China to boost share in PE pie

China's share of the Asian private equity market has tripled from 8 percent in 2005 to 29 percent in 2008, according to a recent report released by Adveq, one of the first fund of funds to be active in Asia.

The report anticipates that this will increase further in 2009, with China representing one-third of the total funds raised for private equity investments in Asia.

From an investment standpoint, China's share of the capital invested in private equity deals in Asia has dropped from around 28 percent in 2005 to around 14 percent in 2007 as the leveraged buyout market in Asia peaked.

Since then, however, China's share of the capital invested has increased significantly as the markets once again looked to China's growth, according to the report.

In the first half of 2009, China represented one-third of the total amount invested in private equity in Asia and the report said this trend will continue into the second half of 2009 and potentially into the first half of next year.

A vibrant private equity industry needs a healthy environment. China's share of private equity-backed IPOs in Asia ranged from 69 percent in 2005 to a peak of 87 percent in 2007.

While the number of IPOs declined significantly in 2008 due to the global financial crisis, Chinese companies still represented 72 percent of all private equity-backed IPOs in Asia that year and 84 percent in the first half of 2009, a reflection of the resilience of the private equity market in China.

"We expect China to continue to lead Asia in terms of the number of private equity-backed IPOs with the new Shenzhen GEM board due to launch soon," the report said.

Offshore funds

Until recently, offshore private equity funds with foreign investors as limited partners were the dominant force in China's private equity industry, as regulations prevented traditional private equity investors like banks and insurance companies from investing in private equity.

From 2008 to the first half of 2009, offshore/overseas funds raised 400 percent more than domestic and joint-venture funds combined, at $17.2 billion compared to $4.3 billion.

The average size of offshore funds is also significantly larger due to the fact that these tend to be more established as well as the increased appetite for risk among foreign investors seeking private equity exposure in China.

However, the industry has seen a rise in the number of domestic, yuan-denominated funds in recent years. Around 16 percent of the funds raised in 2008 were domestic, and this share is expected to increase.

While the emergence of domestic funds is a sign that the market has started to mature, domestic funds also have some benefits over offshore funds. A domestic fund is not restricted to the type of industries it can invest in and the portfolio companies of a domestic fund can be more easily listed on local stock exchanges.

The rise of yuan-denominated domestic funds has also been assisted by the recent approval of the national Social Security Fund's investment in domestic private equity funds. As such, managers of offshore funds have recently started to raise parallel yuan-denominated domestic funds.

The report points out that the rise of domestic private equity funds is a positive development and a sign that the private equity industry in China is beginning to mature.

A well-developed domestic private equity market, alongside foreign capital, can represent an additional funding channel for small- and medium-sized enterprises, which in turn contribute to sustainable economic growth.

Private equity in Western economies has also been used to restructure industries and unlock higher productivity and value.

Through the development of the domestic private equity industry in China, and by allowing domestic banks and insurance companies to invest in private equity, the high level of corporate savings in China can be unlocked and channeled into developing local industries.

Parallel avenues

The emergence of parallel domestic funds, which can invest alongside offshore funds, has increased the dialogue between fund managers and foreign capital holders, facilitating a greater alignment of interests between parties.

Discussions have been initiated with the relevant authorities to potentially allow qualified foreign limited partners to invest alongside local limited partners in domestic funds.

"Such a development would help broaden the domestic private equity industry as experienced foreign investors can encourage the development of best practices among domestic fund managers such as fund governance and international reporting standards," the report said.

Private equity has been instrumental in the rapid development of the clean energy industry in China. Chinese private-equity-backed companies such as Suntech and LDK Solar are fast becoming market leaders.

"We expect that with further government and private equity support the Chinese clean energy industry will leapfrog the Western world to become a leader in technological innovation and implementation," said the Adveq report.

"The Chinese market is a significant component of the private equity industry in Asia and is already starting to attract the attention of institutional investors globally. The offshore fund structure is clearly an interim solution," the report said.

"We anticipate that new regulations and legislative frameworks in the near future are likely to move the industry to yuan-denominated domestic funds only. We expect this to happen before Shanghai becomes a global financial centre by 2020," it added.

Adveq was one of the first fund of funds to be active in Asia and has been supporting high-growth, private companies in China since 1998 through private equity fund investments in the region.

Since then, Adveq has invested in 20 private equity funds in China and, through those funds, has supported more than 230 portfolio companies, a number which is set to increase further as some of these funds are still in an active investment mode.

(China Daily 09/10/2009 page54)