Last Friday, the China Securities Regulatory Commission (“CSRC”) issued a major regulatory document for the private fund industry – the Interim Measures on Operation of Private Fund Asset Management Business of Securities and Futures Operation Institutions (“Interim Measures”). As pointed out by the CSRC in their press release on the same day, the Interim Measures are being issued as part of a reflection on numerous regulatory issues related to the private fund asset management industry in the wake of the Chinese stock market’s abnormally volatile period in 2015. To send a clear message on regulatory policy to the market, the CSRC decided to turn the Detailed Rules on the Prohibited Acts under the “Eight Bottom-Lines” in Asset Management Business Abided by Securities and Futures Operation Institutions originally formulated and amended by the Asset Management Association of China (“AMAC”) into an administrative regulation issued by the CSRC with a more significant legal effect than the AMAC’s rules. Moreover, in order to prevent asset management institutions from issuing products all at once after the promulgation and before the implementation of the document, there is only one weekend separating the release date and the date of implementation. Below is our brief analysis with respect to the key content of the Interim Measures.
The Interim Measures apply to institutions operating securities and futures business, including securities companies, fund management companies, futures companies and their subsidiaries that are duly incorporated in accordance with the laws to engage in the private fund asset management business (collectively, “Licensed Asset Managers”). Furthermore, aiming to prevent regulatory arbitrage, the CSRC also requires private securities investment fund managers registered with the AMAC to be bound by the Interim Measures as well, which means private funds shall also be regulated by the Interim Measures the same as the asset management plans (“AMPs”). In general, the Interim Measures emphasize six regulatory focuses on the operations of private fund asset management business in terms of (i) promotion, marketing and sales; (ii) structured asset management plans (“Structured AMPs”); (iii) illegal securities and futures business activities; (iv) investment recommendations provided by third parties; (v) “fund pooling” business; and (vi) over incentives to fund managers.
We have noticed that prohibitions of guaranteed principal or returns, illegal benefit transfer, and fund pooling provided in the original “Eight Bottom-Lines” are still retained in the Interim Measures and with further elaborations. For example, for the “fund pooling” business, they underscore the prohibition of business activities of a “fund pooling” nature. However, compared with the original “Eight Bottom-Lines”, new issues have been added and emphasized in the Interim Measures, including: (1) re-definition of regulatory requirements on the Structured AMPs; (2) qualification requirement on third parties providing investment recommendations; (3) prevention of private fund asset management business being used as a channel for conducting illegal securities and futures business activities.
The Interim Measures require that a Structured AMP shall be set up without breaching the principle of “profit and loss sharing, risk and return matching”, prohibit any direct or indirect guarantee of the principal or returns to the senior class subscribers, prohibit third parties that provide investment recommendations and their affiliates from subscribing to the junior class of the Structured AMP, and provide leverage multiples for different Structured AMPs. For example, the leverage multiples of stocks or the mixed type products shall not exceed 1x, the leverage multiples of fixed-income products shall not exceed 3x, and the leverage multiples of other products shall not exceed 2x. Additionally, the Interim Measures limit the debt ratio of AMPs by requiring that the proportion of the total assets of a Structured AMP to the net capital thereof shall not exceed 140%, and the proportion of the total asset of a non-structured “one-to-more” AMP to the net capital thereof shall not exceed 200%. A Structured AMP by definition is an AMP separately agreed on by the asset management contract, under which it uses at least one or more class of shares to provide certain risk compensation to other classes of shares, and the profit allocation thereof will not be calculated in proportion to the number of shares. However, an AMP (of which the asset manager provides proprietary funds for limited risk compensation and will not be involved in receiving allocation of returns or obtain any profit higher than the returns calculated in proportion to the number of shares) will not be deemed a Structured AMP defined by the Interim Measures.
In terms of providing investment recommendations by third parties, the Interim Measures provide more profound regulatory requirements than the original “Eight Bottom-Lines”. As required by the Interim Measures, a third party providing investment recommendations shall be either (i) a Licensed Asset Manager; or (ii) a private securities investment fund manager that must (a) be a member registered with the AMAC over one year without any record of material violation against any laws or regulations; (b) have at least three investment managers, who have no bad practice record and have track records in securities or futures investment management which are traceable and run over three consecutive years. This means that any institution failing to obtain the license for asset management or to register with AMAC as a private securities investment fund manager can no longer be an investment advisor to an AMP or private fund or to provide investment recommendations for an AMP or private fund.
Additionally, it is worth noting that the Interim Measures specify that operation of private fund asset management businesses shall not be involved in offering any conveniences of trading for the so-called “illegal securities and futures business activities”, and set forth the following prohibitive acts: (i) setting up sub-accounts or virtual accounts under the units of AMP, or lending the securities or futures account thereof to others, both of which violate the real name account rule; (ii) providing account opening, trading channels, investor introduction or any other service or convenience for illegal securities and futures business activities; (iii) illegally utilizing external access to information systems to facilitate trading, providing systems integrating or trading orders forwarding for illegal securities and futures business activities; (iv) setting up an umbrella AMP, with principals of the umbrella and subsidiaries (or affiliates of the principals) executing investment decisions separately while under the same securities or futures accounts of a single AMP.
A transitional arrangement will be executed under the Interim Measures pursuant to the principle of “new-old cut”, i.e. after the Interim Measures are implemented, it will be treated differently for those existing AMPs which cannot satisfy the relevant requirements, including preventing its leverage multiples from rising, no increase of net subscription before expiry of the asset management contract, and liquidation upon expiry with no renewal rendered.
We believe that the Interim Measures will exert far-reaching impact on the private fund asset management businesses in the long run. The principles of “substance over form” and “penetration supervision” will be further emphasized on the interpretation and execution of regulatory policies, and regulatory bodies will be conferred certain discretionary power to guard against regulatory arbitrage to the extent possible.