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.