PRC: PRIVATE EQUITY'S NASCENT DOMESTIC INDUSTRY

C O N F I D E N T I A L SECTION 01 OF 02 BEIJING 003240

SIPDIS

STATE FOR EAP/CM, EAP/EP, EEB/TPP/BTA
STATE PASS USTR FOR STRATFORD AND ALTBACH
TREASURY FOR OASIA/WINSHIP AND PISA
COMMERCE FOR ITA/MAC/AP

E.O. 12958: DECL: 12/03/2019
TAGS: EINV EFIN CH
SUBJECT: PRC: PRIVATE EQUITY'S NASCENT DOMESTIC INDUSTRY

REF: (A) BEIJING 002952 (B) SHANGHAI 000410 (C)
SHANGHAI 000191

Classified By: Econ Minister Counselor William Weinstein. Reasons: 1.5
(b) and (d).


1. (SBU) SUMMARY: China's national-level regulation over
both domestic and foreign private-equity (PE) firms is in
flux as Beijing's various regulatory bodies engage in a turf
war over who will lead reform efforts and ultimately control
industry regulations, several well-connected EMBASSY contacts
recently told Econoffs. Although Beijing supports the
development of a homegrown PE industry, Chinese PE firms have
a long way to go, our contacts said. Experts are divided on
the question of whether Chinese individuals and institutions
would grow more willing to act as limited partners (LPs) by
giving their funds to a general partner (GP),who would have
ultimate say in deciding on projects in which to invest.

Note: This is the first in a series of three cables
regarding China's nascent domestic Private Equity (PE)
industry, the opportunities and challenges of foreign PE
firms in China, and Beijing's actions to shape the regulatory
landscape. EconOffs in October and November 2009 met with
industry experts from foreign and Chinese private equity
firms to discuss present conditions and trends in China's PE
industry. End Summary.


2. (SBU) An October Deloitte and Touche survey reported that
93 percent of current market participants expect China's PE
industry to expand and to include entries by new funds and
more active investment vehicles. Almost half of the
respondents also believed local investors would account for
the majority of new issuances and fund launches through
October 2010. "PE started very late, but has grown very
fast," according to Chinese PE firm Hony Capital CEO John
Zhao. "The demand is there. The economy is growing. New
companies will form, and there won't be enough capital."
Another contact who works for a small U.S. PE firm agreed,
noting that one of China's biggest looming problems was a
lack of capital to funnel to its small and medium-sized
enterprises. "PE has a big role to play in filling that gap.
U.S. PE believes that, and the Chinese government believes
it too," according to the contact.

"WE WILL ARGUE ABOUT PE REGULATION FOR ANOTHER YEAR"


3. (SBU) Hony's Zhao told EconOffs on November 4 that China's
financial regulatory bodies favored a growing PE industry,
but that each agency was vying to lead regulatory reform
efforts. Zhao, who was a senior advisor to a NDRC-led
working group on PE regulatory reform, noted that NDRC
originally argued China should not regulate PE at all, but
subsequently reversed course by announcing it would lead
reform efforts. Its frontrunner status was seemingly
reinforced by the "Opinions Regarding Deepening of Systemic
Economic Reform" issued by the State Council in May 2009, in
which NDRC was instructed to take the lead on PE regulations.
NDRC in August 2009 submitted draft PE Regulations to the
State Council. Xu Lin, NDRC's Director General for the
Department of Fiscal and Financial Affairs, told the 2009
Annual Beijing Global PE Forum on November 9 that NDRC wanted
"moderate" regulation for the private equity industry, and
that PE firms would be subject to the supervision of the
local governments where they were registered. A China
Securities Regulatory Commission official, however, stated
China should legally treat PE firms as public entities and
heavily regulate them at the national level. This official
displayed no awareness of the irony in his insistence that
"private" equity be treated as though it were "public."


4. (SBU) Hony's Zhao said this debate had been carried to
the State Council. National People's Congress Financial and
Economic Affairs Committee Vice Chair Wu Xiaoling led efforts
to reform the current law covering investment within China,
which originally included only mutual funds. The regulatory
reform working group was working with Wu to define PE firms
as private entities within the law. According to Zhao,
"Madame Wu clearly understands this. She knows any attempt
to make this a turf war will take a lot of time." Wu hoped
the law would define clearly the roles, rights, and
obligations of PE investors and general partners, according
to a November 10 Global Times report on her speech to the
Annual Beijing Global PE Forum.


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5. (C) PE firms did not object to this turf war because it
allowed them to "do what they want," according to Zhao. (See
septel for the mechanisms firms used to circumvent
prohibitive regulations.)

NEXT STEPS


6. (SBU) Hony's Zhao thought the next big change for the PE
industry would be increasing numbers of individuals and
institutions acting as limited partners by providing funds to
a larger pool, rather than insisting on becoming the general
partner with the ability to choose projects. Zhao said this
trend was being fueled by the realization among these actors
that managing money successfully required specialized
knowledge and a lot of hard work. (Note: All of the industry
experts told EconOffs that, historically, Chinese investors
have wanted to be general partners to retain better control
of their own money. RMB onshore funds with Chinese investors
willing to let fund managers manage their money for them
would signal a significant shift in investors' attitudes
toward their own money. End Note) In contrast, Carlyle's
Eric Zhang told EMBASSY officials that private Chinese
entities could contribute money as LPs, but they would not be
a major force despite China's newfound wealth.


7. (C) COMMENT: PE clearly will play a major role in China's
capital markets as they develop, but some Chinese government
officials continue to struggle with an ideological aversion
to the idea of large amounts of capital being managed outside
direct government oversight. While the current turf war
leaves gaps for PE firms to exploit, regulations appear to be
increasingly seeking to favor domestic firms at the expense
of foreign PE. At the same time, however, regulatory
agencies appear to be aware that the domestic industry still
relies on foreign expertise. The government probably will
continue to balance these conflicting agendas over the next
three to five years, but we expect a gradual "crowding out"
of foreign firms as domestic companies gain experience. END
COMMENT
HUNTSMAN