I. Background

In 2018, we offered insights of the legal application, regulatory compliance requirement, investment, operation and management of real property private equity funds after the enactment of the regulation, Administrative Code for the Filing of Private Asset Management Plans of Securities and Futures Operators No. 4 - Private Asset Management Plans to Invest in Real Estate Development Enterprises and Projects (“Specification No. 4”) in article “When Private Equity Funds Encounter Real Estate" [1]. According to the Specification No. 4, unlike those of other types of private equity funds, the regulatory authorities have imposed more stringent regulatory requirements over real property private equity funds in multiple aspects of its daily operation (such as registration and filing, restrictions on the use of funds, investment structure and compliance with underlying assets, etc.).

On November 28, 2022, People’s Bank of China (“PBOC”) and China Banking and Insurance Regulatory Commission (“CBIRS”) jointly issued the Notice on Providing Financial Support for the Stable and Healthy Development of Real Estate Market (“16-Points Plan”). The spokesperson of the China Securities Regulatory Commission (“CSRC”), in response to a reporter’s question in the Q&A session, further established five adjustment measures (the "third arrow") and affirmed that the pilot of real estate private equity investment funds (“Real Estate Funds”) would soon be launched. On this basis, private equity funds (“PE Funds”) may avail itself of this regulation in diversified asset allocation, professional investment operation, and meeting the reasonable financings requests of the real estate market. On February 20, 2023, CSRC announced the official launch of the Real Estate Fund pilot guideline by issuing the CSRC Launches Real Estate Private Investment Fund Pilot to Support the Stable and Healthy Development of the Real Estate Market. The Asset Management Association of China (“AMAC”) also set out a detail guide of Real Estate Funds by issuing the Guidelines for the Pilot Filing of Real Estate Private Investment Funds (Trial) (Zhong Ji Xie Fa [2023] No. 4) (New Regulation) on the same night.

In recent years, China's PE Fund market has flourished as investors are zealously sourcing for investable assets, and the size of PE Funds has been increased. As of the end of January 2023, 146,345 PE Funds are filed with AMAC, with a cumulative fund size of RMB20.23 trillion. According to AMAC’s drafting notes of the New Regulation, as of the end of 2022, AMAC has 838 Real Estate Funds on file with a scale of RMB404.3 billion and 1,424 private equity infrastructure funds with a scale of RMB1.21 trillion. Compared to the entire PE Fund market in all industries, the number and scale of Real Estate PE Funds are relatively limited, and there are still rooms for real estate fund market to develop.

The release and implementation of the New Regulation is another encounter between PE Funds and the real estate industry. It is a valuable opportunity for real estate companies to revive their businesses and explore new development models, and this is key breakthrough in the combination and development of real estate and private equity funds.

II. Key Points Analysis

The New Regulation contains 21 articles which mainly include: the investment scope of Real Estate Funds, qualification requirements for real estate fund managers (“RE Fund Manager”), requirements for fundraising and investors, provision of loans and guarantees for invested enterprises, financing of real estate funds, structuring arrangements, expansion of fundraising, related party transactions, filing materials, information disclosure and other provisions.

1. Investment Scope

According to Article 3 of the New Regulation, the three major investment scope of Real Estate Funds are: (i) specific residential properties (including existing residential property inventories, affordable housings and marketable rental residential properties), (ii) commercial properties and (iii) infrastructure projects. The specific requirements for each of the types are set out below:

From the above table, it appears that the New Regulation sets out a list of construction related permits that Real Estate Funds must obtain before investing in residential properties (i.e. existing residential property inventories, affordable housings and marketable rental residential properties), and our understanding of the arrangement is as follows:

(1) Given the importance the government attaches to revitalizing existing property stock, such arrangement is a signal to encourage Real Estate Funds to invest in the residential property sector as set out in the New Regulation, provided that the required permits are obtained.

(2) The list only sets out the basic requirements of CSRC/AMAC for risk control. From a commercial and compliance perspective, investors in Real Estate Funds may need to examine the construction compliance of the target assets to a higher standard before investing to avoid or mitigate future risk exposures of administrative penalties or construction suspension due to lack of any permits. Depending on the source of funding, certain investors (such as insurance companies or pension funds, etc.) may also need to comply with additional regulatory requirements.

Please note that the allowed investment targets in the table above are not a conclusive list of all types of targets that the New Regulation allows in prospective real estate transactions. In practice, there is still room for Real Estate Funds to explore when making investments (for instance, whether investments in villa or other real estate targets not listed are allowed). Therefore, Real Estate Funds are suggested to approach AMAC and consult their opinions as early as possible before making investment in certain controversial areas of real estate [4].

2. Qualification Requirements of Applicants for RE Fund Managers

Based on the principle of “piloting first and advancing steadily”, Article 4 of the New Regulation contains 2 paragraphs and 10 items, which set out strict qualification requirements from a number of perspectives (which can be summarized as the general qualification, ownership structure, investment management capabilities and other general requirements) for an applicant to be an RE Fund Manager.

(1) General Qualification

According to Article 4.1(1) of the New Regulation, only PE Fund Managers duly registered with AMAC may participate in the pilot. Applicants not yet registered with AMAC or registered as managers for other types of private funds are not qualified for Real Estate Funds.

(2) Ownership Structure

Articles 4.1(2) and (3) of the New Regulation set out (i) stability requirement and (ii) non-affiliate requirement, each relating to the ownership structure of the applicant:

(a) Stability requirement

Article 4.1(2) requires a stabilized ownership structure of the applicant and the major capital contributor and actual controller of the applicant shall remain unchanged for the past two years.

This requirement reflects CSRC/AMAC’s intention that Real Estate Funds should be managed by managers with continuous operation, professional and solid management capability and clear and stable shareholding structure and to certain extent avoid unqualified applicant to by-pass the requirements through equity acquisition or other means.

(b) Non-affiliate requirement

According to Article 4.1(3), the major contributors and the actual controller of the applicant shall not be a real estate development company or any of its affiliates (excluding circumstances where senior management are dispatched to a real estate development company for commercial needs).

To determine whether an entity constitutes a real estate development company or its affiliate, the competent authority usually focuses on the following factors in practice:

  • Business scope – whether its business scope as set out in its Business License includes “real estate development and operation”;
  • Source of revenue – whether any property sale proceeds form a part of the entity’s revenue and if so, what the percentage is;
  • Development qualification - whether the entity is or was holding any real estate development qualification;
  • Type and nature of owned assets – what the type and nature of the owned real estate assets are, and whether there are residential properties for sale; and
  • Others – corporate positioning and market perceptions, etc.

(3) Management Capabilities

Articles 4.1(6), (7) and (8) and 4.2 of the New Regulation set forth comprehensive criteria (i.e. size of managed assets, track-record and required professionals) to evaluate the applicant’s capability of management.

(a) Size of managed assets

The New Regulation apply different standards to the applicant based on whether the Real Estate Funds involve any individual investors.

In addition to the above, the third paragraph of the Drafting Notes for the New Regulation states that the following shall also be considered when calculating the size of the managed assets of the applicant:

  • The managed real estate assets must belong to the PE Funds (excluding venture capital funds) that are filed with AMAC;
  • Assets managed by the applicant’s affiliate or by the senior management of the applicant in the name of the applicant’s affiliate shall be excluded for calculation purpose;
  • The investment scope of the previously managed funds shall be in line with the allowed investment scope set forth in Article 3 of the New Regulation;
  • Only the principal amount of capital contribution shall be included, which shall excludes any amount of external financing and the size of FoF;
  • If the applicant meets the standard set for institutional investors (but not individual investors) above in the table, the applicant shall specify and undertake in the application materials that the Real Estate Fund will only involve institutional investors in future.

(b) Track-record

According to Article 4.1(7), the applicant shall have more than three successful exit experiences from real estate related private equity products.

(c) Required professionals

Article 4.1(8) of the New Regulation requires that the applicant shall have certain number of professionals with relevant years of real estate investment experience (i.e. at least eight professionals each with more than 3 years of experience, among which, at least 3 professionals with more than 5 years of experience).

(d) Other Requirements

In addition to the above qualification requirements, Articles 4.1(4), (5), (9) and (10) of the New Regulation also require that: the paid-in capital of the applicant shall be no less than RMB20 million (while in the Measures for Registration and Filing of Private Equity Investment Funds (Draft for Public Comments) issued by AMAC on December 30, 2022, the paid-in capital requirement is no less than RMB10 million [5]); the applicant has a mature internal compliance system and has no significant records of violations of laws or regulations in the past three years. As can be seen, the requirements for paid-in capital in the New Regulation are more stringent.

3. Fundraising and Investor Requirements

In view of the high capital requirements and risks of real estate funds, the New Regulation has increased risk prevention in terms of the contributed capital for initial subscription and qualified investors.

(1) Contributed capital for initial subscription

The New Regulation has set a higher standard for the amount of contributed capital for the initial offering of a Real Estate Fund. According to Article 6, the contributed capital of the initial offering of a Real Estate Fund shall be no less than RMB30 million (as compared to the threshold of RMB20 million in the Measures for Registration and Filing of Private Equity Investment Funds (Draft for Public Comments) [6]).

(2) Qualified investors

The requirements for the investors eligible to invest in a Real Estate Fund have also been more stringent. According to Article 7 of the New Regulation, qualified investors of a Real Estate Fund must meet the following requirements:

(a) Investor’ contributed capital at the time of the initial offering must be no less than RMB10 million and the total capital contributed by all individual investors must not exceed 20% of the total initial offering, except for investment made by RE Fund Managers or their professionals in the Real Estate Funds managed by them.

(b) In verifying compliance with the above requirements, AMAC will penetrate the shareholding structure to determine the ultimate beneficiary owner of the investors. This requirement is derived from and is consistent with penetration verification requirements set forth in the Instructions for Filing Private Investment Funds issued and implemented by AMAC on December 23, 2019 (“2019 Filing Instructions”). However, the New Regulation specifically mentions that (1) QFLP and (2) asset management products issued by insurance funds or financial institutions are not subject to the penetration verification requirement, which we understand to be a confirmation and implementation of the policy direction of “encouraging foreign investors to invest in Real Estate Funds through QFLP” as announced by CSRC.

4. Loans and Guarantees to Invested Companies

Article 8 of the New Regulation further relaxes the restrictions/limitations on Real Estate Funds providing loans to and guarantees for the benefit of the invested companies. The conditions to be met include:

(1) The loans and guarantees are provided in accordance with fund documents/contracts;

(2) The maturity date should be no later than the liquidation date of the Real Estate Fund; and

(3) The Real Estate Fund has control over the assets it invests in. (Under the New Regulation, “control” means, for Real Estate Funds involving individual investors, the ownership of at least 75% of the target company, for Real Estate Funds involving only institutional investors, (1) the ownership of at least 75% of the target company, or (2) the ownership of at least 51% of the target company and the target company has provided a guarantee or security to the Real Estate Fund).

For Real Estate Funds involving individual investors, the New Regulation also imposes a requirement on the ratio of the debt-financing and equity investment to the target company being invested (i.e. the amount of equity investment shall not be less than 1/3 of the total investment. For Real Estate Funds involving only institutional investors, there are no similar requirements.

For more information on this topic, please refer to paragraph 3.2 in the “Highlights” section below.

5. Financing of Real Estate Funds

Article 3 of the New Regulation allows the Real Estate Funds, by mortgaging or pledging their owned assets, to apply for operating property loans or acquisition loans, provided that they have obtained their internal-approvals and that the financing is based on commercial reasons. Please note that the total assets of a Real Estate Fund following the financing shall not exceed 200% of its net assets. For more information on this topic, please refer to the “Highlights” section below.

6. Structuring arrangement

Article 13 of the New Regulation allows the RE Fund Managers to set reasonable Fund Leverage Ratio (i.e. Preferred LP Interests / Subordinated LP Interests) to the Real Estate Funds, but RE Fund Managers are not allowed to guarantee “return of capital or profit” to the investors by using a “multi-class structure”.

Fund managers (including RE Fund Managers) are expressly prohibited by law from guaranteeing a “return of capital or profit” to investors. Specifically, the following are not permitted:

(1) promising that the principal will not suffer a loss or that the fund manager or sub-investors will bear the loss;

(2) promising a minimum return;

(3) imposing a limit to the amount or proportion of losses;

(4) setting up mechanisms (i.e. injecting additional capital, fee rebates, etc.) to adjust the gains or losses;

(5) subscribing to the Real Estate Fund with own funds and taking losses first;

(6) privately entering into repurchase agreements or commitment letters and other documents with investors; or

(7) authorizing other institutions to repay on behalf of investors, etc.

For more information on this topic, please refer to paragraph 3.4 in the “Highlights” section below.

7. Expansion of Fundraising

According to 2019 Filing Instructions, an AMAC-filed PE Fund or Private Asset Allocation Fund meeting each of the following conditions may offer additional committed capital for new investors to subscribe or increase the committed capital of existing investors, provided that the additional committed capital does not exceed three times of the original amount of the committed capital at the time of AMAC filing:

(1) The fund is organized as a company or partnership;

(2) the fund is held by a custodian duly incorporated under the law and obtained the relevant qualifications for fund custody;

(3) the fund is within the investment period agreed in the fund documents/contract;

(4) the fund invests in a portfolio, with no more than 50% of the capital subscribed and committed by the fund is invested in a single target company or asset; and

(5) the proposal has been approved by the unanimous consent of all investors or by a decision-making mechanism approved by all investors.

The conditions that a Real Estate Fund should meet to expand fundraising in Article 11 of the New Regulation are:

(1) the Real Estate Fund is within the investment period as agreed in the fund documents/contract;

(2) the proposal has been approved by the unanimous consent of all investors or by a decision-making mechanism agreed in the fund documents/contracts;

(3) the qualification requirements for investors in paragraph 2.3(b) above should be met; and

(4) other requirements stipulated by the CSRC and AMAC should be met.

In view of the conditions under the New Regulation, items (a) and (b) are the same as those in the 2019 Filing Instructions. Item (c) is a new requirement and item (d) is a catch-all provision. The detailed scope of the catch-all provision is unclear and is subject to further clarification by AMAC. It is also debatable whether the above-mentioned conditions set out in the 2019 Filing Instructions but not in the New Regulation will continue to be applied to the Real Estate Fund. Given that Real Estate Funds are categorized as a specific type of PE Funds (i.e. Article 5 of the New Regulation), we are inclined to believe that the other conditions set out in the 2019 Filing Instructions also apply to the Real Estate Funds.

8. Others

Other provisions of the New Regulation impose corresponding requirements on other operational and management specifications such as submission of business materials by the RE Fund Managers, the filing of Real Estate Fund, content of fund contracts/documents, risk disclosure and information disclosure.

III. Highlights

1. Partial removal of restrictions on investment in residential property inventories and supporting investment in marketable rental residential properties

Previously, the Specification No. 4 (issued by AMAC in 2017) stipulated that AMAC would not file PE Funds that invest in real estate projects in certain popular cities (where the purchase prices of property are growing rapidly) in the form of entrusted loans, nested investment trust plans and other financial products, transfer of trust beneficiary rights and rights to receive benefits from other assets, equity investment of a debt nature and other forms of debt investment. The Specification No. 4 does not generally prohibit PE Funds from investing in the real estate sector, but adopts a precautionary approach in the approval and filing process. For more information about our analysis of the Specification No. 4, please refer to the article of When Private Equity Meets Real Estate.

A major highlight of the New Regulation is (1) the explicit inclusion of residential property inventories into the investment scope of Real Estate Funds, (2) the removal of the restrictions on PE Funds investing in ordinary residential properties in certain popular cities under the Specification No.4, and (3) the clear measures to support PE Funds to invest in marketable rental housings. On the one hand, with the expansion of the investment scope of PE Funds, real estate assets can be further integrated into PE Funds’ investment portfolio. On the other hand, the principle of revitalizing the existing real estate inventories advocated by the government is demonstrated by limiting the permitted investment targets to those obtain permits and/or fulfill certain construction/sales status requirements.

2. Relaxing the restrictive measures on loans and guarantees from Real Estate Funds to their invested companies

According to the New Regulation, restrictions on term of loans, maturity date and debt leverage ratio for loans or guarantees provided by Real Estate Funds to their invested companies are further relaxed.

(1) Term of loans and guarantees

Under the Certain Provisions on Strengthening the Supervision of Private Investment Funds (“2022 Fund Supervision Provisions”), Private Equity and Venture Capital Fund Filing Concerns (June 2022 version) (“2022 Filing Concerns”) and other provisions, PE Funds may provide loans to and guarantees for the benefit of their invested companies for a term of 1 year or less. In response to the long-term funding needs of the invested companies, in practice, it is common that the loans and guarantees are repaid/renewed on an annual basis to reduce compliance risks, which will impose additional efforts and costs on the PE Funds or invested companies (especially if the existing loan needs to be repaid with cash flows on the maturity date).

In contrast, under the New Regulation, provided that certain necessary conditions are met (see Article 8 of the New Regulation), Real Estate Funds are not subject to the term restrictions when providing loans to and guarantees for the benefit of their invested companies. Therefore, Real Estate Funds can structure their internal financing with more options.

(2) Maturity dates of loans and guarantees

Under the 2020 Fund Supervision Regulations, 2022 Filing Concerns and other regulations, the maturity date of any loans or guarantees provided by the PE Funds for their invested companies shall be on or prior to the “equity investment exit date”.

Under the New Regulation, the maturity date of any loans or guarantees provided by the Real Estate Funds for their invested companies shall be on or prior to “the fund liquidation completion date” (see Article 8.1(2) of the New Regulation), which provides substantial advantages and options for Real Estate Funds investing in multiple projects (i.e. where the fund has other ongoing investments and has not yet met the liquidation conditions agreed in the fund documents, loans or guarantees for certain projects may survive the exit of the fund’s investment).

(3) Balance of loans and guarantees

Under the 2020 Fund Supervision Regulations and other provisions, the balance of loans or guarantees provided by PE Funds for their invested companies shall not exceed 20% of the capital contributed by the funds to the companies.

Under the New Regulation (see Article 8.2), for Real Estate Funds having control over the assets it invests in (see Section 2.4(c) above),

  • where the Real Estate Fund involves individual investors, the amount of equity contribution shall be 1/3 or above (which is substantially higher than the one applicable for other PE Funds) out of the total contribution (including equity and debt) made by the fund to the company, and
  • where the Real Estate Fund involves only institutional investors, the Real Estate Fund may freely determine the amount of its equity contribution based on its fund documents.

The New Regulation does not specifically set out restrictions on the balance of guarantees provided by the Real Estate Funds.

In summary, the New Regulation have lessen the restrictions on the amount of loans and guarantees from Real Estate Funds and increased the flexibility for making investment decisions and allocations, which encourages investors to actively invest in Real Estate Funds. This measure of the New Regulation is one of the most powerful measures to achieve the goal of “supporting the revitalizing the real estate industry”.

3. Clarifying the requirements for the fund financing and debt leverage ratio

Previously, there were no laws or regulations governing the external financing of PE Funds.

In the New Regulation, Article 3 specifies that the Real Estate Funds may apply for operating property loans or acquisition loans, by mortgaging or pledging assets owned by them, provided that they have obtained their internal-approvals and that the financing is based on commercial reasons. In this regards, we understand that the New Regulation permits Real Estate Funds seeking financing for themselves or for their invested companies. In addition, Article 13(2) provides that the overall financing scale of a Real Estate Fund shall be limited by the leverage ratio of ITS liabilities (i.e. “the total assets of a private equity real estate fund shall not exceed 200% of its net assets”).

4. Lessen the restrictions on internal structured arrangements of the fund

In 2022 Filing Focusing Issues Checklist, AMAC provides that PE Funds may adopt a multi-class structure and provide preferential treatment to preferred investors. However, the return distribution ratio and liability cap should be set at a reasonable level (for instance, no capital return distribution to preferred investors is permitted where there are no distributable profits from the fund/underlying assets and the subordinated investors are not allowed to provide additional capital to cover losses of the fund in order to distribute profits to preferred investors). In addition, the Preferred LP Interests / Subordinated LP Interests (“Fund Leverage Ratio”) shall not exceed 1 for private security funds (i.e. private funds investing in the secondary market). There are currently no specific regulations on PE Fund’s Fund Leverage Ratio and, in practice, AMAC may impose additional requirements in this regard on a case-by-case basis.

The New Regulation provides that a RE Fund Manager may, at its discretion, set a reasonable Fund Leverage Ratio for a Real Estate Fund, but in no case may it promise a “return of capital or profit”. In contrast to other PE Funds, the New Regulation does not appear to set a specific threshold for the Fund Leverage Ratio of Real Estate Funds, but rather adopts a “reasonableness” standard and a bottom line of “no promise of return on capital or profit”. However, since there is no clarity for the “reasonable” standard, the extent of relaxation will still depend on the specific implementation criteria of AMAC in the future.

IV. Outlook

The introduction of the New Regulation is another encounter between private equity funds and real estate. Compared to the previous regulations, this “reunion” implements the CSRC’s spirit of “actively playing the role of private equity funds to support a stable and healthy real estate market”, and releases favorable signals to the real estate industry from several angles. Other than that, by identifying and locking up high-value assets at early stage and incubating and cultivating the assets with the standards of public funds (such as REITs), the issuance of New Regulation would effectively enlarge the pool of qualified investment targets for public funds and therefore further promote the development of Pre-REITS. Also, the investors will be more willing to invest where exit by way of REITS (liquidity of which is higher in open market) is available. From expanding the scope of attractive investment targets and stimulating investment intentions, the REITs market would be vitalized with the issuance of the New Regulation.

The New Regulation have broadened the financing channels of real estate and enriched the product types of private equity funds. Under the premise of improving the qualifications of RE Fund Managers and investors, a breakthrough has been achieved in terms of investment scope, loans and guarantees to investees, and structured arrangements, increasing the investment flexibility of real estate funds and strengthening the link between PE Funds and public funds (such as REITs). It is of great significance to the exploration of “revitalizing stock in the real estate market for transformation and development”.