A. Introduction
In July of 1994, the PRC authorities began to draft regulations for the establishment and operation of Sino-foreign joint venture fund management companies ("FMCs"). Now, the China Securities Regulatory Commission ("CSRC") has issued the Regulations Regarding the Establishment of Fund Management Companies with Foreign Investment Participation ("FMC Regulations"), which became effective on the 1st of July 2002. The FMC Regulations confirm that CSRC holds authority to approve the establishment of foreign-invested FMCs and to supervise their operations. The long-awaited FMC Regulations roughly follow draft regulations that was circulated by the CSRC late last year for industry consultation. Apart from confirming that foreign-invested FMCs shall also be subject to the Provisional Measures regarding the Administration of Securities Investment Funds ("Provisional Measures ") and the PRC Company Law, the FMC Regulations also helps clarify a number of matters in relation to the establishment and operation of foreign-invested FMCs in China and raises issues for foreign fund managers looking at entering the China market.
Regulated Investments in FMC's
According to the Provisional Measures issued in 1997, FMCs may engage in the business of fund management and promoting fund establishment. The FMC Regulation now regulates foreign involvement in FMCs in cases where there are:
(i) Foreign companies acquiring interests in existing FMCs, foreign companies subscribing for interests in existing FMCs, and changes in holdings in foreign-invested FMCs; and,
(ii) Applications to establish new Sino-foreign joint venture FMCs.
B. The FMC Regulations
The FMC Regulations were issued on 1 June 2002 and are relatively general in terms of content. A number of provisions in the FMC Regulations refer to compliance with further regulations to be issued by the China Securities Regulatory Commission ("CSRC"), though these regulations have yet to be issued. We examine below some of the key points arising from the FMC Regulations.
Form, Ownership and Capital Contributions
The FMC Regulations regulate the corporate form of FMC's and control foreign ownership levels and capital contributions. An FMC shall be established as limited liability companies. The proportion of holdings in FMC's directly or indirectly owned by foreign companies shall not exceed 33% with the cap on foreign ownership to be raised to 49% within three years of China accession to the World Trade Organisation. Foreign companies' capital contributions must be in cash in freely convertible currencies. The FMC Regulation is silent on many other key issues regarding the establishment and operation of foreign-invested FMC's. Rather, key legal issues such as voting rights, corporate governance, minimum registered capital, and liquidation arrangements will be regulated primarily by the PRC Company Law and the Provisional Measures.
Qualifications of Foreign Investors
The FMC Regulation prescribes that foreign investors to FMC's must meet the following conditions:
- They shall be financial institutions established and legally existing according to their national laws;
- They shall not have been materially punished by securities regulatory or judicial bodies within the last three years;
- The foreign investor's home country will have a complete securities legal system and supervision system and that their home country's securities regulatory body shall have signed a memorandum of understanding on cooperation in securities supervision with the CSRC, and that these two bodies shall have maintained an effective cooperative supervision relationship;
- They shall have a minimum paid-in capital equivalent to RMB 300 million;
- They shall meet other prudential requirements set forth by CSRC.
Qualification of FMC Employees
The FMC Regulations require that the Chairman of the board of directors, the general manager and deputy general manager of an FMC must satisfy certain qualification requirements specified by the CSRC (note: these have yet to be issued).
Authorisation of an FMC
The FMC Regulations provide for a two step process for the authorisation of an FMC. The first step is a requirement to obtain approval from the CSRC for the establishment of an FMC. The CSRC is required to provide a decision on whether to approve the application or not within 60 days of receipt of the application.
Following grant of approval for establishment of an FMC, the FMC must apply to the CSRC to commence business as a fund management company. Again, the CSRC will provide a decision on the application within 60 days of receipt of the application.
C. Issues related to the entry of FMC's into the China Fund Management Market
The Price of Market Entry
With the issuance of the FMC Regulation, it is now confirmed that foreign fund managers are presented with two possible routes to enter the PRC fund management industry. In the case of acquisitions, foreign fund managers may expect to pay a premium for taking stakes in existing FMCs. Many existing FMCs are enjoying success. They increasingly maintain that they will be able to develop in the domestic market independently of foreign fund managers, and that they will be able to acquire the necessary talent and technology to compete in their own right on a long-term basis. However, they have limited operating histories and are small-scale compared to their foreign counterparts. On their own admission, they lack international-standard internal management and control systems and are still developing their service and investment capabilities. Most of the principal Chinese fund management companies have entered into advisory agreements with various leading foreign fund management companies under which information and advice is exchanged between the parties (as might be expected largely flowing from the foreign fund management companies to the Chinese fund management companies) regarding operations, internal controls, dealing functions, compliance, etc. The aim of such agreements was to give the Chinese fund management companies an understanding of international standards of operation of fund management companies, while allowing foreign fund managers the opportunity to gain some local knowledge on the PRC market and establish linkages with an aim towards eventually establishing fund management joint venture companies. Other obstacles for foreign fund managers hoping to establish an FMC is that cross shareholdings within China's FMCs complicate acquisition negotiations.
As for establishing a new joint venture FMC, there is a relatively limited pool of PRC parties that qualify as potential joint venture partners. It will be important for foreign investors to clarify how their new joint ventures will operate without competing head-to-head with their Chinese partners' existing FMCs. Regardless of the entry route, foreign fund managers will need to consider avenues for gaining legal control over key operating functions within the FMCs in the context of a joint venture where they hold minority interests.
D. The Road Forward and Future Areas of Growth
Among the future developments that may occur with the establishment of foreign FMC joint ventures is the offering of local funds that are managed by overseas fund managers, thereby bringing international expertise to the management of such funds. The passage into law in October of 2001 of China's first trusts law establishes a key component of the legal framework needed to create varied products for offer to the public in China. Also, there have been ongoing discussions at the governmental and regulatory level in China on the reform of the country's pension system. At present, China's pension system principally consists of the National Serial Security Fund ("NSSF"), which currently is estimated to have assets of approximately RMB70 Billion. Proposals have been put forward to reform the existing pension system in a number of ways including allowing a portion of the NSSF to be managed by external fund managers, including FMC's. In addition, there are proposals to develop "Second Pillar" system in China to complement the existing NSSF (which would be categorised as a "First Pillar" system i.e. a state provided pension scheme). The Second Pillar would consist of state mandatory occupational retirement schemes, that is to say employer sponsored pension schemes. Various models are being considered for any such scheme, ranging from having a state entity mange such assets (e.g. CPF in Singapore) to allowing various private sector participants to offer schemes that employers and/or employees could participate in (e.g. MPF in Hong Kong). Whatever method is chosen, they present opportunities for growth for various parties, in particular foreign FMC's, given their extensive experience is dealing with Second Pillar Systems in other markets.
The opportunities presented by China's fund management industry are extensive and the industry is growing rapidly. However, there needs to be some additional clarification of the laws and regulations applicable to FMC's and reform of other related areas such as the national pension system. Also, foreign fund managers will be particularly cognisant of the price for entry into the China fund management industry and issues of control as a minority shareholder in an FMC. With the right Chinese partner and joint venture arrangement, coupled with adequate levels of regulation and further governmental reforms, foreign fund managers will be well positioned to participate in this growth and to ultimately position themselves to take China's savings and manage them in the global market place.
For further information, please contact Luke Filei in our Beijing office on luke.filei@cms-cmck.com or + 86 10 6590 0389.
Copyright CMS Cameron McKenna - July 2002
