Global Update

'LOBAL¬5PDATE &ALL¬¬ 'LOBAL¬5PDATE &ALL¬¬ !RTICLES (EADLINES 0EOPLE 0ROJECTS %VENTS Chinese Private Equity: A Paradigm Shift by Jay Tannon Roughly half of the world GDP and two-thirds of world company market value has resided in North America and Europe for decades. But, India and East Asia will likely account for a similar share within the next 25 years. Given the widely acknowledged demographic, socioeconomic and geopolitical trends, relative world GDP and global market capitalization, China will undergo dramatic shifts during the careers of those reading this article. Tom Friedman’s “World is Flat” observation and The Economist’s recent reference to “Great Wall Street” running the global economy reflect a paradigm shift. This is not to suggest a decline in performance or wealth of Western economies. It simply recognizes that India, China and other economic centers present enormous market opportunities. Clever Western private equity funds have already identified these trends and are making India and East Asia a meaningful part of their investment and portfolio development strategies. Nowhere is this more evident than the People’s Republic of China or “PRC.” The balance of this article will focus on the rapid development of private equity funds in China and special challenges for Western private equity funds operating in China. Soaring Fund Activity In the first half of 2005 alone, 39 private equity firms raised China-focused funds. Chinese private equity funds under management rose from approximately $250 million in 2002 to $2 billion in 2004. China received more than $60 billion in foreign direct investment during 2004. Similarly, North American-sponsored business acquisitions in China have soared from less than $500 million in 2002 to over $5.4 billion in 2004. Western market leaders in private equity such as Carlyle, Bain and Blackstone have dramatically increased their China-centered private equity funds. Goldman Sachs, Morgan Stanley and Warburg Pincus recently completed successful exits on high profile Chinese private equity investments. Asian investment is becoming a prime focus for these flagship private equity funds and many others. Innovative investment firms like American Capital are even hiring specialists to coach Western portfolio companies on integrating China into their business strategies through either sourcing, joint ventures or business acquisitions. Intermediaries like R.W. Baird, historically directed toward transatlantic activity, are focusing aggressively on developing China strategies for U.S. and other Western mid-market companies. - 2 - 'LOBAL¬5PDATE &ALL¬¬ !RTICLES (EADLINES 0EOPLE 0ROJECTS %VENTS Chinese Barriers, But No Great Wall Private Equity: With this dramatic surge in interest and investment are the barriers to Western investors dissipating? A Paradigm The most successful investors will have Chinese partners and physical operations in the PRC employing Shift carefully selected Chinese nationals. Beyond the normal challenges of finding qualified investment (continued) opportunities and management, Chinese private equity initiatives face special challenges of exchange controls, lack of transparency, lack of respect for intellectual property rights, and uncertain enforcement of contracts. Risks of overcapacity or an overheated Chinese economy could also undermine investments. Finally, recent Chinese governmental pronouncements further obscure the investment horizon. Circular 11 Adverse administrative changes affecting foreign private equity are illustrated in Circulars 11 and 29. Both are aimed at reducing evasion of PRC exchange control and taxation, but could have nettlesome effects on PRC private equity investment. On January 24, 2005, the State Administration of Foreign Exchange (“SAFE”) issued a notice addressing administration of foreign exchange for business transactions involving foreign investors. This is generally referred to as Circular 11. Among other features, Circular 11 requires Chinese residents to obtain SAFE approval before engaging in foreign business transactions. Specifically, “No onshore resident may establish or control an offshore company, either directly or indirectly, without the approval of SAFE.” This ruling could disrupt foreign equity investment in China, because foreign private equity investors have invested in China projects through offshore companies run at least in part by Chinese citizens. The Bahamas, Bermuda, and especially the Caymans, have been the most popular jurisdictions for these offshore companies. The offshore companies in turn typically establish one or more Chinese subsidiaries, known as foreign invested enterprises or “FIEs,” as operating companies. There have been two approaches to this structure. In one approach, the Chinese citizen(s) would organize an offshore company, and foreign investors would invest in that company. In the second, the foreign investor would organize and fund an offshore company, and either Chinese citizens or a Chinese company would acquire some portion of the offshore entity. Having an offshore parent company has enabled foreign investors to operate largely without fear of Chinese investment restrictions, while benefiting from having Chinese partners, simplified corporate governance and easier exit strategies. Chinese authorities, however, are concerned about the sale of FIE-related offshore assets or equity interests escaping PRC exchange control and taxation. Under Circular 11, Chinese entrepreneurs and their Western private equity partners may no longer engage in these transactions without SAFE approval. Centralized approval in Beijing means inevitable delays and it is unclear what approach will secure that approval. - 3 - 'LOBAL¬5PDATE &ALL¬¬ !RTICLES (EADLINES 0EOPLE 0ROJECTS %VENTS Chinese Circular 29 Private Equity: On April 21, 2005, SAFE issued Circular 29, ostensibly “clarifying” Circular 11 but actually casting a longer A Paradigm shadow on the Chinese private equity community. This circular makes it easier for the government to monitor Shift the capital gains of Chinese entrepreneurs. Circular 29 states that all Chinese citizens holding shares in (continued) foreign companies must carry out certain SAFE registration procedures, as well as declare their offshore transactions with, and receive approval from, Chinese authorities. Investors must remit all capital gains from any offshore transactions involving a sale of shares within 30 days of closing. Circular 29 also requires FIEs to disclose “in detail” the identity of their ultimate shareholder and the nature of their business. Although Circular 29 has the legitimate goal of reducing exchange control and tax evasion, heightened scrutiny by Chinese authorities could hamper transactions between Chinese entrepreneurs and foreign investors. Western private equity funds and their Chinese partners will experience a continually evolving investment landscape, with the current Circulars and the regulations yet to come. Despite these challenges, the race to build successful global private equity firms continues virtually unabated. Whether in North America or Europe, leading venture and buyout funds are concluding that the People’s Republic of China must be part of their global investment strategy to achieve the greatest returns for their investors. The sustained opening of the Chinese market, its scale, and rising levels of consumption within China make the potential rewards far too attractive to resist. Many Western investors are coming to appreciate the Chinese adage: “If we fail to reach the Great Wall, we are no heroes.” Just expect to encounter a few obstacles while on that noble journey. ........................................................................................................................................................................................................ 1 Barrington China Report, Vol. 1, No. 1. 2 Tim LeMaster, “Roadblocks Slow Private Equity Industry,” The Standard (China), May 23, 2005. 3 South China Morning Post, February 14, 2005 and June 25, 2005, reporting information from the PRC Ministry of Commerce. OECD reported a lower figure of $54.9 billion. 4 Zack Dong, National Symposium on M&A in China, American Conference Institute, May 31, 2005. 5 Asia Private Equity News, September 7, 2005. 6 Jerry Borrell, “New Laws Slow Chinese Deal Making,” Venture Capital Journal, August 1, 2005 (“Borrell”). 7 Article 2 of Circular 11. 8 “Rules of the Game,” Asian Private Equity Review, June 1, 2005, and Borrell. 9 Article 5 of Circular 29; see also “Foreign Investment Stalls in China,” Daily Deal, May 4, 2005. - 4 - 'LOBAL¬5PDATE &ALL¬¬ !RTICLES (EADLINES 0EOPLE 0ROJECTS %VENTS European Community Design Registration by Louisa Copeman Most people are aware of the importance of filing trademarks in order to protect their intellectual property rights and their brand. Many are not as familiar with registered design rights and the importance they can play in protecting intellectual property rights and brands. The Registered Community Design System Until recently, design protection in the European Union consisted of a number of different national laws in each member state, each of which offered different levels of protection in that state. In April 2003, the Registered Community Design System introduced a new type of intellectual property right for protecting designs and logos, which brought together rights and characteristics throughout the European Union. This new right is already proving popular, with approximately sixty thousand applications

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