News from China this week of a pilot policy allowing foreign private equity firms to register as local entities in the Shanghai Pudong New Area has caused ripples of excitement.
With debt still scarce and the public markets effectively closed, the Chinese government has increasingly spotlighted private equity as a capital source for its many cash-starved companies. However, since the passing of its seminal Partnership Law in 2007, the emphasis has been on nurturing a fledgling domestic industry – to the exclusion of foreign firms looking to get in on the action.
Long and uncertain approval processes and restrictions on investments in certain industries are one hurdle facing foreign firms. Another has been limitations on their onshore presence and their inability to raise funds in Chinese RMB. This week's pilot scheme to allow foreign firms to establish a proper onshore presence has been taken as a sign the conservative government is now warming to the idea of opening up its private equity industry.
However, in keeping with its customary caution, China appears to be leaving everything open to discussion and it will be another month at least before the full implications of the policy are known. For now, what is clear is that foreign firms have a window of opportunity to the end of June 2010 in which they will be allowed to establish “equity investment management enterprises” in the Shanghai Pudong New Area to manage equity investments.
There are, however, indications that the rules will go further than this. According to Hubert Tse, a managing director and head at Shanghai-based Yuan Tai PRC Attorneys, officials have said it may be possible for equity investment management enterprises to qualify as domestic GPs later on, enabling them to form onshore RMB funds, although further guidelines on this are still to come.
Media reports indicate at least one firm is already pre-empting this conclusion. The Blackstone Group is first in line to take advantage of the policy, according to Reuters, and is reportedly already in talks with the Shanghai city government to set up a wholly-owned Chinese subsidiary, with a view to then launching an RMB-denominated fund.
But is this jumping the gun? It is worth remembering that draft regulation on foreign investment partnerships has been sitting in the government's in-tray since 2007. There has been a draft in place for even longer – since 2006 – to allow for substantive reform around the extremely limited vehicle: Foreign-invested Venture Capital Investment Enterprises, currently the only legally prescribed private equity vehicle for foreign groups wishing to invest in China.
While the equity investment management enterprises policy is unmistakeably a good signal – acknowledgement from the Chinese government that it does need the experience and capital of foreign firms – history would suggest it's unwise to leap ahead.
“It is interesting: if it grows from here, it can potentially become significant,” says Maurice Hoo, attorney at law at Paul Hastings, Janofsky & Walker.
But as always, it's the if that is worth bearing in mind. Foreign private equity investors would do well to remember that when it comes to the building the framework for its private equity industry, the Chinese government always moves at its own pace – and it can be quite a slow one.