China’s Qualified Foreign Limited Partnership (QFLP) investment qualification is a popular route for investing due to its relaxed regulation around capital controls. The first QFLP system originated in Shanghai as a means to reduce hurdles to equity investment in closely held entities. Following the 2020 revamp of China’s foreign investment laws, a coordinated push in cities throughout China was made to ensure that QFLPs are broadly available nationwide. They have also served as a cornerstone for alternative investments.
In particular, Private Equity, Distressed Assets, Real Estate, Hedge Funds, and other alternative investment strategy assets have become widely used in China, and investors in these fields often consider using a QFLP. However, the Qualified Limited Foreign Partnership policy is unnecessarily complex in the opinion of not just attorneys but also policymakers, and this makes it difficult to ascertain whether a particular business model is eligible for QFLP status. A major problem is that QFLPs are defined by local governments, and every city has its own set of rules albeit using a national template.
Following the passage of China’s Foreign Investment Act, a coordinated push for uniform laws standardized much of the QFLP regimes, but an investment plan for each city will nonetheless require an individualized assessment. This article will explain QFLPs in general while also describing some of the regional variations of the most widely used QFLP jurisdictions.
Contents
QFLP Basics—Clearing up Confusion
National Foreign Investment Regulation
Private Equity Regulation Restrictions
“QFLP” is a Confusing Fictional Name for a Private Equity Funding Regime
Understanding what a China Qualified Foreign Limited Partnership means can be very difficult because the words “China”, “Qualified”, and “Partnership” are not part of the law, unlike the real China partnership laws. Nonetheless, since Chinese is so hard to translate, coming up with a fictionalized layman nomenclature in both Chinese and English to name it, has facilitated communication. Below, we will go over what these three words are intending to say about this otherwise excellent investment policy.
There is no China national legislation on QFLPs, rather Qualified Limited Foreign Partnerships are exclusively the domain of local law, often at the municipal level; overall, over thirty city and province governments have their own QFLP laws, which are tailored to meet each region’s policy goals. The first QFLP policy was enacted under Shanghai Local Law No. 17 (2010), which has been copied at a province-wide scale, such as with the 2023 Hunan QFLP law. Since then, the programs have evolved to meet the needs of the economy.
The laws do not form or require a partnership, and as we’ll find out below, banking regulations around QFLPs violate private equity operating norms stemming from the western limited partnership structure. “Qualified Foreign Limited Partner” is actually an American English legal term that is mistranslated back into Chinese as “Hege Jingwai Youxian Hehuoren.” Despite broad adoption among practitioners and regulators, the enabling legislation itself does not actually contain this language, despite it being the typical manner for referencing it.
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There is nonetheless a reason why practitioners and policymakers refer to Qualified Foreign Limited Partnerships, despite Chinese law’s rejection of the concept. Historically, nobody determined how to comprehensibly translate China’s legal terms into English. Thus, an English name was picked from American law concepts and adopted within the legal community, most likely inappropriately borrowing phrases that Blackrock and other private equity managers were using in their English (see below). This translation technique, which we call “whitewashing” over broken English, distorts facts and was later used to circumvent compliance and due diligence processes in furtherance of white collar crime, and has fallen increasingly into disuse.
After its initial success in Shanghai, the central government ordered that QFLP legislation around the country fix their terminology and get it right, which resulted in sweeping terminology changes in 2021. This was noticed by attorneys around China, who didn’t get the memo, and are now talking about “QFLPs with new Chinese terminology.”
The purpose of the Shanghai legislation is to create a pilot program that enables foreign businesses or individuals to be equity partners in investment funds, with a focus on funds for purposes including pensions and sovereign wealth. There is no legislation about being “Qualified,” so that label is simply a misunderstanding. Instead, lawmakers are trying to say “Compliant,” and they are quite serious about the compliance requirements.
There are several key differences in this legal term:
(1) The word “foreign” was changed from “jingwai”, meaning “outside mainland China,” to “waishang touzi,” meaning “foreign owned.” This means the entity can be in China; moreover, mere ownership and not necessarily an investment puts you in this category. “Foreign ownership” applies if a foreign jurisdiction special purpose vehicle (i.e. a US LLC),
(2) “Qualified” is removed totally, being replaced with the word “business entity,” and the entity status necessarily implies that the entity is compliant with the law. Therefore, deleting “qualified” does not change anything.
(3) “Partner” in some cities is replaced with “fund,” in others it’s removed, reflecting the association of “Limited Partnership” with investments. Under the law, China could introduce a special type of Series LLC tailor made for private equity, which would be compliant..
The original Shanghai policy from 2010 uses the “foreign-owned equity investment business entity” concept and also excludes investment in public companies. This requirement is the same as that imposed on the equity investment industry overall at the time. China’s economics regulator at the time required that equity investment entities not invest in public companies and that uninvested funds be deposited in banks or sovereign bonds.
Those rules have since been repealed. Practitioners also comment that there is general agreement that public company equity investment restrictions no longer apply to the Shanghai QFLP; the 2021 Shanghai Economic Development Policy instead recommends that QFLPs be used as a vehicle for alternative investments in China. You can learn about the most recent rules on foreign investor participation in public companies here.
Outside Shanghai, the terminology used to describe QFLPs can include the above terminology and a handful of straggling regions have started explicitly referring to QFLPs.
Beijing and Guangzhou in their documents use a Chinese term meaning “pilot project funds” and also eliminate the equity investment limitation. One interpretation of the Beijing terminology change is to open up the liberalized fund rules to all investors, not just foreign investors.
The sham QFLP language is a good illustration of why a company should use professional translators rather than unprofessional freelancers or in-house staff. In Shanghai, miscommunication about investment funds became so severe that a native English speaker’s incorrect guess about the nature of the fund became its official name despite having nothing to do with what the law really says.
Local Government Legislation Controls Nationwide QFLP Programs Through a Uniform Laws Approach
China’s QFLP pilot program policies are purely a local law matter but nonetheless have the same overall structure and design while having individual differences in detail. Therefore, making decisions related to QFLP usage requires taking a look at the local government’s QFLP rules.
QFLP rules are usually structured using the bilateral investment treaty approach of “negative list + positive list,” specifying what the region wants to incentivize and what is prohibited. The most popular QFLP programs are Shanghai, Hainan, Shenzhen, Beijing, Wuxi, and Guangzhou.
To some extent, these regions’ QFLP rules were prepared using the familiar uniform laws approach used in the United States. On top of the uniform laws template, several additional rules have been added to tailor local laws to the regional political goals. The variation between each region’s QFLP policy has a lot to do with national economic management strategies. What the policies have in common is that all allow foreign-owned equity investment entities (which in Beijing are characterized as “pilot funds”) to invest in companies that are not publicly listed, although some cities allow limited investment in public companies, and relaxed public company investment rules took effect late 2024.
Additionally, they all require compliance with the PRC Foreign Investment Act and preclude investing in any area described on the Investment Access Exceptions List. Investing in high-risk financial derivatives and futures is prohibited, as is investing in real estate (except for own use). Registration with the appropriate government agency and legal compliance is also explicitly required. The policies enable entities to raise funds for private equity placements from both foreign and Chinese investors.
To give you an idea of what the differences between the individual QFLP policies are, we’ve also summarized some of the differences between the most popular regions:
Shenzhen: Funds can invest directly in public companies, with special encouragement for private equity and venture capital investment.
Beijing: Funds are permitted for mezzanine investments, private debt, and distressed assets. The foreign fund may only be utilized for business activities within mainland China.
Wuxi: The investment entity must be organized under the laws of Wuxi City and may provide management consulting services to the companies in which it has a stake.
Guangzhou: Funds may not hold real estate investments, even indirectly such as through REITs, and may not invest through the local government financing platform. Special strategic investment rules apply to a fund’s investment in a public company.
Shanghai: Investment entities may not hold real estate investments or use a third party’s funds for their investments.
Hainan: Secondary market stock and bond investments are permitted upon approval by the appropriate agency. Fundraising activities may be conducted within mainland China, and investments must be used for business activities that occur in Hainan; the terminology used here references general Chinese foreign investment law principles, meaning that assets and workplaces must be located within the jurisdiction. Similar to several other cities, funds may not hold direct or indirect real estate investments, and may not invest through the local government financing platform.
Nationally Applicable Laws Also Govern QFLPs, Namely, Foreign Investment Laws
While there is no law with nationwide applicability on QFLPs, Chinese foreign investment law does govern these kinds of funds, and the PRC Foreign Investment Act classifies QFLPs as foreign-owned entities even if the investors are all Chinese.
Both the foreign-owned equity investment entity and pilot funds can be classified as foreign-owned entities if they fall under foreign investment law. In the QFLP context, this applies where the fundamental business model of the fund is to provide foreign investors with a vehicle with which to place investments in mainland China. If you’re not familiar with China’s foreign investment laws, check out our translation of the official China government guidance with simple, clear, and accurate answers here.
The PRC Foreign Investment Act governs any investment activities occurring in China whether directly or through indirect investment, and covers individuals, business entities, and organizations while expansively covering interests such as corporate equity or REIT shares. National regulators are responsible for imposing the Investment Access Exceptions List system which, as the name implies, provides access exceptions to investments. The domestic reinvestment fact pattern creates some uncertainty under the law. The Exceptions List implies that QFLP funds reinvesting domestically in China can qualify as a domestic investment. Moreover, the rules provide that QFLP funds cannot be treated as a domestic investment. Instead, the Foreign Investment Act and the Information Reporting Procedures apply.
However there are apparently conflicting rules for certain QFLP fund structures, particularly where the general partner of a QFLP is a foreign-owned entity, but all limited partners are Chinese-owned entities. Several QFLP policies, such as that of Shanghai’s, provide that these foreign-managed domestic funds are classified as Chinese Yuan funds and therefore are entitled to national treatment with regard to investment access and regulatory approvals. There is a regulatory precedent for how these cases should be dealt with, under NRDC letter opinion No. 1023 (2012) “Re: Foreign Owned Equity Investment Entities.” In the letter opinion, the well-known fund company Blackrock served as a fund manager for several Chinese LP investors through a GP structure. The NDRC determined that, under this structure, Blackrock’s investments are subject to what is now the Investment Access Exceptions List.
Foreign investment regulation can cause uncertainty even if the general partner is classified as Chinese-owned because FTZ foreign investment law classifications are a separate system from other jurisdictions; and when operating a business in another jurisdiction, those regulators may classify the general partner as foreign-owned. Further, if Investment Access Exceptions List violations apply, the jurisdictional agency may disregard the general partner’s independent legal personality to look for any foreign element that could be deemed a violation of the Exceptions List. According to the legislative history, this approach was adopted from the United States’s CFIUS approach, which in Ralls v. CFIUS was also revealed to be a highly uncertain regulatory approach.
Foreign exchange regulations do not recognize private equity best practices and could paralyze QFLP operations. The QFLP’s foreign-owned entity classification implies that its income from capital and foreign exchange settlements must strictly comply with China’s foreign exchange regulations.
The QFLP system is governed by the rule announced in Foreign Exchange Gaz. No. 42 (2004), which provides that a foreign exchange transaction in excess of USD 200,000 requires a written payment order specifying the underlying purpose associated with the funds. The foreign exchange rules were amended by Foreign Exchange Gaz. No. 28 (2019), which provides that a foreign-owned entity making equity investments within Mainland China is not in violation of the Investment Access Exceptions List.
Payments derived from capital investments, whether foreign exchange or Yuan-denominated funds, are not restricted. Foreign Exchange Gaz. No. 16 (2016) provides requirements for how such Yuan-denominated funds may be spent:
- Must be limited to the entity’s permitted business activities;
- May not be used for securities investment or investment products that do not guarantee the principal;
- Loans prohibited (except to affiliates);
- Cannot be used for real estate development or acquisition (except for the business’s own use, or if licensed as a real estate business).
No nationwide rules for QFLP foreign exchange have been issued. A 2022 pilot program announcing four new free trade zones does emphasize providing improved rules for QFLP foreign exchange.
The local rules each provide for encouraging QFLP development by simplifying FOREX filings and permitting equity and bond investments to the full extent permitted by the Investment Access Exceptions List. (except real estate)
FOREX Shortfalls
China has made a lot of progress in reducing compliance costs for cross-border funds remittances. However, QFLPs are still at a huge disadvantage compared to domestic funds when remitting profits and dividends.
When exiting from an investment, many banks will not treat the investment principal as the paid-in capital, and it cannot be remitted as profits or dividends by the regional banking headquarters. Instead, the bank will demand a complicated and expensive regulatory process involving the local finance regulator to approve a capital reduction.
Many banks will also impose a time-consuming verification process for QFLP funds when remitting profits or dividends. The process is so laborious because the banks often require a comprehensive accounting of the fund’s overall profits and are not allowed to limit the scope to a single investment. Imposing a consolidated accounting of the entire fund also means that the fund will not be allowed to remit any profits or dividends until the entire fund shows overall profits.
The banking rules here also conflict noticeably with how private equity funds are managed internationally, which is to process distributions and exits around individual funds. Each bank’s compliance programs differ; therefore, before choosing any particular bank, we recommend fully understanding its policy beforehand and determining whether it is compatible with your desired business model.
Private Equity Regulation Restricts QFLP Investment Options in Several Ways
The private equity use case involves the Qualified Foreign Limited Partnership fund being formed and financed, where the fund is being used to invest in business within mainland China. In this fact pattern, the fund could be subject to the Private Equity Temporary Procedures and therefore must comply with the numerous rules applicable to private equity operations.
The Securities Regulatory Commission is the lead agency for governing the private equity industry, and it delegates substantial self-regulation authority to the Chinese funds industry. The Commission’s Temporary Procedures provide that the industry self-regulates by requiring that applications and filings be made with the Funds Industry Association, wherein a separate organization must also be listed in the filings as the fund manager. The Association classifies each fund according to its investment strategy, with different rules for each class. This means that the filings should be made based on the intentions of the fund manager and that care needs to be taken to ensure that no misrepresentation about the fund’s direction is made. These representations are material because the regulations impose different regulatory requirements for different kinds of fund operations.
The Association regulations classify funds as follows: (a) securities investments; (b) private equity/venture capital; (c) private equity asset allocations; (d) other private equity. A second classification is also made between direct investment funds and parent funds. In addition, investment categories are assigned to the fund based on what the investment objectives are.
Qualified Foreign Limited Partnerships mostly use the private equity/venture capital classification in Association filings. QFLPs classified as private equity funds are permitted to invest in public companies, but only in stocks that are not traded on an exchange. Funds classified as venture capital cannot make investments in public companies at all. If using a “Fund of Funds” approach, a special filings option is available for a FOF subclassification.
The QFLP pilot programs are cautiously opening up investments to foreigners and thus have many restrictions attached to them. Hainan and Shanghai are focal points for free trade policy, and are representative of what kind of activities are restricted:
- Secondary market stock and bond transactions;
- Financial derivatives such as futures;
- Real estate, even REITs, except for own use;
- Loans and guarantees.
Localities can have unusual restrictions. For example, Qingdao prohibits using parent funds to invest in subsidiary funds.
The Asset Management Association of China has more restrictions on private equity funds, such as a prohibition against carrying on lending business. There are no rules governing the use of private equity for distressed assets, although the existing rules give some vague guidance. Numerous lawyers around China have indicated that the Association has stopped accepting filings for investment in distressed assets. Even if the QFLP policy itself says that distressed asset investments are not restricted, the Association still has jurisdiction to block those investments.
Additionally, the Foreign Investment Access Exceptions List restricts QFLPs from investing in several industries. While it allows bond investments, QFLP bond investments will be restricted by the Association’s rules on private equity funds.
Conclusion
In this article, you’ve learned about a specific program for facilitating foreign investment into China, the Qualified Foreign Investment Partnership model. The QFLP rules are merely local legislation, however, and as we have seen, are also governed by a body of national Chinese law.
FURTHER READING
Get authoritative insights about Chinese foreign investment law in CBL’s translations of official Chinese government guidance :
For a general overview of this topic, see CBL’s Foreign Investment FAQ.