PE Funds Come Hither To the Juciest of Markets

Some say the grass is greener on the other side. Here in China it very well may be for foreign private equity investors. While the banker wankers on the other side of the world have sent the global economy into chaos, China still remains a liquid and robus market and domestic private equity competition is HOT.


Where does this liquidity come from?

• Huge RMB and foreign capital reserves.




• High Net-Worth Individuals.




• National Social Security Fund.




• Chinese Banks.




• State-Owned Enterprises.




• Insurance Companies.
  
  

How were foreign PE firms operating in China in the past?

Historically Chinese regulators had little expirience with Financial Investors and corporate laws failed to accomodate or even address their needs. Foreign private equity investors have had a long history of PE investment in China. However because the laws were in the nascent stage and Chinese regulators turned a blind eye, these foreign PE investors usually held their China based investments via offshore holding companies in jurisdictions such as Hong Kong, Cayman, BVI - documenting shareholder arrangements at the offshore level.

You see, in China governement approvals are required for transaction related documents. Under the old model of investing in China, foreign investors could still enjoy investor protections such as call and put options, preferred sahres, rights of first refusal, etc. without having to first gain Chinese government approval (Noting that the PRC government still to this day is not entirely comfortable with the concept of preferred shareholder rights).

There was also another advantage of this model. Foreign investors could enter industries that were otherwise restricted to foreign investment through contractual arrangements with a domestic Chinese entity. Because the Chinese entity would be owned by a Chinese national, it would be able to secure business licenses for sectors in which foreign investment is prohibited. The 10% capital gains tax in China was also avoided. This was all fun and games until the Chinese economy became healthy and the government no longer needed all this foreign hot money comming in.

Round-Trip Investments Prohibited.

In the mid 2000s is when the tables turned. The M&A rules and SAFE Circular 75 made approval of round-trip investments extremely difficult to achieve.

In China the flow of currency is strictly regulated by the State Administration of Foreign Exchange "SAFE". SAFE Circular 142 for example places restriction on the inflow of foreign capital. Unless the word "investment" is in the business scope of an operating entity - Circular 142 pprohibits entities from converting foreign currency into RMB for the purpose of onshore equity investment. The issue is that getting the word "investment" approved is quite difficult.

Never Fear New Laws are Here!
In the next post I will give you a sneak peak into the FIVCIE Model, FILP Model and EIF Model, which are the newest ONSHORE investment models available to foreign equity investors in China. And a taste of the latest local laws and incentives.