Funds show promise but have yet to deliver
Fledgling mainland private equity investment market faces challenges, write Al Guo and Raymond Li
Six months after its launch, many are starting to wonder if the 20 billion yuan Bohai Industrial Investment Fund - the mainland's first yuan-denominated private equity fund - will live up to its earlier promise. Following much fanfare from the state, the Tianjin-based fund was the official cue to herald in a new era of private equity investment that would soak up excessive domestic capital and direct money to deserving companies.
However, it has yet to deliver an initial investment portfolio even as hundreds of thousands of private enterprises remain cash-strapped.
Bohai's slow start points to a number of challenges for the fledgling private equity market. Although there is no shortage of brains to lead various funds and capital is ample, talent at the lower level to scout for deals is hard to come by. Add to that regulatory and taxation hurdles and the success of private equity in the mainland is not assured.
Tianjin municipal government vice-secretary-general Chen Zongsheng conceded that the delay stemmed from extreme caution - being first carried the responsibility of ensuring satisfactory returns. Competition for investment targets has also come from existing private equity firms, including venture capitalists that are mostly foreign-currency funds.
'The Bohai Industrial Investment Fund will seek to invest in quality, fast-growing companies and help them grow to a degree where we can get handsome returns. The only difference would be that we invest in yuan and get our returns in yuan,' he said.
The Bohai fund was the brainchild of the Tianjin government, with six state-owned companies or funds agreeing to invest one billion yuan each at the start-up stage. Mr Chen said the fund had narrowed down possible investments to no less than six projects.
Since Bohai, Beijing has called for similar yuan funds to be launched across the country as a means to better reallocate an estimated 2.9 trillion yuan or more in private capital and help smaller, privately-held firms. By diverting capital into the private equity sector, the authorities hope to ease financial bottlenecks for these firms, many of which have difficulty securing bank loans.
In recent months, the central government has approved five more yuan funds, including the 20 billion yuan Shanghai Financial Industrial Investment Fund, the Shanxi Coal Energy Industrial Fund and Guangdong Nuclear Power Industrial Investment Fund to raise 10 billion yuan each, and the six billion yuan Sichuan Mianyang High-Technology Industrial Fund.
A Sino-Singapore high-tech industrial investment fund was also authorised to raise 10 billion yuan.
To bolster the sector, the authorities eased taxation rules with the introduction of a partnership law in June. Private equity funds were allowed a tax break on investment earnings and only pay personal income tax rates.
But Mr Chen said that even though fund companies were exempt from taxes on profit, individual partners may still be subject to higher income tax on their investment returns. By contrast, stock and property investors are not taxed on their returns.
'The government should offer special tax breaks to private equity funds because we need to convince them that the private equity sector can offer the same kind of returns, if not better than many other capital markets,' he said.
Robert Woll, a partner at US law firm WilmerHale in Beijing, suggested that o he macro level, mainland firms build domestic funds on the master-feeder model - common among hedge funds - with the funds investing in mainland industries and companies.
With the relevant regulatory framework developed, a 'master yuan fund' registered under mainland law would pool investments from 'feeder funds' (which are limited partnerships and could be formed offshore). The master fund would hold all assets, engage in trading activities and allocate profits and losses to the other funds.
At present, the mainland's private equity sector is unorganised and most funds have raised money offshore with foreign interests, says Hong Kong Venture Capital and Private Equity Association chairman Johnny Chan Kok-chung.
Mr Chan, who is also the managing director of Crosby Capital Partners and has worked with Shenzhen and Guangdong venture capital funds, said the trend was for more foreign firms to buy into yuan-denominated funds.
Yuan funds investing in domestic companies are able to exit through an A-share listing where the market values earnings at a higher price compared with overseas markets such as Hong Kong.
But not everyone is convinced. CDH Investments, one of the country's leading private equity funds, has said it will monitor the A-share market but will not completely shift its focus in that direction.
Beijing-based CDH's concern was the uncertain policy environment, as Beijing has only issued exit guidelines without detailing how that would exactly happen.
CDH assistant deputy president Wang Ping said at a Beijing forum last month that his company would wait for clarification on the policies.
In the long term, he said, the A-share market was likely to offer better opportunities, not only because of its higher valuation but because the mainland's steady economic growth would create massive demand for financing from domestic enterprises.
Established in 2002, CDH was spun off from China International Capital Corp after the government banned securities companies from running private equity funds. With a foreign currency-based capital structure, the firm now has about US$2 billion to invest.
In the past five years, it has made several high-profile investments in Mengniu Dairy, Li Ning Sports, Focus Media, Yurun Group, Paradise Electronics, and SuperData Software, all of which have listed overseas.
It has also enjoyed long-term support from leading international institutional investors, including Stanford Management, GIC Special Investments, AlpInvest Partners, International Finance Corp and AXA Insurance Group.
In the south, Shenzhen-based Nanhai Growth Trust Fund is the first home-grown private equity fund established and registered under the new partnership law. The fund, with 450 limited partners, is aiming to raise 50 million yuan in the start-up stage and would not be limited to being a yuan-denominated fund, according to mainland media reports.
With the government-backed Shenzhen High-Tech Property Exchange as its investment consultant, Nanhai is expected to direct 60 per cent of its investment into small and medium-sized enterprises in Shenzhen.
However, while senior mainland officials trumpet that the golden age of private equity investment has arrived, some warn that it is still early days. 'Mainland people have just started making money. They'd rather leave it for themselves to manage,' said Gavin Ni, president of Beijing-based venture capital consultancy Zero2IPO.
Fifteen private equity funds were operating in the mainland by the end of June but most of them were overseas-based, according to the consultancy. The number is likely to rise in coming months.
Uncertainty over the future of private equity has not stopped a number of high-profile executives and dealmakers jumped on to the bandwagon.
Former China Netcom chief executive Edward Tian Suning has established China Broadband Capital Partners. Frank Tang, former director of China investments at Temasek Holdings, left Singapore's state investment agency to start a China-focused equity fund, while Fang Fenglei, a veteran mainland banker and a partner of Goldman Sachs' joint venture in the mainland, left the venture to start a domestic fund.
It is now a matter of showing up with the money.