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Currency Conversion Issues for Foreign-Invested Private Equity Fund of Funds


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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