A comprehensive adjustment of regulatory thinking with respect to privately offered funds has been unveiled, shifting the emphasis from industry self-regulation to supervision and risk prevention. Shangjing Li reports.
Privately offered funds in China are moving towards orderly development after years of unruly growth.
On April 15, the Asset Management Association of China (AMAC) issued the Administrative Measures for Fundraising by Privately Offered Investment Funds, setting forth regulations on various aspects of fundraising by privately offered funds, including the fundraisers, procedures and obligations. The Measures require fundraising institutions to tailor-fit publicity to specific subjects, set a cooling-off period that lasts no less than 24 hours, and explore a system of confirmation upon return interview.
This move tightens regulations in many aspects, with more stringent requirements imposed on the qualifications of the fundraiser, modes of publicity and promotion, fundraising procedures, specific targets, the setting up of accounts for the funds raised, qualified investor standards, the procedure for fund contracts to take effect and fundraising responsibility, among others. The Measures will officially come into effect on July 15.
As of the end of March, the number of registered private equity (PE) fund managers in China reached 26,000, marking a rapid increase over the span of two years, and the assets under management totalled RMB 5.7 trillion. However, PE institutions generally do not have much might. Only 94 are more than RMB 10 billion in scale and 17,000 or nearly 70 percent of them are “zombie institutions” – institutions that have yet to issue any products.
With such a large number of PE institutions, the good is mixed with the bad. Many have searched for capital under the guise of “privately offered funds”, and this has resulted in an outbreak of illegal fund-raising cases across the country. Quite a number of them are registered funds, including Zhongpu Asset Management, a wealth management platform valued at RMB 10 billion that was recently seized by Shanghai police.
The rapid expansion of the PE industry highlights the three major shortcomings of the previous system. In interviews that ALB conducted with several lawyers, they pointed out that the current market lacks an effective investor risk disclosure and acknowledgment mechanism. There are shortcomings in industry standards and codes of conduct as well as a lack of contractual constraints, self-discipline and constraints in administrative, judicial and other areas, they added.
ALB talked to four senior counsels who are experienced in the field of privately offered funds, namely: Jiang Bin, senior partner at Dentons; Selena She, partner at Llinks Law Offices; Chen Zhen, partner at Fangda Partners; and Sue Liu, partner at Fenxun Partners. During the course of the interviews, they explored the significance and impact of the new regulations and gave some helpful advice.
ALB: The administrative measures for fundraising by privately offered investment funds is being called as the most stringent PE regulatory approach in history. What areas are getting tighter regulation?
Jiang Bin, senior partner at Dentons: The cooling-off period and the system of confirmation upon return interview are two highlights of the new regulations. Fundraisers are expected to give investors a cooling-off period that lasts no less than 24 hours upon completion of the qualified investor confirmation process. According to fund contracts, investors shall reserve the right to terminate the contracts during the cooling-off period. PE fund contracts can only be entered into after the confirmation upon return interview has been conducted following the cooling-off period.
The Measures specifically ban 12 forms of promotion, including giving the warranty in any form that guarantees the investor’s investment will be loss-free or minimum returns. Also, the use of wordings such as “secure”, “guarantee”, “warranty”, “assured”, “risk avoidance”, “secured”, “high-yield” and “risk-free” that may mislead investors in their judgment of risks are prohibited. Nine types of promotion media are banned, and they include “fundraisers’ official websites that do not have specific target determination programmes installed, WeChat’s Moments and other Internet media”. The Measures also prohibit the illegal split and transfer of PE shares or their usufruct and acts that go against the qualified investor standard in a disguised manner.
Selena She, partner at Llinks Law Offices: Firstly, we feel that the Measures can be viewed as the Chinese government’s first attempt to establish an efficient system designed to manage fundraising by privately offered funds. Although the industry still has a certain degree of doubt about establishment of the association’s jurisdiction, we believe that the Measures have a positive significance in terms of the standardised operation of the PE investment fund market.
Secondly, the Measures give a more specific definition of “fundraising” for the first time. According to the Measures, fundraising includes the promotion of PE funds, the sale of fund shares (equities), the handling of fund shares (equities) subscription/purchase and redemption (exit). It can be seen that the Measures have a broader definition of fundraising, and any act that falls under the definition is subject to regulation.
In addition, the Measures strictly limit fundraisers to two kinds, the AMAC-registered PE fund managers and fund sales institutions that had obtained qualifications from the China Securities Regulatory Commission (CSRC) and are AMAC members, as well as impose restrictions on their fundraising activities. The Measures also stipulate for the first time that, “save for those specified, no institution or individual shall engage in fundraising by privately offered funds”. Previously, such an explicit stipulation could not found in any related laws. Once again, the Measures impose detailed and stringent requirements on compliance in the entire fundraising process, with specific guidelines for each step of the process. Prior to this, the relevant provisions were rather general and vague, which led to many regulatory loopholes in practice. This is addressed by the Measures.
ALB: What type of PE funds will be greatly hit? What advice would you would offer your clients?
Chen Zhen, partner at Fangda Partners: The Measures will have the most impact on PE fund managers and third-party sales institutions that consistently fail to comply with the principled requirements of laws, regulations or normative documents in their fundraising activities or walk a fine line and exploit grey areas or even engage in irregular fundraising activities other PE fund managers, PE funds and fund sales institutions as much.
The three-month transition period for the implementation of the Measures could be in consideration of these factors, and PE fund managers and third-party fund sales institutions may consider using this time to carry out several preparatory steps, such as establishing or fine-tuning internal systems and processes such as fundraising and investor appropriateness systems in accordance with the Measures and internal control guidelines.
They should also check if they have qualified people in place, as the Measures require that personnel engaging in fundraising for privately offered funds are to possess the qualifications to practice. They could also adjust the fundraising process of privately offered funds that are currently engaging in fundraising activities. For example, those who have hired third-party fund sale institutions may need to re-conduct due diligence on the qualifications of these institutions. Those that did not introduce specific target determination or qualified investor confirmation programmes need to roll out these programmes as soon as possible for new potential investors. In addition, those that do not specify a cooling-off period in their fund contracts or other related legal documents, do not have a system of confirmation upon return interview or have prohibited wordings in their fund documents can amend these documents promptly.
Sue Liu, partner at Fenxun Partners: The Measures set forth new requirements and specify a number of execution standards with respect to fundraising by privately placed funds. They can be expected to have an impact on funds and fundraising institutions that used to engage in irregular activities or even violate laws and regulations. Many funds that insist on compliance operations will also be affected.
Our understanding of the Measures is that their contents are a shadow of the public offering of fund to a greater degree. In terms of private securities investment funds, they are similar to public offering of fund in investment targets and operation models and their fundraising characteristics may be a better fit to the Measures’ provisions. As such, the impact of the Measures should be relatively smaller on private securities investment funds. Those that may experience a greater impact would be PE funds and venture capital funds. They are different from private securities investment funds in terms of operation model and investor base, and may depart to a greater extent from the requirements of the Measures in terms of fundraising methods, procedures and team composition.
ALB: What do you think will be the influence and impact of the measures?
Sue Liu, partner at Fenxun Partners: As AMAC puts it, the objective of introducing the Measures is to “strengthen the protection of the legitimate rights and interests of private equity investors and further standardize the fundraising market for privately offered funds.” Fundraising is an important part of setting up privately offered funds. It is the “the first line of defense to guard against the risk of non-compliance and an important manifestation of real-time regulation”.
The Measures are conducive to the protection of investors as they allow them to obtain more realistic, effective and complete information that are helpful to their investment decisions before they invest in privately offered funds. They also enable them to directly hold the responsible persons liable after they invest in such funds. In terms of the managers of such funds, the Measures will compel them to improve their fundraising activities and process. This can play a role in regulating market order to a certain extent.
That said, AMAC is an industry self-regulatory organisation. The measures it sets can only be seen as industry self-regulatory rules in terms of their effectiveness. Their binding effect on PE fund managers and PE fund sale institutions is limited in reality. As seen in Chapter Six of the Measures, violations will mainly be punished by disciplinary action such as “mandatory rectification within a stipulated period of time, industry denouncement, blacklisting, public censure, suspension of the acceptance for handling or the handling of related business and manager deregistration” or “measures such as suspension or non-handling of business on recordation” against the offenders. As such, the extent of compliance in the implementation of the Measures remains to be seen.
Selena She, partner at Llinks Law Offices: In our opinion, having the Measures systematically establishes relatively comprehensive and well-defined management systems and requirements on fundraisers, fundraising programmes, account supervision, information disclosure, qualified investors confirmation, risk disclosure, cooling-off period, confirmation upon return interview, legal liability of fundraisers and their personnel and other aspects of fundraising by privately offered funds for the first time. The Measures will promote the standardisation of fundraising by privately offered funds and internal control of such funds, thereby strengthening investor rights protection. This has a positive significance to the growth of China’s fund market.
On the other hand, the specific interpretation and understanding of the provisions of the Measures remain to be tested in practice. For example, what constitutes “going against the qualified investor standard in a disguised manner”? Furthermore, basic concepts that are closely related to fundraising are yet unclear. For example, what constitutes “securities”, “fund”, “promotion”, etc.? These questions are likely to lead to uncertainties in practical operation.
In addition, the Measures will increase the fundraising costs of privately offered funds and the impact of such an increase to China’s fund industry – still at its infancy – and will need to be studied. Another point is that AMAC is a self-regulatory organisation for the securities investment fund industry, so its jurisdiction of fundraising by institutions and individuals other than those approved by the Measures, as well as its right to mete out punishment to them, are open to question.
It has also come to our attention that the Measures do not specify if fundraising activities conducted by foreign funds in China fall under the Measures’ scope of regulation. As such, the handling of this issue in practice awaits clarification.
