China tightens controls on LP participation in offshore funds
China's National Development and Reform Commission (NDRC) has implemented rules that effectively add another layer of approval for LP commitments by domestic investors to offshore private equity funds.
The so-called Circular 11, announced last December, follows the introduction - starting late 2016 - of a slew of measures from key regulators that made it harder for investors to convert renminbi into foreign currency for remittance overseas. The State Council subsequently issued formal guidelines intended to curtail irrational outbound transactions.
In addition to currency conversion obstacles, investors – whether operating through a China-incorporated entity or an overseas entity held by a Chinese group – now require NDRC clearance to make commitments to offshore blind pool funds. Applications must include information such as target fund size, investment objectives, and geographic focus, Morrison Foerster said in a client alert.
Capturing investments made through offshore entities is a significant addition. Previously, Chinese-backed overseas investment vehicles generally weren’t covered by domestic regulations. Institutional investors like Chinese insurance companies only had to comply with regulations issued by their industry body – the China Insurance Regulatory Commission (CIRC) – without reporting to NDRC.
The changes could potentially disrupt fundraising and delay final closes, due to uncertainty about the NDRC’s timeline and approvals process. LPs might also have to withdraw from participation in offshore PE funds if they fail to receive clearance for commitments.
For commitments of less than $300 million to project funds that have pre-identified investments, approval is required at local rather than central government level.
However, qualification for this lower level scrutiny is conditional on funds not participating in “sensitive projects,” which are subject to broad interpretation. The circular refers to projects based in unspecified sensitive countries as well as anything that involves water resources, news and media, weapons manufacturing, and restricted industries mentioned in last year’s State Council guidelines. Real estate and hotels, sports clubs and entertainment all featured in that document.
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