Private Equity in China. The struggle for China's private equity market supremacy between foreign and domestic market participants

Seminar Paper, 2016

24 Pages, Grade: 1,3



1 Introduction

2 Initiation of China’s private equity market and development until 2005
2.1 Development between 2004 and 2014
2.2 Fundraising by FOPE and COPE
2.3 Completed investments by COPE and FOPE
2.4 Short summary of private equity market development

3 Possible reasons for the declining market share of FOPE
3.1 Legal framework and regulations
3.1.1 Government agencies relevant for private equity
3.1.2 Red Chip structure or Round Trip investment
3.1.3 Other important regulations concerning FOPE and COPE
3.1.4 China’s stock market and IPO
3.2 Princeling-returnee constellation
3.3 Other influences

4 Conclusion

5 Bibliography

6 Appendix
6.1 Appendix A
6.1.1 Appendix A
6.1.2 Appendix A
6.2 Appendix B
6.2.1 Appendix B
6.2.2 Appendix B
6.3 Appendix C

1 Introduction

2014 has been a year for the record books concerning private equity. Global investment exits through initial public offerings accumulated two trillion US dollar and about 500 billion US dollar have been collected in private equity funds for future investments. (Bain & Company, 2015, n. p.)

These impressive numbers show how important private equity has become in the international financial sector and China has evolved to one of the biggest private equity markets in the world. This raises the question of who is in power in the Chinese market? Giants like Goldman Sachs, Blackstone or Carlyle dominate the international market. So how are the domestic Chinese private equity firms doing? When China first heard of private equity in the early-1990s, it was already one of the biggest investment markets in the West, mainly in America. Hence, American companies had nearly no competitors in China and made fortunes in this recently opened market. Nevertheless, domestic firms developed quickly and challenged foreign companies to a duel.

This paper will be divided into two parts, firstly it will show the development of Chinese and foreign private equity companies and their shares on the Chinese market. The second part then will try to give an impression on possible reasons for the mentioned development. There won’t be any further explanations about private equity given in this paper, only if they are needed for deeper understanding of the context. However specific knowledge about private equity will not be needed since it won’t discuss specific features of it in detail. The aim of this paper is to answer the questions about how the market developed and the possible reasons for this.

2 Initiation of China’s private equity market and development until 2005

Private equity in China derives its origin from the venture capital (VC) industry which has been a corollary of the economic reforms introduced by Deng Xiaoping in the late 1970s. With the new possibility for private ownership of assets as basic prerequisite the first venture capital fund in China was launched in 1985 but the growth rate was yet still rather slow, mainly due to lack of experience and setbacks caused by false governmental policy. In the early-1990s, the Chinese State Council impelled venture capital to the planning of high-tech industrial parks to boost the development of these projects. Still, doubt about the investment prospects and strict regulations impeded the growth of VC industry. One of the very few exceptions was Goldman Sachs investing in China since the early 1990s. Hence, they benefited from small competition and gained a big market share. (Robertson, 2015, p. 36)

In the mid-1990s, driven by the growing experience of investing in China and also due to the dot-com boom, other big players like Softbank, IDG and Walden, entered the stage. The development of market growth was badly damaged by the Asian crisis (1997-1998). In order to get back on track, Cheng Siwei (成思危), who was the vice chairman of the Chinese’s People’s Political and Consultative Conference (CPPCC) at that time, made the so-called “one proposal” at the 9th CPPCC National Committee meeting in 1998 “to ‘promote and develop the Chinese venture capital industry,’ which attracted wider attention from government bodies.” (Yong, 2012, p.79) This resulted in the “country's first comprehensive set of regulations on venture capital. The move allowed venture capital intermediaries to take the form of a limited liability corporation or a joint stock limited company.” (China Daily USA, 2015, n.p.)

Even though the dot-com bubble bursted in 2000 and with this many venture capital companies were forced to shut down, of those few that survived, several have later become market leaders. The market recovered within a few years, especially when in 2003 new regulations for exiting Chinese venture investments, by listing them on a foreign stock exchange, have been introduced. (Haberich, 2011, p.61) The accession to the World Trade Organization in 2001 also enhanced the foreign investments in China.

This blooming market was nearly entirely dominated by foreign owned private equity firms (FOPE) between the late-1990s to the early-2000s, whereas domestic firms played only minor walk-ons. The Chinese owned private equity funds (COPE) still had “limited experience with and knowledge of new finance.” (Yong, 2012, p.36) The spearhead of successful COPE were CDH Investments and Hony Capital, who both used US-Dollar (USD) capital and became domestic market leaders since their initiations in 2002-2003. Nevertheless, there were hardly any competitors for the FOPE with below 20 COPE and a market share of 9% by 2005, as can be seen in figure 1. (Robertson, 2015, p. 37)

Abbildung in dieser Leseprobe nicht enthalten

Fig. 1. Percentage of investments in USD and RMB (by transaction value) [1]

The FOPE accumulated their USD funds from overseas investors, invested in mainland China and exited in overseas markets using their offshore structure. They prefer this structure because it not only provides a quick exit via initial public offering (IPO) or trade sale but thereby, they also could enjoy the tax treaties and well-established regulatory frameworks in countries like the Cayman Islands. Offshore structures allow them to transfer ownership of shares easily by avoiding governmental regulations and paying Chinese capital gains tax. Bye that, they were able to achieve tremendously profitable investments and FOPE like Carlyle and Morgan Stanley generated investment returns of 6 respectively 17 times on their investments.

2.1 Development between 2004 and 2014

This part will show the development of foreign and domestic private equity firms in the Chinese market. The possible reasons for this development and important facts will be provided in the next chapter. The following part should only reveal the about-turn made from a near entirely foreign dominated market to a rather domestic dominated one.

In order to get an impression of the power balance between domestic and foreign firms, this paper will concentrate on the capital raised by COPE and FOPE for investments, since fund raising represents a statement of trust and future outlook by the investment community, and afterwards it will be examined by whom these investments get completed and controlled.

The execution of investments would also be an interesting aspect, but due to the time lag between fund raising, completed investment and execution, the actual annual power distribution is somehow murky and hard to compare.

2.2 Fundraising by FOPE and COPE

The following data defines domestic firms as firms holding their headquarters in Mainland China or Hong Kong, hence, any other firm is considered to be a foreign private equity firm. Funds raised by domestic and foreign firms together are deemed as joint ventures.Abbildung in dieser Leseprobe nicht enthalten

Fig. 2. Percentage of China focused funds raised in USD and RMB between 2004 and 2014 including investments per year in billion Dollars. [2]

As can be seen in figure 2, there has been a significant downward trend for FOPE regarding their ability to raise capital, compared to their COPE competitors. “From a market position of 67% of all capital raised in 2004, foreign firm‘s share dropped in the ensuing decade, falling below 20% every year after 2008 and reaching only 14% in 2014.” (Robertson, 2015, p. 38)

Even though the total value of funds raised by FOPE increased from 1.1 to 9.6 billion USD between 2004 and 2007, the COPE’s growth was much higher and reached 15.2 billion USD in 2007, starting with only 0.6 billion USD in 2004. While FOPE reached their peak in 2007 and went down ever after since that year, raising only 2.9 billion USD in 2014, COPE increased their funds up to 38.0 billion USD in 2011 and dropped after 2012 with 30.7 billion USD to “only” 17.6 billion USD in 2014. In the whole time span between 2004 and 2014, COPE were able to raise nearly 175 billion USD in capital and were head and shoulders above FOPE with 50.2 billion USD. (Robertson, 2015, p. 38)

For the purpose of better understanding the distribution of power between FOPE and COPE, it is necessary to run the ruler over the RMB and USD funds separately.

As can be seen in figure 3 (Appendix A1), FOPE hardly gained more than 10% of the RMB fund market share. Even though China initiated a policy introducing the so called “Qualified Foreign Limited Partners” (QFLP) pilot program in 2009 with the aim to tempt foreign private equity firms to raise funds in RMB. (Yong, 2012, p. 140)

The year after, FOPE only had a slightly increase with 3.2 billion USD in RMB raised and then dropped durable to under 5% and hit the rocks with 5 million USD raised in 2014. COPE do not only concentrate on raising RMB funds but also are eager to challenge FOPE’s historical supremacy on the USD fund market.

COPE succeeded in convincing international investors to place their foreign currency capital with them as can be seen in figure 4 (Appendix A2). Since 2007, COPE was able to raise more USD funds than FOPE year by year with 2008 and 2014 as exceptions. In average between 2004 and 2014, COPE were able to gather 55 billion USD compared to 44 billion USD by FOPE. This trend appears to be stable after 2008, by raising nearly double as much in the six years after combined. (Robertson, 2015, p. 40) This means that COPE are perceived as a good alternative for investments in China from international investors.

2.3 Completed investments by COPE and FOPE

Though fund raising through limited partners (LP) is one of the most important phases during a private equity investment, the real power lies on the side of the general partners (GP) which are in possession of decision-making power. Hence, it is necessary to regard the shares of FOPE and COPE concerning completed investments intently. This can be either regarded by measuring the deal value or the deal count. This paper will focus on the deal values and only shortly mention the distinctiveness in deal count at the end of this chapter.

The following figures won’t concentrate on single COPE or FOPE entities but rather on so called “syndicate deals” of partnerships between domestic and foreign private equity firms which have been formed to arrange large investments. It will be separated in foreign-foreign syndication (FFS), foreign-local syndication (FLS) and local-local syndication (LLS).

Abbildung in dieser Leseprobe nicht enthalten

Fig. 5. Percentage of investments in USD and RMB between 2004 and 2014, including investments values per year in billion Dollars. [3]

As mentioned in the first chapter, the LLS’s market share was rather low during the early 2000 and has been at 9% in 2005. As could be expected in regard to the development of fund raising, it has changed in the years after and a steady increase in market share can be seen with a peak of 60% in 2013 (See figure 5). 2007 has been the last year of FFS controlling the majority of shares alone. Of very particular importance are the foreign-domestic syndications ever since the late 1990s, when powerful private equity firms like Morgan Stanley and the Chinese CDH Investments started to collaborate. While the relevance of solely FFS is declining, the FLS are still very important. (Robertson, 2015, p. 42)

“The significance is that domestic players are, in most cases, necessary for market access and that major deals, in particular, are nearly always carried out with local firm backing.” (Roberston, 2015, p. 42)

They combine FOPE’s skill of having access to large capital amounts and their established ties to the finance sector with the networking skills of COPE and their connection to Chinas government. The future development of this partnership will have great influence on the power distribution between FOPE and COPE. While FOPE traditionally have been advanced in financial techniques, COPE learned quickly and might already by on par with FOPE. The separation between RMB and USD funds is also in this case advantageous in order for a deeper understanding of the power balance between FFS and LLS.

Figure 6 (Appendix B1) shows that completed RMB investments have grown tremendously between 2009 and 2014, while LLS have been responsible for more than 80% of all investments in this time period. FFS and mostly FLS just have been background actors. In 2014, several big investments have been made by FSL, i.e. two large of them have been made by FOPE Warburg Pincus and two COPE, acquiring Chinese assets for 2.887 billion USD (18 billion RMB). This showed that FOPE are still able to realize large scale RMB investments due to their huge resources and expertise. (Robertson, 2015, p. 44)

Figure 7 (Appendix B2) highlights the development of completed investments with USD funds. Here we can see that foreign companies still have a very strong position and achieved more than 50% of all completed investments in the time between 2005 and 2014. Nonetheless the trend is shifting towards a new supremacy of the COPE being reflected in the years since 2007 onwards, especially if the rising FLS investments get taken into account.

As mentioned earlier it is also possible to compare the number of investments rather than only focusing on the value. The number of deals made by FOPE rose from 79 in 2000 to 370 in 2007, representing 39-44% of the total amount of investments completed. In post 2007 times, it steadily declined with an average of 186 arrangements and less than 25% market share. FLS followed mostly the same path of development with 48 deals in 2000, 128 deals in 2007 and 73 deals in 2013. In 2014 their amount of investments reached a new record with 156 completed investments. COPE however, had a far larger number of deals, especially rising after 2006, with 348 transactions in 2007 and 427 in 2014 while reaching its peak in 2011 with 674 deals. This shows that COPE’s investments have a smaller value in average than FOPE’s deals. (Robertson, 2015, p. 46-47)

This might also be a hint that COPE have more difficulties in completing large value investments, either because they aren’t able to raise that big funds or that they mainly focus on smaller projects as Robertson notices:

Chinese private equity firms are “key providers of capital to smaller Chinese companies and make important decisions about the structure and operation of these companies.” (Robertson, 2015, p. 47)


[1] Adapted from Localizing Global Finance: The Rise of Western-Style Private Equity in China (p. 43), by J. Roberston, 2015, New York, NY: PALGRAVE MACMILLA. Copyright 2015 by Justin Roberston.

[2] Adapted from Localizing Global Finance: The Rise of Western-Style Private Equity in China (p. 38), by J. Roberston, 2015, New York, NY: PALGRAVE MACMILLA. Copyright 2015 by Justin Roberston.

[3] Adapted from Localizing Global Finance: The Rise of Western-Style Private Equity in China (p. 43), by J. Roberston, 2015, New York, NY: PALGRAVE MACMILLA. Copyright 2015 by Justin Roberston.

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Private Equity in China. The struggle for China's private equity market supremacy between foreign and domestic market participants
University of Würzburg
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private, equity, china
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Johannes Gmeiner (Author), 2016, Private Equity in China. The struggle for China's private equity market supremacy between foreign and domestic market participants, Munich, GRIN Verlag,


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