Private funds, or privately offered funds as they are commonly referred to, started in China mainland in the early 1990s, when the Chinese central government reestablished the two stock exchanges in Shanghai and Shenzhen. The initial form was working like a saloon: persons claimed to have financial expertise (some were working employees in brokerages) provided stocking knowledge and trading suggestions to wealthy people for membership fees and commission. Later on, participating members grew and some saloons were further development into trusted wealth management. With the fast development of Chinese economy and the capital market, the size of private funds grew vast fast. Now according to inofficiously estimates, the market value reached some 1000 billion RMB.
Currently private funds in China fall into two categories. One is those companies backed up by the government, including brokers managing pooled property, trust and investment companies’ trust and investment projects, and investment companies managing their own capital. The other is private funds. Under the name of “Investment Consulting Company” or “Investment Management Company”, they provide management for pooled property.
Definition and legal issues
In China, private funds are not legally recognized, and even the concept of private funds is not clearly defined. Private funds are risk-sharing and pooled fund management, which raise money by way of non-public issuance. The money can be invested into either private equity market or securities.
According to the Law of The People’s Republic of China on Securities Investment Fund , the second article stipulates that the Law shall apply to the securities investment activities conducted through the method of portfolio and through public issuance of fund shares to raise securities investment fund, which is managed by fund managers and entrusted to fund trustees for the benefits of the fund share holders; the matters not covered by the Law shall be governed by the Trust Law of the People’s Republic of China, the Securities Law of the People’s Republic of China, and other relevant laws and administrative regulations.
The defining feature for private funds is raising-money through non-public issuance. According to the Securities Law of the People’s Republic of China, the 10th article provides that a public issuance of securities shall satisfy the requirements of the relevant laws and administrative regulations and shall be reported to the securities regulatory authority under the State Council (China’s Cabinet) or a department upon authorization by the State Council for examination and approval according to law. Without any examination and approval according to law, no entity or individual may make a public issuance of any securities. It shall be deemed as a public issuance upon the occurrence of any of the following circumstances:
(1) Making a public issuance of securities to non-specified objects;
(2) Making a public issuance of securities to accumulatively more than 200 specified objects; or
(3) Making a public issuance as prescribed by any law or administrative regulation.
For any securities that are not issued in a public manner, the means of advertising, public inducement or public issuance in any disguised form may not be adopted thereto.
So clearly private funds is not covered by the Fund law. Those private funds with government’s backup to some extent will be supervised by relevant government agencies. Brokers managing pooled property shall be regulated by the China Securities Regulatory Commission (CSRC), while trust and investment companies’ trust and investment projects as well as investment companies managing their own capital, will fall to the auspices of the China Banking Regulatory Commission (CBRC). For those private equity funds, there is conflicting roles between CSRC and China National Development and Reform Commission (NDRC). Either CSRC or NDRC could have some supervisory roles.
What concerns the public most are private funds without government’s backup. There is not much supervision on their activities, such as fund raising, operations, trading, subscription and redemption, and information disclosure, etc. The public view is for the government to strengthen the behavior of those funds. The National People’s Congress (the legislature body of China) is now under the process to modify the Fund law, and some people argue that the revised law should cover private funds, clearing the way how the industry should do their business.
It’s not quite true to see the private fund sector as a direct equivalent of the hedge fund industry elsewhere in the world (at least not now), since most structures remain long-only equity products investing in RMB-denominated A-shares on fundamentals-based strategies. But it is true that they tend to exhibit more absolute return characteristics than the mainstream: a greater ability to go into cash, for example.
Regulators introduced index futures and short selling in April this year, enabling investors to bet on falling as well as rising prices, to ease fluctuations after the Shanghai Composite Index jumped 80 percent in 2009 before slumping. This will give fund managers opportunities to attempt arbitrage strategies. It is likely that the emergence of the Chinese Financial Futures Exchange, allowing the development of financial derivatives, will create a greater opportunity for funds that create short positions, synthetically if not actually. The ability to drift away from the benchmark has become very appealing as an alternative in a market where so many other funds slavishly follow A-share benchmarks, whether by design (index funds and ETFs have been exceptionally popular in recent years) or in practice in active funds.
Some privately raised funds in China have been using stock- index futures to manage risk. The four contracts, agreements to buy or sell the CSI 300 Index at a preset value on an agreed date, are designed to allow investors to bet on and profit from both gains and declines in the market. The index tracks the 300 biggest stocks on the Shanghai and Shenzhen exchanges. The securities regulator in July said it would allow separately managed accounts at asset management companies to trade stock index futures based on clients’ needs. The CSRC won’t regulate the investment purposes, proportion and information disclosure of the accounts targeted at wealthy individuals.
So far this year the private fund industry is gathering pace, no matter whether they have government support or not.
According to fund researchers Z-Ben, 213 private funds without government backup were launched in the first half of 2010 with an average launch size of RMB150 million apiece; all told, the 300-350 funds active in this area by now may well have over US$10 billion in assets between them, and it’s growing all the time.
Z-Ben sees this as evidence of evolution of this nascent industry, “in stark contrast to the popular image of private funds being nothing more than a single portfolio manager-led shop operating in what was seen to be a largely unregulated environment. No longer willing to be relegated to the sidelines, larger private funds are now pushing hard to develop into full-fledged companies and in doing so seeking to integrate themselves into the mainstream of China’s money management industry.”
On the other side, government-supported funds are expanding their business too. E Fund Management Co., China’s second-largest asset management company, started the nation’s first officially registered hedge fund after the securities regulator eased rules in July. E Fund will be able to raise money from high-net-worth individuals in separate managed accounts and use the same investment strategies as hedge funds in what the money manager with about 200 billion yuan ($29 billion) in assets says will be the first institutional hedge-fund product in China.
The crucial moment for this industry will come when the state issues new laws for the sector, loosely referred to as “the fund laws”, and they are expected at any time. When they come, they have the potential to turn this industry on its head or stop it in its tracks. But perhaps that’s unlikely: when China finds a success story within its midst, the savviest thing to do is to keep it in check but allow it to thrive. And China has never been short of savvy.
Against the background of China’s fast growing economy, the number of private fund investors is increasing rapidly in the country, and the total amount of their wealth is increasing in step. By end 2009, China’s residents had some RMB 6-7 trillion in bank deposits, of which 80% was in the name of 20% of the population. According to some report, China has the world’s fourth-largest number of millionaires. With such a huge amount of cash assets in hand, strong investment demand from the wealthy has provided private funds in China with a sufficient supply of capital. In addition, China’s companies also have a huge sum of spare cash, which is also a primary source of capital for hedge funds.
Data showed that hedge funds account for 0.6% of the GDP in the USA, 0.35% in Europe, 0.2% in Asia, while only 0.1% in China. It is expected that China’s GDP would quadruple in 10 years time and hedge funds would be about 0.4% of the country’s GDP. In this case, China’s private funds would expand 12-fold, and place China second in the world for hedge fund investments.