The China National Development and Reform Commission (NDRC), the PRC regulatory authority in charge of venture capital and private equity, recently clarified that China-domiciled Renminbi venture capital and private equity funds with only PRC domestic investors as limited partners and with foreign or foreign-invested companies as their general partners cannot get "national treatment" in China. This means that these types of funds will be treated as foreign-invested funds and their portfolio investments will be subject to foreign investment restrictions. In other words, these funds will not be able to make investments in certain industries (e.g., film production companies, golf course construction and operation, etc.) where foreign investment is completely prohibited as set forth in the PRC Foreign Investment Industrial Guideline Catalogue and will be restricted from making investments in certain industries (e.g., telecommunications companies, securities companies, etc.) where foreign investment is allowed but only to a certain extent, for example, with limitation on the percentage of equity interest or a requirement for regulatory approvals at higher levels,as set forth in the same catalogue.

Under the existing PRC regulatory framework for private equity and venture capital funds, there are generally three avenues for international fund sponsors and managers to participate in China-domiciled Renminbi funds:

1. To raise pure Renminbi funds from PRC domestic investors without making any capital contribution to the funds.

In this structure, international fund sponsors and managers normally set up a management company in China, which is either wholly owned by them or jointly owned with their Chinese partners. The management company will raise Renminbi funds from PRC domestic investors and manage the funds in the capacity as fund manager. All limited partners of the funds come from inside China and contribute Renminbi to the funds. The general partners of the funds are PRC domestic companies without any foreign ownership behind them. All income of international sponsors and managers from these funds will be received contractually through the management company, which does not make any capital contribution to the funds, directly or indirectly. As there is no foreign investor or foreign money in these types of funds, they have always been considered as pure Renminbi funds and, therefore, are not subject to foreign investment restrictions. These funds are not affected by the recent policy clarification by the NDRC.

2. To raise Renminbi funds from PRC domestic investors and make the customary 1-5% sponsor capital contribution to the funds.

In this structure, international fund sponsors and managers normally set up a wholly foreign owned or Sino-foreign joint venture management company in China. The management company will then act as both the manager and the general partner of the Renminbi funds raised from PRC domestic investors. As general partner, it will make the customary 1-5% sponsor capital contribution to the funds, which is permitted to be converted into Renminbi under local QFLP (Qualified Foreign Limited Partner) pilot programs in certain provinces. All of the limited partners of the funds come from inside China and contribute Renminbi into the funds. Although there is a foreign-invested entity (i.e., the management company in the capacity as a general partner) making capital contributions to the funds, these funds were previously treated as PRC domestic funds (instead of foreign-invested funds) in some cities (e.g., Shanghai and Tianjin) under local QFLP pilot programs and, therefore, were not subject to foreign investment restrictions. Such "national treatment" has been considered by international fund sponsors and managers to be a major advantage over traditional offshore US dollar funds and China-domiciled Renminbi funds with foreign investors and has therefore made these funds more attractive to investors.

However, as local QFLP pilot programs were established by local governments and have never been publicly endorsed by any regulatory authority at a national level, such as the NDRC or the Ministry of Commerce (MOFCOM), it has been ambiguous whether such "national treatment" granted under local QFLP pilot programs is consistent with the national foreign investment policies of China. The NDRC has now made this clear by ending the "national treatment" for these funds.

3. To raise US dollars from non-PRC investors and convert the US dollars into Renminbi under local QFLP pilot programs.

In this structure, international fund sponsors and managers raise US dollars from non-PRC investors and apply for a QFLP quota under local QFLP pilot programs to convert the US dollars into Renminbi so as to make portfolio investments inside China in Renminbi. The funds are managed by wholly foreign owned or Sino-foreign joint venture management companies established by the international fund sponsors and mangers in China, which also act as general partners of the funds and make the customary 1-5% sponsor capital contribution to the funds. Compared to traditional offshore US dollar funds, these funds have two main advantages: one being faster approval procedures for portfolio investments and the other being the ability to convert US dollars to Renminbi at the fund level and make portfolio investments in Renminbi in China directly. Since some or all of their limited partners come from outside of China, these funds have always been treated as foreign-invested funds subject to foreign investment restrictions. So the recent policy clarification by the NDRC should not be a concern to sponsors and managers of this type of fund.

Please contact your Proskauer relationship attorney if you would like more information.