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Cayman funds complementary to new initiatives in China

20 Dec 2012

This article was published in AsianInvestor.

2012 has seen a number of developments that will increase the role of offshore funds in China. Ann Ng, a partner at Maples and Calder specialising in the formation of Cayman Islands and BVI investment funds based in Hong Kong together with [Michael Wong, Senior Associate of the Hong Kong office of Allen & Overy] looks at two initiatives of 2012 that will provide further means for offshore hedge and private equity funds to tap into the PRC market using simple and flexible Cayman Islands legal structures.

Qualified Domestic Limited Partner

First, launch of a Qualified Domestic Limited Partner ("QDLP") trial program by Shanghai authorities. Under the QDLP program, foreign fund managers would be able to set up China-based foreign-owned private fund management companies (the "FMC") to launch private onshore funds (the "QDLP Funds"). Each QDLP Fund would raise RMB funds from domestic HNW individuals and institutional investors, convert the RMB funds into foreign currencies, and then remit the funds to an offshore hedge fund. Michael Wong expects that once the Chinese regulators are comfortable that the program achieves its purposes, the potential for managers, especially those based in Asia to establish simple and flexible Cayman corporate hedge funds (which in our experience, is by far the most popular structure used by Asian fund managers especially when establishing hedge funds) to tap into China's vast domestic savings may be enormous.

China's Qualified Foreign Institutional Investor Licence

Second, the potential lowering of the criteria to qualify for China's Qualified Foreign Institutional Investor licence (the "QFII"), which allows foreigners to buy Chinese "A" shares. In 2012, China has nearly tripled the QFII quota ceiling for foreign investors from US$30 billion to US$80 billion. Hedge fund managers and funds of hedge fund managers are expected to be eligible to secure a greater portion of this QFII allocation in the longer term.  It is anticipated that if fund managers are given a QFII allocation directly, this will provide offshore fund managers with greater control over their own QFII quota and potentially lower costs for offshore funds as there will be no need to "use" a third party's QFII quota.

However, it is understood that issues remain to be clarified. For instance, the tax treatment of QDLP Funds and the repatriation of capital is unknown. China's securities regulator is also currently only studying plans to allow hedge funds and private equity funds to join the QFII program – nothing has been set. Lastly, pre-approval is still required from the relevant regulators before undertaking any of the new initiatives. Therefore, many of the details of the approval pre-requisites, process and timing of the approval process will only be known once the first batch of approvals under such initiatives are made.

In the offshore world however, there are no such uncertainties. In the Cayman Islands, the establishment of investment funds is a well-trodden path that provides fund managers with the speed and simplicity required for structuring complex transactions. The Cayman Islands government together with the legal practitioners have worked hard together to promote flexible and practical business laws including the Mutual Funds Law, the Exempted Limited Partnership Law and the Trusts Law, just to name a few. Establishment of a company, limited partnership or a unit trust, which can all be structured as an investment fund in the Cayman Islands can be completed within a short time frame.

With the backdrop of the new initiatives in China which will undoubtedly go through a process of "teething" issues as nearly all pilot schemes do wherever in the world, Ann Ng believes that a Cayman Islands domiciled investment fund would be the perfect complementary offshore structure in light of the Cayman Islands well-established English based legal system together with the well-known and experienced financial services sector.