On April 30, 2024, the Asset Management Association of China (AMAC) issued the Guidelines for the Operation of Private Securities Investment Funds (the “Guidelines”, its draft consultation paper is hereinafter referred to as the “Draft”), which will take effect on August 1, 2024. The Guidelines regulate the fundraising, investment, and operation of private securities investment funds. Private securities investment funds that complete filing after the implementation of the Guidelines need to comply with these provisions.
Here is a summary of the key points of the Guidelines:
I. Requirements for Fundraising and the Scale of Operations
Article 4 makes mandatory provisions for fundraising and the minimum capital amount for funds to survive. Specifically,
(1) the initial paid-in capital of a private securities investment fund should not be less than RMB 10 million, which is consistent with the provisions of the Measures for the Private Fund Manager Registration and Private Fund Filing (the “Registration and Filing Measures”);
(2) if the average daily net asset value of a private securities investment fund in the previous year was below RMB 10 million, the private fund manager (PFM) should disclose the information to investors;
(3) compared to the mandatory requirement in the Draft whereby private securities investment funds with a net asset value below RMB 10 million for 60 consecutive trading days, unless caused by market fluctuations, should be directly liquidated, the Guidelines provide more flexible provisions. If the average daily net asset value of a private securities investment fund in the previous year is below RMB 5 million, or if it experiences a net asset value below RMB 5 million for 60 consecutive trading days, the PFM should disclose the information to investors and suspend the fund’s subscription. Only when the fund’s net asset value remains below RMB 5 million for 120 consecutive trading days after the suspension of subscriptions will it be subject to mandatory liquidation.
The Guidelines stipulate that if a PFM has multiple private securities investment funds with net asset values below RMB 10 million, the AMAC can request an explanation from the PFM. If it is found that multiple funds have not carried out substantial investment activities and have not provided reasonable explanations, the AMAC may suspend the filing of their private funds.
II. Fund Investor Suitability Requirements
Article 5.2 provides that the risk tolerance level of investors shall not be lower than the risk level of the private securities investment fund. According to Article 19 of the Administrative Measures for the Suitability of Securities and Futures Investors, if an investor requests to purchase a private fund with a risk level higher than its risk tolerance level and the PFM or fund distributor has provided a special written risk warning regarding the higher risk level, but the investor still insists on purchasing the fund, they can sell the fund to the investor. After the implementation of the Guidelines, investors in private securities investment funds, in particular ordinary investors, will no longer be exempt from the suitability requirement. Whether the same suitability requirement applies to investors in private equity investment funds still needs to be clarified through further regulatory provisions.
III. Requirements for Fund Marketing and Promotion
PFMs should ensure that the marketing and promotion of private securities investment funds complies with the laws, regulations, self-disciplinary rules, and their own internal control rules. Article 6 introduces requirements for the marketing and promotional activities of private securities investment funds, including:
(1) PFMs and fund distributors should disclose information about their private securities investment funds and their performance in accordance with the relevant provisions;
(2) Except for qualified investors who have undergone specific client identification procedures and fund evaluation agencies that meet certain requirements, PFMs should not provide fund net asset value and other performance-related information to any institutions or individuals that do not have a fund distribution entrustment relationship with the PFM. Except for PFMs and fund distributors that have signed fund distribution agreements with the PFM, no institution or individual should display or transmit fund net asset value and other performance-related information, unless otherwise provided by the China Securities Regulatory Commission (CSRC) and AMAC. We believe these requirements are intended to ensure that the fundraising and marketing activities of PFMs comply with “private placement” requirements and to prohibit the marketing and promoting of private funds to non-specific targets.
(3) The display of fund performance shall be objective, truthful, accurate, and complete. For example, (i) it is prohibited to use the past performance of private securities investment funds with AuM below RMB 10 million and a duration of less than six months for promotional, sales, or ranking purposes; (ii) it is prohibited to selectively display the performance of certain private securities investment funds, or performance during specific fund operational periods with the intention of misleading investors; (iii) it is prohibited to display fund performance that has not been reviewed by a fund custodian; (iv)it is prohibited to rank the performance of a fund with a duration less than six months; and (v) if a fund’s investor is only the PFM itself or its shareholders, partners, de facto controller, or employees, the PFM or fund distributor shall disclose this to investors when promoting, selling, and ranking that fund. We believe this is to implement the provision that no false or misleading statements are allowed in fund promoting and marketing activities in the Regulations on the Supervision and Administration of Private Investment Funds.
IV. Requirements for the Frequency of Open Days and Lock-up Periods
The Guidelines provide clear regulations on the frequency of open days for the subscription and redemption of open-ended private securities investment funds and lock-up periods. It is stipulated that open-ended private securities investment funds can open for the subscription and redemption of fund shares at most once a week, with each opening not exceeding two days. If a private securities investment fund invests in AA-rated and below credit bonds (excluding convertible bonds) and liquidity constraint assets, and the total investment value exceeds 20% of the fund’s net assets, the frequency of open days for the subscription and redemption should be at most once a quarter, with each opening not exceeding five days. The fund contract should stipulate a lock-up period of no less than three months or, alternatively, the short-term redemption fees corresponding to the holding period of fund shares. For PFMs or their employees who invest in private securities investment funds managed by the same PFM, the lock-up period should not be less than six months.
Compared to the Draft, the Guidelines allow most private securities investment funds to open for subscription and redemption on a weekly basis. It also allows the fund contract to stipulate a lock-up period of no less than three months and allows fund investors to be exempt from such lock-up requirements by paying short-term redemption fees. The lock-up period for PFMs or their employees investing in funds managed by the same PFM has been reduced from 12 months to 6 months. We understand that these regulations provide PFMs with greater flexibility. Furthermore, the Guidelines do not require existing private securities investment funds to adjust their subscription and redemption frequencies or lock-up periods.
V. Investment Ratio Restrictions
Article 12 sets out the portfolio investment requirements for private securities investment funds, which is similar to the provisions of the Administrative Provisions on the Operation of Private Asset Management Plans of Securities and Futures Business Operating Institutions previously issued by the CSRC. The Guidelines require that the fund assets invested in a single asset by a single private securities investment fund should not exceed 25% of the net assets of the fund, and the fund assets invested in a single asset by all private securities investment funds managed by the same PFM should not exceed 25% of that asset. However, there is an exception for investments in bank demand deposits, treasury bonds, general pledged bond repos, central bank notes, policy bank bonds, local government bonds, publicly offered funds, and other investment varieties recognized by the CSRC or the AMAC. With these requirements, asset management products cannot circumvent the “double 25%” investment ratio restrictions by investing in private securities investment funds, reducing the space for regulatory arbitrage.
Article 13 provides exemptions to the above investment ratio restrictions. These exemptions apply to (1) closed-end private securities investment funds whose fund contracts stipulate that the fund will only invest in listed company stocks through strategic placements, private placements, block trades, or share transfers by agreements, and all investors of the fund are professional investors as defined by the CSRC with each investing not less than RMB 3 million into the fund (on a look-through basis); (2) private securities investment funds whose fund contracts stipulate that over 90% of the fund assets are invested in a single private fund that complies with the portfolio investment restrictions of Article 12 of the Guidelines; (3) closed-end private securities investment funds whose investors are all professional investors as defined by the CSRC with each investing not less than RMB 10 million into the fund (on a look-through basis). It is worth noting that QDLP funds using the master-feeder structure usually invest over 90% of their assets in an offshore fund managed by their overseas affiliates. We suggest that the regulatory authorities continue to apply the current practice of exempting these QDLP funds from the portfolio investment requirements after the implementation of the Guidelines.
Article 16 stipulates the investment concentration ratio of private securities investment funds investing in listed company stocks. The combined holdings of shares issued by a listed company by the proprietary funds of all securities-type PFMs controlled by the same de facto controller, all private securities investment funds managed by those securities-type PFMs, and asset management products for which those securities-type PFMs act as an investment advisor, should not exceed 30% of the outstanding shares of that listed company, except as otherwise provided by the CSRC or the AMAC.
VI. Requirements for Participating in Over-the-Counter (OTC) Derivatives Trading
For the first time, the Guidelines clarify that private securities investment funds should carry out OTC derivatives trading with the derivative business operating institutions recognized by the CSRC, and should meet the following requirements:
(1) To open new OTC option contracts or extend existing OTC option contracts, the net assets of a fund should not be less than RMB 50 million, and the total amount of OTC option trading margins and premiums paid to all counterparties should not exceed 25% of the net assets of the fund, unless the fund only conducts commodity-based OTC options trading.
(2) To open new OTC swap contracts or extend existing OTC swap contracts, the net assets of a fund should not be less than 10 million RMB. If the fund participates in equity-based swap transactions linked to stocks or stock indices, the margins paid to counterparties should be no less than 50% of the nominal principal of the contract.
(3) If a private securities investment fund participates in OTC option or income certificate transactions provided by securities firms and other institutions with “knock-in” and “knock-out” features (such as “snowball” derivative products), the nominal principal of the contract should not exceed 25% of the net assets of the fund. These requirements are consistent with what is applicable to private asset management plans issued by securities and futures business operating institutions for participating in “snowball” derivative products.
(4) Private securities investment funds should conduct OTC derivative trading with the objective of risk management and asset allocation. It is prohibited to use OTC derivative trading as leveraged financing tools for on-exchange underlying assets such as stocks or bonds, nor should it provide channel services for ineligible investors.
The Guidelines require PFMs to provide information on OTC derivative trading and transaction documents to the fund custodian before the next valuation date of the private securities investment funds. When signing OTC derivative transaction documents, the PFMs should authorize the counterparties and the relevant clearing houses to directly provide OTC derivative transaction documents to the fund custodian before the next valuation date of the private securities investment funds as well as the valuation information on an ongoing basis.
Article 15.1 requires that, in addition to the requirement that the total assets of a private securities investment fund shall not exceed 200% of the net assets of the fund, no private securities investment fund is allowed to evade leverage ratio limits nor engage in shadow margin financing through OTC derivatives trading or other instruments. These requirements are in line with the overall regulatory approach of strengthening the supervision of private funds participating in OTC derivative trading (in particular investment in DMA total return swap or “snowball” derivative products). It requires PFMs to strengthen internal risk control management, implement compliance trading requirements, and prevent disruptions to the normal trading order of exchange-traded securities and futures caused by OTC derivative trading, in order to ensure the stable operation of the market.
VII. Requirements for Participating in Bond Trading
The Registration and Filing Measures prohibit PFMs from disrupting the market order and harming the interests of investors through direct or indirect participation in structured bond issuances or transactions, rebate fees, or other means. Institutions applying for registration as a securities-type PFM that have bond investment as their main investment direction or whose shareholders, legal representatives, executive partners or their appointed representatives, or senior executives have engaged in bond investments or submitted bond investment performances, should submit a commitment letter undertaking not to engage in structured bond issuance.
Articles 15.2, 18, and 19 of the Guidelines set out the requirements for private securities investment funds participating in bond investments, including:
(1) Investment restrictions on liquidity constraint assets: Private securities investment funds investing over 20% of net assets of the fund in AA-rated credit bonds and below (excluding convertible bonds) and liquidity constraint assets should not have total assets exceeding 120% of the net assets of the fund, except for closed-end private securities investment funds whose investors are all professional investors that meet the requirements stipulated by the CSRC, with each investing no less than 10 million RMB (on a look-through basis) in the fund.
(2) Investment portfolio ratio limits: The fund assets invested in a single bond by a single private securities investment fund should not exceed 10% of the net assets of the fund. The quantity of a single bond invested by all private securities investment funds managed by the same PFM should not exceed 10% of the outstanding quantity of the bond, except for a passive breach of the limits due to specific reasons.
(3) Total investment amount limit: The total amount of fund assets invested by a single private securities investment fund in bonds issued by the same issuer and its affiliates should not exceed 25% of the net assets of the fund. The total quantity of bonds issued by the same issuer and its affiliates invested by all private securities investment funds managed by all PFMs controlled by the same de facto controller should not exceed 25% of the outstanding quantity of the bonds.
(4) Bond repo investment ratio limits: If a private securities investment fund participates in pledged bond repo transactions, the above investment limits under (2) and (3) shall apply to the concentration of a single bond that is pledged to or by the fund, and the amount of bond repo transactions with a single counterparty shall not exceed 10% of the net assets of the fund, and the PFM shall provide information to the fund custodian as required by the Guidelines.
(5) Exemptions to the above investment limits under (2) to (4): Investment in treasury bonds, central bank notes, policy bank bonds, local government bonds, convertible bonds, exchangeable bonds, and other investment varieties recognized by the CSRC or the AMAC can be exempted from the above investment limits under (2) to (4).
VIII. Requirements for Engaging in Program Trading
Provisions of the Guidelines
Article 21: Private securities investment funds primarily engaged in program trading should satisfy the following requirements:
(1) The PFM should formulate specialized business management, compliance and risk control rules for program trading, improve the review and monitoring systems for program trading orders, and prevent and control business risks.
(2) The IT systems used by the PFM for program trading should possess the basic functions required by securities or futures exchanges. They should undergo sufficient testing in accordance with provisions to ensure their continuous and stable operation.
(3) The PFM should establish and effectively implement business processes for the development, testing, validation, compliance review, and deployment of program trading strategies.
(4) The PFM should establish sound risk control mechanisms for investment and trading activities, including the liquidity management, concentration ratio of shareholdings, leverage, trading frequency, futures-spot matching, portfolio exposure, and large-amount instantaneous execution of orders, and effectively implement these mechanisms.
(5) Historical trading records, and materials related to investment decisions and trading, such as written descriptions of algorithms or strategies, should be kept for a period of no less than 20 years from the date of fund liquidation.
(6) The PFM should fulfill the program trading reporting obligations in accordance with the requirements of the securities or futures exchanges. It is prohibited to split private securities investment funds to evade program trading reporting requirements or other regulatory obligations.
(7) In the event of force majeure, unforeseen incidents, major technical failures, significant human errors, or other sudden events that may cause significant abnormal fluctuations or affect the normal conduct of securities and futures trading, the PFM should immediately take measures such as suspending trading or canceling orders and promptly report this to the securities or futures companies it has entrusted.
(8) Other requirements stipulated by the CSRC, AMAC, and securities and futures exchanges.
Highlights:
Article 21 of the Guidelines regulates private securities investment funds that primarily engage in program trading. It sets out principles regarding the PFM’s internal controls, the security of program trading systems, data retention, reporting obligations, and abnormal trading monitoring obligations. Securities-type PFMs should establish specialized business management, compliance and risk control rules for their program trading activities, covering risk control arrangements in terms of liquidity management, concentration of shareholdings, leverage, trading frequency, futures-spot matching, portfolio exposure, and large-amount instantaneous execution of orders. The Guidelines replace the term “quantitative trading” in the Draft with “primarily engaging in program trading.” This reflects the recent regulatory efforts to strengthen program trading supervision in the securities market, promote the compliant development of program trading, and safeguard the securities trading order and market fairness. It is also consistent with the requirements on compliance risk and control rules and IT systems in the recent consultation paper Administrative Rules for Program Trading in the Securities Market (Trial).
The Guidelines require securities-type PFMs to retain historical trading records, and materials related to investment decisions and transactions, such as documentation of algorithms or strategies. The retention period should not be less than 20 years from the date of the fund liquidation. This removes the provisions on the retention of the source code of strategies that were set out in the Draft. The Guidelines also require securities-type PFMs to perform program trading obligations in accordance with the requirements of securities or futures exchanges. They are prohibited from splitting private securities investment funds to evade program trading reporting requirements or other regulatory obligations.
IX. Requirements for Warning Lines and Stop-Loss Lines
The Guidelines do not require open-ended private securities investment funds to set warning lines or stop-loss lines in general. However, they still require PFMs and fund custodians to report information regarding warning lines and stop-loss lines to the AMAC.
X. Requirements for PFMs’ Internal Controls
Provisions of the Guidelines
Article 31: PFMs should establish management rules and ethical standards for the reporting, registration, review, and disposal of securities investments, private fund investments, and other investments by their practitioners. They should develop preventive regimes, in-process control measures, and post-accountability mechanisms to prevent practitioners or other stakeholders from engaging in investment activities in violation of the regulations. They should guard against improper acts such as insider trading, market manipulation, trading on undisclosed information, conflicts of interest, and interest tunneling, and ensure that the legitimate rights and interests of investors are not infringed upon.
Article 32: PFMs should establish fair trading rules and abnormal trading monitoring mechanisms. They should treat different private securities investment funds fairly and monitor, analyze, evaluate, and verify investment and trading activities. They should supervise the process and results of investment and trading activities to ensure fair trading principles. They are prohibited from engaging in transactions that may lead to unfair trading or interest tunneling.
PFMs should strictly control same-day reverse transactions and prohibit those that may result in unfair trading or interest tunneling. If same-day reverse transactions are necessary due to investment strategies or liquidity management, PFMs should require portfolio managers to provide decision-making evidence and keep records for future reference.
The above two provisions under Article 32 apply to transactions between the proprietary investment accounts of PFMs/practitioners and the accounts of the private securities investment funds they manage, or the asset management products where they act as investment advisors.
Highlights:
The rules for securities transaction reporting by practitioners and the fair trading rules have always been a fundamental part of the internal controls that PFMs must establish. The Guidelines provide more detailed requirements for these two regimes. PFMs should establish and optimize their internal controls in accordance with the above requirements, strictly adhere to these requirements during the fund’s investment and operational management processes and prevent conflicts of interest and interest tunneling.
XI. Requirements for PFM’s Proprietary Investments
Provisions of the Guidelines
Article 33: PFMs shall conduct proprietary investments on the premise of measurable, controllable, and bearable risks. They should establish management rules for their proprietary investments and mechanisms that align with the interests of external investors. The safety and liquidity of proprietary investments should be ensured, without affecting the normal operations of the PFMs and the private securities investment funds they manage. If PFMs’ proprietary funds invest through separate accounts, private funds, or asset management products, they should be effectively separated from the private securities fund management business and reported to the AMAC as required.
PFMs should treat proprietary investments and investments by the private securities investment funds they manage or the asset management products where they serve as investment advisors in a fair manner. They are prohibited from exploiting their advantages in capital, information, or technology, or strategies to gain undue benefits for their proprietary investments, and they should prevent conflicts of interest and prohibit interest tunneling.
The above two provisions under Article 33 apply to PFM’s employees, natural-person shareholders or partners actually participating in the PFM operation (on a looking-through basis), natural-person de facto controllers, and the capital controlled by the above entities participating in securities, private funds, and other investments.
Highlights:
The Guidelines introduce specific regulations for proprietary investments by PFMs for the first time. They require PFMs to establish internal rules and mechanisms for their proprietary investments. To prioritize investor interests, the effective segregation of their proprietary investments should be ensured, and fair treatment should be given to proprietary investments and investments made by the private securities funds they manage and the asset management products where they serve as investment advisors. PFMs are prohibited from gaining undue benefits for their proprietary investments through various means, and they should prevent conflicts of interest and prohibit interest tunneling. Article 11 and Article 32 of the Guidelines prohibit PFMs from providing risk compensation in the form of bearing losses firstly by the fund shares subscribed with their proprietary funds and ensure that there are no trading activities that may lead to unfair transactions or interest tunneling between their proprietary investment accounts and the accounts of private securities investment funds, or the accounts of asset management products where they serve as investment advisors.
XII. Requirements for Stress Testing and Risk Reserves
Articles 35 and 37 require securities-type PFMs that meet certain thresholds in terms of AuM to conduct stress testing on a quarterly basis and establish sound mechanisms for the monitoring, warning, and emergency disposal of liquidity risks. They should also set aside risk reserves as required. These risk reserves are used to compensate for losses incurred by private securities investment funds or investors due to a PFM’s illegal or non-compliant activities, violation of contracts, operational errors, and technical failures. The specific AuM threshold and the standards for risk reserves are yet to be stipulated by the AMAC.
XIII. Investment Advisors
PFMs engaged in securities investment advisory business should comply with the requirements of the Guidelines. They are not allowed to circumvent the provisions of the Guidelines through acting as investment advisors.
XIV.Transitional Period
After the implementation of the Guidelines on August 1, 2024, those private securities investment funds that have been filed before the implementation date will be subject to the requirements on minimum capital amount for funds to survive as stipulated in the Guidelines. The calculation for the previous year’s average daily net asset value and consecutive 60 trading days starts from January 1, 2025. For those private securities investment funds that have been filed and are engaged in OTC derivative trading before the implementation date but do not meet the requirements of Article 17 of the Guidelines, they are not allowed to admit new investors, extend the fund duration, or increase the fundraising size (except for the need to deposit additional margins), and should be liquidated after the expiration of the OTC derivative contract. For those private securities investment funds that have been filed before the implementation date but do not meet the requirements of Articles 12, 13, 15, 16, and 19 of the Guidelines, a transitional period of 24 months is set by the Guidelines. After the transitional period, if the above funds still do not meet the aforementioned requirements, the Guidelines prohibit them from increasing the fundraising size, admitting new investors, extending the fund duration, and requiring the liquidation of the fund after the expiration of the contract. However, there is no mandatory requirement for portfolio adjustment, minimizing the impact on the existing market.
Our Observations
The Guidelines are a continuation and supplementation of the regulatory requirements and provisions in the Registration and Filing Measures, and the Guidelines for the Filing of Private Investment Funds. The Guidelines provide more detailed requirements for PFMs in terms of prudent operations, sound internal rules, risk controls, prevention of insider trading and interest tunneling and reflect the AMAC’s regulatory approach of “prior filing and ongoing supervision afterward”. PFMs are reminded to comply with the provisions of the Guidelines in the subsequent fund filing, operations, and risk controls. If the fund contracts of already filed private securities investment funds do not comply with the Guidelines, appropriate adjustments should be made according to relevant requirements.