An initial batch of six hedge fund managers have been granted individual quotas of $50 million so that they can exchange renminbi funds raised from Chinese investors into foreign currency, which can then be invested in overseas securities markets. Kenny Lam of PwC Shanghai reports on how Shanghai is aggressively promoting the hedge fund industry.
The Qualified Domestic Limited Partnership (QDLP) programme is now up and running in Shanghai.
Six hedge fund managers – whose names have not yet been made public – have been granted quotas of $50 million each. They can exchange renminbi funds raised from Chinese investors into foreign currency, which can be invested in overseas securities markets.
The QDLP programme allows qualified domestic private renminbi funds established in Shanghai to invest in offshore securities markets and is a key development in the city’s plans to become an international financial centre.
Following an approval process on the part of China’s State Administration of Foreign Exchange, the programme was launched in mid-2013. The first six hedge fund managers have been authorised to set up foreign-owned fund management companies – onshore fund management companies.
Some have already set up their onshore fund management companies and are in the process of fund raising. They are expected to be fully operational and investing into their offshore master funds by early 2014.
The programme represents a milestone for international asset managers seeking to enter the Chinese market.
Despite this, a number of issues still need to be addressed. Chief among these is that asset managers need to craft their marketing strategies carefully.
QDLP products will be new and unfamiliar, so asset managers will have to invest time and effort into building credibility and reputation. The correct combination of marketing activities and channels will be critical: working with a Chinese partner or engaging wealth management institutions and other channels are likely to figure.
Designing an optimal marketing strategy and operational structure now – while quotas are at a small, experimental level – is vital if asset managers are to be ready to reap the rewards as the programme expands.
Arrangements need to be in place with Chinese business partners, fund administrators and custodian banks, and legal and tax advisors.
Creating the best tax structure will be a prerequisite for attracting institutional and individual investors to QDLP funds. Designing an appropriate fee structure to compensate the onshore fund management company will also be key.
Asset managers might consider the commonly used trust structure for individual investors. However, this is not currently approved by the Chinese Banking Regulatory Commission.
An ongoing challenge for asset managers is to explore and identify tax efficient structures for investors that will be acceptable to the relevant Chinese regulatory bodies.
Management and performance fees will most likely be collected by the offshore fund manager of the master fund, first under the master-feeder structure. Compensation for the onshore fund management company needs to be structured to mitigate the risk of being challenged on transfer pricing issues by the tax authorities.
The programme is different from the Qualified Domestic Institutional Investor scheme, which also allows investment in overseas securities markets.
It raises a number of new issues relating to after-tax investment income for investors. As Chinese investors are currently exempt from individual income and business taxes on trading gains in the A-share market, the tax implications for QDLP mostly concern individual investors.
Other issues to consider are that taxation on partnerships is not clear under the current tax regime and that the tax authorities are aiming to move from business tax to value added tax for all industries.
Consequently, asset managers need to ensure that all tax issues relating to QDLP are cleared and that relevant legal documents provide appropriate tax disclosure notes.
Selecting the best location for registering the onshore fund management companies and QDLP fund is a key concern for asset managers. The launch of the Shanghai Free Trade Zone has raised awareness of this issue. However, other districts are also aggressively promoting the hedge fund industry by providing highly favourable policies and incentives.
We expect the QDLP programme to expand as more and more asset managers get on board and individual quotas are raised to a more substantial level. Asset managers need to establish the best operational structure for their QDLP product so that they are ready for the anticipated expansion in this new market.
Kenny Lam is a tax partner at PwC Shanghai
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