Clash of the regulators in China

Chinese fund managers, like GPs the world over, are grappling with new and changing regulations as their industry matures. But unlike most of their peers, it’s unclear exactly who’s going to be doing the regulating.

Some local provinces have issued their own rules around private equity but China’s relatively young private equity market is centrally supervised by the National Development and Reform Commission (NDRC), the nation’s top economic planner. The NDRC issued a “Circular on Further Regulating the Development, and the Administration on Filings, of Equity Investment Enterprises in Pilot Areas” in early 2011, requiring private equity firms with assets under management of over RMB500 million (€61 million; $82 million) to register with the agency. The measure applies to both domestic and foreign GPs with onshore private equity funds registered in Beijing, Shanghai, Tianjin, Jiangsu Province, Zhejiang Province and Hubei Province. 

However in May, Chinese media reported that the China Securities Regulatory Commission (CSRC), which regulates public securities, was expected to be made sole regulator of private equity and venture capital firms.

That would make sense in part given some top tier GPs’ desire to become asset management firms with multiple business lines and products, something that registration with the NDRC currently prohibits.

“The NDRC has rules that say if you register with them you shouldn’t even participate in secondary market activities – so you cannot raise mutual funds or public funds. That kind of goes against the concept of [being] an asset manager,” Shirley Xie, partner at PwC Greater China, said at the HKVCA China Summit 2013. “Right now, the NDRC is not regulating the functionality of asset managers, but rather the upstream – the LPs to the fund and their client policies. Less so on how a fund manager should act, what sort of market it should go into,” she said.  

If the CSRC emerges as the industry’s chief regulator, general partners can reasonably expert more oversight and supervision, says Clifford Chance partner Ying White. “The NDRC doesn’t seem to have a lot of capacity to regulate the private equity and venture capital industry, so supervision and regulation has been very light compared to the US and Europe.”

In comparison, the CSRC, already being a financial regulator, has more oversight capacity, says White.

There have already been signs the CSRC has been positioning itself for the lead role, not least of which was draft guidance brought out by the CSRC in October 2012, requiring private equity funds to register with the regulator in order to raise capital. However in March the NDRC reasserted some of its authority over the industry by issuing fund registration rules that bar GPs from investing in public securities – including bonds, shares, and mutual funds – which conflicted with guidance that was circulated the previous month by the CSRC.

Larry Sussman, managing partner of law firm O’Melveny & Myers’ Beijing office, says the best way to understand China’s national private equity framework is to realize that multiple government bodies will be responsible for supervising the industry. “No one regulator will prevail, that would be uncharacteristic of what experience suggests over the years – the NDRC, CSRC, and Ministry of Commerce will all have roles and take up regulatory territory.”

Reforms to China’s Securities Investment Fund Law, which took effect in June, have created an opportunity for the CSRC to make a power grab on the private equity industry.

CSRC: top PE watchdog?

Under the reforms, if a fund invests a cumulative amount of RMB 100 million in publicly offered shares, bonds and other securities and derivatives overseen by the CSRC, it must register with the Asset Management Association of China, a self-regulatory organization founded by the CSRC last year for funds.

The RMB 100 million in securities investments is a low bar for Chinese funds, according to legal sources, who speculate the new law may capture more than half the existing private equity funds in China (and would help to address some of the ‘rogue’ private equity firms targeting retail investors that have proliferated).

It remains to be seen what the exact impact would be for GPs that meet such criteria, says Sussman. “In addition, the new law left room for interpretation, and the CSRC may be tempted to take advantage of the power granted in the reforms that would allow it to expand the scope of ‘securities’ it covers, meaning that the CSRC could bring equity investment funds that invest in non-public securities under its regulation.”