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24 March, 2017
After about one year of preparation and over 3 months of soliciting feedback, on March 1, 2017, the Asset Management Association of China (“AMAC”) officially promulgated the Administrative Measures on the Private Investment Fund Service Business (“Measures”), which were put into immediate effect. As summarized in the Statement of Drafting by the AMAC, the Measures clarify the legal relationship between a private fund manager (“PFM”) and a private fund servicing institution (“Servicing Institution”), combing out various categories of outsourced services and focusing on the regulation of three service categories i.e. unit registration, valuation calculation and information technology system services, while also reinforcing the protection mechanisms securing the safety of the settlement of the funds raised, emphasizing isolation and cross verification between the custodian business and servicing business, and setting bottom lines for the Servicing Institutions providing investment management systems. The Measures, along with the other AMAC’s major self-discipline regulatory rules targeting private funds, establish a frame of self-discipline regulatory rules for the private fund industry, which is conducive to the healthy development of the industry.
Scope of Application
The Measures apply to five types of services that are available for a PFM to entrust a Servicing Institution to provide for a private fund or a private asset management plan issued by securities or futures operation institution, i.e. fundraising, investment advisory, unit registration, valuation calculation and information technology system services (“Private Fund Servicing Business”), among which, the Measures underline the regulation of unit registration, valuation calculation and information technology system services. Pursuant to the AMAC’s agenda, in addition to regulating the fundraising behaviors by releasing the Administrative Measures on the Private Fundraising, it will issue a separate rule to regulate the investment advisory business. It is noteworthy that compared to the Consultation Paper of the Measures (“Consultation Paper”), the asset custody business has not been included in the scope of application in the Measures as an independent Private Fund Servicing Business, whilst the scope of services available for a Servicing Institution has extended from the private funds to private asset management plans issued by securities or futures operation institutions.
Qualification Requirements
The Measures require the Servicing Institutions to complete the registration with the AMAC and become a member of the association, and they remove the requirement from the Consultation Paper on such institutions to further register based on their different types of business activities. For any Servicing Institution which has not commenced the Private Fund Service Business within 6 months after completing the registration, the AMAC will deregister it. Furthermore, the Measures explicitly prohibit a Servicing Institution from subcontracting or subcontracting in any disguised form the Private Fund Servicing Business it committed.
For engaging in private fund unit registration, valuation calculation or information technology system services, a Servicing Institution shall (i) have good operation status, specifically, the paid-in capital of a Servicing Institution engaged in the private fund unit registration service or information technology system service shall not be lower than RMB 50 million,(ii) have an optimized corporate governance structure with efficient internal controls,(iii) the management and operation of the institution are code-compliant, with no record of material violations of any law or regulation in the last 3 years (the requirement of no record of major litigation or arbitration provided in the Consultation Paper has been removed),(iv) have a complete organizational structure, and set up dedicated service business teams and senior executives in charge of the service businesses, the setup of the service business teams is adequate to ensure the completeness and independence of the business operation, and the service business teams shall have the necessary fixed place of business and safety precaution measures to satisfy the business needs,(v) have the corresponding software and hardware facilities, equipped with the safe, independent, efficient and stable business technology systems, and all of the systems shall pass the related business networking tests, including the central data exchange platform designated by the AMAC,(vi) the person in charge of the department for the private fund servicing business and the legal representative of any independent third party Servicing Institution shall obtain the qualifications to practice the fund related business and all employees engaged in the fund related business shall respectively obtain the qualifications to practice the fund related business within 6 months after their commencement of the private fund service business, and shall participate in the subsequent professional training,(vii) any applicant institution shall evaluate its business to decide whether there is a conflict of interest, and shall set up the corresponding firewall system,(viii) the information technology systems of the applicant institution shall comply with all laws and regulations, the rules of the CSRC and the AMAC and the relevant standards, establish the networking isolation, safety prevention and emergency processing and other risk management systems and disaster backup systems,(ix) any institution applying for providing information technology services shall have the qualification conditions provided by the relevant national department or obtain the related qualifications, have the similar servicing experience, and be equipped with the necessary conditions including the labor, equipment, technology, intellectual property rights and good safety operation records, and(x) other conditions required by the AMAC.
PFM’s Prudent Obligation and Duty of Advance Compensation
The Measures explicitly provide the principle of prudent entrustment of a PFM for service outsourced, to be more specific, a PFM shall:(i) conduct due diligence on the Servicing Institution before such Servicing Institution is authorized to commence services, as well as become familiar with its labor backup, business isolation measures, software and hardware facilities, professional capacities and credit condition,(ii) enter into a written service agreement with such Servicing Institution, under which the rights and obligations of both parties and the related responsibilities for breach of contract shall be specified, and(iii) maintain a consistent level of attention and conduct regular assessments of the operation capacity and service levels of the Servicing Institution.
The Measures underline that the relevant duty which shall be borne by a PFM according to law cannot be discharged as a result of such entrustment, in the meantime, for any loss incurred to the fund property in the course of the business operation by a Servicing Institution due to its violation against law or regulation, breach of the service agreement, technical default, or operational error, it shall be compensated first by such PFM, while the allocation of liabilities with the Servicing Institution and recourse with respect to such loss shall be conducted according to the service agreement thereafter.
Risk Prevention
In principle, a custodian shall not be entrusted to become a Servicing Institution for the same private fund, unless it can properly separate its function for fund services from the custodian function, and it is capable of properly identifying, managing and monitoring the potential conflicts of interest and has fully disclosed them to the investors. In addition, the AMAC particularly pointed out in the Statement of Drafting that, by building up a centralized and unified platform for the data exchange and backup and the registration for the private fund industry, it aims to strengthen the supervision of the private fund industry by virtue of the Servicing Institutions and improve the capability of the AMAC for its interim-and-post regulation.
Fund Safety
The Measures emphasize the protection of the safety of the fund’s property and the investors’ property, which requires the Servicing Institutions to implement strict account-based management of the fund’s property and the property of the investors involved during its provision of services. The special account for the settlement of funds raised shall be effectively monitored by a supervisory institution, the joint and several liability clauses regarding the obligation of the supervisory institution to keep the investors’ funds safe shall be specified under the supervision agreement. A supervisory institution may be the China Securities Depository and Clearing Corporation Limited (CSDC), a securities company, commercial bank or mutual fund management company obtaining the qualification to engage in the fund distribution business or other institutions that may be specified by the AMAC.
Special Provisions for Information Technology Systems Services
The information technology systems services include (i) the core application system for private fund business, (ii) operation maintenance for information systems, and (iii) safety protection services. Among which, the core application systems for private fund business includes but are not limited to the distribution systems, investment trading management systems, unit registration systems, fund clearing systems and valuation calculation systems. A Servicing Institution offering a core application system for fund business shall not engage in the Private Fund Servicing Business corresponding to the systems provided by it, nor shall it be involved in the relevant business operations directly. However, services such as the operation maintenance for information systems and the safety protection services are permissible.
For a Servicing Institution offering the investment trading management systems, the following two requirements are particularly notable: the Servicing Institution shall (i) ensure that independent securities accounts shall be opened for a single fund; no subsidiary account, sub-account or virtual account shall be opened under a single securities account; it will not conduct investment business operation directly; the duty of position liquidation or trading shall not be executed on behalf of a PFM,
(ii) establish the fair trading mechanism, and all private funds managed by one PFM or by different PFMs shall be treated equally.
Our interpretation of the above two requirements are, the investment trading management systems provided by a third party Servicing Institution shall not be used to engage in the prohibited acts provided under the above item (i), while the provision of item (ii) requires the Servicing Institutions to adopt measures to prevent the illegal transfer of benefit which may arise from the use of the same investment trading management systems provided by the same Servicing Institution for various private fund products.
System and Data Processing
As set out in the Consultation Paper, the Measures require all information systems of a Servicing Institution for core business processing to be deployed within the territory of the People’s Republic of China, and the storage and backup of client information, business materials and other data obtained in the course of business operation shall be stored within the territory of the People’s Republic of China. In our observation, for all foreign servicing institutions attempting to enter the Chinese market, finding a solution to satisfy the above requirement may be the first issue to consider.
Legal Opinion, External Auditing and Material Information Reporting
As a premise to accepting the registration of a Servicing Institution, the Measures require a Chinese law firm to issue a legal opinion on the registration of the private investment fund servicing institutions at the time when such Servicing Institution applies to the AMAC for registration, the contents of which include the issuance of an opinion with respect to the internal control and risk management system according to the different types of the proposed servicing business activities. It also proposes an external annual auditing requirement on the Servicing Institutions in the Measures, i.e. each Servicing Institution shall on an annual basis engage an accounting firm qualified to practice the securities related businesses to issue an audit report as to the internal control and status of business implementation of its Private Fund Servicing Business. However, a licensed financial institution can be exempted from such external report by providing an internal business assessment report made by its internal auditing department. In addition, the Measures provide the duties of reporting of a Servicing Institution for changes of material information, and the scope of reporting includes changes of registered capital, registered address, legal representative and senior managers responsible for the Private Fund Servicing Business and material change of equity ownership.
For further information, please contact:
Natasha (Qing) Xie, Partner, Jun He
xieq@junhe.com
