Copyright © 2010 by K&L Gates Solicitors. All rights reserved.

Michael ChanJames ChenAlan Xu

Foreign Investment in RMB Funds- The Current State and Way Forward

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Outline

What are RMB funds

Why RMB funds

Key PRC legislations

Alternative fund models under the existing legal regime

The parallel fund structure

Recent developments

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What Are RMB Funds

Key characteristics

- RMB-denominated funds usually formed by private equities and venture capitals

- Formed under PRC law

- Portfolio investment primarily in China

Two basic types of RMB funds

- Purely domestic RMB funds (e.g., Bohai Industrial Investment Fund)

- Foreign invested RMB funds (e.g., Blackstone Zhonghua Development Investment Fund)

RMB funds can be managed by foreign fund managers through their onshore affiliates

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Why RMB Funds – from A Foreign Fund Manager’s Perspective

Current status

- Skyrocketing number of RMB funds: 29 formed in 2007; 88 formed in 2008; 84 formed in 2009

- Amount of funds raised: RMB25 billion raised in 2009

- Value of deals closed: RMB20 billion closed in 2009

Voices of fund managers[1]

- 91.2% of the surveyed “believe the rise of RMB funds is an inevitable trend and wish to prepare to set up RMB funds”

[1] Based on the data provided by China Venture Capital Association.

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Why RMB Funds – from A Foreign Fund Manager’s Perspective (Cont’d)

Main reasons for foreign investors to set up RMB funds

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Why RMB Funds – from A Foreign Fund Manager’s Perspective (Cont’d)

Opportunities relating to clean technologies

- Pursuant to the CVCA survey, RMB funds’ No. 1 target sector is — ENVIRONMENTAL PROTECTION AND NEW ENERGY!

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Key PRC Regulations Governing Foreign Invested RMB Funds

Stage one (pre-2003): absence of legal basis

- No legal basis to form foreign invested RMB funds

Stage two (2003 – 2006): the inception and rise of FIVCIEs

- Key legislation: The Regulations on the Administration of Foreign Invested Venture Capital Enterprises (the "2003 FIVCIE Regulations")

- An FIVCIE can take the form of an incorporated entity or a non-legal person entity

- Representative funds: SAIF – Tianjin VC Fund (formed in 2005; fund size: around RMB150 million); Infinity – Suzhou VC Fund (formed in 2004, fund size: around RMB75 million); Gobi – Tianjin HiTech (formed in 2007, fund size: RMB150 million)

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Key PRC Regulations Governing Foreign Invested RMB Funds (Cont’d)

Stage three (2007 – 2009): new doors opened by the Partnership Law

- Key legislation: The PRC Partnership Law (the "2006 Partnership Law")

- The 2006 Partnership Law made possible the establishment of a “limited partnership” in China and introduced the concepts of “GP” and “LP”

- Increasing number of local legislations to attract international PE/VC firms to set up funds and fund management entities

- Representative funds: Blackstone Zhonghua Development Investment Fund (estimated fund size: RMB5 billion); Guosheng-CLSA Industrial Investment Fund (estimated fund size: RMB10 billion)

Stage four (2010 onwards): foreign invested partnerships – a new world on the horizon?

- Key legislation: The Administrative Measures relating to the Establishment of Partnerships in China by Foreign Enterprises or Individuals (the "2010 Foreign Invested Partnership Measures")

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Alternative Foreign Invested RMB Fund Models under Existing Legal Regime

Four common models for foreign investors to tap RMB funds market

- Establishment of FIVCIEs

- Establishment of onshore partnerships

- Cooperation with trust companies

- Establishment of a plain-vanilla company to make investments

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Introduction of the FIVCIE Model

Key characteristics of the 2003 FIVCIE Regulations

- 2 to 50 investors, including at least one “Requisite Investor” (the equivalent of GP)

- Stringent qualification requirements of the “Requisite Investor”: at least US$50 million already invested in the VC area; at least 3 VC professionals and each with at least 3 years’ VC experience, etc.

- Can take the form of an incorporated entity or a non-legal person entity

- Minimum committed contributions (from investors) of US$10 million for the non-legal person entity and US$5 million for the incorporated entity

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Illustrative Chart of the FIVCIE Model SAIF Tianjin Growth Fund (the 1st non-legal person FIVCIE)

(based on public information)

Cisco

SAIF Partners

(requisite investor)

SAIF Tianjin Growth Fund

(FIVCIE)

A B C D

Portfolio Companies

SAIF Tianjin

Advisory JV Management Agreement

Fee

Commitment

Offshore

Onshore

Tianjin Venture

Capital

x% Commitment

Softbank

y%

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Key Facts of SAIF Tianjin Growth Fund[2]

Place of formation: Tianjin

Fund size: around RMB150 million

Investment targets: high technology enterprises

Current status: fund formed in January 2005 and already made several investments

[2] Based on public information.

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Downside of the FIVCIE Model

Possible approval hurdles

- Approvals from the Ministry of Commerce and Ministry of Science and Technology

Investment restrictions

- An FIVCIE’s investment is subject to foreign investment industry restrictions

Stringent qualification requirements on the “Requisite Investor”

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Introduction of the Domestic Partnership Model

Legislation

- National level: 2006 Partnership Law

- Selective local legislations:

Shanghai : The Tentative Measures for the Establishment of Foreign Invested Equity Investment Enterprises in the Pudong New District

Beijing : Opinions for Promoting the Development of Equity Investment Funds

Tianjin : Opinions on the Registration of Private Equity Investment Funds and Private Equity Investment Management Enterprises

Chongqing : Opinions on Encouraging the Development of Equity Investment Enterprises

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Representative Benefits Offered under the Local Legislations

Reduced income tax and tax rebates

- Tianjin: waiver of business tax for two years starting from establishment

Financial subsidies

- Tianjin: a one-off subsidy equal to 3% of the relevant entity’s registered capital (capped at RMB5 million)

- Chongqing: for properties purchased by the relevant entity, a one-off subsidy of RMB1,000/square meter

Other types of benefits

- Beijing: government to share its database of IPO candidate companies

- Tianjin: government to grant local residency to the staff of local registered PE funds

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Illustrative Chart of the Domestic Partnership Model

Blackstone Zhonghua Development Investment Fund(based on public information)

Blackstone Group

Blackstone Investment WFOE

(GP)

Shanghai Blackstone Partnership

A B C DPortfolio Companies

Blackstone Advisory WFOE Chinese LPs

Management Agreement

no commitment

Fee

100%

Offshore

Onshore100%

Payments

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Key Facts of Blackstone Zhonghua Development Investment Fund[4]

Place of formation: Pudong New Area, Shanghai

Fund size: RMB5 billion

Investment targets: enterprises located in Shanghai and the neighboring areas in the Yangtze River Delta

Current status: fund management company established in October 2009 and reportedly fundraising completed in July 2010

[4] Based on public information.

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Downside of the Domestic Partnership Model

Government and judicial authorities’ lack of experience in dealing with partnerships

- Relatively new legislation: 2006 Partnership Law

- Relevant agreements seldom tested in courts, so uncertainty over the validity and enforceability of certain arrangements

Difficulties in making offshore investments

Investment restriction

- The fund potentially regarded as a foreign invested fund due to the GP’s foreign background

- Accordingly the fund’s investment is subject to foreign investment industry restrictions and may trigger onshore approval requirements

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A Variation of the Domestic Partnership Model: the Nominee GP Structure

Foreign Investors

Chinese GP

RMB Fund

A B C DPortfolio Companies

Advisory WFOE Chinese LPsManagement Agreement

no commitment

FeeCommitment

Commitment

100%

Offshore

OnshoreContractual arrangements

Payments

Chinese Individual(s)

100%

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Recent Development on Structuring RMB Funds: the Parallel Structure Based on the Domestic Partnership Model

Offshore Advisor

Investment WFOE(GP)

RMB Fund

A B C DPortfolio Companies

Advisory WFOE Chinese LPsManagement Agreement

no commitment

FeeCommitment

Commitment

Offshore

Onshorecontrol

Offshore Fund GPAffiliate

Offshore Fund

Offshore structure

Affiliate

Offshore Fund LPs

Co-investment

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Recent Developments

Key legislations

- The 2010 Foreign Invested Partnership Measures

- SAIC’s implementing rules

Breakthroughs under the legislations

- Foreign investors acting as GP and LP on the horizon

- Possibility for a PRC individual to be a partner

- No government approvals required

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For more information, please contact

Michael ChanPartner, Hong KongTel: +852 2230 3581 Email: michael.chan@klgates.com

James ChenPartner, TaipeiTel: +886 2 2326 5155 Email: james.chen@klgates.com

Alan XuForeign legal consultant, Hong KongTel: +852 2230 3547Email: alan.xu@klgates.com