Outbound investment continues to be a theme in China thanks to encouragement from the state through its Go Out Policy (走出去战略). This has facilitated the emergence of a ‘red circle’ of PRC firms making inroads into Hong Kong and overseas. However, if anything, 2018 has been the year of a global pushback against Chinese ambition heralded by the Committee on Foreign Investment in the United States (CFIUS), which has become more hawkish under the Trump administration. For example, in 2016, direct Chinese investment into the US rose to $46 billion, but it has since fallen off a cliff. From the first half of 2017 to the first half of 2018 Chinese investment into the US dropped by a staggering 92% as the aggregate of $24 billion turned into a modest $2 billion.
There is no doubt that macro policy shifts have forced a deviation in China’s destination for cross-border investment as it now invests nine times more into Europe than the US, but there are signs the suspicion of motives behind Chinese outbound investment is becoming more widespread. The European Union, for example, recently declared it is ready to work on a tough new system to scrutinise inbound investment into the bloc from China. But this is only half the story as there have also been internal reasons for the slowdown too.
An additional reason for curtailing outbound Chinese investment recently was the government’s sudden devaluation of the yuan, resulting in more stringent capital controls on outbound investment. China relaxed rules on outbound investment in 2014 to encourage investment overseas and to promote its One Belt One Road project. However, its push to promote Chinese economic prowess abroad changed to concern that Chinese companies were overleveraging themselves and, in some instances, using the less regulated environment as an opportunity to conceal raw capital flight and corruption by China’s elites.
In response to these developments China has opened up more of its economy to foreign investors by easing foreign investment restrictions in a range of industries from banking to agriculture, and updating its negative list of industries where overseas investors are restricted or banned. This has seen, in the automotive industry, Tesla set up its first overseas assembly in Shanghai’s Lingang area, which is wholly foreign-owned as it became the first car factory in China to operate without a local partner. Despite these developments, however, it remains an open question whether China will be as attractive a destination for foreign investment as it was in the past.
China’s capital markets has seen a number of major reforms since the start of this 2018. The objectives of the measures were: to promote further opening of domestic markets; to strengthen connections between domestic and foreign markets; and to attract high-quality, innovative enterprises to list on the A-share market. Despite the reforms, uncertainty has loomed as the market grappled with the negative consequences to the trend of companies going-private, and dismantling their variable interest entity (or VIE) structures in a bid to relist on the A-share market.
One method by which China has sought to inject new energy into its capital markets was by rolling out and implementing the Chinese depositary receipt (CDR) scheme. For key innovative enterprises listed abroad, the CDR aims to assist them in circumventing such obstacles as VIE structures and effortlessly return home as A-shares. Whether PRC businesses can realise a domestic listing at low cost and high efficiency through means such as the depository receipts remains uncertain, and generally speaking Chinese law firms, along with their clients, are not putting all their eggs in one basket.
There is a definite trend towards overseas listings by Chinese entities, particularly in the US and Hong Kong, and the Chinese legal market is mirroring this trend. However, due to the macro events addressed earlier, the Hong Kong Stock Exchange seems to be an increasingly attractive option and is set to pick up the windfall from all these developments. In fact, we have seen a number of PRC law firms open up offices in Hong Kong in recent times to facilitate their clients in listing on the Hong Kong Stock Exchange. Even the more traditional law firms in China are feeling the pull to allocate more resources to overseas listings by either opening up offices or by strengthening their cooperation with foreign firms.
In a related but wider trend in the Chinese legal market, law firms have been tending to adopt business models that enable them to offer a more complete service chain for clients. That is by taking certain clients through angel rounds of funding, and then through the private equity funding rounds until the client is mature enough and qualified for listing, then handling that exit via a one-stop service. Certain firms such as Han Kun have been very successful with this model and others are seeking to emulate it.
For its part, the Hong Kong legal market itself is made up of a rich mix of international, domestic, offshore, and PRC firms. Owing to its colonial legacy, the UK headquartered magic circle firms have been a mainstay in the legal landscape, but more recently they have been challenged by white shoe law firms in the US and an emerging red circle from the mainland. Rather than developing comprehensive services, PRC firms are following their outbound Chinese clients and many US firms have entered the market specifically targeting high-end lucrative areas such as M&A, private equity and capital markets in profitable sectors such as technology.