• Shanghai Implements QFLP Measures for Foreign RMB Funds and Fund Managers
  • September 27, 2011
  • Law Firm: SNR Denton - Chicago Office
  • Over the past few years, municipal governments in China (including Beijing, Shanghai and Tianjin) have encouraged the growth of the domestic private equity and venture capital industry by enacting regulations that permit the establishment of foreign-invested partnerships in their respective jurisdictions.1 This support, together with investor confidence in the strength of the Chinese economy, has made many foreign fund managers interested in raising RMB denominated private equity funds.

    Despite the many perceived advantages of this type of private equity investment structure, foreign-invested funds have faced obstacles due in large part to myriad restrictions applicable to foreign investments in China and the lack of proven channels to convert foreign currency into RMB for investment purposes. However, Shanghai’s recently enacted measures on qualified foreign limited partnership funds (the "QFLP Measures") creates a potential avenue to structure foreign-invested RMB funds so as to avoid certain foreign investment restrictions while potentially easing the currency conversion process.

    The QFLP Measures were jointly instituted on December 24, 2010, by the Shanghai Municipal Financial Affairs Office, the Shanghai Municipal Commission of Commerce ("Shanghai COFTEC") and the Shanghai Municipal Administration for Industry and Commerce ("Shanghai AIC"). The QFLP Measures provide guidance on the formation and operation of foreign-invested private equity investment entities ("Foreign-invested Funds") and foreign-invested private equity management enterprises ("Foreign-invested Fund Managers") that have been established in Shanghai. In addition, the QFLP Measures have created a special pilot program (the "Pilot Program"), whereby private equity funds raised and managed by qualified Foreign-invested Fund Managers may conditionally be exempt from certain foreign investment restrictions.

    Domestic or Foreign Treatment for Indirectly Foreign-Invested Funds?

    The Ministry of Commerce ("MOFCOM") issued a circular in early 2011 that clarified that the "foreign-invested partnership"2 structure would be regarded by MOFCOM as a foreign entity, and that its investments in underlying portfolio assets in China would be subject to foreign investment restrictions. One of the most important issues in connection with the QFLP Measures is whether a certain type of foreign-invested partnership (i.e., a domestic PRC partnership that is formed by a foreign-invested (rather than purely foreign) general partner and manager, with limited partners that are entirely from the PRC (an "Indirectly Foreign-invested Fund") would be subject to the same foreign investment restrictions as typical "foreign-invested partnerships." Although a plain reading of the QFLP Measures indicates that an Indirectly Foreign-invested Fund raised and managed by a Foreign-invested Fund Manager qualified under the Pilot Program would not be subject to foreign investment restrictions (provided that such a fund is raised solely from domestic limited partners), our preliminary discussions with PRC regulators appears to indicate that "domestic treatment" for Indirectly Foreign-invested Funds may not necessarily extend to all industry sectors and would be determined by the regulators on a case-by-case basis. In addition, even if an Indirectly Foreign-invested Fund is treated as a "domestic fund" by regulatory authorities in Shanghai with respect to its investments in Shanghai, it is unclear whether such a fund would receive similar treatment for its investments in other jurisdictions.

    The 5 Percent Rule

    Another key feature of the Pilot Program is a provision allowing the general partner of a fund (the "GP", i.e., the Foreign-invested Fund Manager) of an Indirectly Foreign-invested Fund to convert its capital contributions into RMB for the purpose of investing in the private equity fund(s) that it sponsors. This conversion is possible if (i) the total amount of the GP’s capital contribution does not exceed 5 percent of the total capital to be raised for the fund and (ii) the Foreign-invested Fund Manager that is acting as the GP otherwise qualifies under the Pilot Program (requirements are set forth below) (the "5 Percent Rule").

    The 5 Percent Rule marks the first time that regulators have lifted the restriction on foreign currency conversion through local regulations. The 5 Percent Rule is thus generally regarded as a significant step forward in the regulatory regime with respect to foreign participated private equity funds. It remains to be seen, however, whether other cities will follow in Shanghai’s footsteps, particularly in light of the tightening macro-economic environment in the PRC.

    Foreign Exchange Advantages

    A significant perceived advantage of being qualified as a pilot Foreign-invested Fund relates to foreign currency conversion. To date, existing regulations by the state administration of foreign exchange ("SAFE") have created substantial obstacles for the onshore investment of foreign-invested private equity funds, given the lack of a sanctioned mechanism for the conversion of foreign partner capital contributions into RMB. It is anticipated that SAFE and the Shanghai Municipal Financial Service Office ("SFSO") may ease currency conversion restrictions with respect to investments by Foreign-invested Funds.

    Summary of Key Features of the QFLP Measures

    Regulatory Authorities

    A joint commission led by the Shanghai Finance Affairs Office, Shanghai Commerce Commission, Shanghai Administration of Industry and Commerce, Shanghai State Administration of Foreign Exchange and other enumerated authorities (the "Joint Commission") will determine whether a Foreign-invested Fund Manager or a Foreign-invested Fund qualifies under the Pilot Program.

    Set forth below are key features with respect to formation and operational requirements of Foreign-invested Funds and Foreign-invested Fund Managers. In addition to the documents and information below, the Joint Commission has discretion to request additional documents from applicants.

    Foreign-invested Equity Investment Enterprises

    The QFLP Measures define a Foreign-invested Fund (i.e., a "foreign-invested equity investment enterprise") as an enterprise formed in Shanghai that is primarily engaged in investing equity in unlisted Chinese companies. As the name implies, the key characteristic of these funds is that some or all of the owners of such funds are foreign entities or individuals.

    • Capital Requirements. The Foreign-invested Fund’s total subscribed capital should be at least US$15 million, contributed in cash. The capital contribution by each limited partner must be no less than US$1 million. The QLFP Measures do not specify a minimum investment amount for the general partner of a fund.
    • Permitted Business Scope. The business scope of Foreign-invested Funds under the Pilot Program may include:
      • Making equity investments (including the establishment of new companies, investment or acquisition of equity interests in an existing target company)
      • Providing management and consulting services to the underlying portfolio companies, the investee companies
      • Other related businesses recognized by the registration authorities
    • Prohibited Business Activities. A Foreign-invested Fund is not permitted to trade stocks or bonds in a public exchange, trade futures or other financial derivatives, invest in a real estate asset that is not for self-use or grant to third parties loans or guaranties.
    • Investor Requirements. Qualified foreign investors of a Foreign-invested Fund under the Pilot Program must satisfy the following requirements, including:
      • Own no less than US$500 million or manage no less than US$1 billion of portfolio assets in the fiscal year immediately preceding the year on which the application is filed
      • Have a sound governance structure and internal control system
      • Not have been subject to any judicial or administrative penalty in the past two years
      • Have an investment track record (it or its affiliates) of at least five years

    Foreign-invested Fund Managers

    The QFLP Measures also regulate the formation and operation of Foreign-invested Fund Managers (i.e., "foreign-invested equity management entities"). A Foreign-invested Fund Manager is typically set up as the general partner of either a Foreign-invested Fund established under the Pilot Program or an RMB fund established under the PRC domestic partnership regime, whose limited partners are all domestic entities or individuals.

    • Capital Requirements. The Foreign-invested Fund Manager must have minimum registered capital of US$2 million, with at least 20 percent of its registered capital contributed within three months after issuance of its business license. The balance of its registered capital must be contributed within two years afterward.
    • Business Scope. The business scope of the Foreign-invested Fund Manager’s investor or such investor’s affiliate must include equity investment or equity investment management business. The Pilot Program specifically permits Foreign-invested Fund Managers to (i) sponsor private equity fund(s), (ii) manage the investment activities of fund(s), (iii) provide investment consulting services and (iv) engage in other relevant business activities approved by the authorities. A Foreign-invested Fund Manager can both sponsor and act as the GP of a fund.
    • Management Experience. The Foreign-invested Fund Manager must engage at least two senior officials who each have (i) more than five years of experience in the equity investment or equity investment management business, (ii) more than two years of experience in a senior management position, (iii) experience with equity investments or financial institutions in China and (iv) a clean five-year track record with respect to economic disputes.

    Application and Reporting Requirements

    Foreign-invested Funds and Foreign-invested Fund Managers seeking qualification under the Pilot Program must file an application with the SFSO through its executive partner or the executive partner of the fund or fund manager that is to be formed. Such executive partner or its affiliate is required to have a solid three-year track record of investing in Chinese companies. The required application documents are set forth below.

    • Application letter, along with required appendices (including supporting documents certifying the aforesaid requirements, business license and audited financial statements for the preceding year)
    • Information on the equity investment enterprise (including prospectus, partnership agreement covering offshore investor’s capital contribution, commitment amount as well as fundraising schedule, and resumes of senior management)
    • Information on the custody bank and relevant documents signed with the custody bank
    • Commitment letter ensuring the authenticity of all the information and documents provided

    Reporting Requirements

    Foreign-invested Funds and Foreign-invested Fund Managers who have qualified under the Pilot Program must register with the AIC and, on a semi-annual basis, report any material events (as set forth in the QFLP Measures) arising out of their investments and management activities to the local government agency overseeing the fund or fund manager.


    The QFLP Measures are a solid step forward for the private equity industry in China. While the ramifications of the QFLP Measures on key issues such as "domestic treatment" of Indirectly Foreign-invested Funds and foreign currency conversion remain to be seen, the QFLP Measures are an encouraging sign that regulatory authorities are taking active steps to bring the industry into a more mature stage of development.

    1 The central Chinese government has not promulgated any national law or regulation that clearly allows Foreign-invested Funds or Foreign-invested Fund Managers to be established in the PRC. Therefore, a Foreign-invested Fund established under a local regulatory regime (e.g., Beijing) may encounter investment restrictions or other regulatory hurdles when it seeks to do business outside its jurisdiction of formation.
    2 A "foreign-invested partnership" or "FIP" typically refers to a partnership that is set up by a wholly foreign general partner entity and limited partners consisting of all or partial foreign entities/individuals.