In a number of incremental steps, the PRC government has been easing restrictions on the cross-border movement of RMB. The latest step for the private equity industry is the Renminbi Qualified Foreign Limited Partner Program (“RQFLP”), which permits offshore-raised RMB to be invested in PRC companies by PRC private equity funds and managers.
Incremental Steps Toward Internationalization
The PRC government is in the process of gradually internationalizing the RMB use for trade and investment. Commentators have surmised that the objective of these incremental steps is to facilitate RMB flows as needed for real operations, while keeping a tight rein on currency speculation.
Regarding currency generated or used in operations, the PRC has eased restrictions governing cash management for multi-national operating companies (“MNC”). For example, the People’s Bank of China recently began permitting certain MNCs to consolidate all incoming or outgoing RMB transactions over a given period into a single payment, rather than requiring approval for each individual transaction. Similarly, last September, the State Administration of Foreign exchange launched a pilot program that allows approved companies to sweep foreign currency generated in China into a single overseas account.
The PRC is also incrementally liberalizing incoming and outgoing currency flows for investment funds. In 2011, Shanghai unveiled its Qualified Foreign Limited Partner program (“QFLP”). Under the QFLP, foreign-invested private equity funds and fund management companies were permitted to convert their foreign currency capital into RMB in order to invest into RMB funds. Factors for foreign funds to be qualified participants under the program included whether (i) the fund identified investors and obtained firm commitments from such investors; (ii) the management team has sufficient PRC investment experience; (iii) the fund had certain favoured investors such as government guidance funds or SOEs; (iv) the fund established a governance structure, investment plans, and capital contribution, distribution and allocation mechanism.
Following the QFLP, the Renminbi Qualified Foreign Institutional Investor (“RQFII”) program was launched in December of 2011. Under the RQFII, Hong Kong subsidiaries of approved PRC securities firms were permitted to raise RMB funds in Hong Kong to invest in the PRC securities markets. Each firm was limited to a quota determined by the State Administration of Foreign Exchange (“SAFE”). RQFII investments are limited to stocks, bonds and warrants traded on stock exchanges, fixed-income products traded on inter-bank bond markets, securities investment funds, stock index futures and other financial instruments permitted by the CSRC.
Both the QFLP and the RQFII were designed to attract RMB currency that has pooled offshore. By providing a mechanism to return offshore RMB to the PRC, the RQFLP is the next small step towards internationalizing RMB currency in the investment industry, and particularly for private equity firms.
RQFLP is effectively an extension of the QFLP, and also follows in the wake of the RQFII. The RQFLP is an extension of the QFLP in that it permits qualified foreign-invested private equity funds to use offshore RMB (as opposed to foreign currency) from qualified foreign investors to make investments in PRC companies. The RQFLP also avoids the necessity of obtaining foreign currency exchange approval. Like the RQFII, RQFLP funds raise and deploy offshore RMB. However, unlike RQFII, the foreign invested fund may invest in convertible instruments, private companies, and private placements in listed companies.
Qualified RQFLP participant funds will include Hong Kong subsidiaries of PRC investment firms and foreign fund managers with an established record and offshore-RMB fundraising capacity. In the PRC, the RQFLP fund will set up a foreign invested fund manager (“FIE Manager”) with registered capital of USD 2 million or a foreign-invested fund (“FIE Fund”) with registered capital of US 15 million to act as a general partner onshore. Each foreign investor in the FIE Fund must own assets of US 500 million or have US 1 billion under management. Limitations for investors in Fund Managers have not been specified.
The RQFLP is geographically limited to Shanghai’s Pudong New Area (though Chongqing government has been reported to open a similar program). It is capped at RMB 1 billion. The QFLP was also initially subject to caps that were expanded shortly after the program was introduced. Likewise, RQFII was initially capped at RMB 6 billion but has expanded to RMB 270 billion. Elevated cap amounts do not, however, correlate to private equity investment. Despite the higher cap, as of last January the QFLP had only raised RMB 15 billion, most of which has not been deployed.
Perhaps the biggest disappointment is that RQFLP funds will still be treated as foreign investors according to the Reply Letter of the General Office of NDRC on Relevant Issues Relating to Foreign-invested Equity Investment Enterprises, 2012 (1023). The letter emphasized that any amount of funds provided by foreign limited partners would make the fund “foreign” and would still be treated as a foreign investment. Therefore, investment into a PRC company by an RQFLP fund will convert the PRC company from a domestic entity to a foreign invested entity (“FIE”). FIE’s cannot invest in certain sectors and must comply with Catalogue for the Guidance of Industries of Foreign Investment.
As practical limitation on both RQFLP and PRC ambitions to internationalize the yuan, the total amount of accessible offshore RMB is a estimated to be a modest RMB 1 trillion . Only a fraction of those funds, which includes dim-sum bonds and certificates of deposit, will be available to fundraisers for RQFLP investment.
Although RQFLP is a discrete step toward RMB internationalization, it is not likely to generate tremendous amounts of investment inflows.