At a major industry conference in Beijing earlier this month, the hall was abuzz with talk of a resurgence in USD-denominated private equity funds. Last year, USD-denominated funds made up 60% of the $40bn raised by managers in China, which was highly unusual given that in the previous decade, RMB-denominated funds dominated the fundraising market.
To understand what and why this happened, we have to travel back in time.
The year is 1995, and TPG have just raised its first USD-denominated fund to invest in Asia, with its sights set on China. Before long, other international GPs – like Actis, Carlyle and Sequoia – are also in the country. The success of this first wave of pioneers led more established brands to set up shop. Industry practitioners who remember that period told us that deals flowed freely, and exits at higher valuations were a dime a dozen.
Fast-forward about 10 years, and spin-outs from Chinese executives who had learnt their craft from these international GPs are starting to dominate the space – so much so that, by 2009, the majority of private equity funds raised in China are RMB denominated. This golden age lasted for almost a decade and coincided with the rising affluence of local corporates, whose founders had excess capital to deploy into higher-yielding private equity instruments.
So why did the pendulum swing back to USD-denominated funds in 2018?
A couple of factors come to mind, but two were particularly damaging for RMB-denominated funds: the rising trade tensions between the US and China and credit tightening in the Chinese economy. Tariffs hit the bottom line of Chinese corporates and reduced the personal net worth of high-net-worth individuals, taking away a key source of capital for RMB-denominated vehicles. The banking regulator’s requirement for banks to properly recognize bad loans reduced liquidity in the market, further destabilizing the position of corporate investors and reducing the viability of RMB-denominated funds.
However, private equity professionals are highly adaptable, and many have pivoted to USD capital sources in response. These are typically GPs that have a successful track record and prior relationships with LPs holding capital in USD. Those without such attributes and accolades now find themselves in unfamiliar territory – and are learning a valuable lesson on capital diversification.
With no let-up in US-China trade tensions on the horizon, the RMB liquidity crunch is set to continue, and it will take some time for Chinese banks to clean up their loan books. It is therefore reasonable to expect USD-denominated funds to once again outnumber RMB-denominated vehicles in 2019; the pendulum will hover above USD-denominated funds for a while yet.
Please note: we will be holding our inaugural Beijing seminar on 18 June 2019. We have invited a panel of international investors to share their insights on the similarities and differences in evaluating RMB vs. USD managers. Find out more about this event here.