RMB fund fever

Many foreign firms have now announced plans to launch RMB funds in Shanghai, but are there enough LPs to go round?

Wouldn’t you know it; since PEI Asia ran a piece in its September issue saying foreign firms were ‘waiting and seeing’ on the new Chinese private equity rules, we have seen a whole host of foreign firms act on Shanghai’s Pudong New Area Initiative.

In August alone, five foreign firms, namely The Blackstone Group, First Eastern Investment Group, CLSA Asia-Pacific Markets, The Carlyle Group, Prax Capital and Abax Global Capital, announced their intentions to establish RMB funds that will look to raise a total of at least RMB23 billion ($3.4 billion; €2.3 billion). KKR is also mulling over the idea, sources told The Wall Street Journal.

The flood of foreign firms taking advantage of the pilot policy introduced in June bodes well for Shanghai as it strives to beat Beijing, Shenzhen, Tianjin, Hangzhou and even Hong Kong to become China’s private equity hub.

Foreign firms are trying to capture the momentum and capitalise on the fact that regulatory hurdles that have prevented them from participating equally in China’s growing domestic private equity industry seem to be dissipating one by one, says Larry Sussman, a managing partner in the Beijing office of law firm O’Melveny & Myers. While confidence is high, he points out that the firms have merely announced their intentions to set up these funds and there is still some work to be done before the funds are established.

In the meantime, the Shanghai government has submitted several policy recommendations to the central government asking for more definitive policies on foreign sponsors establishing funds in the region.

According to one industry practitioner, part of the reason we have yet to see any definitive regulations from the Central government is that there is a power struggle between different government agencies. “China’s National Development and Reform Commission, Ministry of Commerce and other government agencies are fighting with each other in trying to play some role in this nascent sector,” the source said.

Xheader: Where are the LPs?

Even if definitive regulation on the launch of foreign-managed RMB funds is soon forthcoming, one question remains to be answered: who will invest in the RMB funds launched under the Shanghai Pudong New Area Initiative? Are there enough potential LPs in China, with permission to invest in private equity, to back all of these would-be RMB funds?

“No, not really,” says Richard Guo, a partner in the Beijing office of law firm Fangda Partners. “Right now, [the number of] LPs in the China market are really very limited.”

At present, the country’s only stand-out active institutional investors are the National Social Security Fund, China Development Bank (CDB), some large state-backed enterprises such as CITIC Group and Legend Holdings, certain listed companies and a few government-owned fund of funds.

Foreign-managed funds trying to attract domestic investors will also have to consider the differing standards pertaining to the definition of a “professional LP” in China. Institutions that have not previously invested in private equity may not be accustomed to standard fund terms, cautions Sussman. “The money is sitting there but whether it is being deployed is being hindered from a regulatory point of view and a relative development experience point of view,” he says. 

As Sussman mentions, the regulations on investment surrounding many of China’s big institutions are still very constrictive when it comes to alternate asset classes like private equity. For example, right now, Chinese insurance companies can only in invest in private equity following special approval from the China Insurance Regulatory Commission (CIRC).

However, there are promising signs that this too will change – at least for the insurance industry. According to Guo, there are reports in the market that a new regulation will be promulgated by the CIRC in October, allowing insurance firms to make investments in RMB funds.

Nevertheless, if and when this regulation – and similar ones governing other institutions – is approved, foreign-managed private equity funds may still not find a ready LP base. One subsequent challenge they may face is that potential LP will set up private equity businesses of their own and become competitors. 

This is not without precedents. In September, CDB set up China Development Financial Company, a Beijing-based unit focused solely on private equity. As well as managing CDB’s existing commitments to funds including Bohai Industrial Investment Fund, China-Africa Development Fund, and China-ASEAN Investment Fund, the firm will make direct private equity investments and provide advisory services.

Guo explained the reasoning behind institutions’ desires to go it alone. “Since the private equity industry in China is so young, these institutions don’t really believe that anybody else would necessarily do a better job than them. Their thinking is: what is the difference? I can manage just as well as you, so why should I give my money to you?”

The foreign firms must hope they don’t all feel that way.