As Beijing has swiftly dismantled capital controls in recent years, it has increasingly realised that to attract foreign investment it must raise onshore standards of governance and working practices.
As part of this process its financial watchdogs have, in the space of just a few months, moved from holding a laissez faire attitude to tens of thousands of private fund managers to clamping down aggressively upon them.
Many market participants feel the authorities have shifted their stance too far, too fast.
In a crackdown triggered by the Ezubao peer-to-peer platform lending scandal, more than 10,000 private fund firms have been deregistered since stricter rules were implemented in February, according to the Asset Management Association of China (Amac), a regulatory body under the China Securities Regulatory Commission (CSRC).
The industry now has 16,000 private fund firms, of which 12,000 (75%) have registered products, which total some Rmb6.6 trillion ($988 billion) in assets under management (AUM).
Futhermore, on August 19 the CSRC said it had imposed “administrative supervisions” – such as warning letters and correction orders – on 73 private funds after conducting investigations into the industry in the first half of the year. And four private funds have been found to have conducted illegal fund raising and are under police investigation.
Detailed legal opinions – in some cases running to 100 pages or more – are now required to support private fund registrations with Amac, lawyers told AsianInvestor.
There is now an informal moratorium on the establishment of new private funds. With some limited exceptions, essentially registration of new vehicles has slowed to barely a crawl. One counsel that it had become easier to launch an IPO in China than a new private fund in recent weeks.
The CSRC did not respond to an emailed request for comment from AsianInvestor about its shift in regulatory oversight.
The newly demanding process over private fund launches may be justified, but it stems in large part from the authorities’ overly light initial touch. The regulators had allowed funds to flourish largely unhindered ever since introducing a law for them in June 2013.
That lack of oversight fostered the creation of many poorly-run funds, along with outright fraudulent activity - which in turn caused the recent crackdown.
China is well-known for its willingness to abruptly shift regulatory gears when it perceives a need. Yet its U-turn over the regulations around private funds has been seen as particularly jarring.
One Hong Kong-based lawyer reflects a widely held view by telling AsianInvestor: “The pendulum is swinging perhaps too dramatically from one direction to the other as China tries to recalibrate [its policy on the private funds industry].”
Such marked shifts are not conducive to developing a new industry. Market participants are worried by the lack of certainty. Witness the long line of mainland asset managers moving to set up operations in Hong Kong and, to a lesser extent, Singapore.
These companies are ostensibly targeting overseas expansion and attracting foreign capital, but they are in fact more about business and regulatory diversification away from China, argued a veteran of Asia’s hedge fund industry.
Lack of communication
Beijing’s approach to private funds regulation reflects a broader lack of communication and consultation on rule changes. A dearth of regulatory certainty is a common complaint when it comes to key areas of emerging business in the mainland investment industry.
Foreign asset managers moving to set up in China are also affected, as they are now theoretically able to launch private funds under investment wholly foreign-owned entities. Many want to establish mainland operations, but some want to receive more clarity on the regulators' policies before they proceed.
Regulatory risk and scrutiny in China today appears to be much higher than in the past, in line with the faster-changing market and industry environment. This is inevitable to some degree, but Beijing needs to do a better job of both planning its reforms and communicating them to maket players in a timely fashion – especially if it wants to attract and retain international participation.
Chinese regulators seem to be more prepared to admit they are learning from missteps – such as after the stock-trading circuit-breaker debacle in January. That is positive, as is the fact that the mainland private funds industry is now more regulated and has clearer rules.
But the nation's regulators need to accelerate their learning curves and better explain their plans. Violent, unexplained regulatory swings aren't in anybody's interest, least of all Beijing's.