Beijing Outmuscles Shanghai to Take the Lead in China’s PE Industry

Qing dynasty lacquer from China First Capital blog post

It wasn’t supposed to turn out this way. Shanghai has lost its leading position at the center of the private equity industry in China. Instead, Beijing has grabbed the mantle, and is now the city in China with the densest network of active, top tier PE firms.

Could this be an example of the failure of central planning? It’s certainly the case that Chinese governments for the last twenty years have pursued explicitly the goal of making Shanghai the financial capital of China. The frequently-cited analogy: Shanghai, like New York, would serve the center of finance and trade, while Beijing would more closely resemble Washington, as a less commercial, more politically-focused city.

For quite awhile, this division of power prevailed. Shanghai’s stock market became the country’s largest, acting as magnet for banks and brokerage companies. Many of the first PE firms to enter China followed along, setting up their main offices in Shanghai.

Beijing, meanwhile, remained something of a financial backwater. It attracted the headquarters of the largest state-owned companies (like China Mobile, Sinopec, China Telecom), but never developed a capital market of its own. Beijing-based PE firms, in the main, were several steps behind their Shanghai competitors.  The capital and top talent were concentrated in Shanghai.

Today, the axis has shifted. Beijing is clearly in the ascendant. The money, the people and the future of the PE industry in China all seem to be going Beijing’s way. This shift was not the result of any specific government policy benefitting Beijing’s PE firms.

In fact, it’s only in Shanghai where such inducements are in place. The local government in Pudong, for example, has made a special push to attract PE firms, offering them various tax breaks to locate there.

How did Beijing gain the upper hand? Two main factors stand out: China’s central government has become the most significant large new source of PE capital. Second, the locus of IPO activity is also shifting from international stock markets, principally Hong Kong and New York, to China’s domestic exchanges. This has elevated the importance of Beijing-based China Securities Regulatory Commission (CSRC, or证监会  in Chinese). It makes the decisions about which Chinese companies can IPO in China and when.

There is simply no comparison between the work of the CSRC and the US Securities and Exchange Commission (SEC), the institution on which it was loosely modeled. The SEC lets the market decide which companies should IPO. The CSRC is nowhere near that laissez-faire. It decides which companies, from which industries, with what kind of profit level should IPO, and when the IPO should take place.

Any PE firm that needs domestic IPOs to achieve an exit needs to know how the CSRC works, and when necessary, how to properly influence them. Beijing-based PE firms are in the right place to influence this key decision-maker in the process of gaining exit for their portfolio companies.

There is no rule that says investment funds from the central government should be managed in Beijing, by investment firms based there. But, in practice, that’s what’s happening. This is very noticeable when you look at the PE firms selected to received renminbi funds from China’s enormous National Social Security Fund (NSSF or 社保 in Chinese), which has over $100bn in total assets, and growing fast. It plans to invest around 10% of its assets in private equity and other alternative investments. This will soon make the NSSF the largest Limited Partner for private equity firms.

Of the 20 PE firms so far selected to receive NSSF funds, a significant majority are Beijing-based, including powerhouses like SAIF, CDH, Legend Capital, NewHorizon. In addition, the NSSF has chosen to provide capital to a group of domestic PE firms, including Brightstone .

The NSSF isn’t the only Chinese government body providing funding for PE firms. Two other powerful and cash-rich institutions, the National Reform and Development Commission (发改会 in Chinese) , and National Investment Commission (国资会),are also playing a role steering capital to PE firms.

The more crucial advantage, however, is probably the Beijing firms’ deeper connections with the Beijing-based CSRC. Staging an IPO in China is a complex, time-consuming process and not terribly transparent process. It often requires many levels of central government involvement and approval. The CSRC is at the apex of this bureaucratic pyramid. It has the final say on which companies can IPO and when.

For a PE firm, building good relations with the CSRC is almost as important as choosing good companies to invest in. Those portfolio companies will have a better chance of a timely and successful IPO in China if their PE investor knows how the CSRC works, and how to push the approval process through to a successful conclusion. Beijing firms are usually best at working these and other levers of Chinese power. This skill trumps any advantage Shanghai may have as China’s official “financial capital”.

It’s a cumulative process:  the Beijing firms’ are growing richer and more skilled in the intricacies of Chinese decision-making and IPO planning. Their edge over Shanghai firms is therefore only likely to grow in coming years.

My company has felt the impact of this shift towards Beijing, and we’re responding to it. I’m certainly traveling there more and more. Our goal is to help clients become highly successful publicly-traded companies by arranging pre-IPO PE investment. The Beijing PE firms have a decided – and increasingly decisive – advantage.

They are well-integrated into the system that makes the key decisions in China, both by receiving funding from the central government and by building consistent and productive working relationships with the CSRC and other key agencies. We advise our clients to consider very strongly the advantages that Beijing PE firms hold.

Beijing has another key asset. The firms we work with are all well-led, with great people, both at partner level and below. For Chinese companies seeking PE financing, the road to success more often leads to and through Beijing.