Foreign private equity firms attempting to find ways of investing in a straightforward manner in China are perhaps too scarred by experience to allow themselves to celebrate a couple of potentially favourable legislative developments in the last month. I’ll come back to the new developments. First: why the scars?
It was back in 2003 that overseas funds were given their first opportunity to invest onshore in China through the launch of “foreign-invested venture capital enterprises” (FIVCEs). Unfortunately, there were some very obvious drawbacks. Notably, FIVCEs could only invest in equity (not debt); only in technology companies; and could not invest in public securities. Only a few have ever been launched.
The vast majority of foreign funds continued to view the offshore route as preferable, by which investments would be made through holding companies usually incorporated in the Cayman Islands or British Virgin Islands. But then, in August 2006, along came the government’s “Circular 10”, which introduced much tighter regulatory requirements and effectively made offshore investment far more onerous.
Since then, there has been much talk of foreign funds revisiting the FIVCE option, not least because the appreciation of the RMB has alleviated concerns about currency risk. However, many of the same restrictions that existed at the outset are still in place. Furthermore, the apparently growing impression that managing a FIVCE would give you magical access to a swifter deal approval process may be just that – an impression. And probably a wrong one, according to lawyers familiar with the matter, who say there is no supporting evidence.
Meanwhile, as overseas investors desperately seek signs of encouragement, domestic private equity firms are operating in a legislative environment much more to their liking. They can raise funds through domestic partnerships (Chinese partnership law, which does not apply to foreigners, was introduced in June 2007), while a total of 10 “specially approved” domestic funds have now been launched under a “pilot programme” (using a trust structure that cannot be copied without express approval from the Chinese State Council).
With the government having given signs that the pilot programme is now concluded, there are rumours that new fund formation rules may soon be drawn up that might – repeat might – allow foreigners to participate under the new trust structure.
In another, potentially equally seminal development, regulatory oversight of the acquisition approval process in China has passed from the State Council to the Ministry of Commerce and a new Anti-Monopoly Commission. Lawyers say the new regime is likely to take into account precedents set by other, more mature M&A markets and their regulators – making the Chinese M&A (and, by extension, private equity) market more akin to those in the US or Europe.
Should either of these evolutions go in favour of foreign funds, the pistol will have been fired and they will be truly off and running. Given recent experiences, it would not be entirely surprising should they end up being left on the starting blocks.