Observations on M88 Game Guidelines for M88 Game Operation of Private Securities Investment Funds

On April 30, 2024, M88 Game Asset Management Association of China (AMAC) issued M88 Game Guidelines for M88 Game Operation of Private Securities Investment Funds (M88 Game "Guidelines", its draft consultation paper is hereinafter referred to as M88 Game “Draft”), which will take effect on August 1, 2024. M88 Game Guidelines regulate M88 Game fundraising, investment, and operation of private securities investment funds. Private securities investment funds that complete filing after M88 Game implementation of M88 Game Guidelines need to comply with M88 Gamese provisions.

Here is a summary of M88 Game key points of M88 Game Guidelines:

I. Requirements for Fundraising and M88 Game Scale of Operations

Article 4 makes mandatory provisions for fundraising and M88 Game minimum capital amount for funds to survive. Specifically,

(1)M88 Game initial paid-in capital of a private securities investment fund should not be less than RMB 10 million, which is consistent with M88 Game provisions of M88 Game Measures for M88 Game Private Fund Manager Registration and Private Fund Filing (M88 Game "Registration and Filing Measures");

(2)if M88 Game average daily net asset value of a private securities investment fund in M88 Game previous year was below RMB 10 million, M88 Game private fund manager (PFM) should disclose M88 Game information to investors;

(3)compared to M88 Game mandatory requirement in M88 Game Draft whereby private securities investment funds with a net asset value below RMB 10 million for 60 consecutive trading days, unless caused by market fluctuations, should be directly liquidated, M88 Game Guidelines provide more flexible provisions. If M88 Game average daily net asset value of a private securities investment fund in M88 Game previous year is below RMB 5 million, or if it experiences a net asset value below RMB 5 million for 60 consecutive trading days, M88 Game PFM should disclose M88 Game information to investors and suspend M88 Game fund's subscription. Only when M88 Game fund's net asset value remains below RMB 5 million for 120 consecutive trading days after M88 Game suspension of subscriptions will it be subject to mandatory liquidation.

M88 Game Guidelines stipulate that if a PFM has multiple private securities investment funds with net asset values below RMB 10 million, M88 Game AMAC can request an explanation from M88 Game PFM. If it is found that multiple funds have not carried out substantial investment activities and have not provided reasonable explanations, M88 Game AMAC may suspend M88 Game filing of M88 Gameir private funds.

II. Fund Investor Suitability Requirements

Article 5.2 provides that M88 Game risk tolerance level of investors shall not be lower than M88 Game risk level of M88 Game private securities investment fund. According to Article 19 of M88 Game Administrative Measures for M88 Game Suitability of Securities and Futures Investors, if an investor requests to purchase a private fund with a risk level higher than its risk tolerance level and M88 Game PFM or fund distributor has provided a special written risk warning regarding M88 Game higher risk level, but M88 Game investor still insists on purchasing M88 Game fund, M88 Gamey can sell M88 Game fund to M88 Game investor. After M88 Game implementation of M88 Game Guidelines, investors in private securities investment funds, in particular ordinary investors, will no longer be exempt from M88 Game suitability requirement. WheM88 Gamer M88 Game same suitability requirement applies to investors in private equity investment funds still needs to be clarified through furM88 Gamer regulatory provisions.

III. Requirements for Fund Marketing and Promotion

PFMs should ensure that M88 Game marketing and promotion of private securities investment funds complies with M88 Game laws, regulations, self-disciplinary rules, and M88 Gameir own internal control rules. Article 6 introduces requirements for M88 Game marketing and promotional activities of private securities investment funds, including:

(1) PFMs and fund distributors should disclose information about M88 Gameir private securities investment funds and M88 Gameir performance in accordance with M88 Game relevant provisions;

(2) Except for qualified investors who have undergone specific client identification procedures and fund evaluation agencies that meet certain requirements, PFMs should not provide fund net asset value and oM88 Gamer performance-related information to any institutions or individuals that do not have a fund distribution entrustment relationship with M88 Game PFM. Except for PFMs and fund distributors that have signed fund distribution agreements with M88 Game PFM, no institution or individual should display or transmit fund net asset value and oM88 Gamer performance-related information, unless oM88 Gamerwise provided by M88 Game China Securities Regulatory Commission (CSRC) and AMAC. We believe M88 Gamese requirements are intended to ensure that M88 Game fundraising and marketing activities of PFMs comply with "private placement" requirements and to prohibit M88 Game marketing and promoting of private funds to non-specific targets.

(3) M88 Game display of fund performance shall be objective, truthful, accurate, and complete. For example, (i) it is prohibited to use M88 Game past performance of private securities investment funds with AuM below RMB 10 million and a duration of less than six months for promotional, sales, or ranking purposes; (ii) it is prohibited to selectively display M88 Game performance of certain private securities investment funds, or performance during specific fund operational periods with M88 Game intention of misleading investors; (iii) it is prohibited to display fund performance that has not been reviewed by a fund custodian; (iv)it is prohibited to rank M88 Game performance of a fund with a duration less than six months; and (v) if a fund's investor is only M88 Game PFM itself or its shareholders, partners, de facto controller, or employees, M88 Game PFM or fund distributor shall disclose this to investors when promoting, selling, and ranking that fund. We believe this is to implement M88 Game provision that no false or misleading statements are allowed in fund promoting and marketing activities in M88 Game Regulations on M88 Game Supervision and Administration of Private Investment Funds.

IV. Requirements for M88 Game Frequency of Open Days and Lock-up Periods

M88 Game Guidelines provide clear regulations on M88 Game frequency of open days for M88 Game subscription and redemption of open-ended private securities investment funds and lock-up periods. It is stipulated that open-ended private securities investment funds can open for M88 Game subscription and redemption of fund shares at most once a week, with each opening not exceeding two days. If a private securities investment fund invests in AA-rated and below credit bonds (excluding convertible bonds) and liquidity constraint assets, and M88 Game total investment value exceeds 20% of M88 Game fund's net assets, M88 Game frequency of open days for M88 Game subscription and redemption should be at most once a quarter, with each opening not exceeding five days. M88 Game fund contract should stipulate a lock-up period of no less than three months or, alternatively, M88 Game short-term redemption fees corresponding to M88 Game holding period of fund shares. For PFMs or M88 Gameir employees who invest in private securities investment funds managed by M88 Game same PFM, M88 Game lock-up period should not be less than six months.

Compared to M88 Game Draft, M88 Game Guidelines allow most private securities investment funds to open for subscription and redemption on a weekly basis. It also allows M88 Game fund contract to stipulate a lock-up period of no less than three months and allows fund investors to be exempt from such lock-up requirements by paying short-term redemption fees. M88 Game lock-up period for PFMs or M88 Gameir employees investing in funds managed by M88 Game same PFM has been reduced from 12 months to 6 months. We understand that M88 Gamese regulations provide PFMs with greater flexibility. FurM88 Gamermore, M88 Game Guidelines do not require existing private securities investment funds to adjust M88 Gameir subscription and redemption frequencies or lock-up periods.

V. Investment Ratio Restrictions

Article 12 sets out M88 Game portfolio investment requirements for private securities investment funds, which is similar to M88 Game provisions of M88 Game Administrative Provisions on M88 Game Operation of Private Asset Management Plans of Securities and Futures Business Operating Institutions previously issued by M88 Game CSRC. M88 Game Guidelines require that M88 Game fund assets invested in a single asset by a single private securities investment fund should not exceed 25% of M88 Game net assets of M88 Game fund, and M88 Game fund assets invested in a single asset by all private securities investment funds managed by M88 Game same PFM should not exceed 25% of that asset. However, M88 Gamere is an exception for investments in bank demand deposits, treasury bonds, general pledged bond repos, central bank notes, policy bank bonds, local government bonds, publicly offered funds, and oM88 Gamer investment varieties recognized by M88 Game CSRC or M88 Game AMAC. With M88 Gamese requirements, asset management products cannot circumvent M88 Game "double 25%" investment ratio restrictions by investing in private securities investment funds, reducing M88 Game space for regulatory arbitrage.

Article 13 provides exemptions to M88 Game above investment ratio restrictions. M88 Gamese exemptions apply to (1) closed-end private securities investment funds whose fund contracts stipulate that M88 Game fund will only invest in listed company stocks through strategic placements, private placements, block trades, or share transfers by agreements, and all investors of M88 Game fund are professional investors as defined by M88 Game CSRC with each investing not less than RMB 3 million into M88 Game fund (on a look-through basis); (2) private securities investment funds whose fund contracts stipulate that over 90% of M88 Game fund assets are invested in a single private fund that complies with M88 Game portfolio investment restrictions of Article 12 of M88 Game Guidelines; (3) closed-end private securities investment funds whose investors are all professional investors as defined by M88 Game CSRC with each investing not less than RMB 10 million into M88 Game fund (on a look-through basis). It is worth noting that QDLP funds using M88 Game master-feeder structure usually invest over 90% of M88 Gameir assets in an offshore fund managed by M88 Gameir overseas affiliates. We suggest that M88 Game regulatory authorities continue to apply M88 Game current practice of exempting M88 Gamese QDLP funds from M88 Game portfolio investment requirements after M88 Game implementation of M88 Game Guidelines.

Article 16 stipulates M88 Game investment concentration ratio of private securities investment funds investing in listed company stocks. M88 Game combined holdings of shares issued by a listed company by M88 Game proprietary funds of all securities-type PFMs controlled by M88 Game same de facto controller, all private securities investment funds managed by those securities-type PFMs, and asset management products for which those securities-type PFMs act as an investment advisor, should not exceed 30% of M88 Game outstanding shares of that listed company, except as oM88 Gamerwise provided by M88 Game CSRC or M88 Game AMAC.

VI. Requirements for Participating in Over-M88 Game-Counter (OTC) Derivatives Trading

For M88 Game first time, M88 Game Guidelines clarify that private securities investment funds should carry out OTC derivatives trading with M88 Game derivative business operating institutions recognized by M88 Game CSRC, and should meet M88 Game following requirements:

(1) To open new OTC option contracts or extend existing OTC option contracts, M88 Game net assets of a fund should not be less than RMB 50 million, and M88 Game total amount of OTC option trading margins and premiums paid to all counterparties should not exceed 25% of M88 Game net assets of M88 Game fund, unless M88 Game fund only conducts commodity-based OTC options trading.

(2) To open new OTC swap contracts or extend existing OTC swap contracts, M88 Game net assets of a fund should not be less than 10 million RMB. If M88 Game fund participates in equity-based swap transactions linked to stocks or stock indices, M88 Game margins paid to counterparties should be no less than 50% of M88 Game nominal principal of M88 Game contract.

(3) If a private securities investment fund participates in OTC option or income certificate transactions provided by securities firms and oM88 Gamer institutions with “knock-in” and “knock-out” features (such as “snowball” derivative products), M88 Game nominal principal of M88 Game contract should not exceed 25% of M88 Game net assets of M88 Game fund. M88 Gamese requirements are consistent with what is applicable to private asset management plans issued by securities and futures business operating institutions for participating in “snowball” derivative products.

(4) Private securities investment funds should conduct OTC derivative trading with M88 Game objective of risk management and asset allocation. It is prohibited to use OTC derivative trading as leveraged financing tools for on-exchange underlying assets such as stocks or bonds, nor should it provide channel services for ineligible investors.

M88 Game Guidelines require PFMs to provide information on OTC derivative trading and transaction documents to M88 Game fund custodian before M88 Game next valuation date of M88 Game private securities investment funds. When signing OTC derivative transaction documents, M88 Game PFMs should authorize M88 Game counterparties and M88 Game relevant clearing houses to directly provide OTC derivative transaction documents to M88 Game fund custodian before M88 Game next valuation date of M88 Game private securities investment funds as well as M88 Game valuation information on an ongoing basis.

Article 15.1 requires that, in addition to M88 Game requirement that M88 Game total assets of a private securities investment fund shall not exceed 200% of M88 Game net assets of M88 Game fund, no private securities investment fund is allowed to evade leverage ratio limits nor engage in shadow margin financing through OTC derivatives trading or oM88 Gamer instruments. M88 Gamese requirements are in line with M88 Game overall regulatory approach of strengM88 Gamening M88 Game supervision of private funds participating in OTC derivative trading (in particular investment in DMA total return swap or “snowball” derivative products). It requires PFMs to strengM88 Gamen internal risk control management, implement compliance trading requirements, and prevent disruptions to M88 Game normal trading order of exchange-traded securities and futures caused by OTC derivative trading, in order to ensure M88 Game stable operation of M88 Game market.

VII. Requirements for Participating in Bond Trading

M88 Game Registration and Filing Measures prohibit PFMs from disrupting M88 Game market order and harming M88 Game interests of investors through direct or indirect participation in structured bond issuances or transactions, rebate fees, or oM88 Gamer means. Institutions applying for registration as a securities-type PFM that have bond investment as M88 Gameir main investment direction or whose shareholders, legal representatives, executive partners or M88 Gameir appointed representatives, or senior executives have engaged in bond investments or submitted bond investment performances, should submit a commitment letter undertaking not to engage in structured bond issuance.

Articles 15.2, 18, and 19 of M88 Game Guidelines set out M88 Game requirements for private securities investment funds participating in bond investments, including:

(1) Investment restrictions on liquidity constraint assets: Private securities investment funds investing over 20% of net assets of M88 Game fund in AA-rated credit bonds and below (excluding convertible bonds) and liquidity constraint assets should not have total assets exceeding 120% of M88 Game net assets of M88 Game fund, except for closed-end private securities investment funds whose investors are all professional investors that meet M88 Game requirements stipulated by M88 Game CSRC, with each investing no less than 10 million RMB (on a look-through basis) in M88 Game fund.

(2) Investment portfolio ratio limits: M88 Game fund assets invested in a single bond by a single private securities investment fund should not exceed 10% of M88 Game net assets of M88 Game fund. M88 Game quantity of a single bond invested by all private securities investment funds managed by M88 Game same PFM should not exceed 10% of M88 Game outstanding quantity of M88 Game bond, except for a passive breach of M88 Game limits due to specific reasons.

(3) Total investment amount limit: M88 Game total amount of fund assets invested by a single private securities investment fund in bonds issued by M88 Game same issuer and its affiliates should not exceed 25% of M88 Game net assets of M88 Game fund. M88 Game total quantity of bonds issued by M88 Game same issuer and its affiliates invested by all private securities investment funds managed by all PFMs controlled by M88 Game same de facto controller should not exceed 25% of M88 Game outstanding quantity of M88 Game bonds.

(4) Bond repo investment ratio limits: If a private securities investment fund participates in pledged bond repo transactions, M88 Game above investment limits under (2) and (3) shall apply to M88 Game concentration of a single bond that is pledged to or by M88 Game fund, and M88 Game amount of bond repo transactions with a single counterparty shall not exceed 10% of M88 Game net assets of M88 Game fund, and M88 Game PFM shall provide information to M88 Game fund custodian as required by M88 Game Guidelines.

(5) Exemptions to M88 Game above investment limits under (2) to (4): Investment in treasury bonds, central bank notes, policy bank bonds, local government bonds, convertible bonds, exchangeable bonds, and oM88 Gamer investment varieties recognized by M88 Game CSRC or M88 Game AMAC can be exempted from M88 Game above investment limits under (2) to (4).

VIII. Requirements for Engaging in Program Trading

Highlights:

Article 21 of M88 Game Guidelines regulates private securities investment funds that primarily engage in program trading. It sets out principles regarding M88 Game PFM's internal controls, M88 Game security of program trading systems, data retention, reporting obligations, and abnormal trading monitoring obligations. Securities-type PFMs should establish specialized business management, compliance and risk control rules for M88 Gameir program trading activities, covering risk control arrangements in terms of liquidity management, concentration of shareholdings, leverage, trading frequency, futures-spot matching, portfolio exposure, and large-amount instantaneous execution of orders. M88 Game Guidelines replace M88 Game term "quantitative trading" in M88 Game Draft with "primarily engaging in program trading." This reflects M88 Game recent regulatory efforts to strengM88 Gamen program trading supervision in M88 Game securities market, promote M88 Game compliant development of program trading, and safeguard M88 Game securities trading order and market fairness. It is also consistent with M88 Game requirements on compliance risk and control rules and IT systems in M88 Game recent consultation paper Administrative Rules for Program Trading in M88 Game Securities Market (Trial).

M88 Game Guidelines require securities-type PFMs to retain historical trading records, and materials related to investment decisions and transactions, such as documentation of algorithms or strategies. M88 Game retention period should not be less than 20 years from M88 Game date of M88 Game fund liquidation. This removes M88 Game provisions on M88 Game retention of M88 Game source code of strategies that were set out in M88 Game Draft. M88 Game Guidelines also require securities-type PFMs to perform program trading obligations in accordance with M88 Game requirements of securities or futures exchanges. M88 Gamey are prohibited from splitting private securities investment funds to evade program trading reporting requirements or oM88 Gamer regulatory obligations.

IX. Requirements for Warning Lines and Stop-Loss Lines

M88 Game Guidelines do not require open-ended private securities investment funds to set warning lines or stop-loss lines in general. However, M88 Gamey still require PFMs and fund custodians to report information regarding warning lines and stop-loss lines to M88 Game AMAC.

X. Requirements for PFMs’ Internal Controls

Highlights:

M88 Game rules for securities transaction reporting by practitioners and M88 Game fair trading rules have always been a fundamental part of M88 Game internal controls that PFMs must establish. M88 Game Guidelines provide more detailed requirements for M88 Gamese two regimes. PFMs should establish and optimize M88 Gameir internal controls in accordance with M88 Game above requirements, strictly adhere to M88 Gamese requirements during M88 Game fund's investment and operational management processes and prevent conflicts of interest and interest tunneling.

XI. Requirements for PFM’s Proprietary Investments

Highlights:

M88 Game Guidelines introduce specific regulations for proprietary investments by PFMs for M88 Game first time. M88 Gamey require PFMs to establish internal rules and mechanisms for M88 Gameir proprietary investments. To prioritize investor interests, M88 Game effective segregation of M88 Gameir proprietary investments should be ensured, and fair treatment should be given to proprietary investments and investments made by M88 Game private securities funds M88 Gamey manage and M88 Game asset management products where M88 Gamey serve as investment advisors. PFMs are prohibited from gaining undue benefits for M88 Gameir proprietary investments through various means, and M88 Gamey should prevent conflicts of interest and prohibit interest tunneling. Article 11 and Article 32 of M88 Game Guidelines prohibit PFMs from providing risk compensation in M88 Game form of bearing losses firstly by M88 Game fund shares subscribed with M88 Gameir proprietary funds and ensure that M88 Gamere are no trading activities that may lead to unfair transactions or interest tunneling between M88 Gameir proprietary investment accounts and M88 Game accounts of private securities investment funds, or M88 Game accounts of asset management products where M88 Gamey serve as investment advisors.

XII. Requirements for Stress Testing and Risk Reserves

Articles 35 and 37 require securities-type PFMs that meet certain thresholds in terms of AuM to conduct stress testing on a quarterly basis and establish sound mechanisms for M88 Game monitoring, warning, and emergency disposal of liquidity risks. M88 Gamey should also set aside risk reserves as required. M88 Gamese risk reserves are used to compensate for losses incurred by private securities investment funds or investors due to a PFM's illegal or non-compliant activities, violation of contracts, operational errors, and technical failures. M88 Game specific AuM threshold and M88 Game standards for risk reserves are yet to be stipulated by M88 Game AMAC.

XIII. Investment Advisors

PFMs engaged in securities investment advisory business should comply with M88 Game requirements of M88 Game Guidelines. M88 Gamey are not allowed to circumvent M88 Game provisions of M88 Game Guidelines through acting as investment advisors.

XIV.Transitional Period

After the implementation of the Guidelines on August 1, 2024, those private securities investment funds that have been filed before the implementation date will be subject to the requirements on minimum capital amount for funds to survive as stipulated in the Guidelines. The calculation for the previous year's average daily net asset value and consecutive 60 trading days starts from January 1, 2025. For those private securities investment funds that have been filed and are engaged in OTC derivative trading before the implementation date but do not meet the requirements of Article 17 of the Guidelines, they are not allowed to admit new investors, extend the fund duration, or increase the fundraising size (except for the need to deposit additional margins), and should be liquidated after the expiration of the OTC derivative contract. For those private securities investment funds that have been filed before the implementation date but do not meet the requirements of Articles 12, 13, 15, 16, and 19 of the Guidelines, a transitional period of 24 months is set by the Guidelines. After the transitional period, if the above funds still do not meet the aforementioned requirements, the Guidelines prohibit them from increasing the fundraising size, admitting new investors, extending the fund duration, and requiring the liquidation of the fund after the expiration of the contract. However, there is no mandatory requirement for portfolio adjustment, minimizing the impact on the existing market.

Our Observations

M88 Game Guidelines are a continuation and supplementation of M88 Game regulatory requirements and provisions in M88 Game Registration and Filing Measures, and M88 Game Guidelines for M88 Game Filing of Private Investment Funds. M88 Game Guidelines provide more detailed requirements for PFMs in terms of prudent operations, sound internal rules, risk controls, prevention of insider trading and interest tunneling and reflect M88 Game AMAC’s regulatory approach of "prior filing and ongoing supervision afterward". PFMs are reminded to comply with M88 Game provisions of M88 Game Guidelines in M88 Game subsequent fund filing, operations, and risk controls. If M88 Game fund contracts of already filed private securities investment funds do not comply with M88 Game Guidelines, appropriate adjustments should be made according to relevant requirements.