Mar 03, 2017 04:22 PM

New Regulation to Tighten Scrutiny of Privately Offered Funds

(Beijing) — China’s securities regulators are gathering comments about proposed regulations to govern the privately offered fund business — an effort to tighten oversight of the booming sector, which is increasingly plowing money into the “shadow banking” system.

The draft regulations, drawn up by the China Securities Regulatory Commission (CSRC), are based on opinions from various financial regulatory bodies.

“It will be the legal document that establishes the regulatory framework for the privately offered fund industry,” a legal expert said. Currently, the industry encompasses 280,000 professional employees and is an important part of China’s massive asset management market.

Privately offered funds raise money, generally from wealthy individuals or entities, and invest it in securities, financial derivatives, equities of unlisted firms and other assets. Unlike mutual funds, which are offered to public investors, privately offered funds usually target wealthier investors who have higher risk tolerance. These funds are subject to fewer investment restrictions and lower disclosure requirements than publicly offered funds.

Caixin has learned from sources close to the matter that the draft regulations will cover all types of privately offered funds, including those investing in securities and equity, as well as venture capital.

The draft regulation sets clear restrictions on private-fund managers. It bans from the industry those who have a record of violating financial industry regulations or laws. Individuals and firms whose debt-to asset ratios exceed 50% or that are major default risks are also restricted in the industry.

It bans fund managers from splitting a single private placement plan into tranches and sold to small investors who cannot tolerate risky investments. It also requires fund managers to regularly report their investments and leverage ratios. Punishments for violations will also be spelled out by the regulation.

The private-fund industry in China operated in a regulatory vacuum for years until December 2012, when the revised Securities Investment Fund Law spelled out supervisory measures on privately offered funds that invest their money into securities. But private equity funds, including venture capitals, remained in regulatory limbo.

In June 2013, the central government put private equity funds under the supervision of the CSRC, ending a battle on jurisdictions between the commission and the National Development and Reform Commission. The next year, the CSRC proposed a plan to draft a unified regulation on privately offered funds. In the following years, the regulator issued some provisional measures to guide the industry.

“Compared to public funds, which are subject to complete and clear regulatory framework (set by the Securities Investment Fund Law, supervision of) private funds has lagged far behind,” one senior CSRC official said.

The regulatory ambiguity hasn’t stopped the industry’s fast growth, and more than likely spurred it on. As of Jan. 31, China had 18,048 registered private fund management firms, operating 10.98 trillion yuan ($1.59 trillion) raised through 47,523 funds for securities and equity investments, according to data from Asset Management Association of China (AMAC), a semi-official industry organization.

The rapid expansion has been accompanied by problems. In January, Xu Xiang, a well-known private-fund manager, was sentenced to five and a half years in prison for manipulating stock prices for profit. Sources with knowledge of the case told Caixin that Xu and two other fund managers, who were also convicted, poured 40 billion yuan raised through privately offered investment plans to prop up stock prices.

With less-strict disclosure requirements than public funds, the capital operations of many private funds have remained blind spots to investors and regulators. In recent years, privately offered funds have increasingly served as vehicles to channel huge amounts of wealth management funds held by commercial banks into various investment projects. These sometimes-risky investments have become a major building block of a shadow banking system that falls outside regulatory oversight and puts retail investors at risk.

CSRC Chairman Liu Shiyu promised several times last year to speed up work on the regulation of privately offered funds. In April 2016, the State Council, China’s cabinet, listed drafting private-fund regulation among the top priorities of the annual legislative agenda.

The new industry regulation “will put all privately offered funds and investment advisory business under the same supervision network and clearly define their legal responsibilities,” said a lawyer familiar with the private-fund industry.

But experts familiar with the draft said the new regulation still leaves some key questions unanswered. These include whether asset management products issued by securities, trust and other institutions should comply with private fund regulations and whether other financial institutions can conduct private fund investments.

“If measured by U.S. standards, many of the asset management products issued by Chinese securities, trust firms and commercial banks should be put under the category of privately offered funds,” said Deng Huanle, a legal expert at AMAC.

These remaining issues will further raise questions about how the new regulations will dovetail with other industry rules, including a key document under consideration by various financial regulators on the whole asset-management business, which also includes provisions on privately offered funds.

It will take time for regulators and lawmakers to comb through different rules and laws to eliminate conflicts and ambiguities and construct a unified supervisory system. But changes in the loosely regulated industry are expected soon.

The regulation “will bring a new round of reshuffle to the private fund industry,” the lawyer said.

Contact reporter Han Wei (

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