Overseas LPs welcome

China has made strides in its goal of boosting the profile of its private equity industry on a worldwide scale as Shanghai, one of the country's most active financial hubs, is to be the first territory in the PRC to allow overseas investors to make capital contributions in foreign currency for private equity fund investments in China - a giant leap forward given that foreign investors, outside those investing in holdings companies and venture capital enterprises, have traditionally been barred from making capital contributions to PE funds in China.

The Shanghainese government announced that international investors - including fund of funds; sovereign, pension, endowment and charity funds; insurance companies; banks and apparently other institutional investors given the green light by authorities - would be eligible under a pilot program, which reflects some characteristics of the so-called Qualified Foreign Limited Partner (QFLP) scheme as of January 23.

In layman's terms...

While the high-profile program has long been anticipated, specifics surrounding private equity funds' eligibility and investment boundaries are slowly being circulated. Partners at Clifford Chance Matt Feldmann, based in Hong Kong, and TieCheng Yang, based in Beijing, simplified the program's underlying concepts.

They explain that the new rules create two possibilities for foreign PE investors in China. One is foreign-invested equity investment enterprises, or FIE Funds. The other is foreign-invested equity investment management enterprises, or FIE Fund Managers, which will act as general partners of these and other funds. FIE Funds, the two say, are onshore PE funds which must have a minimum of $15 million of capital, with each LP contributing no less than $1 million.

In terms of restrictions, Feldmann and Yang say the FIE Funds can invest in all domestic companies except those in industries where foreign investment is prohibited. They are not permitted to invest in real estate and listed securities either.

Under a pilot program launched under the new rules, qualified FIE Fund Managers are allowed to make a GP commitment to onshore domestic PE funds of up to 5% of the total fund size, which will not change the domestic nature of the PE funds.

Other cities that house burgeoning private equity industries - notably Beijing - are also said to be considering similar schemes, so Shanghai's model may prove to be a basis for policy in the future if all progresses as planned. "Obviously this is a first step and the authorities in Shanghai and elsewhere will be monitoring the performance of the first funds before deciding to extend the program," Feldmann says. "It is very common to introduce measures of this type as a pilot program first before enacting it as permanent legislation - the process can take years."

Shades of grey?

Yet, as with any nascent process, the full impact of the rule cannot yet be known. According to Feldmann and Yang, Clifford Chance's clients, most of whom are foreign sponsors and managers, have raised concerns about whether their contribution to the FIE Funds and FIE Fund Managers can then be converted to RMB for investment purposes. Also, as the new measures allow qualified FIE fund managers to contribute exchanged foreign currency of up to 5% of the PE Fund, it is not yet clear how this process can work in practice, without the implementation of additional rules.

"In addition to FIE Fund Managers, FIE Funds may also be qualified under the pilot program. However, it is unclear under the current rules what special treatment will be provided to the FIE Funds qualified under the pilot program compared to unqualified FIE Funds," Yang says. "It is anticipated that Shanghai will issue a set of supporting policies to clarify this issue. It is also unclear what advantages FIE Funds offer over other types of foreign-investable onshore funds, such as foreign-invested venture capital investment enterprises."

Local reports have also suggested that a $3 billion conversion quota will be put in place to stymie the capital inflow, with the existing funds of Blackstone, Carlyle and First Eastern Investment Group slated to be the first beneficiaries of the program. However, despite the buzz, Feldmann says the newly issued PE measures do not mention such provisions, though further clarification may be issued down the line.

Yet, despite the grey, Shanghainese authorities look to achieve the overarching goal that could make this program a success nationwide: to import fund talent and experience into China, with the aim of eventually creating a domestic private equity industry, which is seen as a key element of the fund raising cycle.

"The world's largest PE funds have already shown huge interest in this program, and their track record and international contacts can only help Chinese investors, funds and companies to develop further both within China and beyond," Feldmann says.

 

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• Topics
• Regulation
• Renminbi fund
• Greater China
• LPs