Sep 07, 2020 09:10 PM

Ling Huawei: Time to Put China’s Private Equity Sector Under the Spotlight

The relationship between PE firms, intermediaries and investors exposes shortcomings that need to be addressed.
The relationship between PE firms, intermediaries and investors exposes shortcomings that need to be addressed.

Ling Huawei is managing editor of Caixin Media and Caixin Weekly.

An investment in fintech giant Ant Group Co. Ltd. by a fund run by a well-known Chinese private equity (PE) group hit the headlines recently as news emerged of an ongoing lawsuit against the firm and the trust company whose financial product was the vehicle for the investment.

A group of aggrieved investors is suing the firm and the trust company over the sale of the investment and is alleging that the PE firm sold the investors' stake in Ant Group at a lower-than-market price for the benefit of insiders. The incident has raised questions about whether the firm used its position to gain profit for itself or its associates.

This entire saga raises deeper, more fundamental questions about the nature and function of China’s PE industry — are these funds suitable investment platforms for smaller investors, especially individuals with low risk tolerance and a lack of investment experience, and should there be a proper mechanism for the selection of qualified investors; are the layers of intermediaries between investors and the final investment creating a trust deficit between fund managers and their investor clients.

PE funds are high-end alternative investment services that provide capital for technology, innovation and industrial integration and create long-term value. While they require investors to be able to bear a high degree of risk, they can also generate high returns from the rapid growth or restructuring of the companies and industries they’ve invested in.

Traditionally, the main investors in PE funds have been institutions such as sovereign wealth funds and pension funds but they now also attract high net worth individual investors who, in the West, need to meet minimum asset requirements and have a verifiable legal source of income.

The PE industry in China is still immature, in part due to the lack of a stable, established source of long-term private capital and in part due to the underdevelopment of institutional investors such as pension funds and sovereign wealth funds. The source of much of the private capital accumulated over the past 40 years since reform and opening up started is not transparent, and it is difficult to distinguish between legitimate income and illegal income. There is also a lack of adequate protection of the legitimate rights and interests of private capital, further increasing opacity.

Even so, over the past decade or two, the wealth management industry in China has grown rapidly and is anxiously looking for investment opportunities. As a result, there has been a growing trend for PE firms to tap into this market, opening their funds to the lower-end segment of high net worth individuals by allowing them to invest through other channels that create layers between the firms and the end-clients.

The above-mentioned dispute is a perfect example of this multi-layering: the investors indirectly invested in the PE fund through a trust plan issued by a trust company.

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In Depth: Private Equity Firm Accused of Selling Ant Group Stake to Chairman’s Siblings

High net worth investors have become an important source of early-stage financing for small, rapidly growing companies, which is provided by financial institutions such as trust firms, private banks and third-party wealth management companies. The minimum investment required can be as little as 1 million yuan ($146 million).

However, many of these individuals do not have professional expertise to assess the quality of their investments and it’s questionable whether they have the appetite for the high risks involved. It’s certainly valid to question whether they really are qualified to invest in PE funds and whether the appropriate legal mechanisms, such as fiduciary obligations, are well established enough to protect them.

It’s evident that trust firms, which should have focused on asset management, have become wealth management institutions that use their financial licenses to raise money from the public and reinvest the money in PE funds who bear the ultimate responsibility for investment. As a result, these trust firms aren’t building up their capabilities in terms of investment and risk management. This high degree of separation of fundraising and investment decision-making seems to be efficient, but in fact conceals a host of problems.

The layers of intermediaries that separate PE funds from investors also creates agency problems, as each layer benefits from information asymmetry and is motivated by maximizing its own returns. As a result, it may not always act in the best interests of the end-client.

The chain of financial products should be kept as short as possible, so that the responsibilities and rights of the various parties are aligned and the pressure for external supervision is reduced. One way of doing this is to be open and transparent about the bonuses awarded to PE fund managers for any excess returns on investment, which would help build long-term trust with investors.

PE fundraising with Chinese characteristics has become very popular, leveraging the powerful ability of financial institutions and wealth management companies to bring in funds from the general public. But in doing so it has severed the relationship between the PE managers and their investors and given rise to a problem of lack of fiduciary obligation on a range of issues such as the sale of maturing assets and a fair mechanism for the distribution of profit. That, in turn, has led to criticism and confusion among investors.

The commentary has been edited for length and clarity.

Translated by Timmy Shen ( Contact editor Nerys Avery (

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