How many private equity funds in China are targeted at domestic investors? No one seems to know. Asia Private Equity Review reports 472, while the AVCJ Database has recorded 1,150. Regardless of the number, however, one thing is clear: the market for domestic Chinese private equity funds is booming. It is but the latest “get rich quick” scheme for a country that has seen many of them over the years. With such rapid growth has come real concerns around the integrity of the domestic market, which regulators are now starting to address.

Domestic Chinese private equity investors have been mostly high net worth individuals (whereas offshore investors have been primarily institutions). Many of these domestic funds seem to be formed by sponsors who have little experience running PE funds. So you have individual investors who may be ill-equipped to police the conduct of the funds and sponsors who may be equipped to operate them using anything resembling best practices. It is a bit of a perfect storm.

According to Chinese news reports, a government official at the National Development and Reform Commission (NDRC), one of the most important Chinese regulatory agencies involved in the regulation of private equity, recently indicated publicly that as many as 1,059 funds are likely involved one way or another in “illegal fundraising.” Tianjin, one of China’s preeminent fund formation hub cities, has been particularly plagued by a series of private equity-related illegal fundraising cases.

On July 1, 2011, in one of the first high profile cases involving private equity, Huang Hao, a twenty-eight-year old, was sentenced to life in prison for the crime of “illegal fundraising.” Huang had apparently raised approximately RMB190 million (~US$30 million) from over 700 Chinese investors by running a ponzi scheme under the guise of a series of private equity investment funds. It seems that the charge of “illegal fundraising” was a bit of euphemism, but there was nothing subtle about the prison term.

Part of the problem to date is that, aside from clearly fraudulent practices such as those apparently engaged in by Huang, there has been no clear guidance on what constitutes “illegal fundraising.” The regulators are now stepping in. In early December of last year, the NDRC issued Circular 2864, which formalized the principal rules under a previously announced “pilot program” and provided, for the first time, nationally applicable guidance with respect to private equity fundraising.1  The NDRC has also posted on its website a series of accompanying “guidelines,” including forms and standard documents, setting forth mandatory requirements concerning specific fund documents (such as the offering memorandum and the limited partnership agreement).

While these new regulations do not directly affect sponsors raising money outside of China (even for investment in China), they will be applicable to all sponsors raising money in China—even large, sophisticated international firms that have started to break into the Chinese domestic fund market in the last few years.

Moreover, any fundraising scandals have the potential to tar the entire industry, and the domestic press is unlikely to distinguish much between fly-by-night operations and established and respected global private equity houses.

Manners of Fundraising

Under Circular 2864, private investment funds may be raised only by private offerings to identified and accredited investors who are capable of appreciating and bearing the risks. Fundraising may no longer be conducted through public announcements in the media (including online), putting up notices in community gathering places, distributing booklets or sending text messages to the general public, or using seminars, lectures or other disguised public solicitations (including leaving offering memoranda at the counters of institutions such as banks, securities firms, trust companies and the like, which has apparently not been an uncommon practice). The sponsor is now required to provide full disclosure of the risks and potential losses associated with the investments, and may not guarantee the return of the investors’ invested capital or any fixed rate of returns on such capital.

However, the new rules still do not provide clear standards in certain areas, such as minimum financial tests for accredited investors, or detailed guidance regarding appropriate disclosure. Nonetheless, they are ground-breaking for this young PE industry, and, given some of the questionable fundraising methods that have been employed (for example, solicitation by three-line text message), having even this basic framework is a good start.

Number of Investors

Under Chinese securities laws, an issuance of securities to more than 200 identified persons in the aggregate requires the approval of an authorized government agency. Circular 2864 re-emphasizes that the number of investors in private equity funds must comply with either the Chinese Company Law (for funds formed as companies, where the limit is either 50 investors for a limited liability company or 200 investors for a joint stock company) or the Chinese Partnership Law (for funds formed as partnerships, where the limit is 50 investors). Circular 2864 goes even further, however, in making it clear that if an investor is a pooled investment trust, partnership or an unincorporated association in other forms (except for a fund of funds), a “look-through” rule shall apply with respect to the qualification and number of the underlying investors. According to market commentary, these rules may have been formulated to curtail the common practice of pooling a large number of investors into one or more trusts which in turn invest directly or indirectly in a fund.

Placement Agents; Funds of Funds; Local Regulations

Placement agents are frequently used in China as intermediaries for fundraising from high net worth individuals. It has been reported that the intermediaries can charge upfront fees as high as 1-2% of the capital commitments raised and then half of the annual management fees and carried interest on the back end. Even well-established general partners sometimes have to live with such exorbitant placement fees due to the scarcity of domestic institutional investors in China. And notwithstanding these high fees, the placement agents tend to assume few risks in acting as intermediaries. For example, many placement agents are not licensed securities firms, and under existing Chinese laws, their fundraising activities arc barely regulated, if at all. That said, the situation may change soon as one of the key laws governing securities and investment funds are currently being reviewed and revised, and it is reported that private equity funds and intermediaries will soon be subject to stricter regulations.

Circular 2864 applies not only to direct investment funds, but also to funds of funds. However, the current rules are general and contain few if any provisions that apply specifically to funds of funds. There are credible indications though that further rules specifically governing funds of funds will be issued by the NDRC.  Last but not least, several local authorities, such as Beijing, Shanghai and Tianjin, have all issued their own rules on private equity funds prior to the issuance of Circular 2864, and the local rules may not necessarily work seamlessly with Circular 2864. It will be interesting to see how these rules evolve and how conflicts are addressed, creating yet another moving target in the fast-changing landscape of the private equity market in China.


Circular 2864 also imposes mandatory registration and filing requirements. Funds raised in China with capital commitments of RMB500 million (~US$79 million) and above must register with the NDRC; all other funds raised in China must register with designated provincial authorities.