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January 24, 2011 | BY

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A new set of rules heralds easier access to Chinese investments for overseas private equity funds

On January 11, the Shanghai municipality officially published its Implementing Measures for the Launch of a Pilot Foreign-invested Equity Investment Enterprise Project in the Municipality (上海市关于本市开展外商投资股权投资企业试点工作的实施办法) (Measures). The Measures provide detailed rules regarding how to set up a Foreign-invested Equity Investment Enterprise (FIEIE) and a Foreign-invested Equity Investment Management Enterprise (FIEIME).

The main purpose of the Measures is to solve hotly-debated issues regarding foreign exchange funds and the legal status of a foreign-invested private equity (PE) fund. Chapter 4 of the Measures is a key part related to the pilot project of FIEIEs and FIEIMEs (Pilot Programme). If an FIEIME or an FIEIE is qualified under the Pilot Programme, Chapter 4 provides solutions to the following three key issues: (i) restrictions of the State Administration of Foreign Exchange (Safe) Circular 142 on an FIEIME when investing in its managed fund; (ii) foreign exchange issues of an FIEIE; and (iii) the legal status of an FIEIE.

Article 9 of the Measures provides the fundamental requirements for setting up an FIEIME. In addition, Article 24 of the Measures provides that if an FIEIME is qualified under the Pilot Programme, it may contribute to an equity investment enterprise established by it as a promoter with foreign exchange funds, up to 5% of the committed capital; and such portion of capital contribution will not affect the original nature of the equity investment enterprise that it has invested in. This means that if an FIEIME manages a domestic equity investment enterprise and invests in this enterprise, its investments in this domestic enterprise do not change the legal nature of this domestic enterprise to a foreign-invested enterprise (FIE). Article 21 of the Measures requires that an FIEIME or its “affiliate” applying to qualify under the Pilot Programme shall have at least a good three-year track record of “direct or indirect investments” in enterprises in China.

Article 14 of the Measures provides the fundamental requirements for setting up an FIEIE. In addition, Article 25 of the Measures provides that if an FIEIE is qualified under the Pilot Programme, it may go through custodian banks to process their onshore equity investments with foreign exchange funds. Articles 19 and 20 of the Measures provide rules regarding how to apply to qualify under the Pilot Programme for an FIEIE which shall have qualified offshore institutional investors, widely known as the Qualified Foreign Limited Partner (QFLP). Additionally, Article 18 provides that an FIEIE shall make equity investments in China in compliance with foreign investment-related laws.

According to the newly-issued Measures, foreign capital may enter the Chinese PE market through three possible alternatives in Shanghai.

The first alternative is that an FIEIME promotes an FIEIE. If both entities are qualified under the Pilot Programme, the FIEIE may use its foreign exchange funds to invest in Chinese enterprises. Meanwhile the FIEIME may convert its foreign exchange funds and invest into its managed FIEIE up to 5% of the committed capital of the FIEIE.

The second alternative is that the management enterprise is an FIEIME but its managed fund is a pure domestic equity investment enterprise. If such an FIEIME is qualified under the Pilot Programme, it may contribute up to 5% of the committed capital to this domestic equity investment enterprise with foreign exchange funds. This portion of the capital contribution will not affect the original nature of the domestic equity investment enterprise that it has invested in.

The third alternative is that the management enterprise is a domestic PE Manager but its managed fund is an FIEIE. In order to solve foreign exchange funds investment issues, this FIEIE needs to be qualified under the Pilot Programme.

It is worth noting that although Chapters 2 and 3 of the Measures provide detailed rules regarding the set-up of FIEIMEs and FIEIEs, they may still encounter foreign exchange issues as before if they are not qualified under the Pilot Programme. Thus, becoming qualified according to Chapter 4 is key for foreign PE players to enter into the Chinese market. Finally, but not surprisingly, although the Measures provide the requirements for the QFLP and Pilot Programme application, local authorities still retain much discretion on approvals of such applications. Although it is widely reported in the media that the QFLP will have a US$3 billion quota, the Measures don't specifically provide a number.

Shawn Sun, Guangsheng & Partners, Beijing

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