By Zhang Yi and Alan Du
The Oriental Morning Post reported that a Trial Plan for the Participation of Foreign Investment into RMB Equity Investment Funds (the "Trial Plan") was approved by the Shanghai government on March 15, 2010. This development will be fully publicized in April and first implemented in the Pudong New Area. The Trial Plan will open a gateway for the conversion of foreign exchange into RMB, which has been a major factor hindering foreign general partners (GP) and limited partners (LP) from becoming involved in the RMB PE fund industry.
According to Circular Hui Zong Fa  142 ("Circular 142"), unless otherwise provided for under law, the capital of a foreign invested enterprise ("FIE") shall not be used for equity investment. If an FIE intends to act as a GP of a RMB PE fund, it will find it difficult to satisfy the GP's RMB commitment (often 1% of the total commitment of the fund) because the FIE cannot convert its capital into RMB. This further effectively blocks the means by which an FIE is able to act as an LP because it is much more difficult for it to satisfy the LP's RMB commitment, which is typically substantially higher than a GP's commitment.
The Trial Plan is intended to establish a Qualified Foreign Limited Partner ("QFLP") mechanism by adopting the approach similar to the QFII (Qualified Foreign Institutional Investor) system, and allows foreign funded GPs and LPs to convert foreign exchange capital into RMB. The aggregate quota for foreign exchange convertible into RMB shall not exceed 50% of the size of the fund, and the quota for a GP shall not exceed 5% of the fund size.
It is unclear if foreign funded GPs and LPs refers to foreign investors only or both foreign investors and FIEs, which are Chinese entities partly or wholly owned by foreign investors. Also, as is known by veterans of the Chinese PE industry, a domestic partnership's partners shall all be Chinese individuals or Chinese entities, which may include FIEs. This allows indirect foreign investment (with difficulties arising from foreign exchange conversion). On the other hand, a foreign invested partnership may directly accommodate a foreign GP or LP. Therefore, either a domestic partnership and a foreign invested partnership both allow the participation of foreign investment. However, it is unclear if the Trial Plan will apply to both domestic partnerships and foreign invested partnerships.
Though not crystal clear, a domestic partnership with indirect foreign investment is likely to be treated equally as other pure domestic funds in terms of portfolio investment, but a foreign invested partnership will be treated as a foreign investor and subject to industrial restrictions and cumbersome approvals. If the Trial Plan does apply to domestic partnerships, that will be a real breakthrough and Pudong will be better positioned to attract RMB PE funds than its competitors in China. Further details will be publicized in April.
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