Shanghai FTZ will have 'massive impact'

Under the new Free Trade Zone, the increased availability of credit and fewer approval requirements could make investing in China easier and more appealing for private equity firms.

The new Free-Trade Zone implemented by the Shanghai government will benefit private equity firms in the long-run by pushing down interest rates and widening access to leverage, Ben Soong, head of North Asia at S&P Capital IQ, told Private Equity International.

In late September, the Shanghai government issued a series of measures and rules under the Free Trade Zone as part of an experimental new strategy to open up the city to banks and businesses, loosening controls on things like interest rates and currency conversion. 

The new zone was announced in July and has already been approved by China’s State Council. 

“I honestly think that the impact is going to be massive. Right now when you look at private equity in China, a local private equity firm can’t really borrow much – the idea of leveraged buyouts doesn’t really exist or is limited, and it’s partly because of lending regulations and restrictions,” Soong explained. 

CITI Bank and DBS have already set up offices in the free trade zone; over time, the move will open up lending, allowing private equity firms in China to make more use of leverage, he said. 

I honestly think that the impact is going to be massive. Right now when you look at private equity in China, a local private equity firm can’t really borrow much – the idea of leveraged buyouts doesn’t really exist or is limited and it’s partly because of lending regulations and
restrictions.

Ben Soong, head of North Asia, S&P Capital IQ

Moreover, competition from international banks will likely boost domestic banks' ability to lend to private equity firms, as they learn from more sophisticated lenders, he added.

“It is going to make lending much more efficient. As of today, if you look at any bank [in China] such as ICBC or CCB, the way they lend is through a very narrow band because of the interest rate ceilings and floors in China. So whether a company is super high risk or low risk, your ability and cost to borrow is about the same. It is inefficient.”

Soong added: “This is where I think international banks coming in and being able to lend and set interest rate levels will create more efficiency. I expect the private equity market to really pick up as a result of that.”

Moreover, foreign investors will also enjoy other benefits from the Free Trade Zone, according to local law firm Fangda Partners.

“[Instead of] the foreign investment monitoring structure [currently] adopted by the Foreign Investment Guidance Catalogue, which classifies industry sectors into four categories, i.e. encouraged, permitted, restricted and prohibited, a more investors-friendly 'negative list' system applies to FDIs in the Free Trade Zone,” a Fangda report said following the guidelines. 

Under the current foreign investment approval regime, any foreign investment is subject to the approval by National Development and Reform Committee and the Ministry of Commerce, which is burdensome for foreign investors. 

However, under the new implementation rules, a foreign investment in the Free Trade Zone is not subject to the approval by NDRC and MOFCOM, unless the sector is specified in the negative list or a similar domestic investment project is subject to the approval requirement, according to Fangda.