When private equity investment funds first entered the PRC, in deference to the sensitivity of the term “private”, and given that “industry fund” was much more appropriate to describe the then economic policy that put the government in the driver’s seat, the term “equity investment fund” was replaced by the term “industry investment fund”.
The Notice of the State Council Approving and Transmitting the Opinions of the National Development and Reform Commission [NDRC] on Intensifying the Key Work Involved in the Reform of the Economic System in 2009, issued by the State Council on 19 May 2009, mentions “accelerating the establishment of an equity investment fund system, and issuing measures for the administration of equity investment funds as soon as possible”. The term “industry investment fund”, whose use at the state level had continued to that time, now formally became “equity investment fund”.
To date, there are no national-level laws or regulations that clearly and uniformly define “industry investment fund” or “equity investment fund”. Based on the definition of “equity investment fund” appearing in article 1 of the Opinions on Promoting the Development of the Equity Investment Fund Business, issued by relevant authorities of Beijing municipality, an industry investment fund in the PRC is an equity investment fund and means a non-security-type investment fund that is established by privately offering units to specific targets, that invests in the equity of non-listed enterprises and that provides value-added services thereto. An equity fund can take the form of a company or a partnership.
The industry investment funds explored in this column are large equity investment funds that, from the perspective of their nature, offering and operation, are a subset of equity investment funds, and particularly refer to those that are subject to the consent of the State Council and the approval of the NDRC, are guided by local governments and directly use the words “industry investment fund” in their names.
Current development status
The history of industry investment funds in China has not been very long, and on the whole they could be said to be in the early stages of growth. A survey of the developmental history of industry investment funds in China reveals the existence of the following issues:
The absence of a sound system of laws. China still lacks national regulations governing industry investment funds and equity investment funds, which makes effective regulation difficult.
Development of industry investment funds is insufficiently market-oriented. Industry investment funds in China are subject to an approval system, giving them a heavily administrative flavour. The reasons for their approval or not are relatively vague, with an insufficiently transparent approval procedure. Additionally, the regional character of industry investment funds is quite marked, limiting their scope of investment and disfavouring market-oriented development. Finally, the mechanism for the establishment of industry investment funds is insufficiently market-oriented.
The sourcing channels for such funds are relatively homogeneous, and proceeds from initial offerings all more or less have a “state-owned” background. For example, Shandong Ocean Investment, the sponsor of the Blue Economic Zone Industry Investment Fund, is a large state-owned enterprise, the establishment of which was approved by the Shandong provincial people’s government.
Industry investment funds lack effective divestment channels. At present, divestment directly through a listing is subject to stringent limitations, such as listing offer limits and offer conditions, and back-door listings are subject to the stringent restrictions of investment banks. Furthermore, second board markets and over-the-counter markets are not yet fully established in China.
Sound operating environment
First, legislative work needs to be pushed forward to establish a sound system of laws for industry investment funds. Sound laws and regulations can protect the lawful rights and interests of investors, and make the investment and management acts of relevant persons in the fund market-compliant. This is the foundation for healthy and stable development of industry investment funds in China. Accordingly, China should accelerate the issuance of the Administrative Measures for Equity Investment Funds and implement a uniform set of compliance standards nationwide to set the development of industry investment funds on a sound law-based track.
Second, there needs to be commitment to a combination of market-oriented operation of industry investment funds and appropriate government regulation and guidance. Industry investment funds are in essence a kind of market act. However, in China they are at the initial stages of development and cannot divorce themselves from government guidance and regulation. A certain degree of regulation can ensure the benign development of industry investment funds, and the government should leverage economic and other means to encourage their development.
Capital market system
Third, the establishment of a multi-faceted capital market system to broaden the sourcing channels for industry funds would provide abundant funding sources for their development. Diversification of fund sources is a major trend in the development of industry investment funds internationally. In China, private funds should be the major source of funds for industry investment funds and certain powerful financial and other such institutions should be developed into the backbone of the industry.
Fourth, establish a multi-faceted capital market system to provide diversified divestment mechanisms for the development of industry investment funds. Since, ultimately, the capital benefits of these funds are secured by cashing in investments, once an enterprise successfully lists, investors must timely divest and cash in on their investment, and thereby put and keep in motion the virtuous cycle development of industry investment funds, i.e. “investment fostering – realisation/profiting – reinvestment”. The establishment of second board markets must be steadily promoted, while also establishing and improving over-the-counter markets.
Industry investment funds in China, as innovative financial products, are in the initial stages of development and are bound to encounter problems. However, as we develop these funds, we can, in respect of offering methods, organisational form and divestment mechanisms, learn from fund development models in other countries and, while taking into account the situation in China, develop these funds in an innovative manner.
Cheng Haiqun is a partner and Hong Yifang is a trainee at Zhonglun W&D Law Firm in Shenzhen
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