Shanghai Giving foreign PE/VC Firms

SHANGHAI (Reuters) – Shanghai has decided to let foreign investors, including private equity and venture capital funds, register legally as local equities investment firms as China's financial hub moves to lure more overseas investment.

Foreign investors with a focus on Chinese equities can set up a Shanghai-registered entity with initial capital of 100 million yuan ($14.56 million) or more with the legal status of a local investment company and receive special tax treatment, according to a city government document dated Aug. 11 and obtained by Reuters on Friday.

Qualified foreign investors would include private equity funds, venture capital funds, buyout funds and hedge funds, it said.

“With the rapid growth of China's economy and expansion of domestic capital markets, private equity and other funds are also growing fast and helping companies to increase their value,” said the document, issued jointly by four departments including the city government's financial services department.

Private equity occupies a regulatory grey area in China, as the government has yet to complete nationwide rules clarifying the legal status and foreign exchange controls for overseas buyout firms.

Most foreign investment funds, including Carlyle Group [CYL.UL] and Bain Capital, have set up shop in China as a consultancy service or representative office, rather than as a fully fledged investment firm.

This has long posed regulatory hurdles, especially in foreign exchange controls and complicated approval procedures for securing deals.

FOREIGN EXCHANGE CONTROLS

Despite uncertainties on the national level, several major Chinese cities including Beijing, Tianjin and Shanghai are attempting to become pioneers in attracting such foreign investment.

Beijing and Tianjin have already won special permission from the central government to offer “legal status” to such foreign investment funds.

Some industry executives who have seen the document said the new Shanghai rules were similar to those in Beijing and Tianjin, although none has addressed the more important issue of China's strict foreign exchange controls.

“Giving legal status to us is like gilding refined gold,” said an executive at a foreign private equity firm in Shanghai.

“We certainly care more about how to make capital flow into or out of the country in an easier and more efficient way,” he said. Industry executives said Shanghai would encourage foreign funds to set up companies in the city in the form of limited liability or partnership firms, which could raise funds from domestic investors to launch yuan-denominated funds.

But for U.S. dollar-denominated funds, which are usually raised from overseas investors, foreign investment companies will still need to apply for foreign exchange quotas and relevant approvals for investments from Chinese ministries and regulators, even if they have legal entities in Shanghai.

The city government also said it would offer preferential tax rates to Shanghai-registered foreign fund firms, with a maximum rate of 35 percent for private equity and venture capital firms with a limited partnership structure and 20 percent on capital gains earned by non-executive partners.

That ratio is still much higher than in Hong Kong, where the corporate tax rate is a maximum 16.5 percent and the individual income tax rate goes up to 15 percent. ($1=6.867 Yuan)

By George Chen
(Editing by Edmund Klamann)