Visitors take photos with a replica of the famous Wall Street bull on the Bund in Shanghai. The mainland regulator has opened doors for overseas yuan capital to invest in mainland private equities. Peter Parks / AFP

The mainland private equity (PE) market is heralding a new stage, as the mainland regulator allows overseas yuan capital to come in to boost PE investments. Oswald Chan examines the new move.

According to the Finance Office of Shanghai, Shanghai will be the first pilot city to launch the Renminbi Qualified Foreign Limited Partnership (RQFLP) program that permits overseas raised yuan to be repatriated back to the mainland to invest in unlisted companies through the PE investment vehicles.

The Finance Office of Shanghai in late October 2012 said that the Shanghai Bank and the Hong Kong subsidiary of Haitong International Securities Group have signed a memorandum of cooperation to launch RQFLP products in Hong Kong. The operation of the RQFLP funds will be under the current Qualified Foreign Limited Partnership (QFLP) policy framework.

According to media reports, the total RQFLP quota is about 1 billion yuan and the overseas yuan will still be treated as foreign currency attributes. The Bank of Shanghai will provide custody services and Haitong Securities will take charge of the design and issuance of the RQFLP products in Hong Kong.

The RQFLP has added a third channel of fund-raising for PE firms targeting mainland companies. Before the launch of the RQFLP, PE firms could either raise yuan through the mainland onshore market or use the current QFLP quota to convert the raised US funds into yuan currency to finance their PE deals.

"The RQFLP program definitively can boost the mainland PE industry development by channeling more offshore market yuan funds into the industry," said Simon Luk, a director at Capital Focus Asset Management, which specializes in mainland PE investment deal-making.

"Many mainland private enterprises and small and medium firms (SMEs) are in dire need for capital. As mainland banks shun their lending to the above-mentioned firms, these companies particularly will be receptive to investment from PE firms when overseas yuan funds can be utilized to make mainland PE investments," Luk told China Daily.

The mainland government had already launched the QFLP program in 2011 that allowed overseas US dollar to convert into yuan to invest in mainland unlisted firms through QFLP funds. Since the QFLP pilot scheme was launched in mid-2012, 17 enterprises which met the QFLP qualifications have raised 15 billion yuan through the QFLP quota. International PE industry players such as Blackstone, TPG and Carlyle all have established their QFLP funds.

The accounting advisory firms based in Hong Kong reckoned that the launch of the RQFLP will pave the way for a healthy development of the mainland PE industry.

More flexibility

"Though not a 'game changer', the RQFLP program will be generally helpful in promoting the mainland PE market because it can provide more flexibility for PE industry players," PricewaterhouseCoopers (PwC) Greater China Private Equity Leader David Brown told China Daily. "It is yet another example of many policy changes that we have seen that are favorable to the mainland PE industry," he added.

"The RQFLP will be a great step forward to attract capital into the mainland PE market by providing a good vehicle for PE funds to target those mainland companies by using the offshore yuan. As the PE investors will ultimately exit their PE investments through initial public offerings (IPOs), this will present as a step forward to develop the mainland capital market as well," Ernst & Young Greater China Transaction Advisory Services Leader Bob Partridge told China Daily.

The launch of the RQFLP program means that Hong Kong can capitalize its offshore yuan financing center role in fostering mainland PE industry development. The city with its bureaucratic structure, taxation regime, PE professional talent supply and geographical proximity to the mainland will also help serve as a regional hub to contribute to the mainland PE industry development.

The mainland PE industry is flourishing in recent years due to the burgeoning economic growth in the country and the fact that mainland private enterprises and SMEs are deprived of funding by the mainland financing infrastructure which is geared heavily to lending to State-owned enterprises.

According to Asian Venture Capital Journal, PE fundraising activities on the mainland have grown exponentially recently, from $13.7 billion in 2007 to $38.8 billion in 2011.

Despite the booming growth of the PE industry, the mainland PE industry is fragmented with more than 10,000 venture capital (VC) and PE firms at the end of 2011, managing nearly 2 trillion yuan ($313.9 billion) in assets, according to National Development and Reform Commission (NDRC).

Tougher regulations

The mainland PE market experienced a slowdown in 2012 compared to 2011 due to the economic slowdown of the Western and mainland economies. The slump of the mainland domestic share market in 2012 also curtailed mainland PE activities as PE firms cannot obtain a higher valuation when they exit their PE investments via IPOs.

Tougher regulation by the mainland financial regulatory bodies regarding IPOs and the lack of investor interest for mainland companies listing on exchanges in other markets also dented the mainland PE activities in this year.

According to Ernst &Young data, the number of PE deals targeting mainland companies from January to October 2012 amounted to 296 with a total value of $7.7 billion, representing a decline in both volume and total value of about 45 percent each from the same period in 2011.

The PwC data revealed that in the nine months of 2012, there were around 360 PE deals recorded on the mainland, compared to more than 800 PE deals in the whole of 2011.

Amid the unfavorable market trend, the local accountant advisory firms reckoned that the mainland PE industry is still in good fundamental shape.

"PwC is optimistic toward the mainland PE market starting in the second quarter in 2013 due to the confluence of the three factors: the demand for capital in the country's private sector, the excess of investment capital earmarked for China which is held by the PE community and pressure to spend that capital; and a pipeline of PE exits, many of which will come to market by way of mergers and acquisitions, as well as the more traditional IPO route (on the mainland)" PwC's Brown said.

"We predict the market momentum of the mainland PE market will revive and expect the value and the number of PE deals will soar 20 percent in 2013 compared to 2012," Ernst & Young's Partridge noted.