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Following is the speech by the Under Secretary for Financial Services and the Treasury, Ms Julia Leung, at the luncheon of the 12th HKVCA China Private Equity Summit today (June 11):
It gives me great pleasure to address the 12th HKVCA China Private Equity Summit. There are many indicators to track the rise and fall in fortunes of the financial industry, and the one I'd like to use is where the financial heavyweights come and go. In 1997 when Robert Rubin stepped down as US Treasury Secretary, he joined Citigroup as Board member. In 2006, when his successor Larry Summers stepped down from the Presidency of Harvard University, he was a part-time managing director at D.E. Shaw, a hedge fund. In 2012 Mitt Romney, the presidential candidate who ran a well-funded campaign against Obama was a co-founder of Bain Capital. The stars are clearly rising for PE funds, you know why? I recently saw Charles Dallara, who had retired from the Institute of International Finance after being its Managing Director for 20 years. He didn't join any of the IIF's member international banks but a PE fund, Partners Group. These are telltale signs of how the global financing landscape has changed.
Indeed, the private equity industry is now a key player in Asia's evolving financing landscape. Asian-focused private equity funds have grown significantly over the last decade. The industry is estimated to have grown by almost four times in the last decade, to about US$422 billion of assets in 2012. The Asian region now accounts for more than 12 per cent of total global private equity investments, up from 6 per cent in 2000. What is noteworthy is this is a significantly larger proportion than the allocation of public market equity investments to Asia.
In terms of total private equity funds raised in 2012, Hong Kong accounted for US$9.3 billion, about 20 per cent of the Asian total, second only to Mainland China's 50 per cent, according to Asian Venture Capital Journal. About 45 per cent of funds raised last year were destined for private equity investments on the Mainland.
This trend of investments on the Mainland is likely to grow. There are several drivers behind the trend.
First, institutional investors from North America to Europe are going to increase their allocation to Asia. Against the background of extended periods of low interest rates, pension funds are seeking diversification into higher-yielding currency and higher yielding assets in Asia. The latest example is provided by CCP Investment Board and Ontario pension fund, which follows a growing trend of real money managers setting up in Hong Kong and investing in PE funds established here. In so doing, they are investing into the growth opportunities of the Mainland.
Second, within the region, there is growing institutional wealth and a burgeoning middle class who live longer, save for the future and want to invest. The demand for funds in the region is also growing faster than in any other region, in line with the growing need for investments in infrastructure.
Third, there is the growth opportunity on the Mainland, the theme of my remarks. By this, I am not referring just to the 7 to 8 per cent growth in GDP and the investment opportunities in the private sector. I am referring to opportunities opened up in Hong Kong when Mainland authorities ease capital controls to allow their funds to invest overseas and for foreign PE funds to bring offshore money to the Mainland.
Let me elaborate on this theme. In the last decade, Mainland authorities have taken steps in a gradual manner to open up portfolio flows under the existing capital control regime. There are three rules of thumb: first inflows then outflows; first institutional, then individual. And the third rule is the use of quotas to regulate the flows. The first step was taken in 2002 to allow portfolio inflows under the Qualified Foreign Institutional Investors (or QFII) program. To date, a cumulative total of US$42 billion of QFII quotas were approved for foreign institutional investors to invest into the Mainland's public debt and equity markets. The second step was taken in 2007 to allow portfolio outflows under the Qualified Domestic Institutional Investors (QDII) program. Institutional investors including Mainland insurance companies, pension funds, fund management companies are allowed to access securities markets overseas. To date, US$85 billion of QDII quotas have been granted.
Last year the pace of opening up to allow portfolio flows gathered momentum. First, the threshold for application to QFII quota was lowered, to a minimum AUM of US$500 million from US$5 billion, allowing PE funds to apply if they wish to get into public debt/securities investments. There is greater ease in the repatriation of funds, such as more frequent redemption. Most significantly, US$15.8 billion in quotas were approved last year, equivalent to 42 per cent of the accumulative total of in the last ten years (i.e. 2003-2012).
An even more encouraging development came in the form of RQFII, which raises offshore funds in yuan. The first two batches of RQFII quotas, 70 billion yuan in total, were granted last year to Hong Kong subsidiaries of Mainland fund management companies and securities companies. In March, participation in RQFII was broadened to all asset managers incorporated in Hong Kong and licensed by the SFC. A further 200 billion yuan was available for structuring into public and private funds. Last Friday, Hang Seng Bank became the first Hong Kong-based financial institution to be awarded RQFII status.
With regard to flows going out of the Mainland, the QDII rules are being revised to lower the eligibility criteria for applicants. But most importantly, Mainland institutional investors including pension and welfare funds would be considering investments in PE funds, like their counterparts elsewhere. This provides significant new opportunities for PE fund managers to tap into Mainland insurance funds.
Now this audience must be wondering why I've gone through a lot of acronyms in the alphabet soup without talking about the one that matters most to those PE funds trying to gain an onshore presence - ie QFLP. The pilot program was introduced in 2010 in the four municipalities, Beijing, Shanghai, Tianjin and Chongqing. The pilot allows for foreign PE funds to raise yuan funds onshore and to bring in foreign funds from overseas. It isn't smooth sailing for these pilots. I spoke to both the local PE fund industry, the finance services offices who run these QFLP programs and the central ministries. Foreign PE funds are still groping for a way that would enable them to acquire unlisted companies as and when they are ready to, just like the local PE funds, without having to deal with conversion and settlement issues from SAFE and Ministry of Commerce (MoC) for each and every deal. Meanwhile, the MoC has an industrial policy to administer foreign direct investment and SAFE has valid concerns that fund managers would bring in foreign currency to profit from yuan appreciation rather than investment in unlisted companies.
Now, the latest city which holds out the promise of doing things differently is Qianhai. Qianhai has a national mandate to be in the forefront of financial liberalisation. The rules announced so far, in November 2012 and March this year, govern the criteria and application for QFLP, RQFLP and QDLP; they are not dealing with the conversion or settlement issues. I participated in a high level meeting in Beijing in February chaired by NDRC, which is co-ordinating cross-ministerial efforts to implement the new Qianhai measures. There is no question about the determination of the CPG to provide a new deal for foreign PE funds in bringing in offshore RMB or converting USD into RMB and in facilitating investments in unlisted shares. I trust that Mr Rong Weihua of the Shenzhen Qianhai Authority will be able to explain that when he speaks next.
Next, I turn to the positioning of Hong Kong.
Hong Kong is well positioned to take advantage of these China opportunities. Our business environment is world-class, our markets are international, and our regulatory regime has strong international acceptance. Hong Kong also has a cluster of financial institutions with the expertise and network on the Mainland and overseas to handle the increased flows in both directions. In addition to the unique position under "One Country, Two Systems", we also have the policy support which is enshrined in the 12th 5-year plan. All the above has strengthened our position as the gateway between China and the rest of the world, and a testing ground for China's financial market liberalisation.
In the past few years, Hong Kong has capitalised on the advantages of the Mainland's gradual opening of its capital account. Financial institutions based in Hong Kong are by far the largest intermediary for capital flows into and out of China. For one, Hong Kong is the biggest destination for QDII investments, with about 60 per cent of assets invested in the Hong Kong market. Similarly, Hong Kong financial institutions are also taking advantage of the expanded RQFII policy to increase the diversity of the RQFII product market in Hong Kong and to distribute them overseas.
Despite all the strengths and opportunities mentioned, we are fully aware of the fierce competition among financial centres and there is no room for complacency at all. To stay competitive, we conduct constant reviews to ensure that this government provides clarity and certainty in tax, regulatory and legal frameworks for funds to operate here.
In the Budget announced in February this year, the Financial Secretary proposed to extend the profits tax exemption for offshore funds to include transactions in private companies which are incorporated or registered outside Hong Kong and do not hold any Hong Kong properties nor carry out any business in Hong Kong. This will allow private equity funds to enjoy the same tax exemption as offshore hedge funds.
When formulating the above new initiative, we will need to consider how we can prevent abuse of the exemption arrangement for tax avoidance. I understand the HKVCA is putting forward its advice to the Financial Services Development Council, and we look forward to working closely with the industry with a view to commencing the relevant legislative exercise as soon as practicable.
At the same time, the Budget also proposed introducing Open-ended Investment Companies (OEICs) as we note that OEICs have become an increasingly popular form used by the fund industry to set up investment funds. We are joining hands with the Securities and Futures Commission (SFC) to formulate legislative proposals to permit the market to establish such companies, and to provide for a regulatory framework governing them, so as to offer an additional choice for the market, and attract more funds to be based in Hong Kong and serve Asia.
Ladies and gentlemen, we are living in challenging times. The exit environment on the Mainland has been difficult, public market valuations on the Mainland have declined, while sellers in the private market have not reduced their valuations. The days GPs can sit back and invest in anything that moves are long gone. This is the new normal. While opportunities abound within the China market, there is no plain sailing. There will always be headwinds. It would take GPs all of your skills to navigate through unchartered waters, to create real value and to be rewarded ultimately. This, afterall, is the nature of your business.
Thank you.
Ends/Tuesday, June 11, 2013
Issued at HKT 16:07
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