China presents both abundant opportunities and frustrating challenges for private equity investment, according to a report from law firm Kaye Scholer.
China presents both abundant opportunities and frustrating challenges for private equity investment, according to a report from law firm Kaye Scholer.
With 25 per cent of the world’s population and one of its fastest-growing economies, China has enjoyed noticeable success.
However, the success of private equity funds in China requires a thorough appreciation of China’s legal regime.
‘Although China seems to be moving towards the creation of a more stable and predictable legal system, private equity practice in China remains a challenging legal puzzle,’ the report says.
Private equity funds initially became popular among Chinese enterprises that needed capital, Western management skills and know-how, and access to international markets.
It has emerged as one of the most promising and active markets for private equity investment. Major international private equity firms have formed funds targeting China investments and have established their presence in the greater China region.
Domestically, Chinese capital, inspired by the success stories of international private equity firms, has also been looking for its own private equity outlets. Initially, such domestic Chinese capital formed principally domestically-owned and managed private equity funds in offshore jurisdictions targeting China investments.
With an increased supply of RMB looking for investment opportunities, RMB-denominated funds under China’s experimental venture capital regulatory regime have also been formed.
In the latest development, the first few RMB-denominated private equity funds were born under China’s newly amended Partnership Law in 2007.
As China’s private equity industry continues to grow, legislative efforts concurrently develop. A draft Provisional Measures Concerning private equity Funds, a legislation that would specifically authorize and regulate the formation, management and operation of PE funds, has been in the works since the early 2000s.
To support the development of venture capital funds and China’s technology industry while defining and guarding their regulatory turf and the interests of their constituents, various PRC ministerial-level authorities and local governments have, over the years, issued their own regulations.
Among them, the 2003 Administrative Regulations on the Foreign Invested Venture Capital Enterprises and the 2005 Provisional Regulations on Venture Capital Enterprises jointly published by several PRC ministerial-level authorities have the longest history and together with the Company Law of the PRC, provide the most commonly used legal framework for private equity funds.
According to the report, the China Banking Regulatory Commission, a ministerial-level authority, seems interested in facilitating the creation of, and regulating, private equity funds on its own terms. The Measures for the Administration of Trust Companies issued by the CBRC authorised, for the first time, trust companies with the required license to raise funds from qualified investors and to make investments for the benefit of such qualified investors in qualified non-public companies.
Finally, the China Insurance Regulatory Commission, also another ministerial level authority, issued the Provisional Regulations Concerning Administration of Insurance Assets Management Companies, under which insurance companies may form insurance assets management firms through which to invest in very limited types of asset.
While these limitations on investment have gradually been lifted, a recent breakthrough is that the State Council has approved insurance companies to invest in non-publicly traded securities. Insurance companies may now form or invest in private equity funds.
In addition to the initiatives of various PRC ministerial level authorities, several local governments are also eager to attract private equity investments into their areas by implementing friendly local measures.
‘These fragmented initiatives and regulations are a puzzle for many. Yet, they epitomize China’s legislative process in the handling of an economic issue in which the Chinese government does not have significant experience. The implementation of these fragmented initiatives and regulations allows the Chinese government to accumulate the necessary experience which it will ultimately use to move toward the enactment of more-comprehensive and higher-level legislation,’ the report states.
One such move came on 1 June 2007, when the Partnership Law of the PRC, as amended, became effective. The Amended Partnership Law provides several fundamental principles that are pillars to the establishment, management and operation of domestic RMB-denominated private equity funds in China.
Another such move is to make the domestic stock market more accessible and attractive to the private equity industry and to encourage the country’s best businesses to remain in China.
The CSRC has approved the shortening of the lock-up period from 36 months to 12 months and is reportedly evaluating plans to adjust listing requirements and to simplify listing procedures. In addition, China has effected a major overhaul of China’s tax regime, which could make private equity investment more attractive.
Aside from the development of the RMB investment fund industry and legislation in China, in recent years major international private equity firms have quickly formed funds targeting investment opportunities in China.
Chinese capital has also flowed to form offshore private equity funds, which would then find their way back into investment opportunities in China.
After two decades of welcoming and encouraging foreign capital, China is now beginning to scrutinize foreign investment. One example of this change in attitude is the Carlyle Group’s proposed USD375m acquisition of an 85 per cent stake in a heavy machinery manufacturer, Xugong, which failed to secure the necessary government approval after three years, notwithstanding willingness by the Carlyle Group to reduce its equity stake and to increase the total valuation of Xugong.
‘All such efforts seem to reflect the intent of the Chinese government to keep economic opportunities inside China and to tighten up tax loopholes in offshore transactions,’ the report says.
