China moves towards regulation of private fund managers

A measure released today requires firms with an AUM of over RMB500m to register with China’s National Development and Reform Commission and submit to regular reviews. The measure will expand the investable universe of China’s SSF, which can only commit to NDRC-approved firms.

China-focused private equity firms with assets under management of over RMB500 million (€55.5 million; $76 million) will be required to register with China’s National Development and Reform Commission (NDRC) and provide regular updates on their activities, according to a measure released today.

The measure, which also takes effect today, is one step towards regulation of the private equity industry in the world’s second largest economy.

It also entitles the NDRC to conduct annual reviews of the private equity firms contained within its records, to check on their operations. Any GPs who don’t conform to the regulations could be publically named and shamed by the government body.

However, the new regulations are not all-encompassing: they only apply to private equity firms registered in Beijing, Shanghai, Tianjin, Jiangsu Province, Zhejiang Province or Hubei Province. Shenzhen, which also has a well-established private equity industry, is not included in its mandate, although no explanation has been given by the NDRC for this. Foreign GPs with China-focused funds do, however, fall under its remit.

The NDRC measure also has implications on the marketing of private equity funds. In a statement, the government body said GPs would no longer be able “promise” returns to potential investors; and they would only be able to raise money from LPs who “recognise and have the ability to shoulder the risk”.

In a question and answer session with Chinese reporters published on its website, the NDRC expanded on this by saying: “The private equity industry has grown very fast in recent years but there are also some problems.

“One of them is that there are no regulations around fundraising. Because private equity investment is relatively high risk, the capital is usually raised from specific targets in a private way so that only the institutional investors and high-net-worth individuals … can participate. But currently, some of the private equity firms in our nation hold seminars and forums to advertise their funds, and therefore let in public investors who don’t have the basic ability to recognise the risk they’re taking.”

One Beijing-based industry source said the measures would have a positive effect on the private equity industry in China.

“There wasn’t an authoritative channel which understood the industry in a more concrete way. For example, we don’t know how big the industry is, how many active players there are and how much money there is. No one can tell,” the source said.

There is also a potential upside for China’s GPs in that disclosure to the NDRC clears them for due diligence from the country’s largest LP – the $120 billion Social Security Fund. With an allocation to private equity of up to 10 percent, SSF has the capacity to deploy about $12 billion to the asset class.

Due to a quirk of Chinese law, the SSF has only ever been able to invest in private equity firms that have passed first through vetting by the NDRC. However, before today’s measure was released the NDRC had not vetted any private equity firms for over a year.

Prior to that, its assessment process had attracted criticism that it was backing untested private equity firms as they were able to file reports to it on a voluntary basis, even before they had started raising money. A total of only 22 private equity firms had reported to NDRC before now.

“The measure will enable the SSF to choose from more GPs, but it means challenges as well as opportunities for the SSF. It is testing the SSF’s ability to choose the cream of the crop,” said the Beijing-based source, who added that we are likely to see the pension fund speed up the pace of its private equity investment programme.