Private equity funds, and the whole sector, have slowed their pace of conducting relevant business since the release of the Guiding Opinions on Regulating Asset Management Business of Financial Institutions and its detailed supporting rules. Almost a year has passed since the new asset management regulations were put into effect, and the author will shed some light on their influence on PE fund
Capital raising. “Great difficulty in raising capital” has become a key phrase in the PE sector. The difficulty lies in the “dire shortage of capital” and investment compliance.
The new asset management regulations set a unified criterion for a qualified investor, making clear the divide between public offering and private offering, stipulating that equity products investing in unlisted companies should be closed-end and the product due date should be later than the date of equity exit, and placing a ban on multi-level nesting (over two layers).
The old capital raising channels have thus been restricted by the above-mentioned provisions. According to the new asset management regulations, one of the prerequisites to investing in PE funds is that the term of the PE products offered by commercial banks to qualified investors should be longer than that of the PE fund. This provision does not correspond to the characteristics (e.g., low capital threshold, short investment term, etc.) of personal financial business, and drastically increases the difficulty for commercial banks to raise capital for qualified products.
The detailed supporting rules, i.e., the Measures on Supervision and Administration of Wealth Management Business of Commercial Banks, also restrict wealth management products from directly investing in PE funds, and ban multi-level nesting. Therefore, PE funds are impacted by the difficulty in raising capital and the limitations on investment pathways, and the negative influence is reflected in not only capital raising, but also investors’ decisions.
In addition, the exchange-traded structure and parent fund investment strategy, which are commonly seen in PE funds, are being questioned. Some people doubt that such practices violate the new asset management regulations. As a result, PE funds become less flexible in structure design when raising capital for asset management products (including parent funds), and try to avoid investing in sub-funds.
Investment management. Overall, the regulators take a flexible attitude towards the investment management of PE funds. In other words, they will refer to the new asset management regulations while continuing to apply the previous PE fund regulations. Meanwhile, they also intend to advance the release of the relevant detailed rules.
Despite that, PE fund subsidiaries of security companies are duly incorporated to engage in private asset management business. Therefore, such PE funds should also comply with the provisions of the Administrative Measures on the Private Asset Management Business of Securities and Futures Institutions and the Administrative Provisions on the Operation of Private Asset Management Plans by Securities and Futures Institutions (collectively referred to as the detailed rules on securities and futures management). These provisions stipulate the following: PE fund products should be closed-end; product scale shall not be expanded after completing the PE fund approval; and investment activities are not allowed before completing the approval.
The above-mentioned provisions will force such PE funds to exercise one-off capital raising instead of having a window period for capital raising with the purpose of conducting investment activities in compliance with the regulations as soon as possible, which makes it harder for PE subsidiaries of security companies to raise capital.
The detailed rules on securities and futures management also set out that any fees incurred before the launch of the products, and any capital raising-related fees, should not be listed in the product expense. This differs from the common practice, i.e., the fees should be borne by the property of the fund, and increases the cost of PE subsidiaries of security companies. Provisions relating to the withdrawal frequency of fund performance payment and the limit of withdrawal proportion also deviate from the common PE sector practices. Regulatory adjustments should be made accordingly in practice.
Exit of investments. Although asset management products, such as banks’ asset management products, boast a huge amount of capital, the issue of “three types of shareholder” emerged after the PE-fund-invested companies’ exit of investment through IPO, which creates a dilemma for PE fund managers. In particular, after the internal review draft of the new asset management regulations flowed into the market, regulators still examine whether the “three types of shareholder” comply with the new asset management regulations.
On the other hand, the detailed supporting rules of the new asset management regulations clarified the trust-wise legal relationship of asset management products. So, since the rights and obligations of mangers, trustees and trusted property are made clear, will concerns over the issue of “three types of shareholder” also be addressed? In this regard, the Listing Rules for the Science and Technology Innovation Board of the Shanghai Securities Exchange (Listing Rules) demonstrate a positive attitude.
The listing rules allow contractual funds, trust schemes or asset management schemes to become a controlling shareholder, the largest shareholder or the actual controller of a listed company as long as such information is disclosed to the end investors. For the “three types of shareholder” who hold more than 5% of the shares of the listed company, the listing rules’ focus is placed on the subject controlling the voting power, and its relationship with controlling shareholders and actual controllers.
Competition pattern. After the new asset management regulations and the detailed supporting rules came into force, commercial banks, security companies, insurers, trusts and funds were able to compete with each other on an equal footing. On the one hand, this promotes fair competition. On the other hand, PE fund managers now face more fierce competition.
Commercial banks, security companies, insurers and public funds enjoy a competitive edge in terms of capital raising. However, PE fund managers may stand out by using more market-oriented operations, competent talent, incentive arrangements, and project research and management. They may also consider co-operating with other institutions. As stated by the Administrative Measures on Wealth Management Subsidiaries of Commercial Banks, subsidiaries of commercial banks may select a qualified PE fund manager to be its partner institution of wealth management to achieve win-win outcomes.
Weng Heqian is an associate at Zhong Lun Law Firm
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