Tighter rules around private fund offerings in China have caused a market shake-out, as regulators seek to put China’s domestic asset management market on a more global footing.
In the past six months 114 Chinese private equity funds have closed down, according to data from the Asset Management Association of China (AMAC). This could be a sign that the recent fundraising bubble – which grew rapidly as China liberalised its market – has burst, according to one industry observer. It is certainly a sign that regulators intend to get tough with unregulated private equity and peer-to-peer (P2P) loan products.
Jimmy Leong, managing director, Asia of Singapore-based private equity fund administrator Augentius, told AsianInvestor that the Chinese private equity market is going through a major transition this year and that many domestic funds have disappeared.
Effie Vasilopoulos, partner at law firm Sidley Austin in Hong Kong, confirmed that a large number of funds have shut up shop, and "it is rumoured that a good deal more will close down."
Leong said that new rules introduced by AMAC and the China Securities Regulatory Commission (CSRC) aim to enforce global operating standards and reinforce that private funds should conform to conventional asset management models, as opposed to the many that are P2P lending businesses or ponzi schemes.
It has long been perceived that the rules for establishing private equity funds in China were too lax, said Vasilopoulos. "Regulatory enforcement was incapable of adequately policing the vast landscape of new funds that were being created in what was an overly permissive regulatory environment."
P2P lending has taken off globally in the last 10 years and is a legitimate form of borrowing, well-regulated in markets like the US and the UK, but in China regulators have been unable to prevent investors from losing their money. Until now, that is.
“This year many private fund managers have de-registered themselves and just fallen off the map with AMAC," Leong said. "These are the guys who did not really follow the rules."
The new regulations, introduced in January this year, made clear that AMAC would not accept new filing applications for products that were not private equity funds in nature.
That was followed by further rules introduced by the CSRC in April, which curbed the distribution of unregulated funds via retail sales channels.
Banks have always been a very good channel for private equity managers to distribute their products in China, Leong said. “Wealth management and P2P lending products – a lot of fund managers went through the banks and securities houses to distribute these products to investors. The new rules limit the banks’ ability to partner with fund managers to manage client money.”
Leong said it was unquestionably a positive development for the long term development of China's private equity market. "There were too many unregulated funds in China," he told AsianInvestor. "The investors in these products were not well informed. They were all after high yield. Personally I have come across funds offering an annualised return of 40%, which in our world is totally unheard of. Obviously investors were not aware of the risks that come with that kind of a promise."
China is currently the world's second-largest private equity fundraising market after the US.
Might the new AMAC rules now stymie that growth? Do they strike the right balance or are they too onerous for local private equity managers?
Leong sounds a cautiously optimistic note. "There’s a lot of illegal fundraising and that will not stop. However, getting rid of a lot of the non-compliant guys in the private equity industry will promote stable growth and scaleability," he said.
He said fears the regulator would kill off the Chinese private equity market were “too strong”.
“By insisting that funds appoint professional custodians and administrators, they are retaining the right fund managers who are in fact qualified to manage client money and not the ones who are looking to make a quick buck,” Leong said.
Fundraising by traditional private equity funds has been strong in the last three years, according to AMAC, which reported $1.5 trillion of assets under management by private equity funds in China at the end of 2017 – a near-sevenfold increase over the last three years.
Another boost to the market is new quota granted to the Qualified Domestic Limited Partnership (QDLP) sector, which allows onshore investors to invest in offshore private equity vehicles. In April, the State Administration of Foreign Exchange (SAFE) announced that the QDLP quota was to increase to $5 billion from $2 billion.
Leong said that despite the contraction in the number of funds, the sector is still in rude health. The Chinese private equity landscape predominantly consists of venture capital and growth funds, which represent 54% and 34%, respectively, of all private equity funds closed there since 2000.
More mature markets, such as the US, tend to be more buyout-heavy. Now, though, as a sign of the market maturing, Leong said buyout funds are emerging in China.
"There’s a diverse range of private equity firms, or General Partners (GPs), in China," said Leong. "Most that we talk to are either spin-offs from the big firms like KKR or they are established Chinese financial institutions.
"However, we do come across relatively new startup funds and the industry is catching up fast. On average it’s not up to global standards, but this trend is developing quickly. I think that in the next decade you’re going to see a lot of very big local fund managers placing a lot of emphasis on corporate governance and compliance," Leong said.
Because Chinese private equity managers are working with global family offices, endowments and institutions, this will force them to raise their standards, he added.
"These overseas LPs [Limited Partners] have stringent controls so the Chinese GPs will have to make sure they come up to those standards. That’s what the regulator is intending with the new AMAC regulations."
As the chart below shows, an anticipated step-up in exit activity in Chinese private equity was seen for the first time in 2017, with a record number of both IPO and trade sale exits.Source: PwC