Lukewarm reception for Shanghai’s QFLP programme

Surprising most people in China’s private equity industry was the announcement in October that Shanghai had received in-principle approval from China’s financial authorities to launch a pilot Qualified Foreign LP (QFLP) programme.

Similar to the Qualified Foreign Institutional Investor scheme already in existence, which allows approved foreign investors access to Chinese equities, the broad aim of the QFLP would be to allow approved foreign LPs access to the domestic private equity industry.

A statement from law firm Debevoise & Plimpton, citing a “source in Shanghai”, said the programme would likely allow approved LPs to convert foreign currency for investment into an onshore RMB-denominated fund established in Shanghai, as long as the aggregate quota for foreign-originated capital does not exceed 50 percent of the total size of the fund.

However, Hubert Tse, a partner at Chinese law firm Boss & Young in Shanghai, told PEI Asia there had been talks about limiting the foreign currency conversion quota to 30 percent, and added that there might also be a $100 million cap on foreign capital converted per fund.

For offshore LPs investing in China’s private equity markets, the news is potentially momentous. The biggest gripe offshore LPs have currently about the Chinese industry is the difference in treatment afforded to USD-denominated funds, which are subject to restrictions around investment and lengthy approval processes, and local currency RMB funds, which are not.

The issue has led to accusations of conflict of interest against Chinese managers of both offshore and onshore funds, with LPs saying managers often prefer to focus their efforts and resources on their RMB funds.

A QFLP programme was held to be a good solution, but although a cautious welcome has been expressed, celebrations are not being seen yet from the LP community.

“It’s just announcement, there’s no details yet,” said one LP, and indeed the fine print on Shanghai’s QFLP programme is still being worked out, with more details expected in November.

In this interim period, LPs can only speculate on whether the QFLP will fulfill their expectations. Crucial to this will be the treatment given to these comingled private equity funds – will they be treated like onshore funds, or will they instead be treated like foreign capital?

According to the Debevoise statement, the signs are good. Domestic RMB funds with no more than 50 percent of capital from QFLPs will be treated “as domestic funds not subject generally to foreign investment restrictions or investment approval processes”, its statement noted.

But not everybody is convinced that clause will make it into the final version of the programme.

“There is the possibility that it may be treated as a pure RMB fund, but in my opinion, given the foreign LP participation, it’s probably more likely that the fund be treated as a foreign invested fund, therefore still subject to regulatory approvals,” said Boss & Young’s Tse.

“This is something entirely unclear at the moment – the lawyers say one thing, the GPs say another thing, and the government says something else,” commented one LP, adding that without it, the QFLP programme has “no practical meaning”.

“As long as dollars are treated as dollars, established Chinese GPs will not want to use the structure because it will limit them from doing all sorts of deals,” the LP said. “And they have dollars fund already, so they don’t really need a comingled fund.”

In fact, said the LP, the only obvious benefit of a QFLP scheme which treated comingled funds as foreign invested funds would be to “third tier” Chinese GPs who would struggle to fundraise by targeting either domestic or offshore LPs alone.

“We back GPs, we don’t back products,” he stated. “Until our GPs adopt this structure, and it’s proven to be practical, we would not take this as a solution.”

Part of the skepticism is down to the speed with which the QFLP programme has appeared.

Shanghai had announced back in March its intention to launch a QFLP scheme, but when approval from the central government proved unforthcoming, it was thought its ambitions had been quietly put on ice. In fact, as recently as August, LPs were predicting the industry could be forced to wait until the upcoming government reshuffle in two years’ time before any advance on this industry game-changer would be seen. Instead, it appears to be happening now.

“Only a month ago, the message we got from the central government was that they were not going to let it happen – it just changed over the weekend,” said the LP, adding: “Usually things that happen that quickly are not very carefully debated before they come through.”