Joining hands with a commercial bank: wholly foreign-owned private funds open a new investment channel

On 28 March Standard Chartered China announced that it would act as distributing agent for an asset management plan investing in private fund products issued in China by a qualified wholly foreign-owned enterprise (a "WOFE"). This is the first time since 2016, when China formally opened registration of private fund manager qualifications to wholly foreign-owned investment and asset management companies, that investors may, through a bank distributing an asset management plan,

invest in the products of a qualified WOFE private fund institution.

It is understood that the plan distributed by Standard Chartered China is the Nanfang Huanqiu Zhenxuan No. 1 special asset management plan, which invests principally in a private fund product issued by a WOFE. That private fund is a securities investment fund manager focused on the domestic market and, drawing on the foreign investment research capacity it possesses, aims to give domestic investors access to A-share investment opportunities from a more professional standpoint and a wider range of perspectives.

A WOFE private securities investment fund means an investment fund established by a wholly foreign-owned enterprise that has completed registration with the Asset Management Association of China (the AMAC) and obtained the qualification of private fund manager, and that raises funds from qualified investors in China by non-public means, investing in shares, bonds and fund units of publicly listed companies and in other publicly issued securities and their derivatives as provided by the CSRC.

On 30 June 2016 the AMAC published Questions and Answers on Registration and Filing of Private Funds (No. 10) (the Q&A No. 10), which made clear that an offshore financial institution may carry on private securities investment fund management business, including secondary market securities trading in China, by setting up a wholly foreign-owned entity in China. Besides meeting the same requirements on staffing and systems as a domestic enterprise, the establishment of a WOFE private fund manager must chiefly satisfy the following:

1. The WOFE is a company established in China. Although article 2 of the Provisions on the Administration of Registration of Foreign-Invested Partnership Enterprises allows two or more foreign enterprises to set up a wholly foreign-owned partnership in China, the Q&A No. 10 confines a WOFE carrying on private fund management business to the corporate form.

2. The securities regulator of the country or region where the WOFE's offshore shareholder is located has signed a memorandum of understanding on securities regulatory cooperation (an MOU) with the CSRC or with another body recognised by the CSRC. The CSRC has to date signed MOUs with the securities regulators of the following countries and regions: Hong Kong, China; the United States; Singapore; Australia;

the United Kingdom; Japan; Malaysia; Brazil; France; Germany; Italy; Egypt; Korea; Romania; South Africa; the Netherlands; Belgium; Canada; Switzerland; Indonesia; New Zealand; Portugal; Nigeria; Vietnam; India; Argentina; Jordan; Norway; Turkey; the United Arab Emirates; Thailand; Liechtenstein; Mongolia; Russia; Dubai; Ireland; Austria; Spain; Taiwan, China; Malta; Kuwait; Pakistan; Israel; Qatar; Laos; Sweden; Cyprus; Ukraine; Lithuania; Guernsey; Belarus; Brunei; Jersey; the Isle of Man; Poland; Kazakhstan; Azerbaijan; Abu Dhabi; and Astana.

In practice a great many offshore financial institutions, having weighed the factors, choose a company incorporated in the Cayman Islands, the British Virgin Islands, Bermuda or another jurisdiction with tax advantages as the offshore shareholder of the WOFE. But because the securities regulators of those countries or regions have not yet signed an MOU with the CSRC, they do not meet the condition for a WOFE's offshore shareholder set by the Q&A No. 10.

Minton's lawyers point out that, when setting up a WOFE, an institution intending to apply to register as a private fund manager must know that a company incorporated in the Cayman Islands, the British Virgin Islands, Bermuda or a similar place does not satisfy the AMAC's requirements as the offshore shareholder of a WOFE, and cannot be registered as a WOFE private fund manager.

3. The WOFE's offshore shareholder is a financial institution approved or licensed by the financial regulatory authority of its country or region. Under the Q&A No. 10 the offshore shareholder of a WOFE must be a licensed financial institution (though it need not hold an asset management licence: an institution holding a banking licence, a securities trading licence, a securities advisory licence or another financial licence equally satisfies the industry category condition for a WOFE's offshore shareholder), and holding companies, SPVs and other unlicensed institutions may not serve as the offshore shareholder of a WOFE.

4. Neither the WOFE nor its offshore shareholder has received a major penalty from a regulatory or judicial body in the last three years. Minton's lawyers suggest that, to ensure that a WOFE completes registration as a private securities investment fund manager smoothly and carries on business, a foreign institution should where possible choose as the WOFE's shareholder an entity that has received no penalty of any kind in the last three years.

5. Where a WOFE has an offshore ultimate controller, that controller should also satisfy conditions 2, 3 and 4 above: the MOU must have been signed between the CSRC and the country or region where the offshore ultimate controller is located, and the controller must be a licensed financial institution that has received no major penalty in the last three years.

According to figures from the AMAC, wholly owned subsidiaries of eleven institutions, among them Fidelity and UBS, have one after another obtained the private fund manager qualification, and have applied to carry on securities investment and equity investment management business.

Industry professionals say that a number of foreign institutions are at present preparing apace to develop localised products that meet the needs of the Chinese market and of investors. The asset classes are diverse, covering the primary market, the secondary market, the bond market and the commodities market. As China's capital markets are steadily regularised and opening to the outside world is further deepened, foreign institutions' enthusiasm for and confidence in investing in China are consolidated and strengthened.

Liang Dawei, managing director of the wealth management division of Standard Chartered China, goes further, holding that the two sessions just concluded have sent a clear signal that China will further open its financial sector to foreign participation. Bringing in excellent foreign institutions will drive the healthy development of the domestic financial sector and give domestic investors advanced and more diversified tools for allocating assets. This brings new opportunities for development to international financial institutions, Standard Chartered Bank among them.

As WOFE private funds join hands with commercial banks, the depth and breadth of investment in China and abroad by those within China is further widened. At the same time Minton's lawyers remind investment institutions and investors at large that, in the contest of investment, risk control must not be neglected. Apart from the rule that a private fund manager may not advance funds, insure itself, provide a fallback or promise a fixed return, the scope within which other professional institutions working with a private fund share risk is also limited. Take commercial banks: under the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions and the consultation draft of the same title jointly drafted by the People's Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission, the China Insurance Regulatory Commission and the State Administration of Foreign Exchange (together, the Guiding Opinions), and other guidance issued by the banking regulators, it is expressly required that implicit repayment be broken, and for the first time implicit repayment is identified. Implicit repayment, put simply, is a fallback adopted by a financial institution towards the asset management products it issues. Under the Guiding Opinions the ways of identifying it chiefly comprise "promising principal and return at issue in breach of the principle of determining net value at fair value, achieving promised principal and return through rolling issuance, raising funds itself or entrusting another financial institution to pay on its behalf, and the circumstances of implicit repayment jointly identified by the People's Bank of China and the financial regulators", which in substance cover the main means by which financial institutions have achieved implicit repayment.

If implicit repayment is broken step by step, there will no longer be a fundamental difference in risk and return between a bank's wealth management products and other types of asset management product. The old rules of the game may then gradually change, and asset management capability will become what funds truly pursue. For investors, that undoubtedly means bearing greater investment risk than in the days when lawful implicit repayment existed.