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Asia In Focus

December 16, 2011

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Orrick's Asia Private Equity Practice

Covering all aspects of the private equity business cycle from fund formation, regulatory issues and capital raising, to investment, company representation and management, and exits via listings or trade sales, Orrick's Asia private equity team represents global private equity investors on a wide range of activities across the Asia-Pacific region. Clients include Mount Kellett Capital, One Equity Partners, PineBridge Capital (formerly AIG Investments) and Warburg Pincus.

For information, please contact:

Maurice Hoo
Partner, Hong Kong
+852 2218 9130

Sook Young Yeu
Partner, Hong Kong
+852 2218 9155

Brad Herrold
Of Counsel, Beijing
+86 10 8595 5616

NDRC Expands Mandatory Filing of RMB Funds Nationwide


On November 23, 2011, China's National Development and Reform Commission (the NDRC) issued the Circular on Promoting the Standardized Development of Equity Investment Enterprises (Fa Gai Ban Cai Jin [2011] No. 2864) (Circular 2864), which came into effect on the date of issuance.  Circular 2864 follows the Circular on Further Regulating the Development, and the Administration on Filings, of Equity Investment Enterprises in Pilot Areas, issued January 31, 2011 (Circular 253) and 11 guidelines issued on March 21, 2011 (the Guidelines).  Circular 253 described certain "best practices" for "equity investment enterprises," which include private equity funds and fund of funds ("EIE") and required certain EIEs established in six pilot locations to carry out a filing procedure with the NDRC.  The Guidelines clarified some ambiguities under Circular 253, set forth various procedures and forms for carrying out the filing, and recommended certain content for the key documents that would accompany a filing submission.  Please see our Asia in Focus newsletters on Circular 253 here and on the Guidelines here.

Expanded Scope of Filing Procedure

Circular 2864 extends the reach of Circular 253 beyond the pilot locations to cover EIEs established in mainland China.  An EIE with a fund size of at least RMB 500 million (or its foreign exchange equivalent) is required to submit to the NDRC an application to carry out the filing procedure within 30 days after the issuance of a business license, unless (i) it is a venture capital enterprise that makes filings in accordance with applicable laws, or (ii) all its capital is contributed by one institutional or individual investor, or by one institution through its wholly owned subsidiaries.  Whereas Circular 253 expressly excluded EIEs with a fund size of less than RMB 500 million, Circular 2864 requires such EIEs to carry out the filing procedure with the relevant filing administration department at the Provincial People's Governments.

Application to Foreign Invested Funds and Fund Managers

It often takes time to determine whether a new rule or policy in China will be applied to foreign investors and foreign invested enterprises, absent an express statement on point.  Like Circular 253 and the Guidelines, Circular 2864 does not distinguish between purely domestic invested funds, foreign invested funds and funds with domestic investors but a foreign or foreign invested fund manager.  Circular 2864, however, requires a foreign invested EIE to carry out the standard NDRC project verification and approval procedure, if applicable, when it makes portfolio investments.  Based on this express reference, it appears that Circular 2864 is intended to apply to foreign invested funds and fund managers.

Lack of National Treatment for Foreign Invested Funds

Circular 2864 does not expressly state whether a foreign invested EIE, or a fund with domestic investors but a foreign or foreign invested fund manager, will be treated as a domestic invested fund or subjected to the restrictions and delayed closing requirements imposed under China's foreign investment regime.  Borrowing from WTO lexicon, this concept is often referred to as an extension of "national treatment."

Foreign investment projects in China generally require project approval from the NDRC (where the project involves fixed assets), foreign investment approval from the Ministry of Commerce (MOFCOM) and registration with the State Administration for Foreign Exchange (the SAIC), or their respective subordinates at the local level.  These procedures are lengthy and document-intensive.  Moreover, foreign investors and foreign invested enterprises are limited in their ability to invest in certain industries, including the internet, media and related sectors.

By contrast, domestic enterprises generally are permitted to make equity investments in other domestic enterprises that operate in these growth industry sectors by carrying out only the registration procedure with the SAIC or its subordinate at the local level.  Hence, if foreign invested EIEs, and funds with domestic investors but a foreign or foreign invested fund manager, are given national treatment, they would be able to compete with purely domestic invested funds on a level playing field.

By requiring a foreign invested EIE to carry out the standard NDRC project verification and approval procedure, where applicable, Circular 2864 appears to consider equity investing by foreign invested funds as subject to the approval delays and other restrictions applicable under China's foreign investment regime.  As Circular 2864 is an internal document, and hence MOFCOM and the SAIC did not participate in its preparation and promulgation (and have not publicly commented on its application), at this time we assume that Circular 2864 does not extend national treatment to foreign invested EIEs.

Unresolved Foreign Exchange Restrictions

In accordance with China's foreign exchange control rules, the foreign currency contributions to a foreign invested enterprise may not be converted into RMB for the purpose of making equity investments, except where such conversion is expressly permitted.  Hence, unless it has independently generated sufficient RMB cash or it qualifies under one of the widely reported quota systems for "qualified foreign limited partners" that are expressly permitted in certain pilot cities, a foreign invested EIE may not be permitted to fund its investments.  Circular 2864 does not address this issue, and it remains to be seen if the central government will issue rules to expressly permit the conversion of foreign currency by foreign invested EIEs, or funds with domestic investors but a foreign or foreign invested fund manager, for the purpose of making equity investments.

Verification of the Number and Qualification of Investors

The Circular 2864 provides that the number of investors in an EIE must conform to the relevant provisions of the Company Law of the People's Republic of China (Company Law) and the Partnership Enterprise Law of the People's Republic of China (Partnership Law).  The Company Law limits a company limited by shares to between two and 200 promoters and a limited liability company to no more than 50 shareholders, while the Partnership Law requires a general partnership to have two or more partners and a limited partnership to have one general partner and no more than 50 limited partners.  The NDRC will calculate the number of investors by examining the actual individual or institutional investors involved without regard to investors who aggregate their investments jointly through a trust, though it will treat a fund of funds as a single investor.  It also will verify the qualifications of each investor.