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Written by Michael Wu and Judy Deng

Although fund managers may form private equity funds of funds in China that have non-Chinese investors (hereinafter referred to as “foreign-invested fund of funds” or “FIE FoFs”), they need to be aware of certain currency conversion issues that may apply based on how the FIE FoF operates.  Foreign-invested funds of funds may be subject to currency conversion issues that do not affect other onshore, or China-based, foreign-invested investment funds because the Administration Regulations on Foreign-Invested Venture Capital Enterprises issued in 2003 (the “FIVCE Regulations”), which are the only comprehensive regulations pertaining to foreign-invested investment funds in China, did not explicitly contemplate the establishment of FIE FoFs.  For more information regarding the FIVCE Regulations, please see Introduction to RMB funds.

The FIVCE Regulations generally require that a foreign-invested investment fund’s portfolio companies be private companies in the high technology industry.  Thus, the regulatory authorities may determine that a FIE FoF that only invests in other onshore investment funds (i.e., a FIE FoF that does not make direct investments in private Chinese companies in the high technology industry), should not be a foreign-invested investment fund covered by the FIVCE Regulations (a “FIVCE”).  To the extent a FIE FoF is not a FIVCE, it may not be able to convert non-renminbi (“RMB”) currency of its foreign investors into RMB for purposes of investing in onshore investment funds.

In August of 2008, China’s State Administration of Foreign Exchange issued “Circular 142,” which provides that foreign invested enterprises (“FIEs”) may not convert their non-RMB currency into RMB for onshore investment, unless the FIEs are organized as “equity investment enterprises” and approved by the regulatory authorities.  Currently, there is no clear guidance regarding what qualifies as an “equity investment enterprise,” but most industry professionals believe that a foreign-invested holding company (“Holding Company”) or FIVCE may qualify.  Unfortunately, most FIE FoFs will not qualify as Holding Companies because Holding Companies are subject to substantial capitalization requirements and direct investment experience in China.  Thus, if a FIE FoF is not deemed a FIVCE, and is consequently treated as a FIE, it may need to qualify as a Holding Company in order to convert its non-RMB currency into RMB.

While the current landscape in China for FIE FoFs may deter some fund managers from forming FIE FoFs, being able to raise a fund of funds that can accept both RMB and non-RMB currencies may motivate other managers to form FIE FoFs.  Please feel free to contact us with any questions regarding foreign-invested funds of funds.

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The Securities and Exchange Commission and Commodity Futures Trading Commission recently adopted interim final rules for the reporting of swaps that were entered into prior to the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and had not expired as of July 21, 2010 (“pre-enactment swaps”). The adoption of these rules was mandated by the Dodd-Frank Act, which required the SEC and CFTC to adopt rules for the reporting of pre-enactment swaps within 90 days of the enactment of the Dodd-Frank Act.

Reporting Obligations

The requirements of the SEC and CFTC rules are substantially similar. They require specified counterparties to pre-enactment swaps to provide to a registered swap data repository or the relevant Commission:

  • a copy of the transaction confirmation, in electronic form, if available, or in written form, if there is no electronic copy; and
  • the time, if available, the transaction was executed.

In addition, a counterparty to a pre-enactment swap is required to report to the relevant Commission upon request any information relating to such swap during the time that the interim final temporary rule is in effect. Such information may include actual trade data as well as summary trade data. Summary data may include a description of the types of a swap dealer’s counterparties or types of reference entities, or the total number of pre-enactment swaps entered into by the dealer and some measure of the frequency and duration of those contracts.

Reporting Party

The new rules require the following parties to report swaps:

  • with respect to a swap in which only one counterparty is a swap dealer or major swap participant, the swap dealer or major swap participant must report the swap;
  • with respect to a swap in which one counterparty is a swap dealer and the other counterparty is a major swap participant, the swap dealer must report the swap;
  • with respect to any other swap, the parties to the swap must select a reporting party.

Record Retention

Each counterparty to a pre-enactment swap that may be required to report such swap must retain information and documents relating to the terms of the transaction. Specifically, such counterparties must retain all information and documents, if available, to the extent and in such form as they currently exist, relating to the terms of the swap, including but not limited to:

  • any information necessary to identify and value the transaction;
  • the date and time of execution of the transaction;
  • all information from which the price of the transaction was derived;
  • whether the transaction was accepted for clearing by any clearing agency or derivatives clearing organization, and, if so, the identity of such clearing agency or derivatives clearing organization;
  • any modification(s) to the terms of the transaction; and
  • the final confirmation of the transaction.

Effective Date

The record retention requirements are effective immediately. Reporting obligations will become effective on the earlier of (i) the compliance dates established by the SEC and CFTC in future rulemaking or (ii) 60 days after a registered swap data repository commences operations.

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The Investment Fund Law Blog has been selected as one of the LexisNexis Top 25 Business Law Blogs for 2010. You can read the full announcement and list of honorees here. We are in very good company in the Top 25, which includes such highly regarded blogs as thecorporatecounsel.net, the Harvard Law School Forum on Corporate Governance, and the M&A Law Prof Blog.

As you’ll note, voting for the top blog begins today and will last one week so please feel free to visit the site and vote to show your support. Thanks to all our readers who supported our nomination for this award.

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Under Secretary for International Affairs Lael Brainard recently delivered a speech at the Institute of International Bankers’ “Regulatory Dialogue with Government Officials” urging other nations to adopt the U.S. approach to hedge fund regulation:

It is also vital to have common agreement on the regulation of hedge funds, and to extend the perimeter of regulation to ensure stronger oversight of these funds. We have pursued international agreement on the same approach adopted by the United States: requiring all advisers to hedge funds, above a threshold, to register and report appropriate information so that regulators can assess whether any fund poses a threat to overall financial stability by virtue of its size, leverage, or interconnectedness. And to impose heightened supervisory and prudential standards on entities that do.

It is essential to ensure convergence of regulatory treatment for hedge funds to avoid a race to the bottom and promote a level playing field. Indeed, all the members of the G-20 committed to the same standards for oversight of hedge funds and to implementing these standards in a nondiscriminatory manner, and we are working hard to ensure these commitments are fulfilled.

The full text of the speech is available here.

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Written by Michael Wu and Judy Deng

Since 2007 there have been a number of circulars (i.e., ordinances issued by industrial regulators) and regulations pertaining to whether Chinese insurance companies are permitted to invest their assets in offshore (i.e., outside of China) private equity.  The following summarizes the relevant laws pertaining to this issue.

  • In 2007, the China Insurance Regulatory Commission (“CIRC”), jointly with China’s central bank (“People’s Bank of China”) and the State Administration of Foreign Exchange (“SAFE”), issued a circular to permit Chinese insurance companies to make certain types of offshore investments. Specifically, the circular stated that Chinese insurance companies were permitted to invest in offshore capital markets products, fixed income products, equity investments and public companies. Although the circular permitted offshore “equity investments,” which under applicable Chinese law includes private equity investments, so far there have not been any publicly reported investments by Chinese insurance companies in offshore private equity in reliance on the circular.
  • In August of 2010, the CIRC issued a circular to clarify certain investment policies applicable to insurance assets (“2010 Insurance Policies”). The 2010 Insurance Policies explicitly permit Chinese insurance companies to invest in offshore publicly issued bonds, investment funds and publicly traded stock; however, investment in offshore private equity was not explicitly listed as a permitted investment.  Accordingly, after the 2010 Insurance Policies were issued, it was not clear whether Chinese insurance companies could invest in offshore private equity.
  • In September of 2010, the CIRC issued a circular permitting Chinese insurance companies to invest in private companies and private equity located in China.  This circular suggests that Chinese insurance companies are not permitted to invest in offshore private equity.  Please refer to the blog titled China Permits Insurance Companies to Invest in Private Equity for additional information regarding the 2010 circular.
  • In addition, there is no consensus regarding whether a Qualified Domestic Institutional Investor (“QDII”) may make offshore private equity investments under the QDII regulations.  Under the QDII regulations, a QDII may apply for a quota to convert its RMB into foreign currency for purposes of making offshore investments. The QDII regulations enable Chinese investors to participate in offshore capital markets by investing in the products offered by QDIIs. The investment scope of QDIIs is strictly limited to banking products, bonds, public securities traded on specified stock exchanges, structured products and futures.

Unfortunately, the circulars and regulations above do not provide clear guidance regarding whether Chinese insurance companies may invest in offshore private equity.  Accordingly, non-Chinese private equity fund managers should contact us before accepting any investment from Chinese insurance companies to determine the risks of such investment and the extent to which such investment is permitted under applicable law in China.

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Written by Michael Wu and Judy Deng

A Chinese foreign-invested fund management company (“FIE FMC”) is a fund management company formed in China with at least one non-Chinese owner.  FIE FMCs are generally formed to manage foreign-invested PE/VC funds located in China (“Foreign-Invested RMB Fund”), such as Foreign-Invested Venture Capital Enterprises (“FIVCEs”) and Foreign-Invested Equity Investment Enterprises (“FIEIEs”).  A FIE FMC is subject to national regulations promulgated by China’s Ministry of Finance (“MOFCOM”), as well as applicable local regulations based on where the FIE FMC is registered.  The following highlights some of the key requirements and considerations for FIE FMCs.

  • Under the national regulations, in order to qualify as a FIE FMC, an entity must have at least three fund management professionals, each of which must have at least three years of venture capital or private equity fund management experience.  The applicable local regulations may have different, more rigorous standards.
  • Under the national regulations, a FIE FMC must have at least US$150,000 of net capital, also referred to as “registered capital,” which must be wired to the account of the FIE FMC generally within one to three years of registering as a FIE FMC with the appropriate regulatory authority.  The net capital requirements under the local regulations vary greatly from city to city and can be as high as US$2,000,000.
  • Retaining a FIE FMC may help a Foreign-Invested RMB Fund reduce its tax exposure in China.  For example, if a Foreign-Invested RMB Fund retains a FIE FMC to serve as its management company, the Foreign-Invested RMB Fund may be able to reduce the tax exposure that arises from being deemed a “permanent establishment” of its offshore investors.
  • Currently, there is no practical way for a FIE FMC to convert foreign currency into RMB to invest into a Foreign-Invested RMB Fund. Although some local authorities are attempting to address this issue, for the time being, a FIE FMC may only invest its foreign currency into a Foreign-Invested RMB Fund indirectly through an offshore affiliate.

Individuals who are thinking about forming a FIE FMC should contact us to determine what the local regulations are for FIE FMCs in the various jurisdictions and/or for any other advice regarding FIE FMCs or Foreign-Invested RMB Funds.

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On September 30, 2010, California Governor Arnold Schwarzenegger signed into law AB 1743, which regulates the activities of placement agents who solicit investments from public pensions on behalf of investment managers. The new law:

  • prohibits a person from acting as a placement agent in connection with any potential investment by a state public retirement system unless that person is registered as a lobbyist; and
  • requires placement agents acting in connection with any potential investment by a local public retirement system to file reports with a local government agency and comply with any applicable requirements imposed by such local government agency.

AB 1743 defines a “placement agent” as any person or entity hired, engaged, or retained by an external manager who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker, or other intermediary in connection with the offer or sale of the securities, assets, or services of an external manager to a California public pension. The definition excludes:

  • employees, officers, directors and equityholders of external managers who spend one-third or more of their time managing the securities or assets of the external manager; and
  • affiliates who manage assets of a California public retirement system if the external manager (i) is registered with the SEC or an appropriate state securities regulator, (ii) is selected by a competitive bidding process and (iii) agrees to a fiduciary standard of care.

AB 1743 is effective as of January 1, 2011.

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Written by Michael Wu and Judy Deng

Most of the “RMB fund” structures currently being used to enable non-Chinese investors to participate in private equity and venture capital investments in China are tax driven.  However, some fund managers are using a RMB fund structure that is not designed to address a particular tax issue, but instead is designed to enable non-Chinese investors to participate in investments in China that, as a regulatory matter, are generally only available to domestic Chinese investors.

At this time, non-Chinese investors may only invest in certain “encouraged” or “permitted” sectors of China’s economy (e.g., the high tech, equipment manufacturing and new materials industries).  Although the Ministry of Commerce’s Foreign Investment Department is expected to increase the number of sectors that are “encouraged” or “permitted,” the extent of such increase and the time frame within which such increase will occur remain unclear.

In order to enable non-Chinese investors to participate in other sectors of China’s economy, some fund managers have utilized a China parallel fund structure.  Unlike a U.S. parallel fund structure, which generally involves two funds that invest side by side, on a pro rata basis, in the same assets, a China parallel fund structure generally involves two funds – one formed outside of China for non-Chinese investors and one formed in China for Chinese domestic investors – that each invest in assets that are not available to the other fund.

The offshore fund would typically receive an option to participate in investments made by the domestic fund in the sectors reserved for domestic Chinese investors and the domestic fund would receive an option to participate in investments made by the offshore fund in companies domiciled outside of China (which due to currency control issues may not be attractive to the domestic fund).  If the restricted sectors subsequently become available to non-Chinese investors as a result of a revision to the foreign investment catalogue by the Ministry of Commerce’s Foreign Investment Department, the offshore fund would presumably exercise the option and participate in any gains that had accrued since the option was granted.  The parallel fund structure, therefore, potentially allows non-Chinese investors to gain immediate access to sectors that are not yet “encouraged” or “permitted” but that are expected to eventually be opened to non-Chinese investors.

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Written by Judy Deng

On September 5, 2010, the China Insurance Regulatory Commission (CIRC) issued a circular (“CIRC Circular 79”) to explicitly permit China’s insurance companies to invest their assets in private equity. Such investments may be either direct or indirect, making China’s insurance companies potential equity investors in onshore industrial companies as well as limited partners in onshore private equity funds (known as “RMB funds”).

In direct investment projects, the portfolio companies are required to be growth-stage, mature or strategic new-industry companies or what are considered “pre-IPO” companies.

In the case of indirect investments (i.e., investments in private equity funds), there are detailed requirements as to the qualifications of the target private equity firms, including minimum registered capital (RMB100 million), management team (10 experienced managers), exit history (3 exits) and pre-investment assets under management (RMB3 billion). The aggregate investment in any one private equity fund may not exceed 20% of the fund’s total offering size.

CIRC Circular 79 also clarifies that outbound equity investment by Chinese insurance companies is governed by a 2007 regulation.

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On August 13, 2010, Governor Paterson signed into law certain technical amendments to New York’s power of attorney statute. These amendments clarify and restrict the application of the sweeping power of attorney statute that went into effect on September 1, 2009, which, while designed to protect the elderly and incapacitated in the context of estate planning, on its face applied to powers of attorney granted in business and commercial transactions, including powers of attorney typically granted by investors to fund managers in subscription documents, partnership agreements and other contracts.  Fund managers with New York-based investors had faced the choice of either foregoing standard powers of attorney or complying with the onerous formalities of, and accepting the fiduciary duties imposed by, New York’s power of attorney statute.  The latest amendments clarify that fund managers will not be subject to the 2009 statute. Specifically, they exclude powers of attorney given for a business purpose or pursuant to a partnership agreement or limited liability company operating agreement from application of the 2009 statute.

The amendments are effective as of September 12, 2010 and apply retroactively to September 1, 2009.

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