Private Equity in China

A few weeks ago, I wrote about China leading the world in IPOs – and how many of these Chinese companies are choosing to list on the NYSE or NASDAQ (much to the delight of these two exchanges).

China’s young private equity scene is also dynamic, attracting investment by global private equity players and domestic Yuan-denominated funds, alike.

Two major trends:

• According to respected financial journal Caixin: “Private equity funds in China have been developing at an unprecedented rate, and are now a hot topic in the country's capital market.”

• Foreign private equity players are establishing Yuan-denominated funds to reach parts of Chinese economy which were previously off limits – but still face red tape

Overall, the outlook for private equity funds in China is positive but regulations still need to be clarified; it’s important to keep in mind that China’s private equity industry is still in its infancy.

Questions surrounding regulations remain:

For example, how should we differentiate foreign capital from domestic capital? Will offshore private equity managed Yuan funds be classified as either foreign capital or domestic capital?

In China, the private equity process relies heavily on Government policy and supervision.

A year after the National Development and Reform Commission (NDRC) submitted its "Provisional Measures for Equity Investment Fund Management" to the State Council, nothing has been approved or implemented.

According to Caixin: “PE in China used to be a simple story of investing and exiting for quick capital gain. Over the course of years, however, it has evolved into a multilayered process of financing, regulation, investment, and exiting. Regulators, local governments, state-owned enterprises, and high net worth individuals now all play roles in the industry.”

With the global financial crisis still on, private equity investors are looking to the emerging markets now more than ever. The largest global funds are increasing their investment in China, India and Brazil.

According to Sarah Alexander, president and chief executive of the Emerging Markets Private Equity Association, “there is a reduced opportunity set in the developed markets--in particular large LBO [leveraged buyout] deals won't be available in the near future…Limited partners want the growth that markets such as China and India provide and are now increasingly choosing to invest with the growing number of experienced local funds.”

Beijing is putting legal structures in place that enable foreign funds to operate as Yuan-denominated onshore entities as opposed to making investments in US dollars through an offshore holding company.

Previously, Chinese government regulations prevented foreign private equity firms from buying up Chinese companies.

The Chinese Government is starting to loosen regulations to encourage foreign private equity companies.

Nearly all of the major global private equity players are operating on-the-ground in China:

Carlyle Group reported that it had raised $2.55 billion from investors for deals in Asia, creating one of the biggest private equity funds in the region since the height of the global financial crisis in 2008.

This is Carlyle’s second Yuan fund.

This follows Blackstone Group’s agreement with the Shanghai city government.

According to the China Venture Capital Association: “41% of 39 foreign venture capital and private equity firms it surveyed have prioritized setting up a yuan fund. More than half of those firms are already in the process of setting up a fund.”

Yuan funds open China’s doors for Western investors, but they still face significant restrictions.

“The possible adoption of rules allowing qualified investors in onshore yuan funds would be a major step toward aligning the interest of private equity firms’ foreign and local investors,” says Lawrence Sussman, head of law firm O’Melveny & Myers LLP’s Beijing office.

The Chinese Government was concerned about too much foreign currency (largely speculative) flowing into China. While welcomed at the regional level in China, it is for the above reason that there have been regulatory hurdles for foreign private equity players in China.

According to one report: “Chinese leaders recently found that the majority of the country's corporate financing still comes from bank loans, and they now apparently realize the need for a domestic private equity industry. Accordingly, the government has created new regulations to allow private equity players access to Chinese companies.”

On March 1, 2010, long-awaited rules for foreign involvement in establishing partnerships in China came into force. The new rules stated that offshore PE could be used to establish domestic partnership enterprises.

According to the rules: "In accordance with its provisions, China has additional regulations regarding foreign enterprises or individuals establishing and investing in partnership enterprises in principal industries."

On June 2, 2009, Shanghai opened the door for foreign investors to establish fund management enterprises in Pudong. Also, the local State Administration of Foreign Exchange department allowed offshore PE funds to be converted into Yuan at predetermined rates, thereby eliminating the Yuan financing problem for offshore PE.

In late 2009, the large-scale Yuan-denominated private equity funds completed their financing efforts.

A few recent highlights of China’s domestic private equity scene:

• In September 2009, CCB International Holdings Ltd., raised 2.6 billion Yuan through a health-care industry investment fund

• In late 2009, Tianjin Shipping Industry Fund raised 2.85 billion Yuan

• In January 2010, CITIC Mianyang Private Equity Fund became the largest Yuan-denominated by raising 9 billion Yuan

The domestic PE scene is still in its early stage of development and has not yet addressed certain issues, such as problematic transfer or interests.

Email the writer: