Foreign private equity braces for rough ride to China -ANALYSIS

May 20, 2011

Helen H. Chan

HONG KONG, May 20 (Business Law Currents) Foreign-invested private equity firms are rallying in Shanghai, eagerly awaiting the results of a second round of applications for the Qualified Foreign Limited Partners (QFLP) scheme. In recent weeks, large international buyout firms such as Blackstone and the Carlyle Group have rejoiced over being some of the first to be awarded a QFLP license.

Although the QFLP seems to have gone one step further in liberalizing private equity deals between foreign investors and domestic targets, perks of the scheme come with a tangle of very sticky red tape. Recently, financial authorities in Shanghai have published several guidelines to facilitate the second round of approvals for QFLP licenses. Aiming to aid domestic entrepreneurial efforts, the newly-issued requirements appear to favor applicants with connections to government-backed funds and homegrown Chinese enterprises.

Established in early 2011, the QFLP permits licensed non-Chinese private equity firms to convert foreign currency into renminbi for onshore investment in China. Once approved, a firm may convert foreign currency, up to a quota permitted by its license, without approval by the State Administration of Foreign Exchange (SAFE).

Previously, SAFE approval was required for every single foreign exchange transaction. Under the QFLP scheme, qualified foreign private equity firms can launch RMB-denominated funds using overseas capital. For more information, please see PRC Private Equity: Destination Shanghai?

Recently, the Shanghai branch of SAFE and the Shanghai Financial Services Offices have issued several guidelines which will be used to review applications for a QFLP license. In addition to considering large buyout firms, authorities have indicated a desire to look at technology-focused funds and firms that support small to medium Chinese enterprises.

Aside from examining whether applicants have concrete investment and capital contribution plans, applicants will be vetted on whether their management team has relevant PRC experience and a successful track record of investing in China.

Of note, authorities have expressly indicated in the guidelines that ties to Chinese government funds and state-owned enterprises are a plus. Similarly, funds focused on favored sectors such as new technology industries may also be closer to winning approval. Overall, preference will be given to applicants that “contribute to the domestic Chinese economy.”

In addition to vying for local connections and a coveted QFLP license, foreign private equity firms face stiff competition from local Chinese funds and smaller firms. Often headed by industry veterans, these smaller competitors may have a more intricate understanding of the investment terrain in China. Earlier this month, a new kid on the block, Primavera Capital, cemented its presence by announcing a buyout of Chemspec International, China’s largest-selling fluorinated specialty chemicals manufacturer. Founded by ex-Goldman Sachs Greater China Chairman Fred Hu, Primavera Capital, in conjunction with two members of Chemspec’s senior management, filed a going-private transaction statement with the SEC in early March.

According to the statement, the buyout has been in the works since September 2010. Pursuant to the terms of a merger agreement, Chemspec will merge with Halogen Mergersub Limited. Mergersub’s parent, Halogen Limited, is a Cayman Islands entity beneficially owned by Primavera and Chemspec’s chairman of the board of directors as well as its chief executive officer.

Earlier this spring, Chemspec’s board of directors, armed with the unanimous blessing of the company’s independent committee, recommended the buyout to its shareholders. The merger, however, needs to be approved either by special resolution or agreed upon by at least two-thirds of the company’s registered shareholders. In the event the merger is successful, shareholders will be entitled to receive US$8.10 per ADS.

David Zhang of Latham & Watkins is advising Primavera Capital on the transaction. Gregory Puff of Shearman & Sterling is representing Chemspec International.

Though the QFLP pilot program has made establishing a RMB fund somewhat easier for qualified foreign firms, a number of challenges remain. While the scheme has eliminated the requirement for SAFE approval, QFLPs will still have to contend with the Ministry of Commerce, which oversees various aspects of foreign investment in China, including investment plans, acquisitions and capital contribution transactions. Even with the QFLP, factors such as competition from local players, unfamiliar investment terrain and complex foreign investment regulations still make China a challenging destination for overseas private equity funds.

(This article was first published by Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk from Thomson Reuters Accelus. Visit Business Law Currents online at


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