Chinese insurers and offshore PE: Tortoise, not hare

Chinese insurers are taking baby steps. More than 18 months after receiving the go-ahead to invest in offshore private equity funds, few have made the leap. China Reinsurance (China Re) was the first, committing $30 million to KKR's eleventh North American fund, which closed last October at $8.3 billion - a classic safe bet.

Industry participants expect much more from this relatively untapped LP constituency, not least because of their huge asset bases and long-dated liabilities are well suited to private equity. For their part, insurers are said to be building in-house investment teams and exploring channels for converting onshore premiums into offshore capital.

With the China Insurance Regulatory Commission (CIRC) taking a significant step to liberalize the rules, insurers might be poised to become a significant target market for international GPs, joining the likes of China Investment Corporation (CIC) and the State Administration of Foreign Exchange (SAFE).

The question is not so much if but how soon and how much. Should investor relations departments be factoring a potential bumper insurance allocation into their projections for the next 3-5 years?

Big ambitions

"Chinese insurers are preparing for it. Quite a few of them have started doing research into what they can or can't do when making alternative investments, but the process is very slow and it takes time to understand the international market," says Lorna Chen, partner with Shearman & Sterling. "When will they take the first steps? It depends. There're several factors."

First of all, not every insurer has decided whether or not it will make private equity allocations outside of China and how significant a role the asset class should play in their wider portfolio.

"It's definitely a group of LPs with a lot of growth potential and a lot of people are trying to establish contacts in the market," says Vincent Ng, a partner at Atlantic-Pacific Capital. "But as a whole, not all China-based insurance companies are actually active in making investments in international funds."

For many, the primary focus is still funds in the domestic market or looking at opportunities for direct deals. Where overseas allocations have come under consideration, it tends to be in the context of diversifying risk. As one insurer tells AVCJ, chasing high returns is the number two priority. The primary concern is that exposure to renminbi-denominated funds ties their fortunes to those of the domestic economy.

Chinese insurers' overall offshore investment is capped at 15% of total assets, including fix-income products and private equity fund investments. No insurer is anywhere near approaching this threshold. China Life Insurance and Ping An Insurance, the two largest players by premiums, each have more than RMB1 trillion in assets, which means around RMB150 billion could feasibly be deployed overseas.

"There will only be small steps at this stage," the aforementioned insurer adds. "There will be some overseas investments over the next two years, but not much. It takes time to build up the team and assess performance once investments have been made. We will only accelerate our pace once we get used to it."

This lack of familiarity is due to the fact that insurers were only allowed to invest in domestic PE from 2011. The following year the cap on exposure to private funds and companies was raised to 10% from 5%. Earlier in 2014, the regulators decreed that investments in public and private equities combined could account for 30% of the total assets.

"Theoretically, insurers' appetite towards private equity should be increasing as the CIRC is easing curbs," says John Qu, vice general manager of asset management at China Re. "However, they may not be as excited about it as people are anticipating."

Insurers are essentially still approaching the asset class with a public markets mindset. They are thinking in terms of immediate results, not developing programs to construct private equity portfolios that generate longer-term returns.

"They understand there should be a return premium in the long term however a short term J-curve can be challenging during the buildup phase," explains Frankie Fang, China representative at LGT Capital Partners. "The majority of their holdings are still in the public equities and the bond markets where the insurance companies have greater visibility and liquidity."

Brand awareness

Even when insurers begin to venture overseas, they will inevitably gravitate towards established brand names, along the lines of China Re's commitment to KKR, which remains the sole offshore manager in its portfolio. Reputation, longevity and track record featured prominently in the selection criteria.

"It's more difficult for us to select overseas GPs because we don't know much about them and it is not as easy to communicate with them as with domestic managers," says Qu. "When we looked at previous KKR vehicles in the same series, there were virtually no losses. Performance might not be as strong as some others, but returns have been very stable."

Wariness is also the product of past failure, albeit not in private equity. Ping An made its first high-profile foreign direct investment in 2007, acquiring a minority stake in Belgian-Dutch financial services group Fortis, with a view to purchasing half of the company's asset management unit.

However, the plan was scrapped as Fortis fell victim to the global financial crisis. Ping An had to write down most of its RMB23.8 billion investment when Fortis was nationalized and sold off in 2008. Two years ago, the insurer filed an international arbitration claim to try and recover some of the losses.

Regardless of the asset class, insurance companies want to understand the risks fully before participating. As such, although they have made contacts with foreign GPs and service providers, and studied overseas private equity portfolios, progress is slow. As one industry participant puts it to AVCJ, "Every insurer is watching and waiting to see who will be the first to invest and what they are investing in order to obtain more reference."

Under the CIRC's rules, insurers are only allowed to participate in private equity only as an LP, which isn't actually what they want. There is a desire to make direct investments independently and, with this in mind, China Life is building its asset management subsidiary to invest in fixed income and public and private equities. The company wants to source capital from its parent and ultimately raise funds from third parties.

"It seems to be in the DNA of Chinese enterprises that they first try to do something on their own before investing or partnering or soliciting the services of an outside party," says Chris Lerner, head of the China practice for Eaton Partners. "In our early conversations with Chinese insurance companies, we find this to be true as well. We expect them to an LP, but when we meet them we find their primary interest lies in raising a direct or joint venture fund that leverages their network and platform."

China Re is one of the few to think from a LP perspective, adopting a passive attitude towards asset allocation and using fund managers, according to Vincent Wang, managing director at consultancy Promise Advisors.

China Re originated from the People's Insurance Company of China (PICC) and remains the country's only state-controlled reinsurer. It set up a two-man alternative investment team in 2011 to cover private equity and real assets. The team now numbers 12.

The insurer has just $100-200 million earmarked for deployment with offshore GPs over the next two years. There is a bias towards bigger funds and plans to develop mid-market exposure via the fund-of-funds route. The group's ultimate aim is to establish itself as a fund-of-funds, following in the footsteps of overseas counterparts HarbourVest Partners, which was originally a subsidiary of John Hancock Insurance.

"However, direct investment will not be our core business; our main job is seeking out the best fund managers." Qu says.

Regulatory obstacles

For all the CIRC's reforms, regulatory uncertainty remains the final - some would say decisive - factor in restricting the pace of overseas investment. There is lack of guidance on specific processes, such as whether insurers have to get approval on a deal-by-deal basis.

"We want to invest overseas, but the regulator has a more conservative attitude towards offshore investments, especially when we talk about product innovation," says one insurer. "Anything that isn't listed in the guidance we can't do and lobbying takes a long time. At some point the rules will have to be revised to reflect the reality."

At present, the CIRC's guidance only covers requirements for fund size, the manager's paid-in capital and team size. Another gray area is whether offshore assets can be used in overseas investments, which would offer a way around all the red tape. China Life, Ping An, China Taiping Life, China Pacific Insurance and PICC all have Hong Kong-listed subsidiaries.

"Restrictions on Chinese insurers' overseas asset allocation will be relaxed over the next five years. However, much of their income comes from selling products to mainland Chinese, so they don't have that many offshore assets," says Promise Advisors' Wang. "It is still not clear whether onshore assets could be transferred offshore to make investments."

However, this doesn't limit the opportunity for China-based insurance companies to learn from their Hong Kong-listed counterparts, which have greater exposure to international investment markets. In this way they can build up their capabilities over a variety of asset classes and emerge as more mature LPs, perhaps with an appetite for PE - although approaches may vary.

"Over the next five years, Chinese institutions, including most of the insurance companies, won't classify themselves clearly as LPs, GPs or fund-of-funds. They will try to invest across all asset classes by playing different roles. It's an evolving process," says says Dayi Sun, managing director at Jade Invest. "Western institutions have also experienced that. When they realized they didn't have expertise in a certain area, they narrowed their focus."

SIDEBAR - Strategic angle

Chinese corporates, both state-owned and private-held, were the first batch of domestic institutions to invest overseas, including making commitments to private equity funds. It is part of a broad effort by the Chinese government to encourage "local champions" to build international exposure as a means of accessing new technologies, assets and expertise.

Last month, Shanghai-listed Hainan Zhenghe Industrial Group agreed to invest $130 million in First Reserve's latest energy-focused PE fund. The commercial property firm said it wanted to expand its portfolio to cover petroleum and natural gas business. Under the agreement, Zhenghe not only has co-investment rights in North American deals but will also set up an Asian-focused fund with First Reserve.

"Given, First Reserve is one of the largest fund investors in the global energy sector, in my opinion, this LP investment is more skewed towards being a strategic investment rather than purely motivated from an asset allocation perspective," says Vincent Ng, a partner at Atlantic-Pacific Capital.

"Investors making such strategic investments are generally motivated with obtaining benefits like getting access to co-investment deal flow or learning about the sector to build knowledge for future direct investment needs."

In contrast to sovereign wealth funds and insurance companies, Chinese corporates with cash in their pockets and a desire for PE exposure are not a standard target market for GPs. As such, they can be difficult to identify. They also come in different forms and have varying motivations, for example one corporate might have a large amount of offshore assets while another wants to cover renminbi assets into US dollars.

Another issue concerns capital outflows. Chinese companies require approval from different authorities before committing to an overseas PE fund.

"For the state-owned enterprises, or private companies in China, if they don't already have US dollars, they have to get approvals from the National Development and Reform Commission and the State Administration of Foreign Exchange. Even companies that already operate overseas need some approvals. This process can be long and painful," says Lorna Chen, a partner with Shearman & Sterling.

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• Topics
• Greater China
• LPs
• Fundraising
• Fundraising
• China
• LPs