“Compliance” is replacing “innovation” as the new theme of 2016 in the financial industry. Local AICs (Administration of Industry and Commerce) in several major cities blocked the registration of “investment-type companies”; a set of self-regulations were published to strictly regulate the private fund industry; and in early April 2016, the State Council announced it would be undertaking a special year-long campaign to standardize “internet financing”. All these activities indicate the government is determined to rein in a chaotic financial industry. Predictably, the survivors of this crackdown will play an essential role in the future of the private fund industry and will lead the entire industry back onto a healthy track.
Through the effort of AMAC, the self-disciplinary rules on private fundraising have emerged in this new environment of compliance. In the short run, the introduction of new rules on private fundraising is meant to combat illegal financial activities such as illegal marketing and promotion, false advertising, or illegal guarantees for principals and returns. In the long run, comprehensive regulations on private fundraising are necessary to ensure the development of China’s private funds industry, and it will usher in a new era for private fund industry’s regulatory development.
On April 15, 2015, the Administrative Measures on Private Investment Fundraising Activities (“Administrative Measures”) was issued by the Asset Management Association of China (“AMAC”), which will become effective on July 15, 2016. The Administrative Measures applies to all funds raised through non-public means within the territory of China. Aiming to regulate both self-distribution by Private Fund Managers (“PFMs”) and agency distribution delegated by PFMs, the Administrative Measures covers the major parts of fundraising, i.e., fund promotion, fund distribution, fund subscription and redemption, involves the entire fundraising process, and stipulates the regulatory obligations and liabilities of Fundraising Institutions (“FIs”) under each step. Below is an outline of key points of the Administrative Measures.
Regulatory Obligations and Liabilities of FIs. Regulatory obligations and liabilities of FIs are key articles of the Administrative Measures. As pointed out by the Drafting Statement issued by the AMAC, the Administrative Measures stipulate that the regulatory obligations owed by PFMs to investors shall not be transferred by delegation of distribution, while on the other hand, it also sets out specific regulatory obligations borne by FIs, i.e. obligations to prevent conflict of interest, duties of explanation and information disclosure, and duty of anti-money laundry. FIs shall also bear the statutory obligations from four aspects of fundraising, i.e. a) completing “specific target confirmation”; b) complying with marketing and promotion restrictions; c) undertaking “investor suitability management”; and d) completing “qualified investor confirmation”. Compared to the Consultation Paper of the Administrative Measures, the Administrative Measures stipulates additional information disclosure obligations of DIs that DIs shall explain to the investors regarding the allocation of obligations and liabilities between the PFMs and the DIs as well as any other content that may impact investors’ interests under the fund distribution agreements.
Six Major Steps of Fundraising. The Administrative Measures sets out six required steps of the fundraising process: a) “specific target confirmation”, b) “investor suitability management”, c) risk disclosure and explanation, d) qualified investor confirmation, e) cooling-off period, and f) return visit. Firstly, among non-specified targets, FIs shall filter out specified targets as potential clients via investigating whether and to what extent they are capable of identifying and bearing risks; secondly, FIs shall complete the investors suitability management, which is to promote appropriate private fund products matching the investor’s capacity of identifying and bearing risks; thirdly, FIs shall implement risk disclosure and explanation duties before signing fund contracts, fourthly, FIs shall sign fund contracts with investors only after substantive examination of the status of qualified investors; after signing fund contracts, there will be a cooling-off period, during which FIs shall not initiate a contact with investors; and a return visit will be the last step. In accordance with the Administrative Measures, completion of signing the fund contract and payment of subscribed amount does not mean the completion of fundraising, and FIs cannot confirm the completion of the fundraising process unless going through the following steps:
 
Restrictions on Marketing and Promotion. The Administrative Measures distinguishes marketing and promotion to non-specified targets and specified targets. Contents promoting to non-specified targets shall be limited to the brand, development strategies, investment strategies, management team, senior management information of PFMs as well as other information publicly published by the AMAC, but no content of any particular product, while marketing and promotion of particular product shall only be aimed to specified targets. The Administrative Measures also require, prior to the commencement of any marketing or promotional activities, the completion of “specific target confirmation” process. PFMs shall undertake or authorize a third party to assess the risk rating of private funds, and promote appropriate funds matching the investor’s capacity of identifying and bearing risks in accordance with such risk ratings. According to the Administrative Measures, the marketing and promotion materials for private funds shall be made by PFMs themselves only, and the use of such materials shall be limited to PFMs and DIs. PFMs shall be responsible for the authenticity, completion and accuracy of such materials.
Duties of Explanation and Process of Confirming Qualified Investors. The Administrative Measures impose duties of explanation on DIs prior to signing of the fund contract and in addition to the procedural arrangements such as the cooling-off period and return visit as well as relevant rights of investors, such explanations shall cover the risk disclosure of the funds. Specifically, the Administrative Measures also requires FIs to ensure investors’ acknowledgement of the conditions of transferring private funds. As for the process of confirming qualified investors, FIs shall ask investors to provide necessary asset certificates or proof of income and perform anti-money laundry obligations. Currently, it is unclear to what extent FIs shall conduct anti-money laundry investigation as required by the AMAC. The Administrative Measures also discharge a few investors from “qualified investment confirmation” process. Qualified investors by nature as confirmed by the AMAC includes pension funds, social welfare funds, private funds registered with the AMAC, financial products regulated by other financial regulators and PFMs who invest in funds established by themselves and personnel of such PFMs.
No Splitting. The Administrative Measures explicitly prohibits splitting and transferring private fund units or their rights to earnings, which are deemed covertly eluding the statutory requirement that private funds can only be sold to qualified investors, and also prohibits any institutions or individuals from raising funds for financial products which are invested by private fund units or their rights to earnings to evade qualified investor requirements.
Custody of Funds. Compared to the Consultation Paper, the Administrative Measures no longer require PFMs to open special accounts for private fundraising and settlement under the joint names of the PFM and either (1) the China Securities Depository and Clearing Company Limited or (2) a commercial bank or securities company that is qualified to engage in the fund distribution business. But for the purpose of safeguarding funds during fundraising, the Administrative Measures still requires all FIs to open special accounts for private fundraising and settlement, and further require FIs to “ensure the funds are transferred back to the accounts where they are originally taken from” and the “safety of fund transfers.”
Qualifications of FIs and Their Personnel. Except for PFMs who may raise private funds they themselves have established, only institutions that both are registered with the China Securities Regulatory Commission (“CSRC”) to carry on the private fund distribution business and are members of the AMAC are allowed to carry out fundraising delegated by PFMs. Meaning that, PFMs are not allowed to conduct fundraising for private funds established by other PFMs; and DIs who are delegated by PFMs shall not delegate their right of fundraising to a third party. Furthermore, individuals employed by FIs that are engaged in fundraising must have obtained the requisite qualifications (include fund distribution qualifications granted previously) for conducting the fund business.
Our Observation. The content of the Administrative Measures regulates fundraising activities in all aspects, and it represents an important step toward consummating the regulation system of private funds. We expect the private fund industry will benefit from healthier development opportunities under the Administrative Measures and other self-disciplinary rules.