Guided growth

Private funds are being subjected to more stringent regulation, but policy revisions are also providing more investment opportunities. Frankie Wang reports

Just as new rules around private equity and venture capital (PE/VC) investment appear to be tightening, so opportunities for expansion and reward are opening as China’s capital reform process takes shape.

With a view to further guarding against systemic financial risks and encouraging capital “to forego the virtual and head for the real”, the regulation to which the PE/VC market is subject continues to intensify in 2018.

On 27 April, the People’s Bank of China, the China Banking and Insurance Regulatory Commission, the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) issued the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions, commonly known as the new asset management rules in industry circles.

The new rules, the objectives of which are to shatter rigid payments, prohibit fund pools, stop channel business and eliminate risks such as multi-layer nesting, are having a major impact on the entire “offer, invest, manage and divest” process of domestic PE/VC, pushing uniformity in regulation.

The new rules extend the transition period in the earlier draft for comment by one year and a half, until the end of 2020, but how to affect the adjustments within the allotted time is still a challenge that investment firms will face.

There are also rules on the management of private fund investor suitability, issued by the CSRC and the Asset Management Association of China (AMAC). The CSRC issued the Several Provisions on Shareholding Reductions by the Shareholders, Directors, Supervisors and Senior Officers of Listed Companies, while the AMAC has strengthened reviews for the registration of private fund managers and the recordal of private fund products. All of these have a significant impact on the PE/VC industry.

Sherry Ma, the managing partner of Co-effort Law Firm in Shanghai, says the regulation of the CSRC and the AMAC in the past 12 months has continuously intensified. “It is my understanding that a major portion of these new regulatory policies will be a blow to the current private fund business model, but, over the longer term, they will be effective medicine for promoting the sound development of PE/VC funds,” says Ma.

Zhou Lin, a partner at Han Kun Law Offices in Beijing, says the most important recent trend has been tighter requirements in respect of the professional operating capabilities and genuine business development of PE/VC managers. “The regulatory policies conform with the state’s macro policy of eliminating gearing, requiring the finance industry to serve the real economy, and emphasizing that private funds are to return to the original essence of the asset management business, differentiating themselves from the lending business and not guaranteeing principal or returns.”

While relevant regulatory systems are being further improved, the advantages for large PE/VC firms are becoming more marked. Wang Lei, a partner at Haiwen & Partners in Beijing, says the top-ranked PE/VC firms “are starting to develop comprehensively in such sectors as project investment, renminbi funds/US dollar funds, etc., and are beginning to demonstrate their systemic advantages in terms of post-investment management and resource protection. We foresee that the leading advantages of the top-ranked PE/VC firms in the market will grow progressively larger in the coming years.”

On the other hand, the variety of participants in the private offering industry has become more diverse. “Investment firms that often took the form of LPs [limited partnerships] in the past are flush with funds, and may now set up new entities and themselves establish private funds to charge management fees, rather than passively handing their funds over to funds sponsored by other GPs [general partnerships] as in the past,” says Wang. Persons and firms with extensive knowledge of specific industries and investment projects may also exploit their advantages to establish funds and expand their teams. “The foregoing two circumstances are showing a growing trend in the market at present.”

Jeremy Dai, a partner at AnJie Law Firm in Beijing, observes that investment orientations are moving more towards real economy industries such as advanced manufacturing, while under the influence of policy, previously hot sectors such as the game and film/TV industries, have started to lose some of their lustre.

Dai contends that the major change that the launch of the pilot project for the “full tradability of H-shares” represents is also presenting new investment opportunities for PE/VC funds. “The review of applications for A-share IPOs has become extremely stringent recently, with the exception of unicorn enterprises, due to the impact of the alleged fraud by Le.com in its listing last year,” he says. “Against such a backdrop, many companies, particularly New Third Board companies, may actively withdraw their applications for A-share IPOs and shift their sights to H-shares.

“Many PE/VC funds are now interested in these domestic companies that are withdrawing their A-share listing materials, because the full tradability of H-shares signifies that PE/VC funds investing in these companies will be able to exit on the H-share market.”

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