Stay Informed with Free Updates from Inside Business
Subscribe now to receive the myFT Daily Digest email, delivering the latest insights and updates on Inside Business directly to your inbox every morning.
One striking example of the deteriorating financial relationship between the United States and China is illustrated by the current challenges facing private equity’s “placement agents.” These firms are hired by buyout groups to assist in raising new funds, and their experiences reveal a troubling trend. When their representatives approach U.S. investors to encourage them to allocate funds to investments that may target opportunities in China, they are not only facing rejection but are also receiving criticism for even suggesting such investments. According to a senior adviser based in Hong Kong, some agents have been labeled as out of touch, tone-deaf, and even unpatriotic, highlighting the growing tension in U.S.-China relations.
The timing of these pitches couldn’t be worse for private equity firms. President Joe Biden’s administration has laid out plans to impose bans on certain U.S. private equity and venture capital investments into sensitive sectors in China. High-profile firms like Sequoia Capital and GGV Capital have already announced their intentions to separate their U.S. and China operations. This strategic shift reflects a broader trend of U.S. firms reassessing their exposure to the Chinese market in light of rising geopolitical tensions.
Adding to the unease among investors are China’s stringent anti-espionage and data laws, coupled with recent raids on U.S. consulting firms. Such actions have created an atmosphere of uncertainty, exemplified by the travel ban on Charles Wang Zhonghe, a banker from Nomura based in Hong Kong. Furthermore, the U.S. House of Representatives’ China committee has accused BlackRock of profiting from investments that allegedly support the Chinese military, prompting other American firms to exercise caution due to the potential for increased scrutiny. Investors are also acutely aware of the risks associated with future sanctions should China engage in aggressive actions toward Taiwan.
In light of these developments, many North American investors are hesitant to invest new capital into the private equity sector in China at this time. A senior dealmaker, who has previously enjoyed successful ventures in the region using funds raised in the U.S., remarked that at best, investors might consider reinvesting a portion of their earnings from earlier funds into new offerings managed by the same firms. This cautious approach reflects a significant shift in investor sentiment regarding the Chinese market.
This pullback from North American investors is particularly noteworthy, given that they have historically been the largest source of capital for the private equity industry. According to data from Preqin, they accounted for 50 percent of all capital invested in private equity globally this year. However, fundraising for Asia-Pacific-focused funds has seen a sharp decline, with only $62 billion raised thus far this year compared to $173 billion during the same timeframe last year. Although fundraising for deals in Europe and the U.S. has also slowed, the decline has not been as pronounced.
The challenge for many private equity firms lies in the fact that they have raised multi-billion-dollar Asia-focused funds in recent years, making it difficult to completely pivot away from deal-making in China. In response to this shift, many firms are increasing their focus on India, with the Asia divisions of major firms like Blackstone and KKR now led by dealmakers based in India.
However, deploying significant amounts of capital in Asia without engaging with the world’s second-largest economy poses a significant challenge. Some non-U.S. investors, particularly sovereign wealth funds from the Middle East, remain keen on gaining more exposure to China, highlighting a complex landscape where different investors have varying interests in the region.
<pConsequently, buyout groups are exploring innovative ways to satisfy both sets of investors. In typical private equity fashion, this is leading to complex legal and financial strategies. According to a lawyer advising the industry, investors are expressing a desire to remain involved in funds while requesting the creation of new structures that exclude Chinese investments, illustrating the nuanced demands shaping the market.
Additionally, U.S. investors are increasingly seeking restrictions on the participation of Chinese investors in the private equity funds to which they contribute, regardless of the fund’s investment focus. This year, buyout executives report that it has become more common for North American pension funds to require that Chinese entities account for less than 10 percent of total fund commitments. Compliance with this demand can result in the loss of substantial capital, as Chinese state-backed organizations often possess the capacity to invest hundreds of millions of dollars in a single transaction.
Once a private equity group accepts investment from Chinese entities, executives at U.S. buyout firms have noted, American investors within the same fund often demand significant restrictions on the influence of mainland investors. This includes denying them a seat on the limited partner advisory committee, which consists of the largest investors who provide guidance to the buyout group. Some investors also insist that Chinese state-backed firms should not have the opportunity to co-invest directly in the companies acquired by the fund, as this could grant them access to sensitive information.
The private equity sector is often characterized by its opacity, making this form of U.S.-China decoupling relatively hidden from public scrutiny, especially compared to other industries. However, its implications are significant, likely signaling a long-term shift in global capital flows. This evolution is compelling dealmakers, who once focused almost exclusively on financial returns, to adopt a more multifaceted role. Nowadays, they find themselves mediating the conflicting demands of a fragmented landscape of global investors, whose interests are becoming increasingly politicized.
