China crackdown on illegal PE funds continues

China’s 50 private equity funds suspected of illegal fundraising activity together brought in 16 billion RMB (€1.9 billion; $2.6 billion) and involved 100,000 investors, according to regulators speaking at a recent domestic forum on illegal fundraising, which was reported in Caixin.

In recent years, illegal fundraising activities in the name of “local economic development support”, “green consumption”, “financial industry innovation” and others have appeared, offering high-yield, high returns as bait, said Liu Zhangjun, director general of the Office of Interagency Anti-illegal Fundraising Taskforce, in the report.

These vehicles often claim to be private equity funds, which gives investors the appearance of legitimacy, adds James Wang, partner at Han Kun Law in Beijing.

“At the peak of the private equity fund activities, local governments encouraged [RMB] private equity funds to be registered in their local jurisdiction with the offering of many preferential policies, which were viewed by unsophisticated investors as a kind of endorsement by the local government,” Wang said.

“Illegal fundraising in China typically works like a Ponzi scheme. The fund manager guarantees a high return on the principal and has to continually attract new investors in order to make good on the guarantee high return promise to the old investors.”

In 2013, however, illegal fundraising has been declining, Wang said, though he did not have any figures. “In the last two years, the government has strengthened regulations to crackdown on those illegal fundraising activities so it is harder for people to do that, at least in the form of a private equity fund.”

However, the fast development of peer-to-peer fundraising and lending platforms has increased the speed and amount of capital raised from the public, but laws and regulations have not kept pace. “The risk of illegal fund-raising in this area is rapidly building up,” Liu added.

He also cited private debt and credit funds as being at high risk for illegal fundraising conduct.

Fundraising conduct considered illegal includes raising money from the general public; fundraising without proper legal approval; advertising funds through public channels such as the media, promotional events, leaflets and SMS; promising specific returns within a timeframe, according to The China Banking Regulatory Commission.