As the world’s second largest capital market, China is one of the most important channels for global investors engaging in asset allocation. With the gradual opening up of its capital market, an increasing number of foreign institutional investors are expanding their business scope across the country. Against headwinds brought about by COVID-19 and global uncertainty, China’s private equity (PE) industry has continued to flourish.
Jointly released by Tricor and JunHe, "Foreign Private Equity Funds In China - Guide to Market Entry and Operations 2022" provides an interpretation of the development of foreign PE funds and relevant regulatory provisions in China, and suggestions for establishment and operations.
The whitepaper outlines the status quo and development trends, main market access forms, key tax-related matters, as well as operations and compliance. We hope that it can serve as a reference for foreign PE fund managers and their peers.
PE funds can be traced back to the late 19th century in the United States. Modern operational patterns and characteristics arose in the mid-20th century. While international PE has continued to develop, PE was first introduced in China just 30 years ago. Despite being a latecomer to the market, China has seen early success owing to the domestic market's high potential and resilient growth since reform and opening up.
Despite having a fairly late start, China’s private equity (PE) and venture capital (VC) market has grown rapidly in size due to vast economic entities and great development potential. Since 2016, China’s PE and VC markets have experienced continual growth in assets under management (AUM) and a rapid rise in global proportion. While international financial markets have been disrupted by COVID-19 and geopolitical factors since 2020, China’s PE market has maintained a strong momentum.
With the advancement of the market economy and the development of multi-level capital market, PE has developed rapidly and will continue to expand. As the market enters a phase of higher quality development, the sector will reshuffle.
Foreign PE funds started to invest in China in 1993. They have taken shape over the last 30 years, and are now entering a phase of systematic operation, and demonstrating distinctive patterns. From the perspective of the fund source, foreign PE fund entities in China’s investment market mainly include: Foreign: PE fund limited partners (LP) comprise one or more foreign entities, and Joint venture (JV): PE fund LP comprises foreign investment. Broadly speaking, foreign investment in these parts constitutes the overall behavior of foreign PE funds investing in China.
Since its introduction to China in 1993, foreign PE funds have played an important role in raising and guiding social capital, developing real economy and promoting technological innovation. As China has recently promoted the opening up of its capital markets, foreign institutional investors are increasingly gaining access. Foreign PE funds exhibit different development characteristics at different stages.
The analysis of foreign PE investment events in China (including JV) between 2012 and 2022 reveals that biotechnology/ healthcare, IT industry, and Internet are the top 3 industries over the past decade in terms of the proportion of foreign PE fund investment in China. Recently, with China attaching great importance to the semiconductor industry, foreign investment in the country’s semiconductor industry is rapidly increasing.
The operation of foreign-invested PE investment funds should, on the whole, be conducted in accordance within the existing regulatory framework. The authorities have issued separate documents on, or specified in relevant documents, the market access, filing, registration and tax administration of foreign-invested funds.
In recent years, amid the opening-up of the financial industry, the regulatory authorities and self-disciplinary organizations for private funds in China have been promoting the opening-up of the private fund management industry, so as to attract more institutions with foreign investment background to China, introduce advanced overseas management experience, and provide more investment and asset management options for domestic investors to engage in overseas investments. On the one hand, the Chinese government has been promoting the opening-up by gradually expanding the financial sector from the pilot regions, encouraging foreign-invested private fund managers to enter the Chinese market and providing convenient options for investment and operation in China. On the other hand, the Chinese government is adhering to the principle of financial prudence, and emphasizes that opening-up shall achieve two objectives, namely, serving the real economy and guarding against systemic risk, and that market access qualifications will be granted only to select high-quality institutions.
Private funds (PF) are “investment funds established for fundraising from investors in a non-public manner”, and their “assets are managed by the fund managers or general partners” and “for the purpose of investment activities”. In accordance with applicable laws and regulations, PE funds in China can take the following three forms: company-type, limited-partnership-type, and contract-type.
In accordance with applicable laws and regulations, PE funds in China can take the following three forms: company-type, limited- partnership-type, and contract-type.
PFs adopt the principles of appropriate supervision and bottom-line supervision. The China Securities Reregulation Commission (CSRC) imposes administrative regulation on PE funds in accordance with the Interim Measures for the Supervision and Administration of Private Investment Funds and other departmental rules and normative documents. The Asset Management Association of China (AMAC) effects self-discipline management of the member institutions of the AMAC in accordance with its self-discipline rules.
The Measures for the Registration of Private Investment Fund Managers and the Filing of Funds (for the Trial Implementation), the Announcement on the Several Issues of Further Regulating the Registration of Private Fund Managers, the Instructions for the Registration of Private Investment Fund Managers, the Questions and Answers regarding the Registration and Filing of Private Funds, the Notice on Matters Related to the Registration and Filing of Private Fund Managers and other regulations released by the AMAC have made detailed provisions on the registration requirements for PFMs.
It is stipulated in Article 7 of the Interim Measures for the Supervision and Administration of Private Investment Funds that PFMs shall apply for registration with the AMAC in accordance with regulations.
The consummation of fund filing is an important prerequisite for smooth investment operations. The Instructions for the Filing of Private Investment Funds, Notice on Matters Related to the Registration and Filing of Private Fund Managers, Key Points for the Filing of PE/VC Funds and other regulations released by the AMAC set out specific provisions regarding the registration of the PFMs.
It is stipulated in Article 8 of the Interim Measures for the Supervision and Administration of Private Investment Funds that after private fundraising is consummated, PFMs shall complete the formalities for filing of funds in accordance with regulations of the AMAC.
The Foreign Investment Law institutionalized, via the highest legislature, results of China’s reform and adjustment of administration of foreign investments in recent years and reshaped the basic legal framework of administration of foreign investments.
Funds’ cross-border investments involving foreign capital mainly include 2 types: Offshore Investments by Onshore Funds and Offshore Investments by Foreign-invested Funds.
Main income streams of PE funds include: (1) Dividends from invested enterprises; and (2) Transfer of equity of invested enterprises. For PE funds, applicable taxes are primarily turnover tax and income tax. Analysis on PE funds should consider both taxation of the funds and of the institutional and individual investors of the funds.
Tax optimization of a PE fund should rely on advance planning. It is imperative to optimize taxation of the fund from inception, by considering the structures of fund investors and relevant factors, to avoid unnecessary tax costs.
PE funds institutionally fall into three types: limited companies, limited partnerships and trusts. The fund manager needs to opt for the appropriate form of organization to its own actual and the conditions of fund investors for the purpose of tax optimization.
For an LP equity investment enterprise or equity investment management enterprise, partners of the enterprise are taxed separately on income from operations and other incomes.
Partnership equity funds and partnership management enterprises shall not act as income taxpayers, and partners shall pay enterprise income tax and individual income tax respectively by following “allocation before tax payment”.
The income obtained by individuals in partnership equity funds is subject to individual income tax at 20% based on dividends, interest, bonuses or income from transfer of property.
To accelerate the construction of the core functional areas of financial centers and support the gathering and development of various financial institutions and talent in Pudong New Area, financial support measures have been promulgated during the “13th Five-Year Plan” period.
To support foreign institutions to invest in private equity investment fund in the Guangdong-Hong Kong-Macao Greater Bay Area through QFLP, as well as the development of the financial industry in Shenzhen. Also with the implementation rules of Qianhai Shenzhen-Hong Kong Modern Service Industry Cooperation Zone of Shenzhen for special funds for supporting the development of the financial industry.
Hainan will proactively promote the inclusion of foreign-invested equity investment enterprises into the Catalog of Encouraged Industries in Hainan Free Trade Port and the Catalog of Industries for Encouraging Foreign Investment, to enjoy corporate income tax preference.
Equity investment management talent can apply to be designated as high-level talent of Hainan province following relevant provisions. Eligible candidates enjoy preferential policies, such as registration of urban residents, purchase of housing and automobile, employment of spouse, enrolment of children, medical and housing security.
With China's multi-level capital market gradually establishing itself and the improvement of financial market opening up, the PE ecosystem is also expanding. Based on the industrial characteristics and business model, PE operations are particularly complex. Fund structure, archival filing and registration, withdrawal allocation, and liquidation exit are all considered. Foreign PE funds must also consider foreign exchange control requirements. In recent years, the internal operational difficulties of PE funds have increased, and operational efficiency has become a focal point.
Based on years of service experience, we have observed that foreign PE fund managers and funds face numerous complexities in their establishment and daily operations.
Operational compliance requirements for PE funds must be considered for registration, recording and submission of data, normalization of internal management and operations, fundraising, suitability management effectiveness, investments, information disclosure integrity, and legal opinions.
CRS (Common Reporting Standard) refers to a common reporting standard based on the same standard among countries and regions.
To implement CRS domestically, the State Administration of Taxation, the Ministry of Finance, the People’s Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission issued the Administrative Measures for the Due Diligence of Tax-Related Information of Financial Accounts Owned by Non-Residents (the Administrative Measures) on May 9, 2017, which came into force on July 1, 2017. The Administrative Measures specify the mode and requirements for the due diligence of financial accounts by domestic financial institutions, as well as the obligation of information submission.
In the operation process of investment, a PE fund shall fulfill the obligation of information disclosure under relevant provisions, including disclosing related information to investors and submitting and copying related information to AMAC. Currently, for PE investment funds, there is no mandatory requirement for quarterly disclosure. However, such funds shall fulfill the obligation of information disclosure at least every half a year.
Raising funds is an important part of the PE fund operations process and has strict compliance requirements.
Recently, restrictions on foreign exchange management and relevant policies have been gradually relaxed, making it more convenient for foreign capital to further participate in and engage in the funds business.
According to the Guidelines for the Valuation of Unlisted Equity Investment of Privately Offered Investment Funds (for Trial Implementation), a PE fund manager is designated as the principal person in charge of fund valuation and shall assume ultimate responsibility for valuation methods and parameters, among others, and test valuation conclusion regularly to prevent possible major deviations. They can combine multiple valuation methods for cross-validation. In recent years, with the development of PE funds, investment forms have become increasingly diversified. Since preferred share and parent, mezzanine, and S funds, among others, have emerged, ensuring a reasonable valuation has become a key element of operational compliance.
After deducting fees, investment income of a PE fund will be distributed between the LP and GP according to the designated method.
According to the distribution rules of a PE fund, operational costs of the fund shall be deducted before distribution. These costs include subscription, administration, custody, investment adviser, and other outsourcing service fees.
Fund liquidation is a legal procedure the PE fund must undergo to terminate its operation and is the last link in its operation. Its core purpose is to check, verify and deal with the PE fund’s property and terminate the legal relationship between the PE fund and its relevant parties.
We support a leading PE firm with a long-term relationship. By solving operational complexity we empower them to focus on their core objectives to achieve sustainable growth.
After PE funds were incorporated into the regulatory scope of the China Securities Regulatory Commission (CSRC) in 2013, the industry has developed rapidly, and plays an important role in promoting the formation of social capital, increasing the proportion of direct financing, facilitating technological innovation, optimizing the investor structure of the capital market, and serving the development of the real economy. Due to accelerated development and expanding scale, the Chinese PE fund market has become increasingly attractive to foreign institutions. For example, 43 wholly foreign-owned PE fund management companies currently conduct business in China and are expanding their business scope.
In 2022, the International Monetary Fund (IMF) adjusted the global economic growth rate to 3.2%. The global economy will continue to face uncertainties, such as inadequate economic boosts, increased inflation, and geopolitical crises, while macroeconomic fluctuations will continue to penetrate the industry-specific economy. The operation of equity funds will be confronted with new challenges. With increasingly strict regulations and more stringent requirements for information disclosure in recent years, PE fund managers not only face evolving compliance requirements, but also the pressure of business expansion based on the efficiency of mid-and back-stage operations.
Download our report and arrange a meeting with one of our specialists to learn how Tricor helps foreign private fund managers navigate the Chinese market.
Foreign asset management institutions recognize the long-term stable development and investment potential of the economy and are continuing to invest in China. In addition to business continuity and performance stability, foreign PE fund managers must also focus on the challenges of evolving compliance requirements, complex mid- and back-stage operations, and fierce local competition. Domestic investors are demanding more in terms of professional competence, investment strategies, and service systems. Based on long-term development strategies, PE fund managers should look to improve their professional investment skills and risk control ability, operational efficiency and compliance levels.
Hailiang ZhangCEO, Tricor Greater China
Recent years have seen increasingly stringent regulation of the PE industry and standardizing compliance has become a focal point. The regulatory authorities have promulgated specific provisions for the registration of PE fund managers and products, management structure, practitioner qualification, performance appraisal, remuneration management, accounting treatment related to asset management products, and finance & tax information reporting. Because of these industry characteristics, foreign PE fund managers face more complex business decisions, daily operational practices and compliance concerns across the entire life cycle of alternative investment business.
Xuting YouCOO, Tricor Mainland China
Following the promulgation and implementation of the Foreign Investment Law of the People’s Republic of China, the framework for the administration of foreign investment has undergone significant changes in recent years. China’s regulatory authorities and industry self-disciplinary organizations has implemented various policies to optimize the business environment for foreign institutions, sends a message to the global market about China’s commitment to firmly open up its financial markets. Foreign PE funds have been actively expanding their business footprints across China.
Shelley WangPartner, JunHe LLP
Foreign PE funds’ active participation in China demonstrates their confidence and long-term investment commitment to the market. The vigorous development of foreign PE funds will hasten the creation of a productive ecosystem that will benefit China's capital market. As leading service providers, JunHe LLP and Tricor are honored to support the growth of foreign PE funds in China. We expect that, notwithstanding past policy changes and market uncertainties, foreign PE funds will continue to grow steadily with the further opening-up and development of China's capital market.
Natasha XiePartner, JunHe LLP
As the world’s second largest capital market, China is one of the most important channels for global investors engaging in asset allocation. With the gradual opening up of its capital market, an increasing number of foreign institutional investors are gaining greater access to China’s colossal opportunities and expanding their business scope cross the country. With its vast economic and market potential, the Chinese PE fund market continues to be an attractive investment destination for foreign investment funds. Setting up a business in another country and managing an international business is much more complicated than it appears. Foreign asset management firms must plan ahead accordingly.
Kim JenkinsCEO, Tricor Group