Lukewarm reception

A new structure to allow foreign investors to access Chinese private equity funds may not be all it is cracked up to be

Approval to launch a Qualified Foreign LP (QFLP) programme in Shanghai – potentially letting offshore investors access domestic Chinese private equity funds – has been met with only muted excitement by the investment community.

Similar to the Qualified Foreign Institutional Investor scheme already in existence, which allows approved foreign investors access to Chinese equities, the broad aim of the QFLP would be to allow approved foreign LPs access to the domestic private equity industry.

A statement from law firm Debevoise & Plimpton, citing a “source in Shanghai”, said the programme would likely allow approved LPs to convert foreign currency for investment into an onshore RMB-denominated fund established in Shanghai, as long as the aggregate quota for foreign-originated capital does not exceed 50 percent of the total size of the fund.

However, Hubert Tse, a partner at Chinese law firm Boss & Young in Shanghai, says there have been talks about limiting the foreign currency conversion quota to 30 percent, and adds that there might also be a $100 million cap on foreign capital converted per fund.

For offshore LPs investing in China’s private equity markets, the news is potentially momentous. The biggest gripe offshore LPs have currently about the Chinese market is the difference in treatment afforded to USD-denominated funds, which are subject to restrictions around investment and lengthy approval processes, and local currency RMB funds, which are not.

The issue has led to accusations against Chinese managers of conflicts of interest between offshore and onshore funds, with LPs saying managers often prefer to focus their efforts and resources on their RMB funds.

A QFLP programme was held to be a good solution, but celebrations among the LP community are not yet being seen.

“It’s just an announcement, there’s no details yet,” says one LP, and indeed the fine print on Shanghai’s QFLP programme is still being worked out, with more details expected in November.

In the interim period, LPs can only speculate on whether the QFLP will fulfill their expectations. Crucial to this will be the treatment given to these comingled private equity funds. Will they be treated like onshore funds, or will they instead be treated like foreign capital?
According to the Debevoise statement, the signs are good. Domestic RMB funds with no more than 50 percent of capital from QFLPs will be treated “as domestic funds not subject generally to foreign investment restrictions or investment approval processes”, its statement noted.

But not everybody is convinced that clause will make it into the final version of the programme.

“There is the possibility that it may be treated as a pure RMB fund, but in my opinion, given the foreign LP participation, it’s probably more likely that the fund will be treated as a foreign invested fund, therefore still subject to regulatory approvals,” said Boss & Young’s Tse.

“This is something entirely unclear at the moment – the lawyers say one thing, the GPs say another thing, and the government says something else,” comments one LP, adding that without it, the QFLP programme has “no practical meaning”.