Money Oriented

China’s private equity market is presenting both opportunities and challenges for international funds as the domestic players make their presence felt in an increasingly fertile environment.

The private equity market in China has been developing rapidly over the past few years. Until recently it was dominated by foreign currency offshore funds run by international investors. ­However, foreign private equity groups are increasingly facing competition from ­aggressive domestic funds encouraged by the Chinese government, which can move quicker to win deals due to less regulatory constraints.

Since 2006 the amount of funds raised and deals done by Chinese private equity and venture capital funds has increased ­rapidly. During 2009 Chinese renminbi (Rmb) funds for the first time dominated in terms of the amount of new capital raised and number of deals. According to ­specialist ­Chinese market researcher Zero2IPO Group, 105 Rmb funds raised $12.3bn (£7.98bn) in 2009, while foreign currency funds only had 19 new fundraisings, raising $6.52bn. The number of new deals concluded by Rmb funds was 328, compared with 189 deals for foreign funds, although the average deal size for Rmb funds is ­significantly smaller. Although the amount of foreign capital raised is likely to increase in 2010, the competition from Rmb funds is here to stay.

Increasing interest in Rmb funds

The past 18 months have also seen rapid ­regulatory changes in China’s private ­equity market. The Chinese central government and a number of municipal governments have introduced new rules enabling Rmb funds to become the private equity fund of choice in China. This has led to increased interest in Rmb funds from international private equity fund managers.

According to the China Venture Capital Association’s ’Foreign Investment in Rmb Funds Survey 2009’, 41 per cent of the respondents (all being international private equity funds having China as a key market) were either setting up Rmb funds or ­planning to, while 55 per cent had prioritised this in their longer-term planning. The survey gives two main reasons for this: an overwhelming view that the increase in Rmb funds is an irreversible trend; and increased domestic exit opportunities.

In 2009 China resumed IPOs on its domestic A-share markets and launched the ChiNext junior market, with huge initial multiples and returns on investment. Increasing numbers of foreign fund ­managers are looking to set up Rmb funds in partnership with Chinese local sponsors.

Shanghai, which is looking to become a leading global financial centre by 2020, has been heavily involved. In March 2010 Carlyle Group and Fosun Group (a China-based company) established a joint partnership in Shanghai (the first of its kind in China) to raise $100m.

Blackstone Group has also set up a wholly owned private equity fund ­management subsidiary in Shanghai to operate an Rmb fund, which is expected to raise $735m. In Beijing, according to the Financial Times, UBS is talking with the Beijing municipal government about setting up an Rmb private equity fund, which would be the first of its kind involving a global investment bank and a Chinese municipal body.

Funding opportunities

A number of Chinese institutions have recently been approved to invest in private equity funds, creating an attractive capital pool for global funds to set up Rmb funds.

China’s two sovereign wealth funds, China Investment Corporation (CIC) and China Social Security Fund (CSSF), are looking overseas to diversify China’s reserves, which are currently concentrated in US dollars. The CSSF is reported to be seeking approval to invest up to $8bn in private equity. CIC had an aggressive second half of 2009, investing in a number of overseas deals ­related mainly to commodities and resources and is reportedly lobbying for an additional Rmb100bn (£9.51bn) to invest.

Continuing challenges

Notwithstanding the rapid development and the high returns on investment in China, challenges remain. The bigger sources of capital for Rmb funds are limited, as many institutional investors are not yet allowed to participate in private equity investments. Many Chinese general partners are ­inexperienced with limited track records, but sell themselves on the basis of allegedly close government ties. Foreign limited ­partners need to do their due diligence well before investing in local funds.

Rmb funds have some advantages over foreign currency funds, including the possibility of making investments with less foreign exchange controls or government approvals and, importantly, the ability to raise funds from Chinese investors. Some rules, though, require clarification, particularly relating to the conversion of foreign currency capital contributions and repatriation of funds (expected later this year).

The increasing availability of Rmb funds and institutional funding, combined with the increase in domestic exit opportunities, is opening up huge opportunities for ­international private equity funds in
China. Chinese funds will, on the other hand, ­present greater competition to ­international investors in China and increasingly abroad.

Jonathan Reardon is head of the China ­corporate practice and Stephen Ye is a ­corporate associate at Pinsent Masons