More relaxation for renminbi funds

Until very recently, all RMB Funds in the form of FIVCIEs have been approved at central Mofcom level, with its local counterparts sharing only certain initial review functions.

On March 5 2009, Mofcom issued Circular 9: the Circular on Matters Relevant to the Examination and Approval of Foreign-invested Venture Capital Enterprises and Venture Capital Management Enterprises
(商务部关于外商投资创业投资企业、创业投资管理企业审批事项的通知), relaxing the approval authorities with respect to FIVCIEs and their managers.

As a procedural matter, typically Mofcom needs to consult Most before an approval can be rendered with respect to an FIVCIE application. On March 30 2009, Most issued a circular with the same title as Circular 9 which reiterates the relevant issues to the extent Most is concerned.

Delegation of approval authority for first-time funds
Starting from March 5, the formation of an FIVCIE with total committed capital of no more than US$100 million will only need to be approved at certain selected local counterparts of Mofcom (the Authorised Local Agencies).

These Authorised Local Agencies include the agencies of the provinces, autonomous regions, municipalities directly under the central government, cities under separate planning, Harbin, Changchun, Shenyang, Jinan, Nanjing, Hangzhou, Guangzhou, Wuhan, Chengdu, Xi'an and Xinjiang Production and Construction Corp, and all national economic and technological development zones.

The approval time limit for an FIVCIE eligible for approval at the local level is reduced from 60 days (including a 15-day initial review at local level and 45 days at central Mofcom level) to 30 days.

FIVCIE manager
The FIVCIE Rules recognise that an RMB Fund may outsource its investment management function to an internal or external FIVCIE manager. If an external manager is retained, it can be either an onshore or offshore entity.

Assuming an onshore FIVCIE manager is to be employed and its total registered capital will be no higher than US$100 million, Circular 9 delegates the approval authority of such FIVCIE manager to the Authorised Local Agencies as well.

What is left with central Mofcom?
Going forward, only FIVCIEs and FIVCIE managers with total committed capital or registered capital of US$100 million or more – which could be labelled as mega funds – will still remain under the auspices of central Mofcom.

Even for these mega funds, with the only exceptions being the following matters that are specifically reserved for central Mofcom, all the subsequent changes could be dealt with at the level of the Authorised Local Agencies:

(i) Increase of capital commitment by US$100 million or more in a single tranche: It is not clear if piecemeal increases (with each batch less than US$100 million) will be tolerated; and

(ii) General partner withdrawal: As a general rule, no general partner withdrawal is allowed during the fund term, unless both (a) the consent of limited partners representing at least 50% of the total committed capital and (b) the approval of central Mofcom is received.

Subsequent approvals and registrations concerning existing funds
For all the other subsequent developments with respect to an existing mega fund, the approval or registration powers, as the case may be, will be exercised at the level of the Authorised Local Agencies.

Approvals of the Authorised Local Agencies are required for such matters as the following:

(i) reduction of capital commitments, provided that both the general partner and the limited partners representing at least 50% of the total committed capital have voted in favour and the total remaining committed capital will not fall below US$10 million;

(ii) extension of fund term;

(iii) early termination of the fund; and

(iv) any other significant amendment to the constitutional document of the fund.

Matters such as the following will need to be registered with the Authorised Local Agencies:

(i) admission of any subsequent investor;

(ii) return of invested capital;

(iii) transfer of equity interests in the fund by limited partners; and

(iv) early termination upon dissolution, provided that exits from all portfolio investments have been realised, all debts have been fully repaid and all the remaining assets have been distributed to its investors.

For an FIVCIE that is in corporate form, there may be additional requirements that would apply under the various laws, provisions and implementing rules on Sino-foreign Equity Joint Venture Enterprises and Wholly Foreign-owned Enterprises.

For instance, any transfer of equity interest in a corporate FIVCIE will need to get the written consent of other parties and the approval of the original approval authority (and most likely the Authorised Local Agencies thanks to Circular 9). On the other hand, transfer of limited partnership interest in a non-legal person FIVCIE will only need to be filed with the Authorised Local Agencies.

Is the FIVCIE still an optimal vehicle?
The recent regulatory developments present foreign investors with both opportunities and challenges.

Quasi-limited partnership that allows direct foreign ownership

As discussed earlier, China does not yet have a national foreign investment partnership law that incorporates a legal form of limited partnership. Therefore, a non-legal person FIVCIE remains as the only viable form, under the present regulatory regime, that could accommodate direct foreign general partners and limited partners in a quasi-limited partnership structure. In such structure, it is possible to incorporate essentially all the terms that are typical in an offshore limited partnership agreement, subject to any existing restrictions or limitations on foreign investments.

Mofcom has reportedly been in the process of promulgating the Administrative Rules on Foreign Invested Partnerships. But from the draft it appears that the Rules are not tailored for private equity or venture capital activities. If promulgated in the current form, the rules will therefore not be completely in line with international private equity norms.

Statutory waiver from Circular 142

On August 29 2008, the State Administration of Foreign Exchange (Safe) issued Circular 142 – the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-funded Enterprises. This Circular explicitly prohibits any “foreign invested enterprise” (FIE) from using any renminbi converted from foreign capital under its capital account to make equity investments in China.

A subsequent Safe circular dated November 14 2008 (Circular 125) creates a specific exception for an FIVCIE, notwithstanding its status as an FIE, giving the FIVCIE a further boost as a preferred form of RMB Fund.

Fast-track approval procedure

Pursuant to the FIVCIE Rules, portfolio investments by FIVCIEs are only subject to a “filing” process which will take no more than 15 days, so long as the portfolio falls into the “encouraged” or “permitted” categories under the 2007 Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录).

If implemented strictly, this filing process will put FIVCIE in a niche position compared to an offshore fund which will be subject to the typical approval procedures that apply universally to any foreign direct investment. However, anecdotal evidence suggests that local counterparts of Mofcom have not always been friendly to FIVCIEs seeking favourable treatment in the “encouraged” or “permitted” sectors.

Uncertainties with pass-through status

Foreign investors in a non-legal person FIVCIE used to rely on Circular 61, promulgated by the State Administration of Taxation in 2003, to avoid the FIVCIE being recognised as their permanent establishment in China. Pursuant to the circular, Issues Related to Payment of Enterprise Income Tax by Foreign-invested Venture Capital Investment Enterprises, foreign investors in a non-legal person FIVCIE would only be subject to withholding tax, at a reduced rate if located in a tax-efficient jurisdiction, but no PRC enterprise income tax.

With the promulgation of the PRC Enterprise Income Tax Law (中华人民共和国企业所得税法), however, the continued validity of Circular 61 is no longer clear. Although on the website of the State Administration of Taxation it has been marked as “ineffective”, it is rumoured that the Administration is in the process of drafting a similar regulation to give non-legal person FIVCIEs (in particular those grand-fathered ones) a renewed life.

Conclusion
With the recent changes to the regulatory landscape, new opportunities arise and challenges remain. Under the present regulatory framework, the FIVCIE remains as the only statutory form that can have both foreign and domestic general partners and limited partners on board. The combined effects of Circular 142 and 125 create a niche position for FIVCIEs in terms of foreign exchange control. At least on paper, an FIVCIE prevails over an offshore fund in terms of downstream investments; in practice, the experiences are not always so pleasant. The biggest challenge, however, arises from the uncertainties surrounding the (continued) life of Circular 61. In that respect, practitioners are keeping their fingers crossed.