VZCZCXRO4637
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #0164/01 0170844
ZNY CCCCC ZZH
P 170844Z JAN 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 4468
INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 000164 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM, EB, AND INR, STATE PASS FOR USTR, 
TREASURY FOR OASIA/ISA 
 
E.O. 12958: DECL: 01/16/2018 
TAGS: CH ECON EFIN ENIV ETRD PGOV SOCI
SUBJECT: BOHAI FUND TO TAKE ADVANTAGE OF HOME-GROWN STATUS 
 
REF: A. BEIJING 7356 
 
     ¶B. BEIJING 614 
     ¶C. BEIJING 3078 
 
Classified By: Ambassador Clark T. Randt for Reasons 1.4(b/d). 
 
Summary 
------- 
¶1. (SBU) The establishment of the new renminbi (RMB) 20 
billion (USD 2.7 billion) Tianjin-based Bohai Industrial 
Investment Fund, the first of a series of home-grown 
RMB-denominated private equity (PE) funds backed by 
state-owned entities, represents an effort by Chinese 
authorities to expand non-bank financing options for domestic 
firms.  The fund is supported by central and local government 
investors, but operates commercially as a PE firm that 
invests solely in domestic entities. Established in late 
December 2006, the Bohai Fund completed its initial round of 
investments in the manufacturing and banking sectors in 
October and November of 2007. Bohai Fund CEO Au Wei told us 
the fund's operations will be completely commercially driven, 
though the fund will maintain close ties to Tianjin local 
authorities and the NDRC -- the lead agency tasked with 
establishing China's PE regulatory framework. The fund enjoys 
several advantages over foreign PE firms, including its 
RMB-denominated status, close relationships with regulators, 
and its freedom to invest in sectors that are restricted for 
foreign investors. Au said that foreign PE firms face more 
restrictions in China, but he expects their opportunities to 
grow along with Chinese firms' demand for direct financing. 
End Summary. 
 
Home-grown private equity 
------------------------- 
 
¶2. (SBU) The Tianjin-based Bohai Industrial Investment Fund 
(Bohai Fund), the first RMB-denominated PE fund of its kind 
in China, represents Chinese regulators' efforts to expand 
direct financing mechanisms for indigenous firms through the 
establishment of a home-grown PE industry. By encouraging 
firms to take advantage of new financing options such as PE, 
Chinese authorities aim to spare state-owned banks from too 
much exposure to market risks. 
 
¶3. (SBU) Established in December 2006, th Bohai Fund 
operates as a limited partnership  It distinguishes itself 
from foreign PE firms by limiting its investments to mainland 
Chinse enterprises and by using only RMB capital.  n 
addition, it receives its funding only fom stateowned 
enterprises (SOEs) and governmnt agencies, including China 
Life Insurance, Cina Development Bank, China's State Social 
Security Fund, China Postal Savings Bank, and Tianjin TEDA 
Investment Holdings. 
 
¶4. (C) The Bohai Fund is the first fund of its kind to 
receive the approval of the State Council and serves as a 
pilot project on which future industrial investment funds 
will be modeled. Similar industrial investment funds are 
currently under interagency review including the Guangdong 
Nuclear Fund, the Shanghai Financial Fund, and the Shanxi 
Energy Fund.  In a January 11 meeting at the fund's 
headquarters in Tianjin, Bohai Fund CEO Au Wei told econoff 
the NDRC plans to approve at least RMB 100 billion (USD 14 
billion) in industrial investment funding each year over the 
next several years to help address the growing direct 
financing needs of Chinese firms. Domestic industrial 
investment funds like Bohai will provide financing 
opportunities to enterprises without subjecting them to 
capital control related restrictions. 
 
Economic interests will drive decision-making 
--------------------------------------------- 
 
¶5. (C) The Bohai Fund is based in the port city of Tianjin 
and counts local government investors among its limited 
partners. Over the past several months, China-based analysts 
have called attention to the relationship between local 
authorities and the new industrial investment funds, noting 
the possibility that such funds could become financing 
vehicles for local governments.  Rumors have hinted at 
tensions between the Bohai Fund and local authorities over 
the fund's investment in a Chengdu bank. 
 
¶6. (C) CEO Au -- who formerly worked as a private equity 
manager for a U.S. firm in Hong Kong -- objected to such 
characterizations, stating that the Bohai Fund's name gives a 
false impression that the fund will only invest in the Bohai 
 
BEIJING 00000164  002 OF 003 
 
 
region. (Note: The fund's name refers to the Bohai Sea, the 
innermost gulf of the Yellow Sea, which includes the port of 
Tianjin and borders the Liaoning and Shandong Peninsulas. End 
Note.)  "The Bohai Fund's foremost concern is making 
profits," Au explained, likening the fund's goals to those of 
any international PE firm. He stated, however, that the 
fund's investors' expectations are slightly lower than he 
experienced as a PE fund manager in Hong Kong.  While Bohai's 
investors would be happy to achieve 20 percent returns, he 
claimed, he and his staff will aim for 30 percent returns 
over a 15 year time frame. 
 
...But fund will retain close ties to government 
--------------------------------------------- 
 
¶7. (C) Although the Bohai Fund operates as a purely 
commercially-driven entity, the fund's management maintains a 
cooperative relationship with local authorities and central 
government regulatory agencies, in particular NDRC. 
According to Au, the fund has been well supported by Tianjin 
authorities, especially Vice Mayor Cui and Mayor Dai 
Xianglong.  (Comment: Reftel B discusses Tianjin's efforts to 
develop the Bohai Rim Economic Circle (BREC) and establish 
the region as northeast China's financial center.  Mayor Dai, 
as former Governor of the People's Bank of China, played a 
major role in obtaining the Central Government's permission 
to establish pilot finance projects in the region. End 
Comment.)  "Tianjin wants to make itself the Delaware of 
China," Au said, though he expressed reservations about the 
plausibility of such plans noting the important role that 
relatively autonomous state governments play in attracting 
investment in the U.S. 
 
¶8. (C) At the central government level, Au explained, NDRC -- 
in particular Director General of the Fiscal and Finance 
Bureau and former Humphrey Fellow, Xu Lin -- is taking the 
lead in coordinating the PE regulatory environment.  (Note: 
See Reftel C for further discussion of Xu Lin's generally 
progressive attitude toward financial liberalization. End 
Note.) Au said NDRC has helped facilitate a constructive 
dialogue between the Bohai Fund and government regulators. 
Under an NDRC mandate, the Bohai Fund employs a team of 
several supervisors assigned to Bohai Fund headquarters from 
NDRC.  These supervisors provide advice and assistance to the 
fund's management, although the fund is under no obligation 
to follow the supervisors' advice, Au explained. 
 
¶9. (C) Au told us the NDRC is now finalizing rules and 
regulations governing PE, likely to be promulgated in 
February 2008.  The Bohai Fund, as China's primary pilot 
industrial investment fund, has played an active role in 
advising NDRC and other agencies on the draft regulations. 
Au predicted that PE will be a regulated industry in China 
long into the future, though he expects that the new 
regulations will not make the PE deal process in China any 
more difficult than it is in other markets, including the 
U.S.  (Note:  According to Au, investments totaling more than 
RMB 5 million or involving government entities will require 
government approval, while smaller deals will likely close 
without much government intervention.  End Note.) 
 
¶10. (C) In Au's view, although the government has "not too 
short a way to go" toward establishing an efficient PE 
regulatory regime, the NDRC's commitment to change is 
"genuine."  Au has been impressed by the speed at which the 
central and local government agencies have responded to the 
development of the PE industry.  However, he noted that due 
to the nascent regulatory environment, he spends nearly 50 
percet of his time as CEO handling political issues. 
 
Fund will target areas off-limits to foreigners 
--------------------------------------------- - 
¶11. (C) Capitalizing on its unique position as a private 
equity firm funded by government and state-owned entities, Au 
said the Bohai Fund will take full advantage of opportunities 
to invest in sectors that restrict foreign investment, 
including banking and defense. The RMB 20 billion fund has 
almost completed its first RMB 6 billion in investments. In 
October 2007 it took a 20 percent stake in Tianjin Pipe and 
in November 2007, the fund purchased a 10 percent stake in 
Chengdu City Commercial Bank Co.  Au said he expects to 
further diversify the fund's investments in 2008.  Potential 
investments could include media, new energy industries, 
finance, consumer goods, and agriculture. 
 
¶12. (C) Au explained that the fund will focus its investments 
in industries that demonstrate strong potential for eventual 
 
BEIJING 00000164  003 OF 003 
 
 
listing on a domestic stock exchange. The fund does not plan 
to go after distressed assets.  In contrast to foreign PE 
firms, Au explained, the fund will aim for minority 
shareholder positions in most of its deals, and will add 
value to its assets through efforts to improve corporate 
governance in advance of initial public offerings. 
 
Implications for foreign private equity firms 
--------------------------------------------- 
¶13. (C) Au acknowledged that foreign PE firms face their own 
set of unique challenges in China.  Over the past three 
years, foreign PE investors have made a tremendous amount of 
money in the Chinese market.  This has generated resentment 
among some Chinese, who question whether so many domestic 
assets should be turned over to foreign control, he 
explained.  In addition, he said, the country's surplus 
foreign exchange reserves have created many hurdles to 
foreign investors who attempt to bring more dollars into the 
market.  Finally, as detailed in the annual investment 
catalog, China continues to prohibit or restrict foreign 
investment in certain sectors.  These factors, combined with 
the growth in the number of PE firms competing for a small 
number of deals, make China a challenging environment for 
many foreign PE investors. 
 
¶14. (C) That said, Au stated that as the demand for 
innovative forms of direct financing grows, so will the 
opportunities for foreign PE investors in China.  Au 
envisions opportunities to work in conjunction with foreign 
PE firms on deals in the future and has already held 
discussions with some firms about prospects for such 
investments.  While foreign firms bring experience and broad 
portfolios, the Bohai Fund has earned the trust of the 
Chinese Government and could share its local expertise in 
joint deals with foreign firms, he explained. 
 
Comment 
------- 
¶15. (C) The Bohai Fund and other new industrial investment 
funds will be inclined to use their status as 
RMB-denominated, state-backed funds to focus their 
investments in sectors that are off-limits to foreign PE 
investors. If that is the case, Bohai and its domestic 
counterparts will be less likely to emerge as major 
competitors to foreign PE firms in the Chinese market. 
However, by providing this new form of financing to domestic 
firms in sectors for which foreign investment is restricted, 
the Chinese Government has created a disincentive to the 
further opening of restricted sectors, as doing so could 
reduce investment opportunities for emerging domestic 
industrial development funds like Bohai.  End Comment. 
RANDT