Private equity fund plan could offer new gateway for foreign investors - International Law Office

The Oriental Morning Post has reported that the Trial Plan for the Participation of Foreign Investment in Renminbi Equity Investment Funds was approved by the Shanghai government on March 15 2010. This development will be fully publicized in April 2010 and will initially be implemented in the Pudong New Area. The trial plan will open a gateway for the conversion of foreign exchange into renminbi, which has been a major factor in preventing foreign general partners and limited partners from becoming involved in the renminbi private equity fund industry.

According to Circular 142/2008, unless otherwise provided for under law, the capital of a foreign-invested enterprise cannot be used for equity investment. If a foreign-invested enterprise intends to act as the general partner of a renminbi private equity fund, it will find it difficult to satisfy the general partner's renminbi commitment - which is often 1% of the total fund commitment - because it cannot convert its capital into renminbi. Furthermore, this effectively blocks the means by which a foreign-invested enterprise can act as a limited partner because it is much more difficult to satisfy the corresponding renminbi commitment, which is typically much higher than a general partner's commitment.

The trial plan is intended to establish a qualified foreign limited partner mechanism by adopting an approach resembling the qualified foreign institutional investor system. This will allow foreign-funded general partners and limited partners to convert foreign exchange capital into renminbi. The aggregate quota for foreign exchange convertible into renminbi may not exceed 50% of the fund and the quota for a general partner may not exceed 5% of the fund size.

It is unclear whether the terminology 'foreign-funded general partners and limited partners' refers to foreign investors only or includes foreign-invested enterprises, which are Chinese entities that are partly or wholly owned by foreign investors. As investors with experience of the Chinese private equity industry will know, a domestic partnership's partners must all be Chinese individuals or Chinese entities (potentially including foreign-invested enterprises). This allows indirect foreign investment, albeit with difficulties arising from foreign exchange conversion. However, a foreign-invested partnership may directly accommodate a foreign general partner or limited partner. Therefore, a Chinese partnership and a foreign-invested partnership both allow for the participation of foreign investment. This said, it is unclear whether the trial plan will apply to both Chinese partnerships and foreign-invested partnerships.

A Chinese partnership with indirect foreign investment is likely to be treated equally with other purely Chinese funds in terms of portfolio investment, but a foreign-invested partnership will be treated as a foreign investor and will be subject to industrial restrictions and cumbersome approvals. If the trial plan applies to Chinese partnerships, that will be a real breakthrough and Pudong will be better positioned to attract renminbi private equity funds than its competitors in China.

For further information on this topic please contact Zhang Yi or Alan Du at King & Wood by telephone (+86 21 2412 6000), fax (+86 21 2412 6150) or email (zhangyi@kingandwood.com or alandul@kingandwood.com).