In recent discussions within the financial sector, an expert remarked that we have entered a new era akin to the Age of Exploration, highlighting the significant developments stemming from the new "9.24" policy that expands the pilot scope for Asset Investment Companies (AICs) across China. This policy not only broadens the landscape for AIC operations beyond Shanghai to include major cities such as Beijing, Tianjin, and Chongqing, but it also eases restrictions on equity investment amounts and proportions, paving the way for deeper engagement in the investment market.
The reaction to this policy has been swift, particularly from bank-affiliated AICs, which are rapidly entering the fray. As of October 18, data presented by Li Yunze, the head of the National Financial Regulatory Administration, revealed that the intended fund scale for the new batch of 18 pilot cities has soared beyond 250 billion yuan. In a series of reports, it has been noted that the total intended fund scale since the announcement has nearly approached 300 billion yuan.
AICs, established by the five major state-owned banks, were initially set up to address issues of non-performing loans and high leverage among enterprises. Although AICs are not yet as mainstream as government-backed mother funds or venture capital/private equity (VC/PE) firms, their role is evolving significantly amid China's booming high-tech industry. These institutions are transitioning their focus from merely converting debt to equity towards broader equity investment fields, thereby cementing their position as key players in the public equity investment market.
Advertisement
While there is great enthusiasm for the AICs, it is essential to recognize that venture capital inherently involves risk, and the contemporary technological revolution demands an elevated level of foresight and strategic thinking. Those engaging in this sector must prioritize early, smaller investments while maintaining a long-term, patient capital outlook, especially when navigating through cyclical economic conditions.
AICs find themselves in their infancy phase and face numerous challenges, including liquidity management, capital allocation, risk control, and the cultivation of a suitably skilled workforce and corporate culture. Increasing their risk tolerance and research capacity is vital for thoroughly exploring and nurturing promising projects in line with the market’s evolving demands.
The expansion of AIC funds is gaining momentum.
The dual General Partner (GP) model is becoming increasingly prevalent.
Since the 9.24 policy announcement, bank-affiliated AICs have accelerated their entrance into the field. Data indicates that within a month of the policy's release, five AICs have signed equity investment funds with an intended scope nearing 300 billion yuan, constituting a significant portion of their existing debt-to-equity asset volume.
For instance, on October 8, Hangzhou launched its equity investment pilot program under the AIC framework. The major state banks, including ICBC, ABC, BOC, CCB, and BOCOM, collaborated with local state-owned enterprises, leading to a fund target of approximately 90 billion yuan. This marked Hangzhou as the first city across the nation to fully cooperate with all five AICs.
On October 10, collaboration agreements were signed between Shenzhen’s Futian District and the relevant parties from Construction Bank and Transport Bank, leading to two AIC equity investment pilot funds being established, raising the total scale of AIC funds in Shenzhen to 32 billion yuan, aiming to facilitate long-term capital entry into the market.
In a similar vein, Beijing has been proactive as well, establishing its own pilot program for AIC equity investments in late August. The first fund set up under this initiative, with a total scope of 2 billion yuan, facilitated its inaugural cooperation in Xicheng District between the Beijing State-owned Capital Operations Management Company and ICBC Financial Assets Investment Company, aimed at supporting pre-IPO innovative small and medium-sized enterprises and industries with specialized focus, thereby helping Beijing in its pursuit of a modernized industrial framework.
According to Wang Gang, general manager at ICBC Investment, the company has established dedicated teams focusing on AIC operations and has strengthened multi-level collaboration with local governments and investment platforms across 18 pilot cities. This strategic approach has led to cooperation agreements surpassing 100 billion yuan, facilitating the establishment of subsequent funds and accelerating project implementations in the pipeline.
Most of these AIC funds partner up with state-owned General Partners (GPs). The investments are primarily directed towards strategic emerging industries, including new-generation information technology, renewable energy, and advanced materials, thereby facilitating local industrial transformation and cultivating new productive capacities. Some industry insiders suggest that their institutions are currently opting for early and mid-stage technology companies or late-stage growth-oriented businesses that support the development of new productive capacities.
The dual GP model is common, as reported. Senior investment bankers have noted that this partnership framework is aligned with regulatory requirements stipulating that AIC subsidiaries must take on roles as fund managers or general partners and be actively involved in the management processes of these funds. This development enhances deeper collaborations between banks and firms, thus offering comprehensive financial services.
Although AICs are finding success in establishing partnerships with state-backed GPs, market-oriented GPs prefer more autonomy in fund management. Understanding the evolving dynamics between AICs and these market firms remains a critical area for development.
Managing investment risks is also at the forefront of AIC operations. The regulatory framework indicates that AICs are to build robust risk management systems to evaluate and summarize their investment activities, thus solidifying their risk management foundation. Establishing a performance assessment system conducive to long-term investments is paramount.
However, many industry insiders suggest that further refinement of regulatory policies is needed for AICs to craft specific operational standards compliant with these guidelines.
The assessment protocols within AICs are reportedly transitioning from project-level evaluations to a fund-centric perspective. This shift allows for a more comprehensive analysis of overall profitability rather than focusing on isolated project outcomes.
Banking Sector's Role in Enterprise Equity Investment: Evolving from Constraints to Key Responsibilities
Despite the rapid developments in AIC operations, a considerable lack of understanding persists in the financial community. Numerous investment banking professionals and VC/PE participants have expressed confusion regarding AICs, with some asking, "What exactly is an AIC?" Even seasoned AIC professionals have remarked on the niche nature of their specialty.
AICs, or Financial Asset Investment Companies, are primarily engaged in converting bank debts into equity and associated support activities. This contrasts with the more recognized entities such as government venture capital and private equity firms, marking AICs as relatively less known in the landscape.
Importantly, AICs represent the culmination of a 29-year gradual evolution regarding bank participation in equity investment—a journey that has moved from a regulatory silence to an expansive and active engagement.
Due to regulatory constraints and the need to ensure capital safety, commercial banks had historically maintained a low profile in equity investments. As reported in the “Interim Report on the Banking Sector Asset Management Market” from the Banking Wealth Management Registration Center, the total investment amount by banks in private equity funds stood at a mere 350 billion yuan as of mid-2024. Chinese banking regulations, notably Article 43 of the Commercial Bank Law enacted in 1995, prohibit banks from engaging directly in trust investments or securities operations, further limiting their investment capabilities.
Prior to loosening these restrictions, banks participated indirectly either through offshore subsidiaries investing in mainland equity markets or by establishing industrial funds to operate within these constraints. Furthermore, they often collaborated with various entities to provide a comprehensive range of financial services, including issuing loans and convertible bonds.
In the latter half of 2017, the major state-owned banks established the initial batch of pilot institutions for debt-to-equity swaps, namely ICBC Investment, ABC Investment, BOC Investment, CCB Investment, and BOCOM Investment. These entities focus on market-based methods to convert debts into equity and support financial mechanisms such as acquiring bank debts from corporations and restructuring unpaid debts into manageable equity arrangements.
By 2018, the potential for commercial banks' participation in equity investments was progressively explored, however, their chief activities remained closer to debt conversion rather than forming authentic equity investments.
It wasn't until 2021 that significant regulatory reforms occurred, permitting banks to engage in equity investment operations that are not solely focused on converting debts into equity within a legally compliant framework in Shanghai.
With the growth of the high-tech sector, equity and venture capital investments emerged as trending topics among decision-makers, establishing a clear pathway for banks to pursue direct equity investments.
The central economic work conference at the end of 2023 explicitly encouraged the development of venture and equity investments. The government work report in March 2024 reiterated support for venture and equity investments alongside optimizing the functions of investment funds. Subsequent discussions in April further emphasized the necessity for fostering a robust environment for investment and the expansion of AIC's direct equity investment scope.
China's financial ecosystem is characterized by a bank-led structure, with over 90% of the aggregate assets held by banking institutions. This creates immense potential for enhancing support for technological innovation and venture investments within a tightly regulated risk framework.
The importance of AICs in promoting technological equity investments has been underlined by experts within the field, as their natural alignment with the extended cycles, elevated risks, and light asset characteristics prevalent in technology companies can provide stable long-term funding and significantly boost innovation. The range of supportive policies issued by the government also highlights an expectation that AICs will dramatically enhance capital backing for innovative endeavors and contribute meaningfully to upcoming ventures at all stages of growth.
Recent data from the Bank of China Research Institute indicates that from 2021 until the beginning of 2024, the major five banks have cumulatively committed over 290 billion yuan in equity investment funds as regular partners in more than 180 funds, signifying their ascendant role within the primary equity investment sector.
Expected to drive over 200 billion yuan in equity investment
Equity investments cater to large investment scales while alleviating the need for regular interest or capital repayments by enterprises, closely reflecting the evolving characteristics of technology enterprises and their growth trajectories.
Yang Ze from the Investment Banking Department at Industrial and Commercial Bank remarked in a recent publication that commercial banks are progressively refining their approaches to nurturing patient capital by leveraging their diverse financial licenses and capabilities. Integrating mechanisms for debt-to-equity swaps, investment, insurance, and funds across their subsidiaries serves to fulfill the capital needs of technology-driven enterprises. It has now become essential for AICs to engage early, smaller investments in hard technology to better service the construction of modern industrial systems.
According to analysis from CITIC, AICs are set to play an integral role in the technology finance sector as they bring a wealth of customer relationships and comprehensive services encompassing both equity and debt financing for tech enterprises.
Moreover, AICs are increasingly emphasizing the intrinsic value, growth prospects, and innovative capabilities of enterprises, enabling them to provide robust financial backing while also engaging in corporate governance for stable and quality operations.
AICs possess the advantage of substantial client resources and a diverse product system that allows them to deliver comprehensive solutions combining equity and debt financing. By utilizing their parent banks' robust capital and diverse funding avenues, AICs can effectively mobilize additional social capital to propel technological innovation.
The policies introduced on "9.24" raised investment ceilings, allowing AICs to leverage even larger capital pools. The proportional increase in AIC shareholdings—from 4% to 10% of total assets—signifies potential growth in equity investment scales from 233 billion yuan to 583 billion yuan, potentially unleashing an additional 1.9 trillion to 2.9 trillion yuan in equity investments.
The impacts of this expansion are expected to enrich the service offerings of major banks while enhancing profitability across various domains, including deposits, loans, and intermediary operations. Ultimately, the presence of these technology firms and their groundbreaking contributions stand poised to bolster the broader economic landscape.
Enhancing investment research capabilities while solidifying mechanisms at the outset phase
As AICs rapidly enter the equity investment arena, the anticipation surrounding their performance is growing, though they face significant hurdles and challenges as they navigate through these early stages.
Industry leaders have indicated that the principal challenge AICs face lies in the inherently high-risk nature of equity investments and the high-return expectations that contrast with the conservative operational styles of commercial banks. This poses a complex scenario for establishing effective performance metrics. Li Yunze remarked in a press conference that regulators must guide related institutions to embrace a reasonable degree of risk tolerance during their performance evaluations, which will in turn cultivate the growth of AICs' equity investment operations.
Moreover, AICs have currently limited experience and research capabilities within the equity investment sphere. To gain traction, they need to enhance their organizational structure, performance review systems, and talent management strategies while optimizing their error-correction mechanisms to attract and retain critical personnel.
A comprehensive review of AIC operations reveals that they are still in the nascent phase of pure equity investments. AICs need to elevate their risk appetites and enhance their professional analytical competencies, while also implementing solid assessment frameworks that motivate their active involvement.
Transitioning from debt-to-equity investments to pure equity plays introduces new tests for AICs. Historically, AICs' debt-to-equity operations primarily focused on large state-owned enterprises, whereas modern equity investments are geared towards smaller, high-tech ventures requiring a distinct approach and mindset.
Another investment professional specializing in AICs noted that identifying and evaluating potential clients remain significant challenges. Fortunately, his institution established a dedicated AIC-focused division early in 2021, accumulating insights into priority industries and potential leaders within those sectors. For newer entrants, accumulating real-world experience will be crucial.
The Bank of China Research Institute's report suggests that AIC equity investments will become a pivotal aspect of commercial banks' approach to technology finance, albeit alongside challenges pertaining to liquidity, capital, risk management, and workforce development.
Firstly, the long duration of equity investments presents liquidity constraints as AICs are under pressure to meet funding requirements. The funding sourced from central bank interest rate cuts constitutes about 70-80% of AICs' financing, complemented by issuing bonds and interbank borrowings. Given the central bank’s limited tools to frequently adjust the market liquidity landscape, reliance on issuing financial bonds adds another layer of complexity, particularly with shorter financing terms.
Secondly, capital management involves inherent challenges due to the high risk rating attached to equity investments. These constraints reinforce the requirement for AICs to establish a sustainable capital replenishment mechanism, particularly when regulatory measures set a baseline core capital adequacy ratio.
Thirdly, AICs must build robust capabilities to manage the specific risks associated with equity investments, which are subject to significant market forces and investment decision complexities. Moreover, equitable assessments are complicated by variations in operating conditions and risk factors across diverse industries.
Lastly, the pursuit of skilled professionals adept in equity investment will become increasingly critical as AICs’ operations expand. The responsibility to attract and retain top talent with necessary expertise and industry insight is vital as organizations strive to enhance their performance support systems within an evolving investment landscape.
Furthermore, exit strategies represent a significant hurdle faced by AIC funds. As observed by investment professionals, the persistent challenge of “exit difficulties” remains prevalent. With initial public offerings (IPOs) being the predominant exit strategy, recent slowdowns in IPO activity have heightened these challenges. Coupled with fundraising difficulties, many private equity fund managers have been left stagnating.
Currently, the reliance on IPOs to recoup investments presents a significant barrier to innovation financing, dampening enthusiasm for early-stage investments. While regional equity markets are exploring systems for transferring equity stakes, the actual volume of these transactions remains modest, necessitating a re-examination of exits.
As stated by Luo Zhiheng, Chief Economist at Yuekai Securities, a shift towards broadening the mergers and acquisitions channel for exits appears crucial moving forward. Supporting the growth of acquisition funds and creating a secondary market for venture investments alongside optimizing fund sharing processes can significantly sharpen the appeal of these financing models.
The prevailing landscape in equity investment has shifted towards a longer-term perspective in search of sustainability and stability instead of rapid profit-seeking maneuvers. Industry stakeholders agree that genuine value and potential must determine where capital flows, dismissing the lure of fleeting trends.
Only those investment institutions capable of diligently surrounding themselves with the right projects and fostering impactful growth will come out on top.
- 2024-08-04
Leave Your Comment