The RMB fund market has grown rapidly in the last three years, in part due to increased market access for foreign funds. However, in an attempt to stem outward flows and promote international usage of the Yuan, China’s new capital controls are working to significantly accelerate growth.
The scale of this boom is quite remarkable; according to Preqin data, RMB denominated private equity activity has nearly doubled since 2015: 17 new funds were launched in 2016, raising a total of 77,804 million Yuan. Additionally, so far in 2017 a total of 36 new RMB funds have been launched raising 672,337 million Yuan – representing a 764 per cent growth in capital raised from the previous year. The RMB funds market has clearly kicked into a higher gear.
The catalysts driving this boom are driven by market related and the regulatory issues. Firstly, the steady opening up of the domestic funds market to international players is obviously playing a key role. It is much easier now for foreign firms to enter into the domestic market than it was just a few years ago, and they are far less limited in their activity than they were previously. The story of China’s staggering economic potential is hardly a new one, and it was inevitable that as the market liberalised in this regard that we would eventually see a substantial influx of foreign funds looking to take advantage of this untapped well of opportunity.
Secondly, new capital controls recently introduced in China are creating waves within the private equity industry. The changes are designed to limit outward direct investment and encourage usage of the RMB both domestically and abroad (offset by further measures designed to boost foreign investment by relaxing various rules). This has created a large pool of money in the domestic market with nowhere else to go, as well as a swathe of promising domestic businesses that are off-limits to foreign-denominated investment. As a consequence foreign firms are lining up to secure a slice of the pie (Blackrock, UBS, and Fidelity are just a few of the big names that have stated their intention to launch RMB funds in the past few months). The evidence suggests that even those who historically stuck to US Dollar funds are getting involved.
Further down the economy, China is also currently enjoying a start-up boom, with a raft of smaller businesses keen to secure investment. This is creating the prospect of attractive returns amid a global market still characterised by a scarcity of investment opportunities and a surplus of dry powder.
Finally, the maturation of the Chinese domestic market, which will be accelerated by new capital controls, is also playing a role. Whereas the previous market for RMB funds was largely limited to HNW and UHNW individuals, China’s institutional investors – insurance companies and so on – are now growing and developing to the point where they are comfortable investing with private equity funds, opening up a whole new market segment.
Although the sheer scale of the recent spike in funds raised may be down to a ‘trigger effect’ from the recent reforms, there is every reason to expect that the broad pattern will continue in the direction of substantial growth. The Chinese Government clearly intends to steadily open the market more and more to foreign investment over time, and we are only part-way through that process. Indeed, further relaxation of restrictions – from preferential tax treatment for FIEs to the forming of national-level ‘development zones’ designed to encourage foreign investment in Western and North-Eastern regions – are already on the imminent horizon.
As the domestic economy continues to mature in turn, this process will create a virtuous cycle; as the market becomes more regulated and standardised, foreign players will become ever more comfortable investing in the region, and domestic institutions will increasingly turn to the private equity market. Some of this will simply mandate increased activity – eg China’s inclusion in the MSCI index now means that a lot of passive money simply has to be invested there at any given time.
China’s regulatory authorities are notorious for making quick, sharp changes without the accompanying periods of consultation and preparation that investors are used to in the West, so there could be bumps in the road. But the mid-to-long term trend seems clear.
As the market grows and matures we will also likely see an accompanying growth in the secondary ecosystem – e.g. the outsourced fund administration, technology, compliance and so on that is already fairly established in Western markets. Augentius’ most recent annual industry survey showed that half of all Asia-based fund managers polled are considering outsourcing their fund administration in the immediate future.
For managers looking to set up new RMB funds, there are of course key considerations The main risk to sidestep is assuming that domestic Chinese investors will behave the same way, and have the same expectations, as their Western counterparts. Although the market will likely ‘Westernise’ in time as it continues to rapidly mature, we are not quite there yet. A successful entry into the RMB market requires more than just a ‘cookie cutter’ approach – instead managers should tailor their offering to the idiosyncrasies of the Chinese market and be willing to do things slightly differently to suit domestic players.
