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Why investors in China private equity might be missing out on most of the market

A lot changes over a decade, especially when it comes to private equity, and especially when it comes to China. The domestic private equity market has grown rapidly, and offers a range of opportunities with tremendous growth potential.

However, without the right fund structure, international investors simply can’t access many of the deals that we think are the most exciting.  

Chinese private equity has become (mostly) self sufficient…

When Schroder Adveq launched its first dedicated Asia private equity fund in 2006, focused on China, international investors were the principal source of private equity capital for Chinese companies. Now international investment is dwarfed by domestic renminbi (RMB) funds.

In 2007, approximately $40 billion was raised from international investors for private equity in China, eight times more than funds raised domestically. In contrast, 2019 saw $163 billion raised domestically and just $22 billion from international investors.

There are a number of reasons for the change. The first is that many Chinese companies – particularly smaller firms - simply do not need to look outside Chinese borders. Deeper pools of domestic capital in China’s RMB funds reduces the need for companies to source overseas capital.

Secondly, domestic capital comes with fewer government restrictions on the industries it can be invested.

Thirdly, there are efficiency savings by raising and investing capital in RMB funds, due to simpler ownership structures and transaction process.

Finally, the development of  domestic stock exchanges, especially the STAR Market[1], support domestic listings by reducing restrictions that previously limited young growth. The IPO market has developed such that domestic Chinese company listings now account for about one-third of IPOs, worldwide, by number.

China PE market fund raising 2007–2019 (US$ billion)


Source: Zero2IPO, Schroder Adveq, 2020. Note: Includes government guidance funds.

Many opportunities are only available in RMB funds

International capital is still sought-after for medium to large Chinese companies, those with international growth firmly on their agenda. For these companies, foreign listing or M&A are still commonplace. Alibaba listed on the New York Stock Exchange in 2014, and Baidu  listed on the NASDAQ in 2005.

However, the rapidly-developing onshore renminbi (RMB) market is where we think investors need to look for the most attractive opportunities. RMB funds offer access to several key themes:

  1. Small and medium sized enterprises

There are 30 million[2] businesses that play a key role in the growth engine of the economy outside of the dominant, state-owned enterprises.

  1. “Made in China 2025”

A key government initiative to support businesses is called “Made in China 2025”, and focuses on target areas including technology, aerospace, biotech and high performance medical equipment.

  1. Domestic service sectors

Domestic service sectors stand to benefit most from the increased disposable income of a growing urban middle class.

The growth of the private equity market in China is also leading to exciting developments in the RMB secondaries market. On the supply side, the growth in private equity fundraising over the last ten years, along with the dependence on private investors, has generated a large source of secondary opportunities. On the demand side, there are few institutional investors, especially with secondary transaction expertise. The mismatch between supply and demand offers attractive discounts.

In addition, RMB funds can secure co-investment opportunities - where speed plays an important role in winning a deal. RMB funds have an advantage over US dollar funds by having pre-settled currency exchange and onshore investment structures.

The “all access pass” to domestic opportunities

The Chinese government still carefully regulates international capital flow into and out of China and restricts foreign ownership of Chinese companies in certain industries. To date, private equity managers have used US dollar funds to overcome this to transfer capital into Chinese companies, often as “Foreign Direct Investments”.

The Chinese government has gradually opened up its domestic capital market to both domestic and international investors for the past two decades. Specific investment programmes have been launched and industry investment restrictions have been rolled back. Between 2017 and 2019 foreign investment encouraged industries have increased by 20%, whilst restricted and prohibited industries have decreased by 55%.

Moreover, gaining direct access to the wider market available in domestic RMB opportunities still requires a specific fund structure, called a Qualified Foreign Limited Partner (QFLP).

Until 2010, foreign private equity managers and investors had been restricted from establishing onshore funds in mainland China. A change in law opened this up, along with the launch of a QFLP pilot programme in 2011, which introduced a number of benefits. Previously, for example, conversion between RMB and US dollars required separate approval for each transaction. Under QFLP, this approval is done at the launch of the fund which improves the agility to make investments.

Establishing a QFLP fund is, however, still a highly regulated process and requires multiple approvals from government agencies. The manager of the fund must themselves be regulated and is subject to minimum staffing and capital levels. The QFLP funds raised are also subject to requirements on capital, limited partner (LP) composition and a domestic custodian. It is partly for this reason that the number of foreign managers with QFLP funds has remained low given the level of commitment required to support an onshore business.

How should investors respond?

Our experience so far has been that international investors interested in RMB private equity already have experience of investing in China through USD funds. These sophisticated investors want to diversify, and access what has become the larger pool of private equity investment potential. It is this last point that we believe makes RMB private equity investing relevant to a growing number of institutional investors seeking a diverse portfolio exposure to China.

Whilst USD funds will remain the starting point for most institutions investing in Chinese private equity, the investable universe is expanding fast outside of current 300 active USD fund managers with at least 10,000 RMB registered fund managers added.

The recent geopolitical tension between China and the US, especially the focus by US legislators on Chinese companies listed on US exchanges, may well add to the case for RMB fundraising to be the first choice of more companies.

There is no denying that investing in RMB funds requires access to the local network of managers which itself takes considerable time to understand. Whilst the market has grown significantly over the last ten years, having an experienced team on the ground that knows the RMB managers is key.

What we have witnessed over the last ten years is not a short-term change but is part of a long-term shift in the world’s second largest private equity market and second largest economy. It is therefore only likely to climb in relevance for international investors when thinking about portfolio construction and diversification.


[1] STAR Market: Science and Technology Innovation Board is a pilot programme that, amongst other things, allows companies to list before they have turned a profit. 

[2]  Ministry of Industry and Information Technology (MIIT)

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