Approved foreign institutional investors will explicitly be allowed to raise renminbi-denominated private equity funds in Shanghai through a foreign-invested fund management company (FMC) under a new pilot scheme.
From February 1, foreign-invested FMCs will be entitled to raise and establish a private equity fund in the city, in addition to carrying on their fund management and consulting businesses.
The new measures also allow a foreign-invested FMC in Shanghai to be set up in partnership form for the first time. Previously they had been required to set up as companies and engage only in fund management and consulting.
However, based on informal consultations with the relevant Shanghai authority, Zou Ji, managing partner of Allen & Overy’s Shanghai office, disclosed: “A foreign investor is still required to raise a fund through an FMC established in Shanghai, which means the door is not yet open for a foreign investor to raise a local fund directly through its offshore fund or entity.”
The limited partners of such private equity funds will be restricted to sovereign wealth funds, pension funds, endowment funds, charitable funds, funds of funds (FOFs), insurance companies, banks, securities companies and other foreign institutional investors approved by the Joint Conference, consisting of 14 municipal authorities.
To qualify to set up a private equity fund, an institution must have its own assets of no less than $500 million or assets under its management (AUM) of at least $1 billion, and more than five years’ relevant investment experience, of which at least three years must be in China.
Under the measures, the minimum capital requirements for a private equity fund have increased slightly to $15 million, with each LP having to commit at least $1 million, compared with Rmb5 million (about $750,000) previously.
From a risk-control perspective, the measures require that each fund must engage a custodian bank in China to manage its fund. Although no clear requirements have yet been spelt out regarding which banks qualify, the China Securities Journal is tipping Pudong Development Bank.
Each private equity fund must also have two management officers with at least five years’ experience in equity investment, of which two must be in a senior management position, and with relevant work experience in China.
Each qualified fund is entitled to preferential treatment under the measures, including a relaxation of foreign exchange conversion limits in relation to its capital contribution to the fund.
A qualified FMC will be entitled to convert its foreign-currency capital, equal to an amount of up to 5% of the fund, into RMB for its capital contribution. Such contributions will not change the domestic nature of the fund, but it is unclear whether such funds can invest in industries restricted from foreign investment.
“The measures have had a considerable improvement on the relaxation of the foreign exchange conversion, which has long been a major obstacle for a foreign investor to raise an RMB fund,” notes Zou.
However, foreign investors will continue to be prohibited from making investments through secondary capital markets, in futures or other financial derivatives and non-self-used real estate.
The formation of RMB private equity funds is gathering pace in China, with a number of large and well-known international firms having entered the country in the past year. The new pilot measures will open the door for more foreign institutions to enter the market.
An industry insider was quoted in the local media as saying the total investment from foreign investors through the pilot scheme in Shanghai would reach about $3 billion, among which the first quota, worth about $300 million, is likely to be granted to Fuson-Carlyle, Blackstone and First Eastern.
Over the past year, international law firms have been bringing on board lawyers with experience in private equity in China.
Only yesterday, US-based O’Melveny & Myers announced the transfer of private equity partner James Ford from London to Hong Kong. He has experience in private equity and venture capital transactions, including traditional fundraising, secondary transactions, mergers and acquisitions, strategic investments and capital markets transactions.