Oxford MBA Essay 2:
Which recent development, world event or book has most influenced your thinking and why?

As a private equity professional, I find a recent policy by Chinese government designed to strengthen the role of PE market in China’s economic development will have a profound impact on China’s PE industry. Based on my research, I offer the following analysis concerning the policy’s implications for both foreign PE and domestic PE in China’s financial market in the years to come.

On December 3, 20XX, the standing committee of the State Council of China issued 9 financial policies designed to promote the country’s economic development. In those policies, the idea of “Private Equity” was explicitly mentioned as a way to expand the channels of corporate financing. Five days later, the State Council issued “Specific Financial Measures for Promoting Economic Development”, which proposed the establishment of mechanisms for managing PE.

The end of the year 20XX, amid the raging global financial crisis, saw the first official acknowledgment of PE in the formal documents of the State Council. Previously, it was referred to as “Industrial Investment Fund” by government departments. The official recognition of PE marked the central government’s open embracement of PE. Chinese leaders have ultimately realized that PE, with its readiness to enter the market on a large scale when the market value is lower than the market prices, can constitute a powerful force to counter economic downturn.

The impact of the global economic cycle, the financial upheavals, and the promotion of the government from above in the form of policies and specific measures, all those factors have contributed to a critical time when China’s domestic PE operations will become well-regulated and considerably expanded. They have also created unprecedented and favorable conditions for foreign PEs, especially large-scale European PEs, to enter the Chinese market. As a PE professional with nearly two years of experience with the country’s Top 4 equity organization, I believe this event will produce a far-reaching impact on China’s financial industry.

The Dilemmas of China’s Domestic PE
PE is a new concept to China’s financial industry. Since the creation of the first venture capital by Walden International (WI) Harper Group in XXXX, PE has been in China for 2 decades but it is only in recent years that its function has come to be realized by China’s central government.

In 20XX, the first large-scale domestic PE—Bohai Industrial Investment Fund—was created and since then 9 more equities were approved by the State Council and National Development and Reform Commission. With a total of 100 billion RMB, those ten equity funds became a strong force in China’s PE market. However, as they are all government sponsored, their organizational structures are extremely complicated. So far, having succeeded in financing 6 billion RMB, only Bohai has been set in operation; none of the remaining 9 have met their financing objectives.

Faced with financing difficulties, equity administrators are now working hard with local governments in seeking possible solutions. On one hand, local governments provide significant preferential conditions for equity companies in registration and taxation. On the other hand, local governments try to attract leading enterprises and investment companies under their jurisdiction to invest heavily. However, many investment companies sponsored by local governments insist on holding certain amounts of shares in the fund management companies. In this way, the “government genes” have been transplanted deep into the PE industry and such genes will prove the most serious technical barriers for China’s domestic PE.

The Absence of Equity Investors
The absence of equity investors is an obvious reason for PE’s financing difficulties. Even in this underdeveloped PE market which is China, those PEs which have performed relatively well in the past have now become very fastidious, focusing only on those long-term and stable LPs (limited partners).

In the international market, PE usually adopts the limited partnership. Fund management institutions act as General Partner (GP）and assume unlimited liabilities. Other investors act as LPs and assume limited liabilities, without being involved in investment management. When doing their financing, many PEs tend to list pension and insurance companies as prime LP candidates, college investment funds and charity funds as secondary candidates. Wealthy families and individuals are not considered prime candidates for their vulnerability to market fluctuations.

However, in China, the number of qualified investors is pathetically limited. Since the enforcement of the Partnership Law of China in June 20XX, there have been thousands of PEs with limited partnership whose capital volume is below 0.5 billion RMB; its LPs are mostly private enterprises and wealthy individuals. For the smaller partnership PEs, their LPs are mostly those individuals and companies engaged in real estates business and stock business, and their capitals are very much susceptible to the changes in the capital market. By now, there have been mobility problems in varying degrees and some LPs are obviously unable to deliver on their investment pledges.

In view of the time limit and the scale of the capitals, only insurance companies, commercial banks large state-owned enterprises and social security funds have the strength to invest in large PEs. But it is not easy to involve those institutions in China’s PE carnival. For one thing, it is not easy for them to obtain approval from the top supervisory and administrative organizations. For another thing, attracted by the high profit margin, insurance companies tend to let their own teams to operate the PE investment. For banks, investment in PE would cause considerable pressure on its capital in cash, therefore, their demand for the profit return will be exceedingly high. If the net profit return on the bank loans is 1%, PE can attract bank capitals only with a return rate of 12.5%. Finally, the National Assets Management Commission imposes strict control over large state-owned enterprises regarding their investment activities in areas other than their main businesses. That is why so far those mainstream capitals have not entered China’s PE market.

The qualifications of LP and GP also have direct bearing on the withdrawal mechanism of those share-controlling enterprises in PE. According to the China Securities Law, companies of limited partnership cannot open security accounts and companies of limited partnership which hold PE shares are impossible to obtain license from the Securities Monitoring Commission to operate business. For government-sponsored PEs, even if they succeed in financing and establishing funds, they will face new problems. As China’s capital market is still not mature, the professional management teams will face major dilemmas when interacting with state-owned investment organizations and local governments.

The China Complex of Foreign PEs
In December 20XX, ten foreign funds which focus on China’s market succeeded in financing 12. 022 billion USD, showing a growth of 70% as compared with the same period the year before. Over 159 enterprises have received capital support and the investment volume exposed so far reaches 1.204 billion USD, indicating a growth of 31.4% and 73.5 respectively over the same period the year before. Those figures are revealing enough.

Despite such superficial investment growth, my own extensive contacts with overseas investors convince me that foreign PEs have failed to achieve any major breakthroughs in the Chinese market over the past few years, extremely incongruent with their reputation and professional expertise on the overseas market. The Carlyle Group failed in investing in XCMG (China’s largest construction machinery manufacturer), my former employer Morgan Stanley failed in SUNCO, a leading real estates development, Baring Private Equity Asia failed in Shandong Ruyi, China’s largest textile corporation, etc. Over the past five year, such failures were numerous.

There are several important reasons for such debacles. The first is the limited understanding of those foreign PEs about China’s business environment. In particular, they have failed to communicate effectively with relevant government functionaries which dominate many investment projects. Then, the process of making investment decisions by foreign PEs is too long for lack of effective and swift communication between overseas PE headquarters and project implementers in China (Chinese agents). Chinese agents are not quite familiar with the concept and mechanisms of foreign PEs.

As far as I am concerned, I have considerable experience of helping foreign funds establish branch offices in China, with my deep connections with the government departments and wide connections in China’s PE world. In the first half of 20XX, I helped SAIF Partners and WI Harper launch their PE funds with a total worth of 700 million USD in Binhai Offshore Finance Center in Tianjin. They are two of the first three PE funds approved since the establishment of the Binhai Offshore Finance Center.

Europe, especially the UK, have a long and rich PE legacy. Unfortunately, the British PEs have failed in the Chinese market. On December 25, 20XX, the otherwise highly successful 3i withdrew from Shanghai and Hong Kong; with this, there is no active British PE in the Chinese market. It is indeed a major regret. At this special stage, such withdrawal is understandable. The financial tsunami has resulted in significant shrinking of individual wealth and the private investors in major countries in Europe and America are weak in their investment impulses. At the same time, due to the severe blow incurred by the security market, the pace for Chinese domestic enterprises to go public has remarkably slowed down; investment institutions find it hard to sell their shares and gain profit by investing in those companies going public. Diverse factors combine to create a sluggish market.

A Carnival for Foreign PEs
Friedman said to this effect—that before the dawn comes, the market is like a nocturnal animal, always in a state of great hunger. In the current global financial crisis, China is the strongest country among the BRICs to withstand the impact of the crisis. According to statistics by the Financial Times, China is ranked first in its capacity to resist the external risks among all the economies in the world, its index reaching 3.4, much higher than even Swiss that immediately follows China. The recent explicit acknowledgement by the China’s government of the legitimate role of PE in promoting China’s economic development has undoubtedly opened a wide door for foreign PEs to enter China. In China where there are countless investment opportunities, when China’s domestic PEs are still mired in dilemmas, are foreign PE investors ready to partake of the PE carnival in the near future?

The impact of the present financial crisis on foreign PE must be evaluated carefully. The downslide of stock markets worldwide will not produce a direct short-term impact on PE. From a long-term perspective, the profit expectations would come to a more rational level. To make PE investment at this phase, there are important advantages. The cost to become a share-holder will be lower, leading to investment opportunities with a much higher “performance ratio”. On the other hand, as withdrawal during present stage means considerable shrinking of gains, both the investing and the financing parties would join efforts to survive the crisis. Meanwhile, the investor will help the enterprise make sufficient fundamental preparations, enhance core competency, control costs, and conduct more effective financial management, and wait for new opportunities. Those investing and financing parties who can survive the crisis in unison are more likely to recover efficiently for a new round of bright development. For foreign PEs, as long as they can pick the right Chinese agents with sufficient experience of operating PE in the Chinese market, those overseas PE institutions with core technical competency much beyond their Chinese counterparts are bound to reap golden harvests.

Those latest developments are what I consider to be influential events for China’s financial industry in the near future. They are closely related to my future career aspirations. I believe I have an important role to play in helping European, particularly British, PEs to thrive in my country.

My special experience of personal development has given me special feelings about the UK. I was an exchange student in the UK at high school, an interpreter for the Major of London in 20XX when he led a business delegation to China, an ardent lover of British culture and literature. For those reasons, I look forward to studying in the UK.