Investment funds wake the sleeping dragon


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Investment funds wake the sleeping dragon

  1. 1. China Investment funds wake company was set up. 2003 Funds Law the sleeping dragon By 2003, it had become apparent that the development of capital markets would be an essential tool for funding China’s strong growth and the capital needs of its companies. At the same time, the Chinese government realized that the Fund management is an ideal vehicle to direct billions of domestic savings fund management industry could be a towards Chinese companies, and China is adjusting its regulatory crucial element in the restructuring of framework towards this end. Raphaël Chantelot and David Boitout of Gide the securities market, and that foreign Loyrette Nouel explain players should be encouraged to contribute their financial expertise in W ith barely a decade of legal result, in November 1997, the Chinese joint-venture fund management existence, fund management authorities promulgated the first set of companies. A permanent and more is a young industry in the unified rules designed to regulate the comprehensive regulatory regime was People’s Republic of China, yet it is one fund management industry: the Interim needed to prepare for strong future of the fastest growing businesses in the Measures for the Administration of growth. As a result, the Funds Law was world. In 2006, China is due to overhaul Securities Investment Funds. These adopted on October 28 2003 by the its stock exchanges and to further open its provisional measures formed the basis for highest legislative body in China, the financial sector to foreign investors, in the current regulatory framework, as they Standing Committee of the National line with its WTO commitments. In that organized the structure of funds and People’s Congress, emphasizing the context, the demand for capital prompted funds management companies, detailed importance of the new law. It came into by China’s growth, and the estimated $1.5 the obligations on their managers and force on June 1 2004. trillion of domestic savings, promise custodians, and made the China On December 31 2005, there were tremendous growth for fund Securities Regulatory Commission (the 218 funds in China (compared with 110 management. CSRC) the main approval and regulatory at end-2003), among which 54 were The Securities Investment Funds Law authority, as well as the industry closed-ended funds and 164 were open- (the Funds Law), adopted in 2003, is watchdog. On these stronger ended funds. These funds were managed the first permanent and comprehensive foundations, fund management in China by 52 management companies set of rules aimed at regulating the fund began a booming expansion that is (compared to 34 at end 2003). The management industry in China. continuing today. aggregate net assets value of the assets However, the scope of the Funds Law is The following under limited to funds investing in listed years saw the management was securities, and it does not encompass establishment of Rmb470 billion, funds such as private equity or venture new, regulated Although the largest fund representing about capital funds. fund management management companies so far a quarter of the companies, the total market Background restructuring of remain purely domestic capitalization on China’s fund management industry began the existing companies, the Sino-foreign the Shanghai and with the establishment of the Shenzhen unregulated funds, Shenzhen stock and Shanghai stock exchanges in the and the joint venture companies are exchanges, a early 1990s. The first securities establishment in catching up, bringing their figure to be investment fund was formed in 1991, 2001 of the first compared with and the first company dedicated to fund open-ended fund. expertise to an industry that the Rmb170 management was established in 1992. This was a lacks skilled and experienced billion recorded at Although evolving in an unregulated breakthrough in end-2003 and environment, this industry prospered. A China’s fund fund managers Rmb6 billion at number of closed-ended funds were set management the end of 1997. up, and more than Rmb6 billion ($750 industry, and since Since 2002 and million) in assets were under then few new closed-ended funds have the approval of the first Sino-foreign management at the end of 1997. been created, as open-ended funds joint venture fund management quickly became investors’ first choice. company, foreign institutions have 1997 Interim Measures The establishment of a number of open- rushed in the industry. There were 20 Faced with the strong development of ended funds was followed in 2002 and joint venture fund management this new industry, the Chinese 2003 by a stream of innovations, companies in China at the end of 2005 government recognized both the notably the introduction of fixed (compared to 13 at end-2004). opportunity for development of the income and index funds, umbrella Although the largest fund management securities markets and the risks associated funds, and the first monetary market companies so far remain purely domestic with a situation where no regulatory fund. In 2002 the first Sino-foreign companies, the Sino-foreign joint framework or oversight existed. As a joint venture fund management venture companies are catching up, A special IFLR supplement 15
  2. 2. China Author biographies bringing their expertise to an industry David Boitout that lacks skilled and experienced fund Gide Loyrette Nouel managers. The Funds Law is a pragmatic The partner managing the firm’s Shanghai office since January codification of the practices and 2004, David Boitout was a member of the mergers and acquisitions solutions adopted under the previous department in GLN’s Paris office from 1996 to 2000 before joining regulatory framework of the 1997 the Shanghai office, where he has been based since the end of Provisional Measures, and of the 2000. Boitout’s practice focuses on international mergers and traditional patterns of securities acquisitions, including cross-border acquisitions, joint ventures and investment funds. Regulated fund corporate restructurings. He has been involved in foreign direct management companies establish investments and acquisitions in China by prominent European groups from several industries contractual funds with approved including: catering services, automotive, distribution, manufacturing and chemicals. His custodians. These funds can be either experience within the firm in Paris and in Shanghai has enabled him to develop specific closed-ended or open-ended, and may expertise in all matters relating to acquisitions by either share deals or asset deals, in the invest in the securities products context of China’s rapidly changing regulatory environment. Boitout is recommended by the authorized by the CSRC (so far, stocks, Asia Pacific Legal 500. bonds, and monetary market products). David Boitout has advised and assisted: An approved fund manager administers • an international industrial group in relation to strategic investment projects in China (2005); each fund, making investment decisions • an international truck manufacturer on establishing a manufacturing joint venture (2005); according to the fund’s contract. The • an international industrial group, which was already present in China through foreign direct assets are held by a commercial bank investment, to make its first acquisition of assets in China, for existing and strategic acting as custodian and implementing production units (2004); the fund manager’s decisions. Investors • a large group to restructure its existing subsidiaries in China through the incorporation of a have the rights provided for in the funds holding company under Chinese law (2003/2004); contract. They also enjoy certain specific • several groups involved in the distribution sectors to set up their distribution networks rights provided for in the Funds Law. (2002/2003); The enforcement of the rules relating to • a German industrial group in the steel sector with a disinvestment project and the fund management remains in the hands simultaneous acquisition of two domestic companies in the north of China (2002/2003); of the CRSC, which has broad approval and and oversight powers. • a French group to finance and acquire a majority stake in a holding company in Hong Kong and to obtain ownership of several subsidiaries involved in the aviation maintenance Funds and fund management business in China(200/2001). companies He was admitted to the Paris Bar in 1998. He holds a postgraduate degree (DEA) in Under the Funds Law, funds are private law (1996) and an honours degree (Maîtrise) in business law (1995). He speaks structured as contractual arrangements French, English, Spanish and Chinese. between a fund management company, a custodian and investors, without the Raphaël Chantelot creation of a separate legal entity. It is Gide Loyrette Nouel likely that the CSRC will soon also authorize funds structured as corporate A senior associate based in Shanghai, Raphaël Chantelot joined funds, because the revised PRC Gide Loyrette Nouel in 2005, after working for five years in the M&A Company Law (which came into force and capital markets departments of a leading US firm in Paris. on January 1 2006) has removed the Raphaël Chantelot started practising law in 1998 and is a member traditional prohibition pursuant to which of the New York Bar and the Paris Bar. He received an LLM degree investments by a PRC company in other from Georgetown University (Washington DC), a postgraduate companies should not represent more degree in business law from the University of Paris (Sorbonne), and than 50% of its net assets. he graduated from the Institute for Political Studies in Paris. Only fund management companies Raphaël Chantelot’s practice focuses on corporate and financial matters, including capital approved by the CSRC may establish and market transactions, joint ventures, and international mergers and acquisitions. Recent manage funds. In 2004, the CSRC transactions in which he was involved include: the €150 million acquisition of the electrical adopted a specific set of procedures further appliances division of a Chinese group; the merger between two French telecom companies to detailing the rules applying to the setting create the second-largest provider of fixed-line internet and telephone services in France; the up, approval and regulation of fund €300 million acquisition of pharmaceutical assets by a US laboratory; the €300 million management companies, the leveraged acquisition of a French services company by a US fund; a €500 million rights issue Administration of Securities Investment by a global French advertising company; and the €200 million refinancing of the real estate Fund Management Companies Procedures arm of a financial institution. In the past, he also participated in the preparation of a number of (the FMC Procedures), which became tender offers, rights issues and bonds issues, as well as in the negotiation of a number of joint effective on October 1 2004. ventures and acquisitions, and several financing projects. Fund management companies A fund management company must have 16 A special IFLR supplement
  3. 3. China a registered capital of at least Rmb100 other funds, the fund management million. It must have a staff engaging in Authorized investments company, the custodian, or their research investment, valuation and The Funds Law initially limited funds in controlling shareholders or related marketing, with at least 15 senior their investments to shares and bonds. parties, or buying shares underwritten management personnel who have However, making use of the powers by them. qualifications in the fund management granted to it by the Funds Law, in 2004 industry. Any fund management company the CSRC approved the establishment of Fund managers and must have a main shareholder, who must money market funds, and in 2005 issued custodians hold at least 25% of its registered capital. several circulars regarding investments in The CSRC has set out detailed rules This main shareholder must have at least short-term financial instruments. More regulating the qualifications, duties and Rmb300 million of registered capital and innovations are expected, although funds responsibilities of senior management in must have operated in the securities and so far remain prohibited from investing fund management companies and assets management industry for three full in other funds, making it impossible to custodian companies (the Administration years, with sound corporate governance establish funds of funds. Also in terms of of Appointment of Senior Management and internal control innovation, in Personnel of the Securities Investment systems. In 2004 a listed Fund Industry Procedures, which took addition, it must The CSRC assumes a pivotal open-ended fund effect on October 1 2004). show “good was created, Under these rules, the chairman and business results” role: it combines the powers to providing general manager of a fund management (meaning it made approve the players, to make enhanced liquidity company or a custodian company, as profits over a three- for investors by well as the head of compliance and the year period), and it regulations, to control their offering the persons in charge of the operations and must have no enforcement and to impose choice to either investments in a fund management record of violating ask for the company, must have at least three years laws or regulations sanctions redemption of of experience in the financial industry in the past three their shares or to and must have passed an examination years. sell them in the market. administered by the CSRC regarding the The other shareholders in a fund The Chinese authorities have also Funds Law and related regulations. management company need only have recently taken several steps to further These persons must also have Rmb100 million of registered capital develop the funds sector. In February obtained “qualifications to engage in the and three years of operation. Overall, 2005, for instance, the CSRC funds business”. These qualifications are these are quite high capital authorized Chinese commercial banks to assessed by the CSRC according to a requirements, by which Chinese establish separate fund management series of criteria that also apply to non- authorities are probably aiming to make companies, although so far these Chinese persons appointed to such the young fund management industry companies are not authorized to invest positions. Among the main criteria, safer by limiting its access to fairly large in shares but rather into a limited candidates are screened to see if they: investors. The FMC Procedures provide number of money market instruments. (i) have the relevant overseas licence; that the same shareholder (and its The CSRC adopted a circular that (ii) have been engaged in the relevant corporate group) may not invest in more authorized funds to invest in the financial industry over the past five than two fund management companies, warrants issued in connection with the years; and (iii) have passed a specific only one of which they may control. reform of the A-shares, which could examination administered by the CSRC. The FMC Procedures also set out potentially be an important market if specific requirements applying to foreign the A-shares reform goes through and Investors’ rights and CSRC shareholders in joint venture fund expands in 2006. Pension funds are control management companies. The foreign another promising development, as the A clear concern on the part of the shareholder must be a financial Chinese authorities are now encouraging Chinese authorities when adopting the institution with financial assets companies to set up corporate pension Funds Law and later regulations was to management experience, its registered funds and open up their management to design a sound securities investment capital must be at least equivalent to fund management companies. industry and to ensure investors were Rmb300 million, and its country of The Funds Law does not allow funds protected. This concern led to some incorporation must have a sound to borrow money to finance innovation with respect to investors’ securities regulation framework and have redemptions when requested by rights, and granting increased powers to established channels of cooperation with investors in the fund. This could be an the CSRC. the CSRC. The maximum ownership issue for certain funds in China, given allowed to foreign shareholders in fund the level of redemptions in the months Investors’ rights management companies is limited to after a fund is set up, and more One of the innovations of the CSRC in 49% of the registered capital of the generally if there is a sharp downturn in the field of investors’ rights is to provide company. The application procedure for the market. Fund management that holders of units constituting more setting up a fund management company companies are also prohibited from than 10% of the fund’s total units may (and for the approval of any subsequent using the assets of their funds to extend convene a general meeting of unit big changes) is handled by the CSRC. loans, underwrite securities, or invest in holders to decide a particular issue. A special IFLR supplement 17
  4. 4. China However, the quorum for the general management team, and annual reports. responsible individuals” (which appears meetings of the unit holders is 50%, Furthermore, fund managers are to be a broad catch-all provision) could which will make this new right difficult prohibited from issuing forecasts face sanctions for breaching the in practice for investors to exercise. In regarding the future performances of regulations applicable to fund addition, a two-third majority vote of the their funds. management or causing prejudice to unit holders represented at the meeting is investors. required for taking actions such as the The CSRC’s role removal of the fund manager, the early The CSRC assumes a pivotal role in the The way forward termination of the fund or the regulation of the fund management Recent years have witnessed a conversion from a closed-ended fund to industry: it combines the powers to tremendous growth in the fund an open-ended one. This might be an approve the players in the industry, to management industry in China, and interesting exit possibility for holders of make regulations, to control their investment funds have become one of the units in underperforming closed-ended enforcement and to impose sanctions for most widely used investment tools in the funds trading at discounts. their violation. The CSRC is in charge of Chinese securities markets. This strong Aside from the general enforcement numerous approvals, from the approval growth is poised to continue, as Chinese powers granted to the CSRC, the Funds of fund management companies and of authorities are hastening the pace for Law grants private enforcement rights to the funds themselves, to issuing business their stock exchange reform by investors. It authorizes them to bring an licences to fund managers and other addressing the problem of non-tradable action against any person who is industry professionals. The CSRC also shares and opening the A-shares market involved in the fund’s management (the has an important rule-making function, to strategic foreign investors. fund management company, fund as it is granted the power to issue Chinese authorities are willing to managers and custodians) or interacts at additional rules to regulate funds, fund restructure and develop the securities some point in the life of the fund management companies and their markets to make them a main element (lawyers, accountants, sales persons) personnel, or to expand the scope of in financing the Chinese economy, in when they have contravened the certain provisions of the Funds Law (for contrast to bank lending which remains regulations applying to funds. However, example, types of authorized rather inefficient and scarce. From this similar private enforcement provisions investments). perspective, they will certainly continue were introduced in the 1998 PRC Lastly, the CSRC oversees fund to promote the development of the fund Securities Law but proved to be management companies and the management industry, as they view it as inefficient in practice, as courts rejected practices of fund managers. To that a safe and controlled way to direct the suits brought by individual effect, the CSRC may conduct on-site billions of domestic savings towards investors. Enforcement of the provisions inspections of fund management Chinese companies. Foreign investors of the Funds Law will therefore remain companies to check that they have and international financial firms are now primarily, if not exclusively, the maintained sound operating systems ready to play in this game and their responsibility of the CSRC. (which are to be separated from those of efforts to enter such an enormous The Funds Law also marks an effort their shareholders), as required by the market will certainly redouble in 2006. to increase the accuracy of the FMC Procedures. If the Funds Law and information disclosed about funds. This the related regulations have been is particularly welcome in light of the violated, the CRSC may issue orders or abuses that tarnished the nascent funds suspend the fund management Gide Loyrette Nouel industry in the past. The Funds Law company’s activities and impose C/o GLN Support International Shanghai Office expressly prohibits misleading disciplinary sanctions. The CSRC also Shui On Plaza, Suite 2008 statements and omissions, which sets the holds the power to levy administrative 333 Huai Hai Zhong Road, Shanghai basis for a civil action by investors for fines or, when a criminal offence is China breach of fiduciary duties. It also suspected, transfer the case for criminal provides for various disclosure prosecution. The CSRC’s reach extends Tel +86 21 53 06 88 99 obligations, including the publication of beyond fund managements companies, Fax +86 21 53 06 89 89 the net asset value of the funds, the fund managers and custodians. Other E-mail: purchase and redemption price, persons such as law firms and Web: quarterly interim reports, change in accounting firms and other “directly 18 A special IFLR supplement