It is well known that China is on its way to being the next superpower. However, its recent success has led to excess liquidity and huge foreign exchange reserves. A need for greater outward investment has come to the fore. China's 12th five-year plan, which was passed in March, sets out key target areas for outbound investment, including energy resources, technology, research and development (R&D), manufacturing, agriculture and financial sectors. This should lead to a greater level of investment in the UK over the coming years. This article discusses the regulations Chinese companies face, recent investments in the UK and some of the reasons it is expected bilateral trade will increase with China. In terms of London real estate, investment is being driven by a number of factors. Richard Zhang, CBRE's director of Chinese business, cites the need of Chinese investors to diversify risk and the relative weakness of the British pound. He says Chinese investors are looking to take advantage of the relative higher rental yield and the stable central London residential market and that it is "very on-trend" for wealthy Chinese to own London property. They are also buying residential property for their children while they study at UK universities. High rental yields have led to a growing trend for these properties to be kept after their children have finished university. Zhang says there have been deals in London worth £1m and above but there is also a lot of interest in the £250-500k bracket.
There is no doubt regarding the level of investment coming from China outside the residential real estate market in areas such as pharmaceuticals and technology. However, current regulations make investing overseas complicated for Chinese companies. Wendy Yan, a partner at Faegre & Benson LLP's Shanghai office, says that investing in offshore real estate may involve a number of issues. "Different Chinese rules apply depending on whether the Chinese buyer is a company or individual and whether the buyer purchases the property directly or via an offshore entity". Although new rules to make outward investment easier for companies from mainland China were introduced in 2009, the current system remains complex.
Chinese domestic institutions that want to establish or acquire a right or interest overseas will need to obtain clearance from three government authorities:
- the National Development and Reform Commission (NDRC);
- the Ministry of Commerce (MOFCOM), which approves the commercial contracts; and
- the State Administration of Foreign Exchange (SAFE), which gives foreign exchange clearance.
In 2009, and more recently in March, the rules were simplified. More MOFCOM and SAFE approvals can now be conducted at provincial level and certain investments can follow a fast-track. However, large-scale land developments still need central approval because China likes to monitor politically sensitive areas. None the less, the guidance in circulation emphasises that the economic and feasibility aspects of overseas investment should be left to the individual company and the provincial NDRC should concern itself only with potentially political, macro-economic or legal risks. One issue for Chinese companies is that the rules create a time-lag that can put them at a commercial disadvantage in competitive situations. Generally there will be a longer delay than is standard in the UK between exchange of a transaction and completion. Though it is usual for MOFCOM and SAFE approvals to follow soon after the NDRC approval, the process can take a number of months.
Melanie Wadsworth, a corporate partner at Faegre & Benson LLP, says that when acting for Chinese companies buying in the UK, it is important to ensure that the seller understands the nature of the regulations that the company must navigate before the sale can proceed otherwise sellers might misjudge the seriousness of the company's investment.
Obviously, in a competitive market, a seller will consider not only the price to be paid but the time to completion and although the rules are going in the right direction, there will be a time-lag where Chinese investment is involved. It can be difficult for UK sellers to appreciate the regulatory requirements that the Chinese purchasers face; this adds a layer of uncertainty and complexity. It is important for UK sellers to understand that it is not a complexity designed to allow the Chinese investor to walk away – only 8% of overseas transactions were rejected by Chinese authorities in the last three years.
Zhang says that "there are a lot of rumors about when and how the foreign exchange policy will be changed and become more open". It is known that China's increasing foreign exchange reserves are putting pressure towards relaxation and more open direct foreign investment.
The residents of Shanghai may be the first to benefit from further relaxations. Proposals have been laid before the State Council, which, if approved, would allow Shanghai residents to invest directly in private overseas enterprises and real estate markets. Commentators have said encouraging individuals to conduct overseas investment could help balance China's foreign exchange reserves, which may exceed $3.2 trillion this year. Individual investors would be unable to use the Chinese currency renminbi (RMB) to carry out their investment and would therefore need to use foreign exchange. However, the full details of the scheme are not yet public. It is understood that the proposed scheme for Shanghai will allow investment in real estate, but overseas investment on the stock market will not be allowed.
The Shanghai proposal follows an earlier scheme in the eastern city of Wenzhou. That scheme was suspended after two weeks because of procedural problems, but the main difference is that the Shanghai proposals will allow direct investment into the property, financial and energy sectors. If the Shanghai proposal is approved, it is likely that more investment will flow into the UK as individuals must invest overseas through a company, with the additional costs and administration that involves.
In London, many of the large Chinese banks have already taken premises near the Bank of England. CBRE has advised on high-profile Chinese investments, including the Bank of China's £100m property acquisition of the prestigious One Lothbury, adjacent to the Bank of England, and Industrial & Commercial Bank of China's (ICBC) freehold purchase of 81 King William Street. It is expected that other tier 1 and tier 2 Chinese banks will also be setting up here. Zhang says that Bank of China and ICBC have invested in their own sites, while China Agricultural Bank, China Communications Bank, CICC and China Merchant Bank are leasing around the Bank of England.
The increase in the number of Chinese banks is a reflection of the growing encouragement by both Chinese and UK governments to boost bilateral trade, Vince Cable, secretary of state for business, has said: "We want to increase bilateral trade by 2015 to US$100bn, but this is not something that can be achieved overnight. It is a marathon not a sprint". This would be a significant increase from the US$58bn bilateral trade in 2009.
According to Business Innovation and Skills, more than 400 Chinese firms have invested in the UK. In early 2011, the Chinese vice-premier Li Keqiang was accompanied on his visit to the UK by more than 150 business leaders, most of them billionaires looking to invest in the UK. In January, deputy prime minister Nick Clegg and Chinese vice president Li announced that Beijing-based Xiking Culture Media is to invest £10m in a Soho-based data centre dedicated to the video and television industries. According to the government, this is part of a wider package of trade deals between the UK and China worth more than $2.6bn. It is reported that the investment by Xiking will allow Soho Data Holdings to move forward with a 4,000m² facility in Cleveland Street supporting TV, 3D animation and online TV industries.
Pharmaceutical giant Xiangxue confirmed its expansion in the UK last year by announcing that it is establishing its own R&D centre in Cambridge. The centre follows Xiangxue Pharmaceutical's arrival in the UK in 2007. It is reported that the company will continue its research for the next three to five years before marketing its products as complimentary supplements to traditional medicine and using its UK presence as a springboard to Europe.
Last year Chongqing Machinery & Electric Co (CQME), which is listed on the Hong Kong Stock Exchange, acquired Holroyd Precision Ltd and other subsidiaries of the Precision Technologies Group based in Rochdale for £20m. One of the world's leading suppliers of commercial vehicle parts and components to the automotive industry, CQME has committed itself to investing in its UK subsidiaries and so far there have been no redundancies following the acquisition.
Even though there are strict restrictions on money coming out of China, investments are being made. Zhang says the RMB will become one of the most powerful currencies in the next five to 10 years, but it needs to become a "freely convertible currency". Many international banks already cite RMB trading as a future potential for business growth.
In terms of outward investment from the UK, it is understood Grosvenor aims to raise at least $270m for a fund that will invest in Chinese properties as part of its expansion in Asia.
So what does the future hold? In order to cool surging inflation and currency appreciation, which is increasing the cost of Chinese exports, it is likely China will continue to relax the regulations on overseas trade. The Shanghai proposal may be ratified and allow individual investors to make overseas direct investments. Opening up foreign investment could provide China with more investment channels for China's vast household savings.
This article was first published in Estates Gazette on 9th July 2011.