China opens up to private equity

China starts to allow foreign private equity firms to raise money in local currency, reports WSJ:

China is opening up to foreign private equity firms -- but the promised land is no paradise yet.

For the first time, foreign firms have the green light to raise yuan-denominated funds. It's a significant, but qualified, breakthrough for the likes of Blackstone Group, Carlyle Group, and the private equity arms of CLSA and Macquarie Group -- all of which have announced, or will soon announce, new funds.

Raising funds in yuan means being able to tap wealthy Chinese investors, as well as state-backed institutions like China's national pension fund.

And using local currency should mean the funds can more speedily take advantage of investment opportunities in China.

But this isn't going to be easy -- both when it comes to raising money and deploying it.

For starters, the foreign firms face competition in raising funds from China-based private equity groups that have a purely Chinese focus -- and better local knowledge.

It's unclear, also, whether the foreign firms will be allowed to bring their own money into China, convert it into yuan and take equity stakes in mainland companies, says William Liu, a partner at law firm Linklaters.

That's important if the firms are to follow the model of investing alongside their limited partners -- ensuring some of their own money is on the line too.

A regulatory uncertainty applies to investment opportunities as well -- whether or not the foreign firms setting up local currency funds will be treated as foreign or domestic investors. The difference being a heap of approval procedures for investments, as well as restrictions on sectors to invest in.

It's questionable, too, whether local governments and regulators will want to give foreign firms access to China's best investment opportunities. For now, with Chinese banks offering so much credit to companies, turning to private equity is anyway less of priority for China Inc.

In a smart move, foreigners setting up yuan funds are aligning their strategies with government priorities. Hong Kong-based First Eastern Investment Group will set up three funds, investing in small and medium sized enterprises, green companies and infrastructure firms respectively.

First Eastern is typical in that it's scaled back its ambitions: The three funds, worth $850 million together, will be smaller in total than initial plans for two funds raising $1.5 billion.

Keeping the funds small, for now, is reasonable. Plenty of uncertainty remains over private equity's freedom to maneuver in a country that is still some way from having capital allocation guided purely by market forces.