The Era of the Renminbi Is at Hand

So far this year, the IPO market in China is 2.5 times larger than the IPO market in the U.S.

Image: iStockphoto, designed by Sean Driscoll

A recent side-by-side comparison of the U.S. and Chinese economies produced a startling result: There were $34.8 billion of initial public offerings in China this year and only $13.7 billion in the U.S.

With numbers like that, is it any surprise that Western fund managers are scrambling to get a bite of the immensely profitable Chinese market for new companies? As the New York Times reported, U.S.-based Blackstone Group has formed a partnership with Shanghai’s municipal government to raise a $732 million private equity fund.

What’s different this time is that Blackstone’s fund is denominated in the Chinese currency, which is officially called the renminbi. Blackstone’s idea is to take advantage of capital from China’s increasingly wealthy institutional and private investors. The fund will then use the investments to buy companies and take them public, earning a hopefully large profit along the way.

What’s not clear is whether the funds raised by Blackstone can only be used in China or could be deployed globally to find attractive investments. There is plenty of interest in the Chinese market for new companies—Carlyle Group announced this week that it had invested $60 million in three Chinese growth companies. So there is no shortage of domestic companies ripe for turnaround.

According to Zero2IPO, a Beijing-based research firm, more than 190 funds denominated in renminbi have been established in the last two and a half years with a combined total of more than $30 billion. In the past, investments in Chinese companies were largely done through offshore holding companies in tax havens like the Cayman Islands.

Bear in mind that the Chinese currency is not traded on the foreign exchange market. The government sets the exchange rate, which has been pegged to the U.S. dollar for the past year. As the dollar has declined in the last year, the cost of renminbi-denominated exports have also declined against the euro and the British pound, angering Western governments, which argue that the Chinese currency should be allowed to appreciate.

Trade tensions over China’s currency heated up earlier this week when President Obama met Chinese President Hu Jintao in Beijing. Obama called on Hu to allow the renminbi to move to a “more market-oriented exchange rate over time.”

So there is some currency risk.

The fact that Blackstone, which sold a $3 billion stake to the Chinese government in 2007, partnered with a municipality is an indication that Beijing is proceeding with typical extreme caution when allowing foreign investors to collect investment funds from domestic investors. While the new investments will take advantage of foreign expertise, there is a Chinese government official looking over their shoulders.

But that doesn’t seem to have slaked the interest of foreign fund managers. Under new IPO rules, private equity funds can sell their companies on the Chinese stock market, meaning an easier exit compared with the past practice of selling them in offshore locations like Hong Kong. China’s stock market is up 84 percent this year, which many investors feel is just too good to pass up.