2020.09.16 XIE, Qing (Natasha)、 QIN, Ttianyu、 FANG, Hao
On September 11, 2020, the China Securities Regulatory Commission (CSRC) issued the Several Provisions on Strengthening the Regulation of Private Investment Funds (Consultation Paper) (“Consultation Paper”) and the corresponding drafting notes (“Drafting Notes”). In consideration of law enforcement practices, as well as the kinds of violations emerging in the past couple of years, the CSRC, by issuing the Consultation Paper, intends to reiterate and clarify the “bottom line” regulatory requirements, as well as strengthen regulation of private fund industry.
We have briefly summarized below the key points of the Consultation Paper.
1. In terms of the corporate name and business scope, the Consultation Paper requires a private fund manager (PFM) to adopt a standard naming format – specifically, the words “private fund” and “private fund management” must appear in its name and business scope. Furthermore, it provides that if the name and business scope of a PFM do not meet the foregoing requirements, it shall make rectifications. The Q&As on Registration and Filing of Private Investment Funds No. 7 and the Instructions on Registration of Private Fund Managers (December 2018) (“Registration Instructions”) issued by the Asset Management Association of China (AMAC) stipulate that the corporate name and business scope of a PFM shall include words such as “fund management”, “investment management”, “asset management”, “equity investment”, “venture capital” or other similar words. The requirements under the Consultation Paper differ from the above existing AMAC rules as the Consultation Paper explicitly requires to have the word “private” in the corporate name and business scope.
We understand the requirement that a PFM shall have the word “private” in its corporate name and business scope intends to draw a clear distinction between public fund management companies (FMC) and PFMs, and require PFMs to engage exclusively in private fund management businesses, based on the dedicated business operation principle. It is, however, noteworthy that once the Consultation Paper is officially implemented, more than 20,000 existing PFMs will need to change their names and business scopes to comply with the new requirements under the Consultation Paper, which may increase their operating costs. We would recommend the CSRC to give existing PFMs a stated grace period and sufficient time for rectification on a “new-old-cut” basis. Meanwhile, for a QDLP fund manager, its name and business scope are currently required to include the words “overseas investment fund management” due to the particularity of its business. As a QDLP fund manager is also a PFM, it remains to be clarified by the CSRC how the name and business scope of a QDLP fund manager should conform to the requirements under the Consultation Paper.
2. In terms of business activities, the Consultation Paper requires a PFM to focus on investment management business, and carry out fund raising, investment management, and advisory services solely for the purpose of private fund management. It further reiterates that a PFM shall not manage private funds that are not duly filed according to law, nor shall it engage in any business in conflict with or unrelated to private fund management.
The Consultation Paper reorganizes and integrates the provisions of the Interim Measures on the Supervision and Administration of Private Investment Funds (“Interim Measures”), the Administrative Measures on the Fundraising by Private Investment Funds and the Interim Provisions on the Administration of Securities and Futures Operating Institutions Regarding the Operation of Private Asset Management Business (“Interim Provisions on Business Operation”) with respect to the prohibited activities for private fund raising. Moreover, the Consultation Paper adds the following two prohibitions: (1) a PFM shall not disseminate misleading marketing or promotional materials which mention completion of registration and filing with the AMAC, custody by financial institution, funding sourced from government, etc. as a means of credit enhancement; (2) a PFM shall not, directly or in any disguised form, establish a branch for the purpose of engaging in fundraising activities.
At the same time, the Consultation Paper emphasizes that the investors, de facto controllers, and affiliates of a PFM shall not engage in the marketing and promotion of private funds. In practice, the shareholders and affiliates of some PFMs may have been assisting the PFMs in raising funds. Since such entities are not qualified to distribute private funds, by doing so they may potentially violate relevant regulations. We recommend the shareholders and affiliates of PFMs strictly avoid all activities that may be considered to be fund marketing and promotion.
On the basis of the Instructions on the Filing of Private Funds issued in December 2019, the Consultation Paper further reorganizes the negative list of investments by private funds. The Consultation Paper strictly prohibits a PFM from using fund assets to engage in the following activities, namely, (i) non-private fund investment activities such as borrowing (depositing) loans, guarantees, and debts in the name of shares; (ii) investment in credit assets or their beneficial rights, and (iii) investment with unlimited liabilities, or investment in projects prohibited or restricted by the state. The Consultation Paper allows a private fund set up for the purpose of investing in equities to provide loans or guarantees for portfolio companies for less than one year, but further stipulates that the due date of such loan or guarantee shall not be later than the date of withdrawal of the equity investment, and the total amount of the loan or guarantee provided shall not exceed 20% of the total assets of the private fund, with the amount of multiple loans and guarantees being calculated in aggregate.
Pursuant to the Drafting Notes, the purpose of clarifying the negative list is to guide private funds in focusing on investment business, while simultaneously reiterating the nature of “profit sharing and risk sharing” in investment activities.
On the basis of the Interim Measures and the Interim Provisions on Business Operation as well as the cases of punishment by the CSRC, the Consultation Paper summarizes the “ten don’ts” (i.e. ten prohibited activities) for PFMs and their relevant personnel: compliance of related party transactions; prohibition on the mixing of fund assets, pooling businesses, embezzlement or misappropriation of fund assets and interest tunneling; prohibition of the use of private fund assets to directly or indirectly invest in PFMs, their controlling shareholders, de facto controllers or the enterprises or projects de facto controlled by the foregoing entities; and other self-financing activities, insider trading, market manipulation, unfair treatment of fund assets and investors, and other activities in violation of laws and regulations.
Notably, the Consultation Paper also provides that private fund custodians, fund distribution agencies and other service providers and their personnel shall neither engage in the aforementioned prohibited activities nor provide convenience for such activities.
In addition to the four points above, the Consultation Paper also reiterates the “bottom line” requirements for private funds, such as non-public fund raising from qualified investors, information disclosure and reporting obligations of PFMs, custodians, fund distribution agencies, and other service providers. It also emphasizes the tightened regulation of “corporate group-type” PFMs as stipulated in the Registration Instructions.
We believe that the release of the Consultation Paper signals the regulators’ determination for strictly regulating the private fund industry and cracking down on violations of laws and regulations. After the Consultation Paper is officially implemented, PFMs that do not meet the relevant requirements shall make rectifications in accordance with the Consultation Paper. We will continue monitoring the official implementation of the Consultation Paper and issue alerts to clients on those compliance issues.