On January 31, 2011, China’s National Development and Reform Commission (NDRC) issued a “Notice on Further Regulating the Development and Record-Filing Administration of Equity Investment Enterprises in Pilot Regions” (the Notice). The Notice provides a more specific operating and compliance guidance for equity investment enterprises (EIEs) established in four pilot regions (specified below). Generally speaking, a private equity (PE) firm, whether domestic or foreign-invested, is an EIE as defined in the Notice.
Before the issuance of the Notice, NDRC had proposed to issue jointly with other ministries and departments the “Interim Measures on the Administration of Equity Investment Enterprises” (the Interim Measures), which were supposed to regulate all EIEs established under Chinese law. The Interim Measures were not adopted. In contrast, the Notice is applicable only to EIEs established in four pilot regions, i.e., Tianjin Binhai New Area, Beijing Zhongguancun Science Park, Wuhan East Lake Hi-Tech Development Zone, and the Yangtze River Delta region (including Ningbo, Wuxi, and Shanghai Pudong District).
The Notice requires that an EIE be formed as a company or partnership. Fundraising for an EIE is to be handled through private placement, and all investors must be able to identify commercial risks and afford possible losses. The fundraisers should completely disclose the potential risks. Any promise of a fixed investment return is strictly forbidden. The investment scope of an EIE is limited to nonpublicly traded shares of a company, which distinguishes EIEs from securities investment funds, the latter being regulated under other laws and regulations, such as the Law on Securities Investment Funds.
An EIE must establish risk-control mechanisms, and constantly improve them. When an EIE has idl funds, such funds should be kept in its bank account or used to purchase government bonds or other financial products that provide a fixed investment return. Warranties can be provided only to the enterprises in which the EIE invests, and when the prospective investee is a related party to the EIE, a director, shareholder, or investment committee member that is related to such investee is not permitted to vote in the decision-making process.
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