Regulations –

VCJ: Here’s a loaded question. Are deals being affected by all the regulatory requirements that the China government imposes?

Toronto: The State Administration of Foreign Exchange (SAFE) has promulgated two notices, which attempt to control the structuring processes. They’ve been trying to close the loopholes that currently are available for the movement of assets, presumably offshore. But there is ongoing interplay between SAFE and other agencies, and they are discussing how to address various regulatory issues and how to address SAFE’s notices and the fact that SAFE for now has taken an initial step of its own.

So, yes, we’re seeing a lot of VC deals that people are evaluating carefully in light of SAFE’s notice. We’ve seen the impact of this notice on the progress of IPOs, as companies have slowed their IPO process a bit. And it is having an impact on M&A activity, as well.

Grady: We’re expecting a clarification, from the Tax Bureau and others, on these issues by early July. The clarification will make clear that China’s government regulators are not trying to preclude private equity from China, nor are they trying to discourage it. Rather, the regulatory changes are aimed at tax issues relating to Chinese citizens.

The regulatory clarifications will be beneficial.

VCJ: Do you foresee the China government making it easier to take companies public?

Grady: I think it’s a timing issue, tied to broader economic concerns and currency concerns. Last year, a group of us met with Vice Premier Zang just after the opening of the second trading floor in Shenzen, and we asked him that same question. It’s a matter of time for it to happen more regularly. But if you think about it, it’s a miracle how much progress has been made to date.

The day that China takes steps to have more transparent, liquid and streamlined capital markets, Shanghai will overnight become a multi, multi-billion-dollar financial services, investment banking, mutual fund management industry center. The government is leaving it on the sidelines for now, in part, because maybe they don’t need it right away.

Toronto: The corporate legal regime in China isn’t sufficiently flexible to do the kinds of things that most investors want to do. The domestic exits just aren’t a decent option because of the process of getting governmental approval for them.

When you consider the great capital needs of the state-owned enterprises and the fact that one of the few options for them is the domestic markets, you can tell who’s going to get out into that market if that market opportunity is being allocated by a regulator. So the ability to predict when you can actually get out with a company is just not there. It’s not the kind of free hand market that generates the depth of information that leads to the right kind of valuations, and right kind of exits, and right kind of liquidity.

Therefore, everything’s going offshore.

Steve Toronto

Managing Partner

Morrison & Foerster.

Offices: Beijing, Shanghai

and Hong Kong.

Focus: Offers various areas of legal coverage in China.

Active in China since the mid-1990s.

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