Renminbi funds: This week's thing or a long-term trend?

John Fadely, a funds partner at Clifford Chance, sheds light on recent private equity fund offerings that are denominated in renminbi and discusses the role of the sponsors.

Renminbi onshore private equity funds are the flavour of the week -- why?
Simple. They provide access to Chinese capital and deal flow in China, as well as avoiding regulatory approvals that offshore funds have to obtain when investing in the mainland.  

Sounds great. So when can we expect to see the first deals?
These are important milestones for the funds industry, but read closer and you'll see that these announcements are just that -- announcements of MoU signings or intentions to raise capital. Now the hard work begins. The capital must be raised and the funds must be structured before the first investments can be made.

Do you foresee problems?
Challenges rather than problems. Will the offshore sponsor control the general partner of an onshore limited partnership and take carried interest onshore?  If so, how will it contribute capital given China's foreign exchange regime? Or will the sponsor instead form only an onshore management company that earns a management fee? The answers to these questions affect the sponsor's economics.

Obtaining proprietary access to deal flow in the locality where the fund is formed is a potential advantage, but how will sponsors ensure the integrity of the investment decision-making process?  Will investment decisions be made entirely onshore and, if so, by whom? 

Will offshore funds formed by the same sponsor co-invest with the sponsor's onshore fund? If so, how will they ensure a separation of onshore and offshore decision-making, which is key to insulating the offshore fund from PRC tax?

Working out a credible fund structure in advance will avoid problems down the road.

What does the law say?
It doesn't say anything yet. We're awaiting a framework for the development of the private equity industry from the NDRC [The National Development and Reform Commission]. We hope it will be issued this year. We're also awaiting the potential promulgation of a foreign-invested limited partnership law and amendments to the foreign-invested venture capital investment enterprise (FIVCIE) law. In all cases, the devil is expected to be in the details.

This sounds like a grey area.
It is, but that's the nature of most rapidly developing markets. Also, the sponsors pioneering these funds are well-respected and highly connected in China, which allows them to understand and manage the risk better than most. There's an inevitable trade-off to be made between the current lack of certainty and the potential "first mover" advantage, and that trade-off will look different to each sponsor.  

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