Alert – China introduces private equity filing and disclosure procedures
2 March 2011
China's National Development and Reform Commission (NDRC) has moved to regulate the private equity sector in that country. This reflects increased interest from Central government authorities in ensuring there is adequate regulatory control over this growing investment sector.
Under the new rules, enterprises are being encouraged (and in some cases required) to file certain information. This represents a significant development for an industry that has not been accustomed to mandatory disclosure of financial and investment details.
Foreign-funded private equity enterprises, including management firms and funds, will be affected.
The “National Development and Reform Commission Notice on Progressively Standardising the Development and Filing Management Work of Equity Investment Enterprises in Pilot Areas” (the “Notice”) was issued on 31 January 2011 and took effect on 23 February 2011. It applies to private equity enterprises registered in Beijing, Shanghai, Tianjin, Jiangsu province, Zhejiang province and Hubei province, which have rolled out pilot schemes to encourage private equity investment.
The Notice covers six broad areas that touch on the activities and disclosure requirements of equity investment enterprises in the pilot areas.
- Establishment, capital raising and investing: Equity investment enterprises must be established in accordance with the Company Law or the Partnership Enterprise Law and may be either self-managed through an internal management team or may entrust management to another enterprise. Capital must be raised through private placement to investors who are capable of understanding the risks, and fixed returns cannot be guaranteed. Capital cannot be invested in publicly traded shares.
- Risk control: Equity investment enterprises have to diversify investments and cannot use investments as security for the liabilities of other enterprises. Procedures must be implemented that require related parties to abstain from voting on the equity investment enterprise's decisions on investing in those related parties. Performance incentives and risk control procedures must be set out in the legal and constituent documents of the enterprise. Where the entrusted management institutions are themselves foreign-invested, the assets of the equity investment enterprise must be placed under custodianship of a local trustee company.
- Entrusted management responsibilities: Entrusted management institutions must disclose information about investment activities to the equity investment enterprise and periodically prepare financial statements to fulfil the reporting responsibilities of the equity investment enterprise. The entrusted management institution must give equal treatment to the managed assets of different equity investment enterprises and should not use the assets to profit a third party. Investors may require the entrusted management institution to retire if they have suffered loss.
- Information disclosure and filing: In addition to disclosing investment activity information to investors, certain equity investment enterprises must submit annual business and financial reports to the NDRC within four months of the end of the financial year. They must also promptly report major events occurring in the course of investment activities.
- Equity investment enterprises who must file: Equity investment enterprises registered in the pilot areas with registered capital of more than RMB 500,000,000 must submit filings. Enterprises that submit filings in accordance with the Interim Measures on Venture Capital Enterprises Management, however, or that are funded by one institution or natural person or by two or more institutions that are wholly owned subsidiaries of the same institution, are exempted from the filing requirements.
Equity investment enterprises and entrusted management institutions that are not required to file are still encouraged to undertake filing procedures - those that do not do so risk being potentially publicly named as “non-filing equity investment enterprises and management institutions”.
- Encouraging self-regulation: The Notice seeks to combine government regulation with industry self-supervision. Enterprises that complete their filing will be subject to an annual inspection within five months of the end of the financial year. Enterprises that fail the filing requirements will be asked to rectify the situation. If they fail to do so within the required time, they may be publicly named as “non-filing equity investment enterprises and management institutions”. Equity investment enterprises are required to establish a national trade association for self-supervision of its members.
The main impact of the new rules will be seen in how strenuously the NDRC enforces the filing and annual inspection requirements on private equity enterprises, and whether it follows through on publicly naming "non-filing" enterprises, including those who do not meet the RMB 500,000,000 registered capital threshold for mandatory filing.
It has been speculated that other authorities, such as the China Securities Regulatory Commission (CSRC), have also been planning their own regulatory regimes. CSRC may yet impose further requirements, in a bid to stake its own claim as a regulator of the private equity sector. Thus, there could be more changes in store for the industry in China.