Stricter regulations eliminate unqualified funds, but holes remain

By Li Xuanmin Source:Global Times Published: 2017/1/24 19:08:39

Reining in private equity


China's private equity (PE) industry had an eventful year in 2016. The industry's regulator tightened the rules for funds, initiating a registration system for PE fund managers. It also required fund managers to pass a national qualification exam to take a job in the industry. The regulations have eliminated many unqualified funds from the market, a change that one fund manager applauded as contributing to the industry's sound development. However, people in the industry pointed out that holes remain in the regulations. One suggested regulators focus on cracking down on illegal fundraising. Despite fluctuations in fund returns, experts forecast the PE industry will grow quickly in 2017. 

Illustration: CFP - GT

Illustration: CFP - GT



Since Wang Hua (pseudonym), a private finance lawyer, sent out a message on Friday to a private placement WeChat group about a client's desire to acquire a "shell" company to create a private fundraising organization, about eight firms have contacted him with offers.

Such organizations, which invest in stocks, bonds and real estate and are only open to private investors, are generally known in China as private equity (PE) funds.

"The client is in a hurry to issue PE products, but if he followed proper procedures, it would take more than two months," Wang told the Global Times on Sunday. "Buying a shell PE company will cut the time to about a month, even though it is against the rules."

The price of a shell PE firm runs from 500,000 yuan ($72,920) to 1 million yuan.

The procedure Wang referred to is the registration of PE firms. In 2016, the Asset Management Association of China (AMAC) strengthened compliance requirements and asked PE funds to put their qualifications on file.

The registration qualification is detailed, according to people in the industry. For example, it requires at least three senior executives at a PE fund to have passed the national qualification exam for private investment fund practitioners, said Qi Mingyang, chairman of asset management firm Fortune Valley Capital Investment Group. "The exam has been a big change to the industry."

In addition, PE funds are supposed to provide a legal advisory paper to the AMAC, Qi told the Global Times on Sunday, noting that the legal fees for such documents add up to 100,000 yuan.

"The sector has been developing too fast, so fund regulators launched stringent measures in 2016 to rein in emerging risks," Qi said.

Fundraising and fraud

As of the end of 2016, there were about 17,400 registered PE organizations on the Chinese mainland, managing 10.24 trillion yuan in assets, double the amount of 2015, according to AMAC data. The amount has surpassed that of public offered funds.

Since the rules got stricter, however, the number of people in the business has plunged. As of the end of 2016, there were 272,000 professionals involved in the business, down 30.24 percent from the previous year, the data showed.

About 12,000 PE funds were stuck from AMAC's records in 2016, including 1,015 funds whose operations appeared "abnormal." Among those, 26 have "lost contact," including Shanghai Zexi Investment. Zexi's chairman, Xu Xiang, who had been the country's top hedge fund manager, was sentenced to five and a half years in prison on Monday for stock market manipulation.

The PE sector has been plagued by illegal fundraising, a practice in which some funds raise money from ordinary people to invest in private funds, Qi said.

Under industry rules, PE funds are not allowed to solicit money from individuals who cannot afford to invest at least 1 million yuan because of the risky nature of the funds.

PE funds have also been involved in online lending, including peer to peer (P2P) platforms, which have been plagued by default scandals, said Chen Guodong, co-founder of Matrix Partners Capital. In extreme cases, fund managers promised high returns to investors, only to then disappear in an apparent "Ponzi scheme."

Another problem is zombie companies, experts said. In some cases, people outside the industry register PE funds merely because they want to get in on what appears to be a lucrative business, Wang said. Later, they realize that raising money for private funds is difficult and it's hard to make a lot of money managing a small amount of assets, according to Wang.

"So some of them quit, while others disappear," Wang noted.

The regulatory changes have led to an industry reshuffle, "but clearing out disqualified organizations is conducive to fair competition and sound development in the industry," Chen told the Global Times on Tuesday.

Outside the lines

There are some areas of the PE industry that still fall outside the regulatory boundaries the AMAC set up in 2016, according to a PE fund manager at data company simuwang.com, who preferred not to be identified.

For example, a qualified private fund advisor in the PE industry must have at least three years of experience managing securities and futures without any black marks on his or her record, the manager said. An advisor also needs to have been a registered member of the AMAC for at least a year.

The problem is that there aren't enough qualified people to meet demand. "So currently, it is easier to find private fund advisors serving at several different PE funds," the manager told the Global Times on Monday.

The manager suggested that the AMAC open up its registration to employees at PE funds, effectively curbing such scenario and lifting the threshold to entry.

He also claimed that buying "shell" PE firms that already have the necessary qualifications is one way to get around the rules.

Wang agreed. But he pointed out that the key problem plaguing China's PE industry is the fundraising process, rather than unqualified managers, "which means regulators should focus on this area and release more detailed rules."

'High-speed growth'

PE funds that invest in the primary market have performed much better than funds that invest in the secondary market. In 2016, 74 percent of funds that invested in stocks posted net losses, according to data from simuwang.com. In 2015, only 21 percent of funds that invested in stocks posted net losses.

In primary market, investment has remained lucrative, according to industry information. Qi company's rate of return on several products averaged at 8.5 percent annually in 2016.

Qi predicted that there will be a change in the investment structure of PE funds. "More funds will flow into the primary market, as investors expect the rate of return to rise due to the revival of China's real economy, the government's push for innovative and high-tech industries, as well as an upcoming tightened credit policy."

Overall, the PE industry will experience "high-speed growth," Qi said.

   

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