Private Equity in China

Recent difficulties for the industry

Geo-political tensions, strong policy moves and a global pandemic have given rise to shifts in the private equity (PE) market in China for foreign investors, with industry sources reporting a steady decline in new international investors or even divestiture of China holdings. However, there may be light at the end of the tunnel. In this article, Shane Farrelly and Divya Hazra of D’Andrea & Partners Legal Counsel seek to clarify the current environment for PE in China, ranging from legislative developments to peculiarities of the Chinese jurisdiction for PE investments.

Recent growth and strengths in China’s PE market

Private equity in China has been a steady growth story over the last decade, with Chinese Internet and technology firms in particular capturing a growing share of global PE and venture investment, indicating just how much has changed since 2010. The Asset Management Association of China recently reported that the value of PE under management grew by Chinese yuan (CNY) 2.17 trillion (United States dollars (USD) 335 billion) between December 2019 and November 2020 to total more than CNY 15.91 trillion. According to McKinsey, China is now the third-largest PE market in the world, before it is not yet fully mature.[1]

For businesses, the prospect of reaching higher profit margins, alongside the introduction of strategic expertise through PE funds to grow their business, adds significant value to their long-term projections in comparison to traditional business loans.

The advantages for international investors are also clear to see, such as higher returns on their PE investments than in other jurisdictions, the fast-developing Chinese marketplace and consumer base at their disposal, and the abundant opportunities for expansion within the Middle Kingdom and beyond. It is no wonder that, in recent years, China has seen industry giants such as UBS, BlackRock, Allianz and Bridgewater Associates start to operate PE funds within its borders.

Battles with domestic PE funds

International investors had been the principal source of PE capital for Chinese companies in the past but—as with everything in the Chinese market—the PE market too runs at ‘China speed’.

International investment now has the task of catching up on domestic funds, as a sharp drop from USD 40 billion in 2007 to USD 22 billion in 2019 is in stark contrast to domestic fund investments, which were estimated at USD 163 billion in 2019.[2]

Factors such as fewer government restrictions on the industries open to foreign investment, and simpler ownership structures and transaction processes, allow for a more efficient process when utilising renminbi (RMB) funds. The recent geopolitical tension between China and the US, and China’s national policy of dual circulation as per the 14th Five-year Plan (2021–2025), may well push companies to choose RMB fundraising as their first choice.

Effective management of potential barriers for foreign PE funds

For foreign investors interested in the Chinese PE market, it should be noted that a detailed and thorough due diligence procedure by an established law firm is deemed essential. As reliable data about the economic activity of a target company may be hard to come by, any documentation supplied by the target company, publicly available information and insights from third-party sources all come within the remit of a legal due diligence report.

Thus, conventional due diligence checklists should be expanded to look into aspects such as the validity of the target company’s business certificates, the founder’s family background and guanxi, as well as any scandals founders may have previously been engaged in.

Recent regulatory updates of relevance

On 8th January 2021, the China Securities Regulatory Commission (CSRC) officially issued the Several Provisions on Strengthening the Regulation of Private Investment Funds (Provisions), which became retrospectively effective from 30th December 2020. The Provisions gather together most of the regulatory rules for private funds previously scattered across various industry voluntary rules and notices.

Highlights of the Provisions include the recognition of qualified foreign institutional investors (QFII) as exempt investors – meaning they can utilise much more streamlined procedures, which facilitates their investments. Previously, a full set of procedures—including suitability test, the signing of a risk disclosure letter, confirmation of qualified investor status, contract signing, cooling-off period—would apply when onboarding a qualified investor (certain types can skip some of these procedures).

In addition, the Provisions prohibit a private fund manager from using fund assets to engage in borrowing and lending, guarantees or pledges. It also places restrictions on a private fund providing loans or guarantees to its portfolio companies.

The Provisions regulate conflicts of interest concerning private fund managers, requiring the manager using the fund asset to: establish a regime to prevent conflicts of interest; seek consent or approval from all the investors or through the pre-agreed decision-making mechanism; and report to investors after making an investment which falls under the definition of a conflict of interest.

Concluding thoughts

China’s financial regulator has been tightening its supervision of PE managers as well as implementing measures to safeguard investor interests. However, despite the growth of the PE market in China over the last decade, it is still rife with obstacles for international investors, in particular due to the rise of domestic investors and the role of SOEs.

However, should foreign investors choose to venture into the market, a thorough due diligence procedure shall be implemented inclusive of not only legal but also financial, accounting, environmental, taxation, stakeholders, labour, internal control and operations et al.

D’Andrea & Partners Legal CounselDP Group, was founded in 2013 by Carlo Diego D’Andrea and Matteo Hanbin Zhi, both of whom have extensive backgrounds in Chinese and EU law. DP Group currently has four service entities: D’Andrea & Partners Legal Counsel, PHC Tax & Accounting Advisory, EASTANT Communication and Events, and Chance & Better Education Consulting. DP Group has a variety of branches around the world, with locations in several major developing economies.

[1] In search of alpha: Updating the playbook for private equity in China (