Localizing Global Finance: The Rise of Western-Style Private Equity in China

The Rise of Western-Style Private Equity in China

J. Robertson

• Publisher: Palgrave Pivot
• Year: 2015
• ISBN:
  9781137514028
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

Localizing Global Finance illustrates that private equity has become a more significant component of China's economy based on a pattern of new domestic elites importing and implementing a largely Western financial model.

1

Introduction

Abstract: The introduction outlines the rise of “new” finance in the global economy, the significance of private equity funds in China and other emerging markets, and two indicators to measure localized global finance (change in Western business models and market share gained by local and international private equity firms). Then, the findings and the significance of this analysis are briefly reviewed.

Robertson, Justin. Localizing Global Finance: The Rise of Western-Style Private Equity in China. New York: Palgrave Macmillan, 2015. DOI: 10.1057/9781137514028.0003.

New financial forms deserve close attention from analysts of the global economy. While scholars have cautioned against modeling larger processes of global social and economic change as part of “Americanization” (Scholte 2005), finance is potentially different. “New” finance is a term that captures the array of developments in the financial sector beyond traditional bonds and equities. The vast majority of such new financial processes that are spreading globally—including derivatives, hedge funds, leverage, and mergers and acquisitions (M&A)—originated in the American market and remain most advanced there. Consider the case of hedge funds. Despite the changing face of hedge funds, where Brazil, for example, has become the third largest center in the world, US hedge fund managers still control 70%, or $1.8 trillion, of the total capital managed by hedge funds globally (Prequin 2014: 25). As many aspects of global finance have migrated to developing and emerging markets over the past 15 years, East Asia has experienced a growing and substantial engagement with “new” finance.¹ This monograph examines the extent to which one prominent example of a new financial practice, private equity, has been transplanted from its historical American base to a key Asian market, China. “The question of whether PE [private equity] investors—who are mostly large Anglo-Saxon funds—can simply transfer their business model to other markets still remains unanswered,” according to one study (Andres, Betzer and Gider 2012). The analytical framework and findings presented here offer some clear answers to this question.

The growth of private equity in the world economy

Lying at the juncture of the real economy and the financial economy, private equity funds draw upon capital and debt in financial markets to acquire stakes in companies that are intended to be sold for profit after a number of years.² Private equity is now globally significant with firms in this industry holding assets under management valued at $3.8 trillion in 2014, an increase from $716 million in 2000 (Prequin 2015: 5). US firms pioneered private equity and remain its dominant practitioners.³ However, private equity has moved beyond the confines of the US economy with Europe, in particular, rivaling the US as a market for transactions. The American model of private equity is now better referred to as Western private equity since Europe has largely followed American practice in its private equity markets (Robertson 2009). Private equity is actively gathering pace in emerging markets. The share of private equity financing raised for emerging markets as a proportion of the global total has more than doubled when comparing 2011–2013 to a three-year average of the early–mid-2000s.⁴ Private equity funds are no longer only Anglo-Saxon enterprises as implied by Andres, Betzer, and Gider above. More private equity firms are now headquartered in Asia than in Europe and the fast growth of these firms is captured by one major index illustrating that over 40% of firms on the list of the largest Asian private equity firms are recent entrants (PE Asia 2012a).

Among emerging markets, China has been the primary story, and the scale of its private equity market is striking. China’s private equity industry has grown from only 10 firms in 1995 to more than 6,000.⁵ China has long surpassed Japan as the largest private equity market in East Asia, and investors allocated 52% of all private equity capital in Asia in the 2000–2013 period to China; Japan and India were a distant second and third at 13% and 10%, respectively.⁶ The private equity industry has received scant attention in the scholarly literature on China’s political economy, and specifically its Chinese financial sector. Either this results from the assumption that private equity and other so-called alternative assets are peripheral in comparison to the driving forces of state-owned banks and state-owned enterprises (SOEs). Or private equity is simply an understudied process and one that scholars should examine more closely. I contend that deals struck by private equity firms have become economically and politically noteworthy in China, with private equity representing between one-quarter and half of all M&A in the Chinese economy in recent years.⁷ In 2014 alone, $31.9 billion of private equity investments were conducted in both US dollars (USD) and renminbi (RMB). As an originally American/Western financial form has appeared in China, several questions concerning financial globalization and localization can be raised. Is private equity in China really the same as private equity found in North America and Europe? And what roles are domestic and international actors playing as foreign models come into contact with domestic processes and environments? These are the two central questions explored in the monograph.

Though each particular financial class must be assessed in its own right, the globalization of new finance has introduced elevated levels of risk for workers, households, firms, and financial institutions.⁸ Unlike hedge funds, which mostly engage in short-term trading, private equity funds hold ownership and management positions in corporations. This is a key reason why they have leapt into public consciousness in many countries, as concerns have arisen over labor retrenchment, unsustainable debt, low rates of taxation, and the compensation levels of fund managers. The Western model of private equity is, on the whole, marked by several characteristics:

private equity funds are registered in offshore jurisdictions;

global institutional investors, especially pension funds, are key sources of capital;

these financiers grant private equity teams autonomy to pursue investments;

complex global finance is deployed, especially leveraged finance;

investments are driven by due diligence more than by relationships;

significant management influence is sought in investments, ideally through majority control of acquired companies;

investee companies undergo significant restructuring orchestrated by operating partners and by consultancy companies;

companies are sometimes privatized but also sometimes relisted on stock exchanges;

private equity managers are entitled to 20% of all profits as well as a high management fee.

Should Western private equity be replicated, this could be significant for the trajectory of China’s political economy. Private equity, as practiced in Western markets, is associated with new ownership structures, revised management practices, firm restructuring through M&A, and intensified financial engineering.

A typology of localization

To assess the extent to which global finance has been adopted domestically, localization is measured according to two indicators: by examining how much external financial models are tailored to suit local circumstances and by assessing whether local business elites capture market power. Four outcomes are possible on a spectrum of localization—what I term full localization, modified localization, replica localization, and absent localization. Full localization entails extensive revisions to foreign business models and the displacement of outside actors by domestic elites. In modified localization, foreign firms remain central actors but they localize and behave differently from how they do in their home market. The Western model of private equity advances in replica localization but the lead agents are domestic capitalists. Localization is absent when either foreign firms with foreign approaches dominate the landscape, or when new financial processes gain little traction in emerging markets. This typology is outlined in greater detail in the third chapter. As with all typologies, there will be mixed outcomes in practice, and the project’s research goal is to determine the dominant pattern. Replica localization is the strongest pattern in China. Chapters 5–6 present the empirical findings on the incorporation of foreign practices and models by domestic Chinese private equity firms.

An influential view of China’s financial system is that state control is high and change unfolds slowly. One widely read book on China’s political economy delivers a skeptical view of the reach of global finance. According to Walter and Howie (2012: 240), there is a belief that China has “all the trappings of Western finance.” They argue that it is a mirage and international observers fail to recognize that the Chinese financial system is wholly subservient to state officials and SOEs. Hersh (2014) shares this assessment when he writes that Chinese SOEs “assume the form of modern global businesses; however, they continue to operate on a nonmarket basis.” New finance, in this view, is largely absent—or at least fully secondary—in China’s political economy. In less sweeping terms, Breslin (2007: 27) notes: “now that China has stock markets, it is tempting to assume that they serve the same functions in China and work in the same way as they do in London, Frankfurt or New York.” Chinese stock markets, Breslin suggests, are qualitatively different from Western stock markets (see also Heep 2014). Walter (2011: 238) summarizes well this school of thought on the depth of China’s financial reorientation: “the country’s adaptation of the Western capital model is superficial.” Stock markets might be one example of a more fully localized financial process, but the argument in this monograph is that some new financial processes, unlike the above positions, are, indeed, replicas of their Western equivalents.

The argument in brief

Compared to the Western model of private equity, Chinese private equity exhibits much greater similarity in practice than difference. The monograph marshals evidence that a global business model is being integrated in China through change at the domestic level. Foreign practitioners are being replaced by domestic elites while the Anglo-American model of private equity remains largely untouched. Following the monograph’s terminology, loc...

Table of contents

• Cover
• Title
• 1  Introduction
• 2  A Middle Ground between Global and Local Levels of Analysis
• 3  Global Finance and Localization: Four Possible Outcomes
• 4  Where to Study Domestic Actors and New Finance
• 5  Replica Localization and Private Equity in China
• 6  Elite Formations and Cases of Success and Failure
• 7  Revisiting the Literature and the Significance of the Findings
• 8  Conclusion
• References
• Index