While government intervention is a fact of life for many Chinese market participants, a recent spate of domestic regulatory actions could have serious implications for both manager and investor strategies.

Until this summer, China had enjoyed a reasonably strong year. The country is now expected to overtake the US as the world’s largest economy by 2028 – five years earlier than previously predicted thanks to its handling of the pandemic relative to other nations, according to the UK’s Centre for Economics and Business Research.

Private equity firms have remained active. China’s total deal value rose to $97 billion last year, up 42 percent from 2019 and 22 percent higher than the previous five-year average, according to Bain and Co’s Asia-Pacific Private Equity Report 2021. Domestic GPs were more active than global investors, who remained cautious in the face of covid-19 and geopolitical tensions.

China was also one of the few markets in Asia-Pacific to report an increase in exit activity during the pandemic. Private equity owners completed 930 exits of Chinese companies last year, almost double the 550 completed in 2019, according to PwC. Firms racked up 388 exits in H1 2021, up 45 percent from the same period last year.

The country has delivered some stellar returns. Chinese buyout and venture capital investments have on average delivered a 2x gross multiple of invested capital to date, outperforming every other country bar Japan, albeit with the greatest selection risk, according to a 2021 report from eFront. By comparison, Sweden, Germany, the Netherlands, the US and France generated MOICs of between 1.65x and 1.75x – though with at least half the selection risk of China.

On this basis alone, China seems a no-brainer for alpha-hungry institutional investors with an appetite for risk. However, rising tensions between East and West in recent years – coupled with the inability to do in-person due diligence during the pandemic – has made it harder for Chinese managers to raise money.

Managers collected $82.9 billion between 2018 and 2020, down from $103.2 billion between 2015 and 2017, according to PEI data. They raised $12.5 billion in the first half of this year. “Today’s not an easy environment to fundraise in, especially coupled with covid,” says one senior executive at a Chinese GP in market with a fund. “Investors have negative concerns front and centre.”

The causes of these concerns have proliferated following a series of regulatory actions in China designed to cap the growing power of its tech giants and protect national security. These moves, which we are unlikely to have seen the last of, could have implications for sectors much beloved by private equity firms and investors alike.

Tighter controls

The latest flurry of intervention appears to have started in November of last year, when Ant Financial’s highly anticipated and potentially record-breaking listing in Shanghai and Hong Kong was pulled amid a crackdown on the company’s lending business. The following April, China’s central bank said Ant would apply to become a financial holding company, subjecting it to regulations similar to those governing banks, per The Wall Street Journal.

This was followed by Beijing’s decision in July to ban private tutoring companies from making a profit through teaching core school subjects and raising capital. The industry – which some have estimated at around $70 billion – has attracted billions from private equity and venture capital investors in recent years, including Boyu Capital and Hillhouse Capital, as well as Singaporean sovereign wealth fund GIC and state investor Temasek, per Al Jazeera.

Vish Ramaswami Cambridge Associates
“Data suggests that the proportion of dollars invested in education in China PE or VC is a very small single-digit figure as a percentage over the last five or six years, despite 2020 seeming really healthy in absolute dollar terms in education”
Vish Ramaswani
Cambridge Associates

So far, the impact of the new rules for private tutoring companies appears to have been fairly muted.

“Data suggests the proportion of dollars invested in education in China PE or VC is a very small single-digit figure as a percentage over the last five or six years, despite 2020 seeming really healthy in absolute dollar terms in education,” says Vish Ramaswani, managing director and head of Asia-Pacific investment research at Cambridge Associates.

“It’s never become the dominant sector such that pressure or stress on those companies is going to massively downgrade performance. It will downgrade performance – there will possibly be write-downs or write-offs – but some [companies] might be salvageable.”

Perhaps more alarming for private equity is the regulator’s heightened focus on data. A new Data Security Law, passed in June, and a Personal Information Protection Law passed in September, expand upon existing restrictions on the cross-border transfer of Chinese data without permission, governing how data is stored and exchanged.

Meanwhile, the proposed Measures for Cybersecurity Review, introduced as a draft in July, stipulates that companies holding data on more than one million Chinese citizens will be required to obtain approval before they list outside of China.

IPOs accounted for about 40 percent of private equity exits in 2020 and some 59 percent of exits in the first half of this year, with Shanghai’s high-tech STAR market and Shenzhen the two most popular bourses, according to PwC. About 9 percent of Chinese private equity-backed listings since January 2018 have been on US exchanges.

Also in July, ride-hailing company Didi and more than two-dozen related apps were pulled from Chinese app stores just days after a $4 billion IPO on the New York Stock Exchange. The Cyberspace Administration of China said the move related to the violation of data security rules and announced a network security review into Didi to safeguard public interest. The internet watchdog later ordered 129 Chinese apps, including one owned by Nike, to rectify their data collection processes.

Prior to the government’s legal changes, private equity firms had been piling into data-intensive sectors such as internet and mobile internet assets. The 549 deals recorded in the second half of 2020 marked a 44 percent increase from the first half of the year, according to PwC. Total investment value reached $11.6 billion in the period, up 141 percent from H1 2020 and marking a two-year high.

What could make the situation worse is a lack of clarity around how the overseas listing approval process will be implemented and how long it could take.

“The norm in China is when you have a new regulation that sets up a completely different approval process it takes some time even for the administration which is going to accept your application to figure out how to deal with that approval process,” says Marcia Ellis, partner and global chair of the private equity group at law firm Morrison & Foerster.

“We’re all starting to understand from things we’re hearing from the regulator what types of companies they’re really going after, but on the face of the regulations, the companies that are required to apply for this approval is quite broad, especially in a place like China where the corner grocery store will probably have data on a million people. People are looking at that and saying, ‘OK, that may make exits very difficult’.”

The US has also made its bourses less hospitable to Chinese businesses. In July, the Securities and Exchange Commission said it would start requiring Chinese companies seeking a US listing to disclose their legal structures and the risk of China’s government interfering in their business – a move likely to deter some businesses from listing overseas.

Feature continues after the charts


While no industry participant can fairly claim to have a functioning crystal ball, regulatory changes are to be expected in China. “There are some important changes underway in China, but this is not the first time we have seen significant reforms,” says Yang Xiang-Dong, managing director and chair of Carlyle Asia.

“We have been investing here for 20 years and have learned to adapt to a changing landscape. We are patient and long-term capital, which is well suited to this environment.”

In private equity real estate, for example, some managers have learned to swim with the regulatory tide. Last year, government policy favoured investment in sectors such as logistics and data centres, with the One Belt, One Road infrastructure-led initiative among the safest routes for international capital to achieve success. There, Blackstone completed its landmark acquisition of a logistics park in Guangzhou for a reported $1.1 billion, and Singapore-headquartered logistics specialist GLP raised more than $3 billion across two China funds – both notable events for the asset class.

However, swimming with the current in real estate has become more challenging this year. In September, Blackstone and property developer Soho China cancelled a potential acquisition while it was under a review by China’s antitrust regulator. The previous month, the government-endorsed Asset Management Association of China announced that it would halt private equity funds from raising money to invest in residential developments amid a broader crackdown on the country’s highly leveraged property sector.

Marcia Ellis Morrison & Foerster
“I don’t think people aren’t going to invest in China for very long – it’s just too big of a market – but they will take a pause here”
Marcia Ellis
Morrison & Foerster

Like their counterparties in real estate, private equity managers must adapt to the new reality and effectively hedge themselves against regulatory changes in the future. “We’re in the midst of dealing with a lot of situations that are resulting from the regulations,” Ellis says.

“But on a more long-term strategic basis a lot of our clients are thinking about what they’re going to do and how this impacts their investment strategy for the next six months to a year. At this point, a lot of people are thinking about whether they should put more emphasis on acquiring businesses outside of China, but where there’s a China story, or companies in China but in industries that are safer with a reasonable chance of exit.”

For some managers, this could mean pivoting away from sectors that have attracted a disproportionate level of regulatory attention, such as education and consumer technology, and towards businesses such as semiconductors, advanced manufacturing, renewable energy or healthcare.

“If you’re in consumer tech related to entertainment that’s being targeted, for example, then it’s not just exits which will be a key consideration, but also whether you will still be able to make investments into those sectors on a go-forward basis,” says Vince Ng, a Hong Kong-based partner at GP advisory Atlantic-Pacific Capital.

“The strategy part will also be impacted, and LPs will need to get sufficient clarification on that for any fund that has a meaningful or dedicated sector exposure. There are groups that are essentially pivoting or leaning toward one central spectrum of their strategy at the expense of others that are too sensitive or no longer viable for investment.”

Firms that are not directly affected by the regulatory environment might experience secondary impacts. “Competition has always been quite significant in China’s late-stage market,” says the managing director of a China-focused venture capital and growth equity firm who asked not to be named, citing regulatory sensitivities. “We’ll see even higher valuations due to this narrowing of sector focus.”

Still, there may also be opportunities arising from diminished appetites for certain assets. The Hang Seng TECH Index, which represents the 30 largest technology companies in Hong Kong and is something of a bellwether for Asian market sentiment towards the sector, was down about 40 percent from its February peak to mid-October.

“We see attractive investment opportunities that are underpinned by the mega-trends of consumption growth [and] the changes brought about by digitisation and world-leading technological innovations, especially given the recent the corrections in valuations,” Carlyle’s Yang notes.

Survival of the fittest

Shifting focus away from certain businesses could prove an existential decision for some firms.

“Those groups who are only focused on consumer tech or whose exposure has historically been in those sectors would have a more fundamental discussion,” Ng says.

“Even if they were to pivot, would they be able to convince LPs they have the pedigree to do that? And if they can’t, does that spell the end of that operation? No one’s calling it quits at this moment because it’s too early, but there could be questions around that.”

This dynamic could prove a particular headache for LPs, who might not only have to re-evaluate their existing exposure to China, but also reassess their relationships with managers that are being forced into a smaller number or different set of sectors.

“To a certain extent LPs are still weighing things in the same way they always do, which is by looking at how a fund manager has done up until now,” says Ellis of Morrison & Foerster.

“They’re also having hard conversations with people about what their strategy is now given the changes. I don’t think people aren’t going to invest in China for very long – it’s just too big of a market – but they will take a pause here.”

As of last year, nearly half of China’s GPs anticipated a geographic shift in the composition of their investor base, according to Bain & Co. Most anticipated an increase in commitments from Asian and Middle Eastern LPs, accompanied by a decline in North American LPs – a dynamic that may be influenced by geopolitical tensions and regulatory uncertainty.

“If you’re coming to the end of your current fund and have not raised a new fund, at least in the next six months it’s going to be difficult,” Ellis says. “Especially, if, like most of the firms we deal with, US institutional investors are major LPs. What I’m hearing from LPs in the US is they’re trying to digest what is happening and they’ll be much more reluctant to make allocations in the next few months than they would have.”

Yang Xiang-Dong Carlyle Asia
“We have been investing [in China] for 20 years and have learned to adapt to a changing landscape”
Yang Xiang-Dong
Carlyle Asia
For some public markets investors, this decision has already been made for them. In May 2020, President Trump ordered the Federal Retirement Thrift Investment Board, a US government agency that oversees about $760 billion, to halt plans to back an index containing Chinese stocks because of national security concerns. The US Department of State later warned university endowments to divest from Chinese stocks lest enhanced listing standards spark a wave of de-listings from US exchanges.


“One of the most important investment decisions that institutional CIOs, trustees and boards have to make is what to do about China,” says Art Wang, managing partner of San Francisco-based fund of funds FTPE, which is currently overweight China life sciences. Wang is also the former head of private equity at New York State Common Retirement Fund and a two-decade veteran of Asian private equity investing.

“Do we want to be underweight, equal weight or overweight China – why and, more importantly, how?” Wang adds. “These decisions are increasingly critical to driving portfolio returns. Each institution will have to answer these questions for themselves, but it’s a decision that fiduciaries must eventually make actively… or accept passively.”

Some of the world’s biggest LPs are already engaging on this issue. “As far as balancing the risk and returns in China, it is a great question and one that the investment staff frankly debates fairly consistently,” Dan Bienvenue, interim chief investment officer at the California Public Employees’ Retirement System, said at its September investment committee meeting.

“It’s a major economic engine and frankly, relative to that economic engine, it’s under-represented in our portfolio and in the capital markets,” Bienvenue said, noting that the most populous country in the world wields the second-largest economy and is the largest contributor to the world’s economic growth.

“But it is a challenging balance that we’re looking at and certainly something that we’re spending quite a bit of time on trying to navigate, [while] generating the returns that we need.”