Foreign PE enterprises should gear up for evolving legal regime
March 07, 2011 | BY
Candice MakNew circular provides detailed operational rules
Private equity (PE) players must pay attention to new operational rules and make prospective arrangements to keep up with the rapidly-changing legal environment.
On February 22, the National Development and Reform Commission (NDRC) published an announcement on its website that it had issued a new law further governing the registration and administration of private equity (PE) funds. The Circular on Further Regulating the Development and the Administration by Record Filing of Equity Investment Enterprises in Pilot Areas (关于进一步规范试点地区股权投资企业发展和备案管理工作的通知)(the Circular) was distributed to provincial governments, but has not been published to the general public. It will apply in Beijing, Shanghai, Tianjin, Zhejiang, Jiangsu and Hubei.
The Circular is a significant attempt from the central government to regulate PE players in the Chinese market. Most current state and local PE regulations are general and focused on market entrance and incentive policies, but the Circular focuses on detailed operational issues of PE funds. William Liu, a Shanghai-based partner at Boss & Young said: “The Chinese government is adopting certain experiences and practices prevailing in more developed PE markets, such as information disclosure, voting for affiliate transaction, and moderate supervision, among other things.”
According to market commentators, the release of the Circular by a national regulator is an indicator that the central government is planning to establish a relatively uniform legal regime for PE enterprises in China. Up until now, most regulations pertaining to these were established and developed by local governments in “pilot areas” such as Beijing, Shanghai and Tianjin. “It is expected that the central government will issue more national administrative rules on PE enterprises, and at the same time, expand pilot areas to allow them to do business in more cities in China,” said Liu.
“I believe the legal system for PE enterprises in China will be more complicated and improved in the future,” he continued. “PE enterprises will have to pay more attention to national administrative rules rather than different local policies.”
The new measure requires that private equity firms managing assets worth over Rmb500 million must register with and provide regular reports to the NDRC. “One of the rules' key objectives is enabling the NDRC to keep tabs on these registered funds in order for the National Social Security Fund (NSSF) to better commit investment to these funds,” said Hubert Tse, another partner in the Shanghai office of Boss & Young. The NSSF is China's largest Limited Partner (LP) and can invest up to US$12 billion into the asset class. If PE funds want NSSF money, they must register with the NDRC because the NSSF is restricted to investing only in NDRC-approved PE enterprises.
Funds that do not register with the NDRC will be listed on the regulator's website and labeled “规避备案监管股权投资企业和受托管理机构”, which roughly translates to “equity investment enterprises and appointed management institutions circumventing record-filing or regulation”. Tse noted: “This likely will not look so good on them from the perspectives of potential local or foreign LPs”.
In addition to this registration requirement, the new regulation also provides detailed rules on capital raising, areas of investment and risk control.
PE enterprises must disclose investment risks to its investors, make no guarantees on repayment of capital or fixed returns, invest only in the equity interest of non-publicly traded enterprises, and they cannot provide guarantees for any enterprises other than those they have invested into. If a PE enterprise wants to invest into its affiliates, these affiliates should have no part in the decision-making process of the investment.
The Circular says investors can only use their legitimate self-owned cash to make investments and that capital can only be collected through private placements from “specific investors” who have investment risk-identification abilities and relevant risk-bearing capacities. Unused capital must be deposited in banks or be used to purchase government bonds or other securities with
fixed returns.
During fundraising, these activities are prohibited: 1) making public announcements through the media; 2) posting notices ; 3) distributing leaflets; 4) sending SMSs; 5) holding public seminars or giving lectures; and 6) placing the prospectus on the counters of any financial institutions.
Legal specialists are expecting the new PRC Securities Investment Fund Law to be submitted for approval soon. CM
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