Private equity is a core part of the business for Caceis’ Hong Kong office, which looks after clients in China and Europe. David Li, chief executive officer, explains why private equity enjoys strong client demand and how it is being used to fund China’s international infrastructure ambitions. In August 2018 you mentioned that your clients are showing strong interest in private equity and real estate funds. Why does private equity continue to garner strong interest and where are you looking for opportunities in 2019?
We are still seeing this strong interest in private equity and real estate funds from our clients in 2019. It is a trend we see in Asia, as in many other global markets, that is driven by investor demands for diversification in terms of stable returns that are not linked to the financial markets, as well as a readiness to accept more illiquid, longer-term investment opportunities. This is especially true in Asia, where, for example, a new Japanese government ruling allows pension funds to invest up to 5% of their assets in alternative products to diversify portfolios and help achieve a stable return. Private equity and real estate still offer a host of investment opportunities, especially in Asia, and their proven ability to create value keeps them at the forefront of investors’ and fund promotors’ minds. The current uncertainty in the financial markets stemming from the China–US trade war and the UK’s withdrawal process from the EU is another factor that is steering investors away from traditional markets. Finally, developments in jurisdictions like the EU that have put in place a well-defined regulatory framework that both facilitates alternative fund creation and distribution while ensuring tight legal protection for investors, are facilitating the entire process. An aggregate of $757 billion was raised globally in 2018 by private capital funds in general, according to industry data provider Preqin. Over 56% of this capital was raised by private equity funds in particular, which still represents the lion’s share of private markets. Nevertheless, infrastructure and private debt have also seen vital progression in terms of amounts raised in 2018. More specifically, the private equity sector is seeing a significant up-tick in pre-IPO venture capital investments in the technology, media and telecom (TMT) sectors, with numbers for last year’s venture capital deals in China rising to $38 billion, representing over 56% of the US ($67 billion). What are the major trends in the private equity market at present and how is Caceis’ Hong Kong tailoring its services to meet the needs of its clients both in China and Europe?
As mentioned, there is a major global trend of new regulations permitting pension funds and life insurance company funds to invest some of their assets into alternative investments to allow them to better diversify and benefit from private markets’ stable, risk-adjusted returns. This figure can be 5% of pension funds’ and life insurance funds’ overall allocations, but can sometimes reach 20%. Another factor that is having a major impact on the private equity sector is the Belt and Road Initiative (BRI) and the Chinese government’s initiative to promote infrastructure development and investments in countries throughout Europe, Asia and Africa. The BRI aims to address an “infrastructure gap” and estimates determine that over the next ten years, projects will require some $10 trillion in infrastructure investment. Two public sector structures are designed to provide some of this funding: the Asian Infrastructure Investment Bank (AIIB), a multilateral development bank focused on debt financing, and the Silk Road Fund, a state-owned investment fund of the Chinese government funded through equity investment. So far, these two public-led finance initiatives have managed to channel some $70 billion into BRI projects, but this still falls far short of the BRI’s financing goal of $10 trillion. In order to fill the gaping need for long-term capital, the Chinese government is promoting public-private-partnership (PPP) projects, which help channel private equity money into infrastructure. The combination of PPP and private equity benefits from both government oversight and private capital’s efficiency requirements. Caceis has first-hand experience in supporting the needs of companies involved in BRI financing initiatives. We assist Asian clients in structuring investments via optimum European onshore vehicles, fully compliant with the AIFM Directive, which establishes much-needed risk control procedures, affords high levels of investor protection and enables the fund to be commercialised via passporting in most European countries. Ever more Asian promotors are seeing their peers benefit from Luxembourg’s jurisdictional advantages and broad “toolbox” of fund structures, supported by Caceis’ private equity, real estate and infrastructure fund services via its dedicated business line, and they are inspired to follow suit. What impact is the US-China trade war likely to have on private equity deals in the region?
Tariffs imposed on goods manufactured in China may reduce the valuations of certain Chinese companies, but on the other hand, may increase the value of competing manufacturers in other countries such as Vietnam or Bangladesh. There have clearly been cases where deals have been called off due to tariff-related uncertainties but nevertheless, the company was quick to find another buyer with a more positive outlook on the valuation. So there is increased unpredictability, but that often leads to more investment opportunities. The trade war is definitely having an impact on the TMT sector, where China and the US represent the two largest TMT private equity markets. There is a huge amount of cross investment between the US and China, but the flow has recently started to slow down. Private equity capital raised by China-focused and headquartered private equity firms reportedly reached just $3.6 billion in the first half of 2018, which represents a 50% decline on 2017’s half-year figure. However, the decline is a sign of something else – a change in allocation strategy. Caceis is seeing many clients favour a model designed to attract European investors, or even set up a new, highly regulated structure domiciled in Europe. With the Chinese government looking to promote foreign direct investment (FDI) and increasing the flexibility of the QFII and RQFII programmes, the process of investing in China’s TMT sector is greatly facilitated. Do you think Asia will continue to account for a greater proportion of dry powder?
The trends emerging from our client base show that investors and promotors believe that Asia holds great opportunities both for successful buy-out deals and investment into growth industries. Capital destined for Asian investment continues to flow into the private equity space at a steady speed and we are seeing a surge in deal-making boosted by the huge volumes of capital available to finance it. We see internet and tech, particularly in China, as having the largest sums of dry powder focused on it. As demand for diversification in terms of asset type sees illiquid alternative funds feature ever more prominently in pension and insurance funds, so the same drivers also push for geographic diversification. Deal flow is picking up strongly and last year, Asia saw more private equity funds closed than Europe for the first time – 250 vs 196 respectively. However, private equity does face challenges, with trade tension and regulatory scrutiny impacting outbound deals from China, so we have yet to see what impact this has for our clients and the wider private equity business. ©2019 funds global asia