On April 23, 2012, the National Development and Reform Commission ("NDRC"), China's national agency for economic planning, made an announcement uniformly clarifying its policy with respect to RMB-denominated funds ("RMB Funds")1 that contain foreign-sourced RMB as investment capital.2

The NDRC issued a proclamation that outlined its views towards RMB Funds, specifically citing an RMB Fund in Shanghai managed by the Blackstone Group L.P. In its proclamation, the NDRC stated that unless all of the capital in an RMB Fund comes from domestic (i.e. local China-based) investors, that the fund will be classified as "foreign" ("NDRC Proclamation")3 and is subject both to Ministry of Commerce ("MOFCOM") rules and regulations including the Guidance Catalogue of Industries for Foreign Investment ("MOFCOM Catalogue").4 (For more information please refer to CWT Clients & Friends Memorandum No. 602 "China Establishes National Security Review Procedures for Acquisitions of Domestic Enterprises and Assets by Foreign Investors" May 23, 2011 and to CWT Clients & Friends Memorandum No. 605 "A Primer on Foreign Investments, Investment Structures & Special Development Zones in China" June 2011).

A contribution of even a de minimis amount of foreign-sourced RMB comprising a small fraction of the total fund size would make the fund "foreign."5

The NDRC Proclamation is significant because PRC regulators treat investment funds classified as "foreign" differently than investment funds classified as "domestic." Foreign investment funds are subject to more investment restrictions and require lengthy approval procedures to convert foreign-denominated capital into RMB ("Foreign Treatment"). In contrast, domestic investment funds are not subject to the same investment restrictions or foreign exchange regulations as foreign investment funds and are generally accorded relatively favorable treatment by Chinese regulators ("Domestic Treatment"). Therefore, RMB Funds with any amount of foreign-sourced RMB are considered inferior to RMB Funds comprised entirely of domestically-sourced RMB.

Foreign private equity firms in China have long had an interest in leveling the playing field by obtaining Domestic Treatment for their RMB Funds. One way for foreign general partners ("GPs") to manage RMB Funds and still receive Domestic Treatment is to raise capital from only domestic sources. This puts a burden on the GP to verify the source of the fund's RMB. The NDRC Proclamation reaffirms the well-established notion that an investment by a foreign investor by way of onshore FIE re-investment or through an RMB Fund still requires MOFCOM review.

The NDRC Proclamation's Impact on Pilot Program Designed to Attract Private Equity Investment into the PRC

The qualified foreign limited partner pilot program ("QFLP Pilot Program") was intended to attract foreign investment into the PRC by providing a means for foreign investors and LPs to invest in Chinese equities. However, the NDRC Proclamation weakens the utility of the QFLP Pilot Program.

Shanghai was the first city in China to introduce a QFLP Pilot Program on January 11, 2011. Shanghai's QFLP Pilot Program was subsequently emulated by Beijing (February 28, 2011), Tianjin (October 14, 2011), and Chongqing.6

Under Shanghai's QFLP Pilot Program, foreign investors through RMB Funds can enjoy favorable Domestic Treatment provided that no more than five percent (5%) of the fund's total capital originated offshore ("5% Rule").7

Broad Scope of the NDRC Proclamation

According to the NDRC Proclamation, a foreign-sourced RMB Fund is "foreign" and subject to investment restrictions set forth in the MOFCOM Catalogue which prohibit the foreign-sourced RMB Fund from investing in certain restricted sectors, such as media, education, telecommunications, Internet, technology, etc. Moreover, such foreign-sourced RMB Funds will also be prohibited from investing in industries and companies with national security implications, including defense companies and weapons suppliers, as well as energy and commodities, and oil and gas to name a few. (For more information please refer to CWT Clients & Friends Memorandum No. 603 "New Laws in China Regarding "State Secrets" and Related Issues" May 6, 2011)

Furthermore, we expect that domestic China listings of companies in China with foreign-sourced RMB Fund investors will attract greater administrative scrutiny to the issuer, rendering the China listing more challenging and time consuming. We have seen the China Securities Regulatory Commission challenge the ownership of restricted industries when such ownership is held by RMB Funds with foreign-sourced capital.

The NDRC Proclamation represents a major setback to foreign private equity firms operating in China and those currently taking advantage of the QFLP Pilot Program. It is unclear whether the NDRC Proclamation will impact other favorable policies granted to foreign private equity funds, such as preferential tax treatment and expedited foreign exchange treatment.


1 In China, there is a difference between RMB-denominated funds and U.S. dollar-denominated funds due to foreign exchange considerations. RMB-denominated funds invest from within China while U.S. dollar-denominated funds invest from outside China via special purpose vehicles.

2 Foreign-sourced RMB is RMB that is the result of a foreign exchange conversion from a foreign currency such as U.S. dollars. Domestically-sourced RMB is RMB that is not the product of a foreign exchange conversion. For the sake of clarity, any RMB from a foreign-invested enterprise ("FIE") is deemed to be foreign-sourced RMB.

3 The NDRC sent the NDRC Proclamation to its Shanghai bureau and all of its other local bureaus in China. We suspect this was a written response to clarification requests on behalf of the local Shanghai NDRC pertaining to its own QFLP Pilot Program.

4 Waishang Touzi Chanye Zhidao Mulu (外商投资产业指导目录) [Guidance Catalogue of Industries for Foreign Investment] (promulgated by the NDRC and the Ministry of Commerce, Dec. 24, 2011, effective Jan. 30, 2012) (Westlaw) (China).

5 Traditionally, general partners contribute up to one percent (1%) of the fund's total capital to align their interests with those of the fund. Such a percentage would be sufficient to cause the RMB Fund to receive Foreign Treatment.

6 The local government of Chongqing has not yet promulgated any official municipal regulations or rules concerning its QFLP Pilot Program. However, on May 24, 2011, seven QFLPs signed cooperation agreements with the Chongqing Foreign Affairs Office in order to establish private equity funds in Chongqing totaling U.S.$8.7 billion.

7 Guanyu Benshi Kaizhan Waishang Touzi Guquan Touzi Qiye Shidian Gongzuo De Shishi Banfa (关于本市开展外商投资股权投资企业试点工作的实施办法) [Implementation Measures for Launching a Pilot Program for Foreign-funded Equity Investment Enterprises in Shanghai] (promulgated by the Shanghai Financial Services Office, the Shanghai Municipal Comm. of Commerce, and the Shanghai Admin. for Industry and Commerce, Dec. 24, 2010, effective Dec. 24, 2010) (Westlaw) (China).

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