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December 23, 2009

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Yuan funds prove force for the future

YUAN-DENOMINATED funds are eclipsing their foreign peers in China, spurred by favorable government policies and growing domestic markets in venture capital and private equity.

Among 90 venture capital funds started in the first 11 months of this year, 82 of them were denominated in yuan and raised the equivalent of US$3.5 billion. That accounted for about 70 percent of the total raised, as foreign limited partners retreated amid the global credit crunch, according to a report by the Zero2IPO Research Center.

"Investment by yuan funds will exceed US dollar-denominated funds in three to five years as more institutional investors join in the market," said Roman Shaw, founding partner of DT Capital Partners.

In the first 11 months, yuan-denominated investments, accounting for 45.5 percent of venture capital investment in China, totaled US$1.09 billion.

Investment firms are setting up more yuan funds because the funds enjoy looser government approval procedures and are allowed to invest in more sectors than traditional foreign-currency funds.

The Chinese government wants to encourage the development of the private equity market as part of its efforts to propel the economic recovery, which has relied heavily on stimulus spending.

"Stimulus policies by the government and the launch of the growth-enterprise market ChiNext have laid the foundation for the domestic private equity market," Hu Zhanghong, chief executive of CCB International, said at a recent private equity conference in Shanghai.

Exit channel

The launch of ChiNext, China's Nasdaq-style board, has fueled the number of private equity funds offering yuan funds as an exit channel for stock market investors.

Of the 36 companies that went public on the new board, 25 of them are backed by venture capital and private equity firms. Their returns were about six times their investments on average, thanks to the high valuations on ChiNext.

"More funds will be raised domestically and exit through domestic channels in the future, so we are expecting to raise dozens of billions of yuan from the domestic market," Hu said.

Some foreign investors have switched their focus to yuan-denominated funds. For example, the US-based Blackstone Group plans to launch a 5-billion-yuan fund focusing on Shanghai-based investments.

The China Venture Capital Association said in a recent survey that 41 percent of foreign private equity and venture capital firms not yet offering yuan-denominated funds plan to do so in the near future.

Among those already offering these funds, almost one in six plans to expand its yuan offerings, according to the survey, which covered 39 foreign private equity and venture capital investors.

About 84 percent of respondents said they are optimistic about the exit channels in China, which underpins their interest in offering yuan funds.

At the same time, many of these investors are looking for the government to adopt even more preferential policies, the survey said.

One drawback that concerned respondents is the lack of transparency in Chinese government policy, the survey found.

The government in November said that it would allow foreign investors, excluding private equity and venture capital firms, to set up limited partnership companies in China starting in March.

Private equity and venture capital firms are required to set up limited liability companies or non-legal person entities to do business in China. Non-legal person entities are similar to limited partnerships in the US in terms of liability and taxes.

About 71 percent of respondents said they expect China to improve transparency in its tax policies, foreign-exchange settlement procedures and rules governing investment for foreign-backed yuan funds.

Lack of qualified limited partners in China is another concern. About 70 percent of respondents said foreign investors don't have a sufficiently wide pool of domestic partners to choose from.

"The development of yuan funds is an irresistible force in the years to come, but the most pressing problem is lack of mature limited partnerships," said Andrew Yan, managing partner of Hong Kong-based SAIF Partners.

Only the national pension fund is an experienced limited partnership in China, while banks, insurers and state-owned companies are not allowed to invest in yuan funds, he said.


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