Private Equity Firms Settling Into China

Sep. 8.10 | About: The Blackstone (BX)

I have been closely following the growth of private equity in China because I believe it is one of the most important and exciting new markets for the industry. As the country opens up more and more to financial institutions by easing typically stringent regulations, the potential for buyout firms operating in China is huge. This is why you see many firms moving into China even though they may not begin doing large deals for a few years still. It's about getting your foot in the door and setting up offices in the country before your competition.

There are still major obstacles to working in China but the prospects are bright and many firms believe it is worth navigating complicated (and sometimes unfair) regulations. The government is working to make the country more receptive to private equity firms, with actions like this week's announcement that China will allow insurers to invest up to 5% of their total assets in private equity. These types of initiatives are key in developing private equity activity in China.

Yuan-Denominated Funds Dominate

Although there have been some promising private equity funds in China, the industry still lacks the credibility that it has gained in other parts of the world. It is encouraging that private equity firms have started opening funds in the Chinese yuan currency. Having a fund denominated in the local currency has helped these buyout firms attract local investors, which is a key step to working in the country successfully.

David Rubenstein told the audience at a WSJ China Financial Markets Conference, "“For any of the large private-equity firms in the West to be a real player in China, you probably should have a [yuan] fund." (source) His firm, Carlyle Group, has already launched its second yuan fund in the country after partnering with the cities of Beijing and Shanghai. And it appears that Mr. Rubenstein is correct, funds denominated in the yuan have raised 77% China-focused private-equity funds raised in 2010.

US Looks to Raise Taxes While China Offers Breaks

According to a recent article, cities across China are competing to be crowned the capital of private equity. Various Chinese cities including Shanghai, Chongqing and Beijing have been offering incentives such as tax breaks, giving financial aid, and policy support. All of this is aimed at luring private equity firms into setting up shop in the cities. This is in stark comparison to the actions of US state and federal government and those in Europe, too.

In the West, governments have been making moves to close the carried interest tax "loophole" and have been increasing regulation of banks, private equity and hedge funds. All of this only makes other countries like China that much more appealing to private equity firms looking to make returns without too much oversight and taxation. So we see private equity firms receiving tax cuts in China while the U.S. looks to increase the tax burden on domestic buyout shops.

Buyout firms--including Blackstone (NYSE:BX), Carlyle and TPG--have been meeting with representatives from each city. The reception to foreign private equity firms has been surprisingly welcoming considering the criticism that the industry still faces even here in the U.S. which is generally regarded as more embracing of free markets and capitalism. TPG recently set up its second China fund, the Western China Growth fund in Chongqing, with other private equity firms expected to follow suit moving into China.

Looking to the Future

Most of the major international players in private equity have recognized the enormous growth potential in China--with a population of 1.3 billion people and a climbing GDP--and are in the process of opening or have already opened offices in the country. It will be exciting to see in the coming years how private equity firms are able to generate returns in emerging markets like China and India. There are so many new and expanding companies in China and I believe that there is a real need for the kind of services and management that a strong private equity firm provides.

Disclosure: No positions