In 2007, approximately $40 billion was raised from international investors for PE in China – eight times more than funds raised domestically. By contrast, 2019 saw $163 billion raised domestically while just $22 billion came from international investors.
One reason for the change is that many Chinese companies – particularly smaller firms – simply do not need to look outside Chinese borders. Deeper pools of domestic RMB funds reduce the need for companies to look overseas for capital. Domestic capital also comes with fewer government restrictions, while raising and investing capital in RMB funds is more efficient due to simpler ownership structures and transaction processes.
Finally, domestic stock exchanges such as the STAR Market1 support domestic listings by reducing growth-limiting restrictions. The IPO market has developed such that domestic Chinese company listings now account for about one-third of the number of global IPOs.
China PE market fund raising in 2007–2019 (US$ billion)
Source: Zero2IPO, Schroder Adveq, 2020. Note: Includes government guidance funds.
Many opportunities are only available in RMB funds
International capital is still sought by medium-to-large Chinese companies with international growth in mind. For these companies, foreign listings or M&A are still commonplace.
However, the rapidly-developing onshore renminbi (RMB) market is where we think holds the most attractive opportunities for investors, offering access to several key themes:
1. Small and medium sized enterprises
There are 30 million2 businesses that play a key role in the economy beyond state-owned enterprises.
2. “Made in China 2025”
A key government initiative to support businesses is “Made in China 2025”, which focuses on target areas such as technology, aerospace, biotech and high-performance medical equipment.
3. Domestic service sectors
Domestic service sectors stand to benefit from increased disposable income among a growing urban middle class.
The growth of the PE market in China has also led to exciting developments in the RMB secondaries market. On the supply side, growth in PE fundraising over the last 10 years, along with dependence on private investors, has generated a large source of secondary opportunities. On the demand side, there are few institutional investors, especially with secondary transaction expertise. The mismatch between supply and demand offers attractive discounts.
RMB funds can also secure co-investment opportunities – where speed can help win a deal – and have an advantage over US dollar funds due to pre-settled currency exchange and onshore investment structures.
The “all access pass” to domestic opportunities
Over the past two decades, the Chinese government has launched investment programmes and rolled back restrictions as part of a broader opening up of capital markets. Between 2017 and 2019, foreign investment encouraged industries have increased by 20%, whilst restricted and prohibited industries have decreased by 55%.
Moreover, gaining direct access to the wider market available in domestic RMB opportunities still requires a specific fund structure, called a Qualified Foreign Limited Partner (QFLP).
Foreign PE managers and investors were first allowed to establish onshore funds in 2010, a change which was followed by the launch of a QFLP pilot programme in 2011. Whereas conversion between RMB and US dollars previously required separate approval for each transaction, it can now be done at the fund’s launch.
Establishing a QFLP fund is still a highly regulated process, requiring multiple approvals from government agencies, while the fund manager must be regulated and subject to minimum staffing and capital levels. Funds raised are also subject to capital requirements, limited partner (LP) composition and a domestic custodian. As such, the number of foreign managers with QFLP funds has remained low, given the required commitments.
How should investors respond?
Thus far, international investors interested in RMB PE have already experienced investing in China through USD funds. These sophisticated investors want to diversify and access a larger pool of investment potential, seeking a diverse portfolio exposure to China.
Whilst USD funds will remain a starting point, the investable universe is quickly expanding beyond the current 300 active USD fund managers with over 10,000 RMB registered fund managers. Geopolitical considerations may also add to the case for RMB fundraising to be the first choice of more companies.
Investing in RMB funds requires access to a local network of managers, which takes time to understand. While the market has grown significantly over the past ten years, having an experienced team on the ground that knows the RMB managers is key. Changes over the past decade in China are part of a long-term shift; which international investors should bear in mind when considering portfolio construction and diversification.
Please click here to learn more about various PE opportunities as we move past this year’s disruptions.
Investment involves risks. This material is issued by Schroder Investment Management (Hong Kong) Limited and has not been reviewed by the SFC.
1 STAR Market: Science and Technology Innovation Board is a pilot programme that, amongst other things, allows companies to list before they have turned a profit.
2 Ministry of Industry and Information Technology (MIIT)