China QFLP funds: Back from the brink?

Private equity is hardly Nomura Asset Management's core business but two weeks ago the Japanese firm announced the launch of a fund in China.

Having received a license to operate under the Qualified Foreign Limited Partnership (QFLP) program, Nomura set up a 50-50 joint venture with a local fund manager Shenzhen Hua Xia Ren He Capital Management in Shenzhen's Qianhai Economic Zone.

The move comes after Singapore-based OCBC Bank launched a $100 million PE fund under the QFLP program in Shanghai earlier this year. It represents a reawakening of interest in onshore private equity funds among foreign investors following a couple of years of relative inactivity. Why is it happening?

"Public market funds in mainland China have not performed well, especially after the financial crisis. However, there is a huge growth in the private markets," says Nakano Hiroyuki, a Nomura spokesperson. "We really think PE assets could reflect the actual growth of Chinese economy. We want to launch PE fund products to high net worth individuals and capture this growth."

Broken dreams

The QFLP program was introduced in 2011, allowing foreign capital to be channeled more easily into renminbi-denominated vehicles. More than 20 private equity firms, including The Blackstone Group and The Carlyle Group, soon applied for the quotas and launched funds.

It was hoped that these vehicles would be treated as local entities, removing the bureaucracy that restricts offshore funds. Shanghai went as far as to say that local treatment would apply if less than 5% of these funds' total corpus came from overseas. However, the regulators vetoed the move - all foreign-invested funds would be treated as foreign.

"From our observation, QFLP isn't as popular as two years ago. International firms won't bother to apply for the quotas if they are still going to be treated as foreign investors," says Flora Qian, Hong Kong-based legal counsel at Fangda Law. "Fund managers may need to get Ministry of Commerce approval for every transaction, just like every other foreign investor in China."

The key point is that Nomura and OCBC are no Blackstone or Carlyle. OCBC is a bank while Nomura's core business is managing listed securities. It has been investing in China's A-share market for several years through the Qualified Foreign Institutional Investor (QFII) scheme.

The slowdown in the A-share market has seen international mutual fund managers' local joint ventures lose traction. These enterprises also have a structural failing. Foreign ownership is capped at 49% stake and this has enabled the local partner to wield more power, often pushing the foreign player into a financial advisory role.

"Global asset managers may not have much influence over how the business develops," says Ivan Shi, research director at Shanghai-based consultancy Z-ben Advisors. "Because of the weak demand for mutual fund products in recent years, a few international groups - in particular those set up in China within the last three years - are winding down their joint ventures."

By comparison, the growth prospects for PE appear strong. Industry participants point to the government's pledge to restructure state-owned enterprises, which could lead to more PE deal flow, and announcements by local governments to boost internationalization of the renminbi and cross-border investments. Foreign PE firms are setting up in Qianhai and Shanghai's Free Trade Zone in anticipation of a breakthrough.

Nomura's investment banking division, Nomura Holdings, has already established another JV in the Shanghai Free Trade Zone. It will own 60% of the venture, with the rest held by two local investors. The JV cannot sell financial products directly to Chinese clients, but it can offer products and advice to the retail operation of the local partner. Hiroyuki says Nomura will look for ways in which the PE and investment banking JVs can work together.

Rising demand

Another factor behind the foray into PE is demand from domestic investors that want to deploy capital overseas. It has prompted several large local financial institutions to try and diversify business lines.

"There is an increasing amount of capital being allocated into alternative asset classes in Japan, such as private equity. At the same time, China is liberalizing its capital markets. If you put these two trends together, it would suggest that local fund managers like Nomura will be attracted to private equity," says Dean Moroz, Hong Kong-based legal counsel at Ashurst.

Nomura wants to raise capital from Asian high net worth individuals and sovereign wealth funds, as well as from investors in the US and Europe, but this is no easy task. Moroz cautions that mutual fund managers are hardly likely to be the first port of call for pension funds that want to invest in private equity.

Nomura says it will address this by having Shenzhen Hua Xia Ren to bring in capital from Chinese investors. The company was founded by ex-employees of China Asset Management, one of China's biggest mutual fund management firms.

As to how and where the joint venture will invest, the plan is to back late-stage private companies through the acquisition of minority and controlling stakes. There will also be PIPE deals. Nomura's Hiroyuki emphasizes the ultimate aim is to create a wider range of products for investors - in the private equity and secondary markets as well as through the construction of diversified A-share portfolio.

For OCBC, the strategy is to invest in privately-owned growth-stage companies with aspirations to list on the A-share market. Sectors such as modern agriculture, consumer, healthcare, clean and environmental technology and advanced manufacturing are of particular interest.

Each firm sees PE as part of a broader effort to develop its exposure to other financial businesses. But are industry participants are cautious as to whether this can inspire other foreign institutions to play a larger role in QFLP. After all, the Blackstone local treatment issue has yet to be resolved.

"From a commercial perspective, I don't see a lot of fund managers following suit because the program doesn't provide any significant benefits to investing in China," says Fangda's Qian.

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• Topics
• Greater China
• Fundraising
• Renminbi fund
• Nomura Principal Finance
• OCBC
• Fundraising
• Renminbi
• QFLP
• China