China Hedge Fund Report 2022

China’s Economic Development

Since the beginning of reforms to open up its economy to foreign investors in 1978, China has experienced remarkable economic development, emerging as the world’s second largest economy. With the COVID-19 pandemic in 2020 dealing unprecedented blows to the global economy, China is the only major economy to have maintained positive economic growth in 2020. According to National Bureau of Statistics of China, GDP expanded 8.1% in 2021.

Chinese Households’ Wealth Management

The growing demand for wealth management among Chinese households is ushering in unprecedented possibilities for development. The vast proportion of financial assets within the portfolios of Chinese households and a growth in demand for diversified asset allocation present great potential to investors.

China's Stock Market

With the comprehensive registration system reform in full swing, the stock market in China has continued to expand to foreign investors in recent years. Concurrently, as China presses ahead with its financial opening, a myriad of regulations and rules on inbound and outbound investment have been introduced.

ESG and Responsible Investment in China

Thanks to the promotion of environmental, social and governance (ESG) and the rise of responsible investment, companies with strong ESG performance are increasingly attractive investment vehicles for foreign investors to reap stable and sustainable returns. Though the market for ESG and responsible investment is still in the early stages of development with limited scale, this highly promising sector is picking up pace.

The Private Fund Market Overview

With a stable macroeconomic environment and steadily growing capital markets, the private fund sector in China has experienced rapid development in recent years. Private fund investors are mostly institutions or wealthy individuals who are strictly subject to the qualified investor management system and have a strong risk tolerance. Compared to public funds, they enjoy a comparatively open regulatory environment and more flexible investment strategies.

The Hedge Fund Market Trends

China's hedge fund market is advancing rapidly and steadily. The number of hedge fund managers in China gradually stabilized at around 8,900 in the past four years, with approximately 400 new managers registered each year. As of December 2021, there were over 70,000 hedge fund products in China amounting to over RMB6 trillion (US$0.94 trillion). Many have begun to take ESG and sustainability-related factors into account in their investment strategies.

Regulations on Private Funds

Private funds in the Chinese market are subject to the administrative supervision and regulation of the China Securities Regulatory Commission (CSRC), as well the membership-based self-discipline management of the Asset Management Association of China (AMAC). Most private fund management companies are established under the corporate system or the limited partnership system. The Securities Investment Fund Law and the Interim Measures for the Supervision and Administration of Private Funds stipulate that private fund managers must apply and register with the AMAC. Private funds must apply to the AMAC for record-filing.

QFII, RQFII, QDLP and SH/SZ-HK Stock Connect

There are two main ways for foreign investors to increase their presence in China’s capital market. The first way is for a foreign parent company to convert its assets into Renminbi (RMB) via the foreign exchange system and use the currency to invest directly in China’s capital market. This involves three mechanisms: QFII (Qualified Foreign Institutional Investors), RQFII (RMB Qualified Foreign Institutional Investors), and SH/SZ-HK Stock Connect (notably, RQFII enables fundraising in RMB directly). The second way is to establish a foreign-invested private fund firms in China. QDLP (Qualified Domestic Limited Partners) can register overseas and raise RMB funds from investors based in China to invest in overseas markets.

Development of the Foreign Private Fund Market

In recent years, China's private fund market has experienced significant development, with an increase in foreign investment. As of December 2021, China had a total of 355 foreign private fund managers, of which 233 were wholly foreign-owned, 118 were Sino-foreign joint ventures and 4 were Sino-foreign cooperatives. With policies currently in place, foreign capital enters the Chinese A-share market mainly via the mechanisms of Mainland Trading Link and QFII, or in the form of private funds. From the perspective of industry, foreign investors have a preference for industrial and information technology.

Regulations on Foreign Private Funds

China’s acceptance into the World Trade Organization (WTO) in 2001 marked an important milestone in its capital market opening to the outside world. It was during this period that China began to establish mechanisms enabling listed companies to finance QFII via the HKEX and foreign investment. China has doubled down on its efforts to build a more attractive capital market in accordance with global standards.

Foreign Private Fund Managers

According to Wind, a provider of financial information services in China, there were 57 hedge fund managers in China as of December 2021. Currently, a total of 10 wholly foreign-owned hedge fund managers boast an asset under management (AUM) of over RMB1 billion (US$156.8 million). Shanghai has become one of the cities with the most well-equipped financial market system, an investor-friendly financial environment offering the widest varieties of financial institutions in China. The Chinese government has promoted financial reform and innovation in Shanghai, including the construction of the Shanghai Pilot Free Trade Zone, Lingang Special Area, providing a favorable environment for foreign investors.

Foreign Private Fund Products

According to Wind, as of December 31, 2021, China had a total of 2,095 registered foreign private funds, including 1,995 under entrusted management and 99 under consultative management, with 1,190 foreign fund products in operation. A review of the Chinese market reveals that global wealth management groups and foreign funds have continued to step up efforts, building their presence in China to further tap into the benefits brought about by the country’s steady economic growth.

As China's financial and capital markets become increasingly diversified and internationalized, the business scope of Wholly Foreign Owned Enterprise Private Fund Management (WFOE PFM) in China continues to expand. Many international private funds and hedge funds are eyeing the market, planning to set up subsidiaries in China and explore the potential. Hedge fund business can be quite complex at the practical level. Many considerations must be taken into account, including organizational form, naming requirements, place of registration, registered capital, personnel/ management structure, foreign exchange management requirements, establishment processes and taxation issues.

Operation models and key practical considerations

Many foreign asset managers choose to set up WFOE PFM to carry out hedge fund management business in China. Hedge fund managers are mainly organized in the form of a corporation. Private securities funds are organized in the form of a contractual fund, with a few in the form of a corporation or partnership.

Tax Considerations for Foreign Hedge Fund Managers and Funds

As China's taxation system improves, taxation on funds is also becoming increasingly refined and rationalized. Tax is an important factor shaping investors' returns. As financial products and derivative transactions experience evolve, there will be an increased demand for professional tax advice.

With a stable macroeconomic environment and steadily growing, increasingly diversified financial and capital markets, China has experienced rapid development in recent years. With support from China’s opening-up policy, foreign businesses have been stepping up efforts to increase their presence in the market. Many international private fund managers, hedge fund managers and global wealth management groups are eyeing opportunities.

At the same time, driven by a boom in ESG investment abroad and China’s 2030/60 carbon reduction and neutrality goals, more and more hedge funds are taking ESG and sustainability factors into account when implementing investment decisions.

Despite the rising popularity of hedge funds in China, foreign investors still face headwinds on multiple fronts – including ever-evolving compliance requirements and fierce local competition. The hedge fund business is complicated by nature, from fund registration to operation. Many considerations must be taken into account, including organizational form, place of registration, registered capital, personnel and management structure, foreign exchange management requirements and taxation issues. It is recommended that foreign private fund managers plan ahead accordingly.