Banking & Finance

Ten mainland China banks given access to venture capital and private equity business

Way cleared for investment in young tech companies

PUBLISHED : Wednesday, 11 May, 2016, 8:29pm
UPDATED : Wednesday, 11 May, 2016, 8:29pm

Ten banks, led by Bank of China and state policy lender China Development Bank, have been granted access to the mainland’s venture capital and private equity markets following the removal of a legal bar on banks holding equity in non-financial companies they lend money to.

Under the initial phase of a pilot scheme – as the China Banking Regulatory Commission and lenders test out the amended law – banks will be able to structure mezzanine financing deals via a mix of loans, debt capital and equity financing as venture capital or private equity investments in young technology companies.

The lenders will be entitled to equity in the companies, in part as capital investment and in part as a hedge in case they do not get repaid. They will have the freedom to pick the project maturity they want, ranging from early-stage seed capital for the unproven, to late stage pre-IPO funding for companies with proven technology.

This is just the first step in allowing banks to be involved in early-stage equity investments
Leon Qi, Daiwa Capital Markets

Leon Qi, head of greater China financials research at Daiwa Capital Markets, said that unlike the mainland’s planned debt-to-equity swap programme – which would involve banks taking equity in struggling companies operating in industries with excess capacity – the venture capital move was a way for the mainland banking industry to catch a new wave.

Mainland banks have found themselves engaged in frequent skirmishes with young tech companies seeking to disrupt their revenue models in everything from payments to wealth management sales.

“This is just the first step in allowing banks to be involved in early-stage equity investments,” Qi said. “To banks, it will blaze a trail of stepping into non-bank financial businesses, which is a long-term trend in the China financials industry.”

Fitch Ratings said the move would also remedy a longstanding malaise that had seen Chinese tech companies driven offshore to seek their first seed capital.

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“Since tech companies tend to have longer payback periods as start-up companies, it would be difficult for banks to justify the loan approval at times, as there is minimal collateral available,” Fitch senior director Grace Wu said. “This limits the availability of credit to tech companies.

“Arguably, in order for China to accelerate its economic rebalancing, more efforts are needed to help these new industries and help China shift away from a credit-driven economy. Allowing the banks to take equity stakes would provide easier access to credit for tech companies.”

Qi said, however, that banks would need strict internal fire walls at the organisational, fund management and ownership levels.

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Other banks involved in the pilot project include Bank of Beijing, Bank of Shanghai and newly listed Bank of Tianjin, along with city commercial players ranging from Shandong-based Henfeng Bank, to Wuhan’s Bank of Hankou, Bank of Xian, SPD Silicon Valley Bank and the newly set up Shanghai Hua Rui Bank. They will have to establish dedicated asset-management entities to hold the equity investments.

“An investment subsidiary is required to carry out the investments,” Qi said. “The investment decision will be made independently, as in the loan department. Different parts of the funds will come from different business lines. Equity interest and loan interest will be clearly separated.”

There are clear risks as banks take up equity investments, but Wu said she expected they would be limited for now.

“The amount of loan-equity investment is not expected to be significant during the pilot stage, so we do not expect this to have material impact on the Fitch-rated banks’ risk profiles,” she said.