China’s State Council last week released a new set of rules that will allow companies including private equity firms to set up partnerships less burdened by regulations and taxes beginning in March 2010.
But although the new rules were designed with “convenience for foreign entities and individuals to invest in China in the form of partnerships” in mind, it’s unlikely GPs are going to rush to register under the new structures – there are still too many questions about the structure’s viability for private equity investments.
Currently, non-Chinese private equity managers operate in China through structures called foreign-invested enterprises, or foreign invested venture capital investment enterprises. But starting on 1 March 2010, foreign firms will be able to form structures called foreign-invested partnerships (FIP) with other foreign-based companies or with domestic partnerships.
The new structure would confer the benefits of greater flexibility in the timing and form of capital contributions and the mechanism of profit distribution. Critically, it would also allow tax pass-through to the investors.
Foreign-invested enterprises are also subject to requirements governing the establishment and rights and duties of the board of directors, board of supervisors and shareholders' meetings, whereas the partnerships are governed only by the partnership agreement.
The partnerships also can be established without prior approval by the Ministry of Commerce. The partners can apply directly to the local Administration for Industry and Commerce, a process that can often be completed on the spot.
But despite the comparative convenience of this structure for private equity managers, there are many significant areas of uncertainty about its practical application.
It’s unclear if partnerships can hold shares on companies listed on the A-share market (China's Mainland Stock Exchange), said Maurice Hoo, a partner at law firm Paul Hastings.
“Right now there are no public companies in China that have shareholders that are partnerships,” Hoo said. “Even if CFRC [China’s securities regulatory authority] says partnerships can be shareholders, or gives a special approval, it remains unclear whether that partnership, if it is a FIP, will make the company to be listed what we call ‘foreign invested’. I don’t think there are any foreign controlled companies that have been listed on the A-share market.”
There’s also the matter of China’s currency controls. The government restricts the conversion of foreign currency into RMB, so it’s unclear whether a GP would be able to get any money into a new FIP after it registers. Similarly, it’s unclear how profits could be repatriated.
And finally, foreign invested partnerships would continue to be subject to the same investment industry restrictions as foreign invested enterprises. And as with foreign invested enterprises, certain investment projects will still require prior approval from the appropriate authorities.
The new regulations include a section that allows the government flexibility to further clarify regulation for specific types of FIPs, so many of these issues may be addressed before March. Until then, the FIP structure will be of limited use for private equity.
“I don’t think the industry players here are all rushing to form partnerships,” Hoo said. “I think everyone recognises that it’s one step, but they are waiting for the fund-specific rules.”