China’s domestic secondaries market has attracted increasing attention as the value of Chinese asset slumps amid the economic downturn and tightening capital market regulations.

A growing number of international firms are venturing into yuan-denominated secondaries, including Coller Capital, Schroders Capital and Hamilton Lane. Coller established its Beijing office in 2021 and launched a debut yuan-denominated secondaries vehicle last year, as Secondaries Investor reported. Hamilton Lane opened its Shanghai office in February last year and is launching its inaugural RMB fund focused on secondaries.

While opportunities are abundant in the market, international firms may also find themselves in a world of unique challenges, including navigating data scarcity, managing pricing complexities and building robust relationships with local GPs.

Here are three essential things to know about China’s domestic market for global investors eyeing the opportunity.

Booming LP-led market

The size of China’s LP-led secondaries market has been growing consistently since 2017, according to Zerone, a Chinese secondaries marketplace and data platform. LP-led secondaries transaction volume in China’s RMB market reached 102.1 billion yuan ($14.2 billion; €13.1 billion) in 2022, up 53 percent from 2021, Zerone noted in a 2023 white paper.

The rapid growth of China’s LP-led market is fuelled by a few factors, according to Tao Tian, a market specialist at Zerone. The first driver was the rollout of strict asset management rules in 2018, which required bank-related financial institutions to divest from equity investments, resulting in a surge of sellers in the secondaries market. The second was the 2018 stock market downturn, which triggered margin calls for certain public company shareholders. To address these margin calls, some shareholders turned to selling their private market investments. The third – and most important – driver is that private equity funds formed during the peak period of 2014 to 2017 are approaching the end of their life cycles, adding exit pressures for LPs, Tian added.

Figures suggest that 2023 was a slow year for LP portfolio sales, with the combined transaction volume for the first three quarters totalling 43.7 billion yuan, according to data Zerone shared with Secondaries Investor.

It is worth noting that, until now, Zerone has only reported deal volume data on LP-led transactions. Such data is compiled using public records that companies file to China’s market regulator, the State Administration for Industry and Commerce, Zerone’s chief marketing officer Shaoyan Song tells Secondaries Investor.

Non-government funds are the dominant player in the LP-led secondaries market. Only 26 percent of Chinese private equity and venture capital funds, either active or planning to engage in buying and selling in the secondaries market, are funded by the government, according to a report by PwC last December. The report was based on a survey of 93 top Chinese PE and VC funds with a combined AUM of 1.49 trillion yuan.

Emerging GP-led market

Data on GP-led RMB transactions remains scarce, given the relatively nascent nature of such deals in the market, multiple buyers active in RMB secondaries tell Secondaries Investor. Still, several high-profile GP-led deals have surfaced in recent years, providing a glimpse into deal activities in this opaque market.

In 2020, Hong Kong-based TR Capital led a group of buyers in a GP-led process to provide Beijing-based Kinzon Capital access to foreign US-dollar capital. The same year, Beijing-based IDG Capital was understood to be the first to use the Qualified Foreign Limited Partnership programme in a GP-led transaction, transferring $600 million of assets from a mature yuan-denominated fund into a dollar-denominated vehicle with backing from HarbourVest Partners and LGT Capital Partners. In 2021, TR Capital co-led a process that involved transferring six healthcare assets from three funds managed by China’s Huagai Capital into a 800 million-yuan continuation fund.

Zerone plans to compile GP-led data for the first time this year. The effort will primarily rely on news articles and press releases, according to Song.

Compared with LP-led deals, sponsor-initiated transactions in China are usually larger in size and more concentrated on several assets, according to Zhan Yang, a Beijing-based investment principal at Coller Capital. LP-led transactions tend to happen on a “more opportunistic and more frequent” basis in the RMB secondaries market, he adds.

“We are highly unlikely to do a tiny transaction on the GP-side,” Yang says. “From a capital deployment efficiency perspective, it’s just too low… That leads to the relatively bulky transaction size on the GP side.”

Challenges for international investors

Connections with local managers are key for international firms aiming at the GP-led market. Coller’s first transaction in its debut RMB fund involved moving six healthcare assets out of an existing vehicle managed by Legend Capital, “a very established GP we have worked with before”, Yang says.

Hamilton Lane also emphasises the importance of local relationships as a source of dealflow.

“Our business opportunities in China primarily arise from GPs we’ve partnered with in the past,” Mingchen Xia, managing director and co-head of Asia investments at Hamilton Lane, tells Secondaries Investor.

He adds that the firm has expanded its network to include more local LPs, who have been increasingly interested in exploring liquidity options through the secondaries market.

The quality of local GPs is top of mind for many market participants. Bonnie Lo, chief operating officer at TPG NewQuest, which has engaged in several RMB-to-USD fund restructurings, says her team is very selective when choosing local managers.

“The focus needs to be on high-quality domestic funds with a proven track record,” says Lo. “They [need to] have a quality asset portfolio [and] the level of professionalism that could be attractive to the international USD investors… All of those boxes have to be checked.”

Coller’s Yang agrees: “Each time we do a GP-led secondary transaction, the GP’s quality is as important as, if not more important than, the asset’s quality,” he told Secondaries Investor in a previous interview. “As we just started our RMB transactions, we would very much like to work with high, institutional-quality GPs.”

Pricing complexities are among the biggest challenges for firms eyeing the RMB GP-led market. Striking an attractive deal in the market remains difficult despite the steep discounts on offer, which can reach up to 40 percent, affiliate title Private Equity International reported.

Pricing is also an issue for firms that have yet to enter the RMB secondaries market. Partners Group, for example, has been investing in China’s secondaries opportunities via US dollar funds. The firm does not manage any RMB capital at the moment.

“We find [China] a very difficult place to underwrite with conviction given the geopolitical tensions and the regulatory uncertainty,” says Martin Liew, head of private equity partnership investments Asia at Partners Group. “What is a fair price today? You don’t really have the visibility… We continue to look for the right opportunity with the best risk return profile but remain very cautious.”