Shanghai chips away at PE currency barrier

A pilot scheme would allow the conversion of up to 50% of an RMB fund from foreign currency, removing a huge hurdle facing foreign investors seeking access to China's private equity market.

The Shanghai Municipal Government is to introduce a pilot programme enabling up to 50 percent of the total capital of RMB-denominated funds domiciled in its area to be converted from foreign currency, according to a client note from the Hong Kong office of law firm Debevoise & Plimpton.

Currently, foreign currency conversion for the purposes of investment is restricted in China under a 2008 law from the State Administration of Foreign Exchange (SAFE) called Circular 142.

This remains one of the major hurdles for foreign investors seeking access to China’s booming private equity market, since foreign-denominated investment into Chinese companies, for example from a USD fund, is subject to lengthier and more stringent approval processes than RMB-denominated investment. As such, the Shanghai pilot scheme would be a significant step in leveling the playing field between foreign and domestic funds.

“If promulgated by the Shanghai Municipal Government, this pilot program would represent by far the most important development to date for foreign investors in the Chinese private equity market,” stated the Debevoise & Plimpton note.

Citing a source in Shanghai, the note says that GPs meeting “certain experience and capital-under-management criteria” will be able to obtain foreign exchange “quotas” for GP and LP commitments to RMB funds domiciled in Shanghai Pudong. “Each quota would be expressed as an amount of foreign currency that an approved person is pre-approved to convert into RMB,” it added.

Under the terms of the pilot programme, up to a total of 50 percent of any RMB fund’s capital will be able to be converted from foreign currency. Within that 50 percent foreign exchange limit, GPs themselves will be able to convert and commit a maximum of 5 percent of the total of the fund.

If promulgated by the Shanghai Municipal Government, this pilot program would represent by far the most important development to date for foreign investors in the Chinese private equity market.

Debevoise & Plimpton

This policy is a second advance for Shanghai in tackling the foreign currency problem. In November last year, the municipality reached an agreement with SAFE allowing GPs themselves to convert up to 1 percent of total capital commitments to a fund from foreign currency.

As such, it should give Shanghai a significant advantage as it jostles with other regional governments to attract foreign private equity firms to their region. In the absence of a comprehensive framework for the industry from the Central government, various cities have introduced incentive programs designed to promote the formation of private equity funds and fund management companies in their local jurisdictions.

Shanghai New Pudong Area was one of the first movers, announcing a pilot scheme for foreign firms in June 2009 which attracted several firms, including Blackstone, which launched a RMB5 billion fund under the initiative. The Beijing Municipal Bureau of Financial Work became the latest local authority to join the fray when it announced pilot measures to attract foreign private equity firms to its Zhong Guan Cun area in January. The Carlyle Group was the first firm to act on the measures, announcing the launch of a fund under the scheme which is reportedly targeting RMB5 billion.

At the same time, the Central government itself has been taking baby steps towards the greater inclusion of foreign firms. In November 2009, it raised hopes when it issued a set of rules on foreign invested partnerships. However, though these did give the green light to the inclusion of foreign investors under China’s limited partnership laws, they failed to address other key hurdles such as the restrictions around investment and foreign currency conversion.