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[Original Research] Economic Logic behind Game of Capital

Date: 2017-06-15
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China Venture Capital Co., Ltd., the local earliest private equity investment institution, was incorporated in 1986. Since 30 years of development, China is currently the second largest global equity investment market, and privately offered fund becomes indispensable player in China’s capital market. Recent years have witnessed favorable policies in private equity investment. Exit channels of capital market present a tendency of diversity, for example, IPO normalization, process simplification of review by M & A Committee, and NEEQ’s encouraging excellent enterprises to transfer. In 2017 Government Work Report, China will work to push ahead with securitization of corporate assets, expand equity financing, vigorously develop seed fund to guide private equity investment, and direct long-term capital investment “from virtual to real”. Driven by multiple favorable policies and market, the private equity fund industry enters the fast lane. According to Asset Management Association of China, towards the end of 2016, 48,700 privately offered funds were registered, reaching the subscribed volume of RMB 10 trillion Yuan, which outpaced publicly offered fund management assets at the same period.

The privately offered fund industry is still encountered with dilemma, though it showed rapid growth. For example, asset shortage means investors have no profitable projects invested with a large amount of money, and the yield of fixed-income assets generally falls. The competition is stiff. There are so many equity investment institutions, but they are in disordered competition. Therefore, institutions have to seek investment programs at the cost of reduction in standard and expected return. With these two factors, project valuation keeps soaring. What’s more, the termination of market expansion and increasingly stringent regulatory environment make project exit more difficult.

TTGG is one of the earliest private equity investment institutions in China. Through over a decade of growth, it has gotten to the top ten rankings, and is a trusted service provider to more than 100 listed companies, large industry groups. It vigorously supports real economy, well demonstrated by the aggregate investment amount of RMB 20 billion Yuan. Its all-round presence in 3 business segments plays an exemplary role.

There is a huge gap between China and the developed world in private placement industry. For example, USA privately offered fund industry is 10 times larger than China’s in asset scale under management. Its management scale is 20 times larger than Chinese peers on average. While Chinese privately offered fund investors are main HNWIs, USA objects are institution investors, including pension fund organizations, sovereign wealth fund organizations, non-profit organizations, insurance companies, banks. In USA, public pension funds account for 27% of the privately offered fund, and this figure is still on the rise, compared with 13.9% of individual investors.

The era of capital game is coming

Along with the falling return of real economy, financial capital is surplus that requires “from virtual to real”, and more and more industry capital needs seeking for new ways out. The game between financial and industry capital creates a favorable tendency of integration of industry and finance.

As real economy and ROE of leading companies are intensively improved, and industry oligarchs become mature gradually, equity M&A of listed companies gains momentum under the background of lower capital costs. Meanwhile, industry capital tends to transfer and banner by virtue of secondary market agreements as backdoor restructuring and other exit channels are obstructed. According to data of Wind, equity transfer of listed companies stood at 20 deals in 2014, adding to 80 in 2016. The growth is obvious.

Similarly, financial capital aspires to its participation in real industry economy. The better-known insurance capital has frequent actions. For example, Anbang Insurance has purchased several listed companies with banner. They feature high ROE, high dividend, abundant cash flow, low valuation, and separation of ownership, enabling financial capital to obtain good return and have a greater say.

In the trend of integration of industry and finance, financial holding platform mode is emerging. That means industry capital registers, or holds shares of, a financial institution, or buys financial service license, to build a financial holding platform. As a result, it may receive investment return and financing facilities, increase use efficiency of capital, reduce capital lending costs, while continuing the superiority with capital. Financial capital will be hindered if it goes ahead with single business. But the incorporation of financial holding platform with several financial service licenses may help it enter investment field.

Deleverage is the core of current policy

In recent years, interest rates are determined by the market, money supply is sufficient, and bank off-balance sheet activities make progress. That triggers highly indebted and underestimated stock situation in finance system, rising leverage, and capital “form virtual to real”. On the whole, China’s overall leverage ratio stood at 237.6% in 2016, lower than that of major developed countries, including USA, Europe, and Japan. To be specific, government and household leverage ratios were not higher, but that of non-financial companies climbed to 141%, a little high.

Statistics showed that four big banks put 60% of loan increment in real estate industry, up to 23% of total investment. When it comes to total housing loans, the balance rose to RMB 3.5 trillion Yuan in 2016, equivalent to 2.5 times of the level of Japan. The housing loan solvency ratio of USA residents declined to 4.5% in 2016 from 7.2% in 2007, while that of Chinese residents reached 6.6% in 2016. As mentioned above, payment burden of Chinese people exceed USA’s. The above figures revealed that there was a bubble in Chinese real estate market. That results from several reasons, including land scarcity, capital shortage in household investment and use of leverage.

Therefore, the core of policies before us is to prevent risks, deleverage, and strengthen inter-bank regulation. In new thinking mode, we may reduce enterprise production costs and improve efficiency by reduction of interest, tax, expenses. We can launch PPP to boost aspiration of private investors. We also include off-balance sheet financial management in MPA, standardize financial regulation and other ways to realize deleverage.

We need to see that push ahead with securitization of corporate assets, the idle assets of enterprises are put to use, and complete structural financing. These efforts may help us deleverage. The securitization of corporate assets refers to ABS, MBS and REITS which are shown in the left side of a balance sheet. It aims to drive left development trend of finance.

Middle- and long-term economic cycle features “sharp decline and slow rise”

During the first 30 years of reform and opening up, China’s economy presented obvious “10-year period”. After 2007 global financial crisis, China’s economic cycle of “10-year period” was broken. In 2016, experts reckoned Chinese economy developed in L growth path. Today, Chinese economy is still hovering over the bottom.

China attributes economy slowdown to the following 7 reasons: diminishing demographic dividend; due to high cost of urban living, fewer employment opportunities, the progress of urbanization slows down; the expansion effect with WTO accession is less influential; the peak construction of infrastructure investment is over; global industry focus shifts for many times; the state intensifies the constraint of resources and environmental carrying capacity; the side effect of excessive money stock occurs.

China sees economy begins to stabilize in short term, and investment is the first impetus for economic growth. According to statistics of Wind, infrastructure investment serves as the vanguard of ensuring growth among four categories. PPP strongly supported by Chinese government starts a new wave of infrastructure fever.

China experienced a long journey from underdeveloped to developed: traditional society → preparations → growth → mature → high consumption → quality life. If the first cycle (1978-1988) after reform and opening up is considered as economic preparations, and the later period (1992-) of the second cycle (1989-1997) as growth stage, China currently is still in the later growth stage (from WTO accession until now).

China is at an intermediate stage of development, and efficiency is improved. That marks it now becomes a middle-income country from a low-income one with labor-intensive economy. If economy is driven more by innovation, and China is transformed to capital-intensive economy, China will gradually grow up.

(This article is based on lecture of PhD GUO Feng, TTGG Managing Partner and President of TTGG Financial Research Institute on “AFR Financial Innovation and Development Seminar” on June 9)

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