Guidelines for the Operation of Private Securities Investment Funds
We are writing to inform you of the recent release by the Asset Management Association of China (the “AMAC”) of the "Guidelines for the Operation of Private Securities Investment Funds" (the “Guidelines”, in Chinese, “《私募证券投资基金运作指引》”) on 30 April 2024, which will take effect on 1 August 2024 (“Effective Day”). The Guidelines mark a significant development in the regulatory landscape governing all major aspects of private securities investment funds, i.e., hedge funds and long-only funds, in China.
Legislative Background:
The issuance of the Guidelines comes amidst a broader regulatory push by Chinese authorities to enhance oversight and transparency in the asset management industry. With the rapid growth of private securities investment funds (the “Private Securities Funds”) in recent years, regulators have sought to further address potential risks and ensure the stability and integrity of the financial markets.
The Guidelines build upon existing regulatory frameworks and aim to establish clearer rules and (higher) standards for the operation of the Private Securities Fund.
Key Contents and Implications:
The Guidelines outline comprehensive requirements across various aspects of fund operations, covering scale of funds, investor suitability, marketing, dealings, lock-ups, classification of Private Securities Funds, portfolio investments (including diversification, leverage and OTC derivatives investments), programme trading, proprietary trading, risk capital, transitional arrangements, etc.
1. Scale of funds
According to Article 4 of the Guidelines, Private Securities Funds shall raise no less than RMB 10 million as its initial fund size and maintain such scale. Specifically,
- if the daily average NAV of a Private Securities Fund falls below RMB 10 million in the preceding year, it shall make disclosures to investors;
- if the daily average NAV of a Private Securities Fund falls below RMB 5 million in the preceding year or for a consecutive of 60 trading days, it shall suspend subscriptions and make disclosures to investors, and once such NAV remains below RMB 5 million for another 120 trading days after the suspension of subscriptions, the fund shall be liquidated.
Such measurement will start from 1 January 2025 for the pre-existing Private Securities Fund or the date of the Private Securities Fund’s incorporation if it is incorporated after 1 January 2025.
2. Investor suitability
According to Article 5 of the Guidelines, a Private Securities Fund must be sold to investors with a compatible risk rating. The Guidelines no longer allow an investor to invest into a Private Securities Fund with a risk level higher than that of the investor’s own risk appetite, even if the investor voluntarily elects to do so, as was allowed in the past.
3. Marketing
According to Article 6 of the Guidelines, a Private Securities Fund is also subject to enhanced promotion and marketing rules under the Guidelines, and shall not disclose any fund performance data to any third party, except for a designated placement agent, potential investors who have completed designated client onboarding process, or funds rating agency meeting relevant requirements. Track records of managing any funds with a size of less than RMB 10 million or in existence of less than six months are no longer eligible to be used in promotion, marketing, and ranking.
4. Dealings
According to Article 7 of the Guidelines, a Private Securities Fund may be established in the form of an open-ended fund or a close end fund. With respect to open-ended Private Securities Funds, the dealings for subscriptions and redemptions shall be no more frequent than weekly and the dealing day may last for up to 2 days each time.
That said, if a Private Securities Fund invests into less liquid assets which take up over 20% of the total NAV, such as credit debts (excluding convertible bonds) rated at or below “AA”, the dealings shall be no more frequent than quarterly and may last for up to 5 days each time.
5. Lock-ups
According to Article 7 of the Guidelines, a Private Securities Fund shall have a lock-up period of no less than 3 months. That said, such 3 months’ period is a soft lock-up and investors may exit earlier by paying a redemption fee, which belongs to the fund assets. If the private fund manager (“PFM”) and its employees co-invests into the Private Securities Fund managed by such PFM, their respective lock-up period shall be no less than 6 months.
6. Classification of Private Securities Funds
According to Article 41 of the Guidelines, Private Securities Funds are classified into equities type (with no less than 80% of the fund’s deployed capital investing into equities), fixed income type (with no less than 80% of the fund’s deployed capital investing into depositaries and bonds), futures and derivatives type (with value derived from futures and derivatives trading exceeding 20% or more of the fund’s deployed capital and their total contract value exceeding 80% of the deployed capital), fund of fund (the “FoF”) type (with no less than 80% of the fund’s deployed capital investing into other private securities funds) and hybrid type (none of the above).
For clarification, according to the Guidelines, the deployed capital does not include the capital invested into cash management instruments, such as demand deposits, treasury bonds, central bank notes, policy bank bonds, local government bonds, money funds and other instruments recognised by the China Securities Regulatory Commission (the “CSRC”).
7. Investments – diversification
Following rules applicable to other financial products, and according to Articles 12 and 13, the Guidelines impose a diversification requirement on Private Securities Funds, i.e., (1) one Private Securities Fund may deploy up to 25% of NAV of that said fund on the same asset; and (2) all Private Securities Funds managed by the same PFM may not collectively hold more than 25% of the same asset. Certain exemptions apply to such limits under both (1) and (2), or (2) only. For example, certain close end Private Securities Funds, certain FoFs, wrapper products that invest 90% of their fund assets into another Private Securities Fund that complies with such double 25% rules, are exempt from the compliance with both criteria.
As to what constitutes “the same asset”, each single stock, debt instrument, centrally traded and/or cleared futures or options contract is deemed as the same asset, whilst other OTC products such as option, non-principal-protected note, TRS, etc., will be measured based on either the counterparty or the underlying asset referenced by the structured products.
Such double 25% may be measured by either NAV or face value of the relevant asset. PFMs would be given 20 trading days to make adjustments if any of the limits are exceeded passively. Furthermore, extra diversification restrictions may apply with respect to investment into stocks and bonds (according to Article 16, and Articles 18 and 19 of the Guidelines).
8. Investments – leverage
According to Article 15 of the Guidelines, the total assets of a Private Securities Fund shall not exceed 200% of its NAV. More restrictive leverage ratio may apply if a Private Securities Fund substantially invests into credit debts (excluding convertible bonds) rated at or below “AA” rating and other less liquid assets, except for close-end Private Securities Funds meeting certain extra requirements.
9. Investments – OTC derivatives
According to Article 17 of the Guidelines, a Private Securities Fund shall have a NAV of no less than
- RMB 50 million if it wishes to carry out new OTC options trading or extend the terms of its existing OTC options (excluding options referencing to commodities),with the total amount of margins and option premiums payable to counterparties capped at 25% of the fund’s NAV.
- RMB 10 million if it wishes to carry out total return swaps (“TRS”) or extend the terms of its existing TRS products, with the total amount of margin payable to counterparties capped at 50% of the nominal contract value.
Furthermore, the nominal contract value of all autocall structured derivatives shall not exceed 25% of the fund’s NAV, except for close-end Private Securities Funds meeting certain extra requirements.
10. Programme trading and source code
What is noteworthy is that Article 21 of the Guidelines sets out corresponding regulatory requirements for Private Securities Funds that primarily engage in programme trading or algorithm trading.
We have noticed that the language used by the AMAC in Article 21 of the Guidelines is largely consistent with the provisions in the recent consultation paper on programme trading rules released by the CSRC (with our recent client alert on the latter attached). However, the Guidelines have set forth some more operational details, as follows:
- Internal Controls and Operational Procedures: PFMs are required to develop dedicated business management, compliance and risks control systems specifically for programme trading, enhancing the scrutiny and monitoring of programme trading instructions. They shall also establish and effectively implement operational procedures for the research, testing, validation, compliance review, and deployment of programme trading strategies.
- IT System Stability: PFMs are required to ensure that the IT systems utilised for programme trading possess the fundamental functionalities mandated by securities and futures exchanges. They shall also conduct thorough testing as required to ensure continuous and stable operation.
- Record Retention: PFMs shall preserve materials concerning investment decision and trading such as historical transaction records, explanations of algorithms or strategies in words for a period of not less than 20 years after the completion of the relevant fund’s liquidation.
Since we began the consultation process in May of last year, there have been several rounds of consultation between us representing the quant fund managers, the AMAC, and CSRC officials. We are now very pleased to see that the provisions on the retention of the source code of strategies onshore have been removed from the current wording of Article 21 together with some other positive changes and revisions. It remains to be clarified by the AMAC what specific materials they are expected to receive and how extensive these materials should be, in order to satisfy such requirement.
- Reporting Obligations: PFMs now are required to comply with the procedures outlined in the reporting rules for programme trading established by securities and futures exchanges. They are also prohibited from splitting Private Securities Funds into multiple smaller sized ones with the intention of circumventing reporting requirements or other regulatory obligations.
- Emergency Plan: In the event of force majeure, accidents, major technical malfunctions, significant human errors, or other unforeseen incidents that may lead to significant abnormal fluctuations or disrupt the normal operation of securities and futures markets, PFMs must promptly implement measures such as suspending trading or cancelling orders. Furthermore, they shall also promptly report to the securities or futures brokers entrusted by them.
11. Proprietary trading
Article 33 of the Guidelines also introduced new requirements for PFMs to carry out proprietary trading, which apply to PFMs, their employees, natural person shareholders or partners participating in actual operations of the PFMs (on a looking-through basis), and natural person de facto controllers of the aforementioned entities, as well as funds controlled by the aforementioned entities when engaging in investment into securities, Private Securities Funds, and other investments.
PFMs are required to establish internal rules and mechanisms for their proprietary investments, for the purpose of prioritising investors’ interests, ensuring the effective segregation of their proprietary investments, and providing fair treatment to proprietary trading accounts, Private Securities Funds they manage and other asset management products where they serve as investment advisors.
12. Risk capital
According to Article 37 of the Guidelines, PFMs meeting certain thresholds such as a designated AUM, shall allocate risk capital in compliance with relevant provisions to cover for the losses suffered by the Private Securities Funds or their investors due to the PFM’s violation of laws or regulations, breach of contract, operational errors, or technical failure failures. However, the specific details of risk capital, such as its triggers, allocation ratio, and calculation methods, are pending further guidelines from the AMAC.
13. Application and transitional arrangement
Considering the significant impacts associated with the Guidelines on the Private Securities Fund industry, AMAC has further softened its transitional arrangements.
- As a general principle (save for exceptions set out under b) – e) of this Part 13), for those Private Securities Funds that have been filed with the AMAC before the Effective Day (“Pre-existing Funds”), any subsequent change occurring to their fund contracts of such funds shall follow new requirements set out under the Guidelines.
- During the 24-month transitional period from the Effective Day until 1 August, 2026 (the “Grace Period”), all Pre-existing Funds are allowed to carry out normal dealings, operations and investments as they have been, except for those that fail to meet the minimum scale of funds (see Part 1 of this client alert);
- Pre-existing Funds failing in the requirements around OTC derivatives (see Part 9 of this client alert) shall be closed to new investors, lose the ability to extend fund term or increase fund scale otherwise (except for meeting margin calls) and shall be liquidated after the expiry of the fund contract;
- After the lapse of the Grace Period, Pre-existing Funds failing in the requirements on diversification requirements (see Part 7 of this client alert) or leverage (see Part 8 of this client alert) shall be closed to new investors, lose the ability to extend fund term or increase fund scale, and shall be liquidated after the expiry of the fund contract,
- After the lapse of the Grace Period, Pre-existing Funds without a fixed term shall be closed to new investors, lose the ability to extend fund term or increase fund scale otherwise.
Summary
As your trusted legal counsel, we have always been very committed to helping you navigate these regulatory changes. If it is helpful for us to advise to what extent the above-mentioned requirements shall be incorporated into the fund contract of your onshore fund product, or alternatively your marketing and internal control policies, please feel free to reach out.
This article was written by the Investment Funds and Asset Management team at YaoWang Law Offices.
Contact:
Melody Yang
Co-head, Shanghai/Beijing
T +86 21 8013 5022
Sherry Si
Partner, Shanghai
T +86 21 8013 5158
