The Shanghai Free Trade Zone: A New Solution to the Chinese Capital Trap

The Shanghai Free Trade Zone: A New Solution to the Chinese Capital Trap

You know the Chinese finger trap? It's a tube of bamboo woven in such way that it tightens up if you pull on it. The idea is you put your fingers in, but the harder you try to pull them out, the tighter the trap will grip you. And it was the only thing my daughter wanted me to bring back as a souvenir of China.

Pangaea has been an investor into China for a few years now, having co-led the Series A into Cnano, now the world leading supplier of multi-walled carbon nanotubes, mostly used in battery or composite plastics applications. But when I heard the reciprocal might be possible – i.e. China investing in Pangaea – I had to check it out.

Pangaea was invited to tour China as part of a national trade mission organized by the Canadian Venture Capital Association (CVCA). We met with Chinese GP and LP investors, as well as entrepreneurs and innovators. I found it to be a welcoming and beautiful country, full of friendly people who enjoy a level of freedom far above what is depicted in the media. I was impressed with the balance between a driven, entrepreneurial culture and the warmth and collaborative spirit of the people I met. The contrasts between Beijing, Shanghai and Hong Kong are striking, and the business interests of the groups we met in each city were quite different as well.

Although Pangaea is not in a focused fund-raising mode, we are of course always interested in building our network of people interested in advanced materials innovation and venture capital. And so I was dismayed to learn the legal realities of mainland Chinese companies or individuals investing into non-Chinese companies. There are no fewer than seven government regulatory bodies that oversee such investments! That applies to M&A activity as well.

The regulations are extensive. For example, a corporate investor must first file a project with the National Development and Reform Commission (NDRC). Once they have confirmed that a project may proceed, the investor must apply for an anti-trust review by the Ministry of Commerce (MOFCOM). Following this, the project returns to the NDRC for approval, then it is back to MOFCOM for the issuance of an Enterprise Outbound Investment Certificate, and finally to the State Administration of Foreign Exchange (SAFE) for issuance of a Foreign Exchange Registration Certificate for Outbound Direct Investment and completion of outward remittance of foreign exchange.

Phew! Assuming success, that just took three months, and cost a bundle. And if the investor was a State Owned Enterprise, the process would be even more complex, involving also the State-owned Assets Supervision and Administration Commission of the State Council (SASAC).

So is this like the finger trap? The harder the Chinese investor tries to pull their money out of China, the tighter the trap grips them?

The solution to the finger trap, of course, is to stop pulling your fingers away from the trap, and instead to push them together, which causes the trap to release its grip.

Perhaps that is happening now. We were told it was coming, and shortly after my return to Canada, the Shanghai Free Trade Zone (FTZ) was officially announced on September 29. The FTZ is a 28 km2 region that will allow companies registered within it (even if they do not reside there) to freely exchange money outside of China. In theory, this should allow Chinese companies to freely invest in foreign entities without the burdensome regulatory process enjoyed today. Allowing more movement of capital and drawing investors closer, rather than having them always trying to pull away.

You might expect such a development to create a gold rush of companies registering to take advantage of the opportunity. After all, the Chinese housing bubble ended in 2011 and real estate prices have been down ever since (though 2013 has seen a bit of a recovery). After years of making steady and sizeable returns, Chinese investors are looking for the next big thing. However, it seems the FTZ is off to a slow start. As of this writing, only eight Chinese and two foreign banks have applied to set up branches in the FTZ.

The reason is regulatory oversight, a problem very familiar to Chinese investors. The exact details of the FTZ have not been worked out, or at least not announced, but some of the regulatory requirements unveiled to date include a need for banks setting up in the FTZ to establish entirely separate operations and procedures. Beyond a "Chinese wall", this has been described as a "hermetic operational seal". No wonder so many groups are taking a wait-and-see attitude!

Nevertheless, the intent of the FTZ is clear, and I believe Chinese ambition will work the kinks out of the system. As China becomes a developed nation and its GDP growth inevitably slows, Chinese investors will look beyond their borders for greater growth opportunities. This could be a great gain not just for VC firms like Pangaea, but for capital-starved start-up companies as well.

As for the finger trap itself, I went from store to store in every city, trying to buy one for my daughter. I even made a DIY one out of paper to show people what I meant. Nobody had ever heard of one. Seems it's not so Chinese after all.

General Partner, Pangaea Ventures Ltd. Keith has been making cleantech and advanced material venture investments since 2001, having managed Mitsubishi Corporation's Canadian VC activities and BASF Venture Capital America out of Silicon Valley.View Keith Gillard's profile on LinkedIn


  • No comments made yet. Be the first to submit a comment

Leave your comment

Guest Monday, 20 January 2020