment targets shall be stipulated separately. This may imply that certain types of private investment funds may not be accepted for filing until the relevant rules and regulations governing them are promulgated.