Jurisdiction - China
China’s NDRC Strengthens Regulation of Equity Investment Enterprises.

15 January, 2012


Legal News & Analysis – Asia Pacific – ChinaBanking & Finance – Capital MarketsInvestment FundsCorporate/M&A – Private Equity


On December 8, 2011, the General Office of China’s National Development and Reform Commission (the “NDRC”) issued  the Circular on Promoting the Standardized Development of Equity Investment Enterprises (关于促进股权投资企业规范发展的通知)(the “New Circular”).  The New Circular represents the first effort by a national agency in the PRC to regulate in a comprehensive way Equity Investment Enterprises (“EIEs”).  The term “EIE” refers to enterprises engaged in the business of investing in equities of non-publicly traded enterprises.  The term excludes enterprises engaged in investments in listed securities, since they are separately regulated by the China Securities Regulatory Commission.  We understand it does not include purely offshore funds but would include funds of funds established in China investing into an EIE.  The NDRC’s website states that the purpose of the Circular is to address illegal fundraising activities and irregular operations of equity investment funds in the PRC.   
The New Circular is a further development in the regulation of EIEs, following the Circular on Further Regulating the Development and Record Filing Administration of EIEs in Pilot Areas (关于进一步规范试点地区股权投资企业发展和备案管理工作的通知) (the “Pilot Circular”), issued by the NDRC on January 31, 2011. The New Circular covers the same regulated scope as the Pilot Circular: (1) the establishment, fundraising and investment of EIEs; (2) risk-control mechanisms of EIEs; (3) responsibilities of Equity Investment Management Entities (the “EIMEs”, as entrusted management entities of EIEs); (4) information disclosure systems of EIEs; and (5) the record filings and industry self-discipline of EIEs.   
The New Circular further confirms that EIEs may be formed as a limited liability company, a joint stock company, or a partnership in China.  This conforms to the current common practice of PRC domestic private equity funds, all of which are either formed as limited liability companies or domestic partnerships (most of which are limited partnerships).  However, it should be noted that under the Regulation on the Administration of Foreign-Invested Venture Capital Enterprises (外商投资创业投资企业管理规定) (the “FIVCE Regulation”), a FIVCE, (which as discussed below may be deemed to be an EIE under the New Circular), can be formed as a wholly-foreign-owned enterprise, an equity joint venture, a contractual joint venture as legal person, a contractual joint venture as a non-legal person, or as a foreigninvested partnership.  It is not very clear whether a non-legal person joint venture may still be available to a FIVCE under the New Circular. 
Notably, the New Circular distinguishes the Pilot Circular in the following aspects:  
  • The New Circular expands the geographic application of the post-formation record filing requirement under the Pilot Circular.  Under the Pilot Circular, the pilot areas include Beijing, Tianjin, Shanghai, Jiangsu Province, Zhejiang Province and Hubei Province. Experimental record filing of the EIEs formed in these pilot areas began as early as June 2008.  Filings are now required nationwide rather than being limited to the pilot areas.  Similar to the Pilot Circular, to apply for the filing, an EIE must submit: (1) a filing application; (2) a photocopy of its business license; (3) its prospectus; (4) its articles of association or partnership agreement; (5) a letter of commitment to subscription signed by all investors; (6) a capital verification report issued by a capital verification institution on the paid-in contributions from all investors; (7) a written explanation by the promoters on the compliance of the fund raising process with laws and regulations; (8) the resumes of all of its senior managers and the corresponding verification documents; (9) a custody agreement or the letter of consent signed by all of the investors if they consent that assets of the EIEs may be free from custody; and (10) a legal opinion issued by a law firm on the documents and materials involved in the filing. If the EIE has adopted entrusted management, it must also submit a trust agreement signed with its entrusted EIME.  


  • The New Circular requires EIEs to complete a provincial-level record filing procedure where the capital size of the EIEs (including paid-in and committed capital contributions) is less than RMB500 million (or equivalent foreign currency).  Previously, the Pilot Circular only required EIEs with a capital size of RMB500 million or more to complete record filings with the NDRC. National-level record filing requirements remain the same as specified in the Pilot Circular: only EIEs with capital size of RMB500 million or more must file with the NDRC.


  • The New Circular allows EIEs to raise funds only from “accredited investors.”  Furthermore, the number of investors of an EIE must be in compliance with the PRC Company Law and the PRC Partnership Law. Specifically, (a) if an EIE is structured as a limited partnership (“LP”), such EIE must have at least 2 and at most 50 investors or partners, one of whom must serve as the general partner (“GP”); (b) if an EIE is structured as a limited liability company, the number of investors or shareholders of such EIE must not exceed 50; (c) if an EIE is structured as a joint stock company, such EIE must have at least 2 and at most 200 investors or promoters.  In the event an investor to an EIE is a non-legal-person entity, e.g., a partnership, unless such investor is the parent fund to a fund of funds, the New Circular requires the promoters to “look through” or “penetrate” such non-legalperson entity to examine whether or not the ultimate natural persons and legal-person entities are “accredited investors” and to calculate whether or not the total number of investors is within the statutory limitation.  It should be noted that this “look-through” requirement is a relatively new concept in the PRC legal regime and its implementation in practice remains untested.


  • The New Circular also specifies the qualification requirements for serving as a senior manager of the EIEs and its entrusted management entities.  More specifically, no senior manager may have any violation on record in the last 5 years or have been involved in any substantial economic disputes.  Further, at least three senior managers in an EIE must have two or more years’ experience in the equity investment business or other relevant experience.


  • The New Circular further provides that the assets of the EIEs must be entrusted with independent assets custodial institutions, unless all of the investors consent that the assets may be free from such custody. Consistent with the Pilot Circular, the New Circular continues to require that where the entrusted EIMEs are wholly foreign-owned or Chinese-foreign joint ventures, assets of the EIEs must be entrusted with independent custodial institutions incorporated as legal persons within China. 
The New Circular does not distinguish private equity investments from venture capital investments.  As such, venture capital firms or funds would presumably fall under the coverage of the New Circular as well.  However, the New Circular does provide an exemption that venture capital firms or funds that have previously filed as venture capital investment enterprises pursuant to the Interim Measures for the Administration of Venture Capital Enterprises (创业投资企业管理暂行办法) (the “Interim Measures for VCEs”)with the NDRC and its provincial-level counterparts are not required to file under the New Circular. Pursuant to the Interim Measures for VCEs, the record filings of VCEs are encouraged but not mandatory. Though it seems to be a logical reasoning, the New Circular does not explicitly specify VCEs that have not previously filed in accordance with the Interim Measures for VCEs must file under the New Circular unless the VCE falls into a category exempting it from record filings. Exemptions exist for a VCE that is fully-funded and established by a single entity or a single natural person; a VCE that is jointly funded and established by the same entity with its wholly-owned subsidiary (ies); or, a VCE that was jointly funded and established by several wholly-owned subsidiaries of the same entity.  
For foreign private equity (“PE”) or venture capital (“VC”) investors who wish to establish and operate a PE or VC firm or fund in China, in addition to required compliance under the New Circular, such foreign PE or VC investors will also be required to observe other existing regulations previously promulgated by the Ministry of Commerce (“MOFCOM”) and other governmental authorities at the central and local levels such as the FIVCE Regulation and the provincial-level 
implementation rules of the FIVCE Regulation.  According to the FIVCE Regulation, approval by MOFCOM and its provincial counterparts for the establishment of an FIVCE is a pre-formation requirement, whereas the record filing procedure mandated by the NDRC is a post-formation administrative procedure.  While there appears to be no overlap between the jurisdiction of the MOFCOM and the NDRC with respect to the regulation of FIVCEs, the promulgation by the NDRC of the New Circular enhances the NDRC’s authority over EIEs.  Moreover, the industry (for both domestic-funded and foreign-invested firms) may view the filing with the NDRC (and its provincial counterparts) as a blessing given by the NDRC to a newly established EIE. Therefore, a successful filing is perceived to provide an EIE enhanced credibility to source investment opportunities.  Given this benefit, investors of an EIE may require that such EIE complete the record filing with the NDRC as a condition for the investors to fulfill their capital commitments. 
Penalties for circumventing the filing requirements and for non-compliant operations are the same under the New Circular, i.e., such non-compliance of the EIEs and the entrusted EIMEs will be published on the website of the relevant record filing authorities. One obvious consequence of being blacklisted by the NDRC (or its provincial counterpart) on its official website is that the reputation of the affected EIE and the entrusted EIME would be adversely affected.  Such EIEs and EIMEs would lose credibility in the market when competing against peers for deals. 
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