2016.11.17 XIE, Qing (Natasha)、Brigitte（Bing）Lu
The Interim Measures on Operation of Private Fund Asset Management Business of Securities and Futures Operation Institutions (“Interim Measures”) promulgated by the China Securities Regulatory Commission (“CSRC”) on July 14, 2016 is a significant regulatory document regarding the private securities investment fund industry. Recently, the CSRC has clarified a few issues involved in implementation of the Interim Measures by issuing the Frequently Ask Questions on Relevant Issues (“FAQ”).
As in our analysis in the JunHe Client Alert dated July 18, the regulators continue to emphasize the principles of “substance over form” and “penetration” in the interpretation and execution of regulatory policies to prevent regulatory arbitrage. From our perspective, it is noteworthy for the market that in issuing the FAQ the regulators have sent a clear message to the market. Below is our brief analysis with respect to the key content of the FAQ.
The Interim Measures underscore six areas of focus for regulating the operation of private fund asset management businesses: (i) promotion, marketing and sales; (ii) structured asset management plans (“Structured AMPs”); (iii) illegal securities and futures business activities; (iv) investment recommendations provided by third parties; (v) “fund pooling” business; and (vi) improper incentives offered to fund managers. The FAQ further clarifies the regulatory requirements in terms of the scope of application, prohibited conduct, promotion and marketing, Structured AMPs, investment recommendations from third parties and rectification of existing products.
Scope of Application
The FAQ clarifies the scope of application for the Interim Measures, specifying that the private equity investment fund or venture capital investment fund shall not be governed by the Interim Measures. The QDII businesses focusing on investment in overseas secondary markets of securities companies or fund management companies shall be governed by the Interim Measures. However, for any engagement of overseas investment advisors which is subject to special QDII related rules, such special rules shall prevail. Meanwhile, the FAQ also clarifies the Interim Measures for private securities fund products, noting that regardless of the scope of the license held by a private fund manager, the Interim Measures shall apply where it constitutes a private securities investment fund product.
The Interim Measures prohibit any manager from setting up multiple AMPs for a “single financing project”. The FAQ analyzes the specific aspects of such prohibited conduct in terms of investment operation, purpose of transaction and nature of the underlying asset, and offers examples such as the setup of multiple products in stages, investment in a single entrusted loan, a single equity in a non-publicly-offered company, a single trust plan or AMP, and makes it clear that a manager duplicating an investment strategy, issuing multiple AMPs and holding the same securities portfolio does not fall under the scope of the aforementioned prohibition.
The FAQ also requires that the risk and return and investment operation of any cash management type products shall be consistent with their product names, match the frequency of product raising, and be mainly invested in monetary market instruments with high liquidity, which in effect blocks the channel of investing cash management type products in non-standardized credit assets.
Promotion and Marketing
We have noted that the regulators require the promotion and marketing of any AMP to be governed by Article 20 of the Administrative Measures of the Private Investment Funds Raising Behaviors issued by the Asset Management Association of China (“AMAC”). This reflects the merger between the AMPs and private funds with respect to regulatory policy. In addition, as pointed out in the FAQ, the determination of any improper promotion related to the rate of return or performance falls under the discretion of the regulatory departments based on the law enforcement principle of “substance over form”.
The FAQ illustrates the principle of “profit and loss sharing” with examples, i.e. if a Structured AMP makes profits or suffers losses as a whole, all investors shall enjoy profits or bear losses accordingly; it is prohibited that an investor holding whatever class of unit may gain profits without bearing any risk at any time. To be specific, if the total net value of a product≥1, even the investors of the junior class shall not bear any loss; if the total net value of a product＜1, even the investors of the senior class shall not make any profit or have their principal secured.
In order to prevent surreptitiously evading any regulation, in addition to the manager’s duty of penetration review towards the “investment end”, the FAQ also prohibits a manager from intentionally arranging other Structured AMPs to be invested in the AMP as the entrusted funds from the “capital end” for evasion against the applicable upper limit of leverage multiples. The FAQ further elaborates on the determination of various types of Structured AMPs so as to decide the applicable upper limit of leverage multiples.
Investment Recommendations from Third Parties
It is interesting that the FAQ, as an official public document of CSRC, for the first time distinguishes between the two different activities of the “investment advice provided for ordinary clients” and the “operational recommendation provided for AMP portfolio management”. The former activity is subject to the relevant securities investment advisory license issued by the CSRC, while the latter, as explained by the FAQ, is actually an extension of the asset management business. According to the FAQ, securities and futures operational institutions or securities investment advisory institutions are not necessarily qualified to provide operational recommendations for AMP portfolio management. Only those securities and futures operational institutions qualified to engage in asset management business and those private fund management institutions with robust past performances can provide such operational recommendations for AMP portfolio management.
The FAQ further clarifies that private securities investment fund managers, in order to be qualified to provide investment recommendations shall “have at least three investment managers, who have no record of bad practices and have track records in securities or futures investment management, which are traceable and run over three consecutive years”, in particular, “investment managers” refer to individuals employed by a licensed financial institution regulated by the financial administrative department of the State Council or a private fund company registered with the AMAC, with management experience in relation to the securities or futures proprietary trading accounts or entrusted products; “track records run over three consecutive years” in principle shall refer to consecutive investment management performance without interruption, and shall be recalculated upon any interruption; “traceable track records” are not limited to publicly disclosed performance; for those that have no publicly disclosed performance, the manager shall request the relevant third party institution to provide the investment performance documentation of the relevant personnel, and such documentation shall comply with the requirement of being “verifiable and inspectable”.
Additionally, the FAQ clarifies the regulatory requirements of the “engagement of third party institutions”, and underscores: (i) the management experience and professional capacity for a third party institution to be engaged shall match the actual situation of the product; (ii) there is no inconsistency between the appearance and actual situation of the engagement. As for the latter, both the manager and the corresponding third party institution will be held liable if there is any violation.
Rectification of Existing Products
Notwithstanding the “New-Old Cut” transitional arrangement of the Interim Measures, i.e. the existing products issued before the implementation of the Interim Measures may be exempted from some requirements for survival, such exemption, as emphasized by the FAQ, will not be unlimited. The regulators urge managers to take timely measures to clean up or rectify existing products which are inconsistent with the requirements of the Interim Measures as long as the original investors’ interests have been properly taken into account and risk is under control.