Hedge Funds in China November 2012
Q1: What is the definition of “Hedge Fund” in China?
A1: There is no comprehensive legal or universally accepted definition of “Hedge Fund” in China. Generally, they share certain common characteristics, including: being privately offered; requiring investors to have a certain minimum net worth and/or level of financial sophistication; investing in equity securities, fixed income securities, derivatives, futures and other financial instruments; having a perpetual term; imposing liquidity restrictions on investors’ capital; pursuing absolute return rather than measuring investment performance in relation to a benchmark; compensating managers with incentive fees; allowing considerable flexibility in investment strategies; being highly leveraged; and being subject to limited regulatory supervision.
Q2: What is the current investment and legal protection environment in China in respect of Hedge Fund?
A2: Currently, hedge funds are not recognized by law. Nevertheless, various regulated hedge fund-like financial products have been thriving in the Chinese market for 10 years. International managers have been accessing Chinese stock markets for over a decade. The regulatory framework for this is now fairly established. By contrast, foreign exchange controls and the lack of a private placement regime have prohibited international managers from accessing Chinese investor capital. Shanghai announced that it has initiated a pilot program to allow qualified Chinese investors (including those domiciled outside Shanghai) to invest in qualified international hedge funds, and this brings the possibility for the new, stable source of investor capital to access the global hedge funds industry.
Q3: Why the Hedge Fund is not recognized and unregulated in China?
A3: It is largely attributable to the fact that ‘securities’ regulated under the Securities Law of the People’s Republic of China are narrowly confined to stocks, bonds and shares in regulated mutual funds. As such, the private offering provision in the Securities Law technically does not apply to the offering of interests in hedge funds, whether they are organized as limited partnerships or limited liability companies. Another factor is that the application of the PRC Securities Investment Funds Law is limited. It only applies to publicly offered mutual funds. Provisions concerning privately offered funds were removed from the final text of the law following intense debate on whether the Chinese regulators should recognize such privately offered funds, how to regulate them and when would be the appropriate time to enact legislation.
Q4: What is the recent development of the security investment fund in China?
A4: At the beginning of 2011, a consultation draft of a proposed amendment to the Securities Investment Funds Law was circulated to various governmental authorities and certain market participants for comment. One main feature of the proposed amendment is to extend the application of the law to privately offered investment funds. Among other things, a noteworthy provision in the consultation draft is that privately offered funds will generally be required to register with the appropriate regulators, with the exception for those funds whose assets under management or number of investors is below a threshold to be specified by the regulators. In July 2012, a revised consultation draft of the proposed amendment to the Securities Investment Funds Law was published by the Chinese National People’s Congress on its website to solicit public comments.
Q5: What is the structure of Chinese financial regulatory regime?
A5: In China, unlike the USA or other countries, banks and trust companies, as well as their financial products, are regulated by the China Banking Regulatory Commission (CBRC’), while securities companies and fund management companies, and their financial products, are regulated by the China Securities Regulatory Commission (CSRC). Similarly, insurance companies and their products are regulated by the China Insurance Regulatory Commission (CIRC). Thus, hedge fund-like products developed by different financial institutions are regulated by different regulators and are subject to different regulations.
Q6: Are there any representation of the regulated Chinese Hedge Funds?
A6: Currently ‘sunshine funds’, a closed-end product offered by trust companies and regulated by the CBRC, are widely regarded by the market as the best representation of Chinese hedge funds. There is no official definition of ‘sunshine funds’ in any regulation. The term “sunshine funds” was created to distinguish from unregulated (underground) privately offered funds. From a regulatory perspective, ‘sunshine funds’ refers to pooled funds schemes or ‘trust units’ launched by trust companies under the Administrative Measures on the Pooled Funds Schemes of Trust Companies (Hereinafter referred to as the “(Pooled Funds Schemes Measures”) promulgated by the CBRC and brought into force on March 1 2007. In addition to sunshine funds offered by trust companies, the CSRC permits two types of regulated private asset management service for China onshore fund management companies and securities companies, respectively
Q7: What kind of investor could be considered as qualified under the Pooled Funds Schemes Measures?
A7: Generally, qualified investors have to meet at least one of the following tests:
1. Capable of investing a minimum of RMB 1.0 million in a single trust unit;
2. (For natural persons) Having verifiable personal or family financial assets in excess of RMB 1.0 million at the time of subscription; or
3. Having verifiable annual income in excess of RMB 200,000 (or RMB 300,000 if counting spouse’s annual income) in each of the previous three years.
Q8: How to distribute the sunshine funds under the Pooled Funds Schemes Measures?
A8: In practice, sunshine funds are distributed through many channels in China, including commercial banks’ wealth management divisions, private banks, securities companies, fund management companies and trust companies themselves.
Q9: What is the so called “underground privately offered funds” in China?
A9: It refers to the funds managed by unlicensed asset managers that raise capital privately through their personal contacts. Underground privately offered funds have been thriving despite their ‘illegitimate’ status.
Q10: What is QFII?
A10: It refers to the Qualified Foreign Institutional Investor.
Q11: How to access the Chinese stock market?
A11: To access the Chinese stock market, the QFII regime or a presence in China could be used, while the new way is through qualified domestic limited partner pilot scheme.
Q12: What kind of structures could be used for the non- QFII hedge funds to access Chinese A shares market?
A12: There are mainly three ways:
1. By using a direct trading facility, whereby an international hedge fund could place orders to buy or sell A shares by borrowing a proportion of a QFII’s quota;
2. By entering into a total return swap with a QFII, which created an equivalent economic exposure to the relevant A shares via a direct trading facility; and
3. By investing in indirect market access products, such as participatory notes or other structured products offered by QFIIs.
Q13: What structures could be chosen for establishing the presence.
A13: Generally, there are three structures that can be deployed:
1. Representative offices of foreign securities institutions (securities rep offices);
2. Unregulated general representative offices (general rep offices); and
3. Wholly foreign owned consulting companies.