In this episode of China Money Podcast, guest Hubert Tse, senior partner at Shanghai-based law firm Boss & Young, answers ten questions about the QFLP (Qualified Foreign Limited Partner) program: from what QFLP allows foreign investors do, the pros and cons of becoming a QFLP, to what the future of QFLP program holds.
Listen to the full interview in the audio podcast, or read an excerpt.
Q: Just last week, news reports came out claiming that Shanghai has been approved to start the so-called RQFLP test program. Before we talk about this new development, let’s first explain what QFLP (Qualified Foreign Limited Partner) program is? What does the QFLP program allow investors to do?
A: Shanghai was the first city to launch a QFLP pilot program in 2010. Beijing and Tianjin followed later. It allows foreign investors to form an onshore RMB fund to invest in private Chinese companies. The foreign investors need to first set up a foreign management entity onshore with a minimum registered capital of US$2 million. When you get the QFLP approval, then you can set up a QFLP fund. You can raise money from both domestic and international investors. Once you get the approval, the USD can be converted to RMB.
Q: Which institutions so far have established QFLP funds?
A: We have known that big private equity players such as Blackstone, TPG, Carlyle, have all established QFLP funds. JPMorgan also has a QFLP fund in Beijing. But there are quite a number of domestic and regional players who have set up QFLP funds in Shanghai. We have seen big domestic security firms and fund managers who do not have a lot of private equity experience partnering with experienced foreign private equity firms under this program via a joint-venture.
Q: For those big-name private equity firms you mentioned, how much have they been able to achieve in terms of fund raising and investing?
A: News reports show that some of them have raised funds with several billion RMB each. (Blackstone reportedly has a RMB 5 billion QFLP fund; JP Morgan reportedly has a US$1 billion RMB fund) But there are no official data on the size of the funds operating under the program.
Q: For those funds with a mixture of LPs with both domestic and foreign capital, are their money deemed as foreign capital or domestic capital when they make an investment?
A: When you look at the Shanghai rule, the management entity is allowed to contribute anywhere from 2% to 5% of capital to the fund. The rules indicate indirectly that, if aside from the contributions from the management entity, the rest of the capital are raised domestically, this fund should be subjected to national treatment, meaning this fund is a domestic fund. But if you raised money from foreign LPs, then this fund will be treated as a foreign fund.
The National Development and Reform Commission (NDRC) issued a statement at the end of last year that contradicted the Shanghai rule. It states that even if capital contributions are all from domestic LPs, it will still be treated as a foreign fund.
So the current situation is that whether you have all domestic LPs or a mixed LP base, a QFLP fund is still most likely to be treated as a foreign fund, subjected to all foreign investment restrictions and regulations. When this fund makes an investment into a Chinese company, this company will change from a purely domestic company to a foreign invested enterprise (FIE), which falls under different regulatory rules.
Q: Doesn’t it defeat the purpose, then? What is the benefit of having a RMB fund when the capital is deemed as foreign capital?
A: When the NDRC rule came out, we were all disappointed. The NDRC is not the official regulator for private equity. Right now, there aren’t any designated authorities regulating private equity in China. But any private equity fund in China with over US$500 million of capital needs to file with the NDRC. If you do not file, you will probably not be able to get any money from the National Social Security Fund (NSSF) in the future if the opportunity arises, because the NDRC runs the private equity fund investment for NSSF. In addition, not filing could also lead to penalties.
It does sort of defeat the purpose, as the original intention was to allow foreign investors to set up onshore RMB funds. But from another perspective, suppose a QFLP fund would be treated as a domestic fund, it could somehow circumvent the whole foreign investment rules. It would give the private equity space more advantage than other potential foreign investors (and potentially create a loophole for non-private equity foreign investors).
So, what are the advantages of having a QFLP fund? First, you have an onshore fund and can attract capital from domestic LPs. You will also have a higher profile, more opportunity to build local relationships and networks. The disadvantages would be when a QFLP fund makes investments into a Chinese company, it will change the company to a foreign invested enterprise subjected to more scrutiny and compliance. In addition, when this company wants to go public in China, it will also go through more processes.
Q: It seems as if there aren’t enough benefits for foreign firms to consider joining the QFLP program?
A: Some funds do think this way. If you already have an offshore USD fund, why have another onshore RMB fund that really doesn’t allow you do much more than what could be done through the USD fund?
But there are benefits. When a QFLP fund invests in companies that are categorized as "Permitted" or "Encouraged" by the Ministry of Commerce (Click here for the Ministry of Commerce’s complete foreign investment guidance list), it does not need approval from Ministry of Commerce and State Administration of Foreign Exchange for currency conversion.
Q: So, how many hurdles does a foreign fund face when they invest in those two categories?
A: Usually there shouldn’t be lots of issues. But there are always uncertainties with government approvals. And there are also the issues of timing. If your investment is sensitive to time, then having to go through this extra approval adds uncertainties.
Q: What’s your advice for foreign investors thinking about potentially applying for the QFLP program?
A: It depends on the objective, experience, and time horizon of the foreign fund. I have some clients who prefer to have offshore USD funds. But for funds who don’t have a fund in China who want to raise their profile and build up institutional investor relations in China, they could consider the QFLP program. Of course, the foreign investors have to meet certain qualifications as the objective of the QFLP program is to bring in private equity expertise to China.
Q: It’s hard to predict how Chinese regulations will evolve in the future, but do you have any predictions on how regulations regarding QFLP will likely change?
A: We saw last week some news reports about a potential RQFLP pilot program in Shanghai, in which the capital is from offshore RMB and the fund is operating under the QFLP framework. Combined with some other policies and reforms, it might be possible that the QFLP program will be able to achieve national treatment at some point, of course, it also depends on the progress of the RMB’s internationalization.
Q: Aside from the source and currency of the capital, are there any other differences between the RQFLP and QFLP program?
A: So far, there hasn’t been any official announcement from the Shanghai government yet regarding this RQFLP program. We’ve only seen news reports. But what we have seen suggests that the RQFLP might be able to get approval to issue RMB products publicly in Hong Kong, then channel the RMB back to Shanghai to invest under the QFLP framework. For the QFLP program, however, the fund raising is done in China. The RQFLP program, similar to RQFII program, is part of the effort to internationalize the RMB by increasing circulation of the RMB cross-border.
About Hubert Tse:
Hubert Tse is senior partner at Shanghai-based law firm, Boss & Young. He has advised Chinese and global financial institutions on the structuring and formation of onshore and offshore funds, investment advisory operations in the PRC, and the QDII, QFII and QFLP programs. He holds a B.Com, LL.B. from The University of Queensland.