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China's busiest internet banker warns of 'lawless' markets

Thursday, March 3, 2016 - 07:47

[HONG KONG] China's most prolific Internet dealmaker has issued a stern warning about the dangers facing investors in "lawless" venture capital and startup markets, urging regulators to step in and curb irrational investment and asset bubbles.

Individual investors lured by promises of extravagant returns are flooding into the high-risk realm of venture capital, Fan Bao, head of China Renaissance Partners, wrote in a column. They're disrupting markets by inflating values and could get burned when the bubble bursts, he wrote in the influential business magazine Caixin.

"The influx of retail investors into primary markets is dangerous," he wrote in a piece penned in Chinese and published online this week. "This market isn't suitable for retail investors, it's not the same as in secondary markets where price fluctuations correct rapidly. Primary markets aren't liquid, there's no process for regulating risk, and retail investors could lose their shirts." That's a stark warning from one of the most visible players in China's Internet boom. It echoes the views of economists and market participants who've argued that easy monetary policy is boosting liquidity, stoking a retail investor frenzy and encouraging investment bubbles.

In the last three years, Bao's firm played more advisory roles on Internet deals than any other investment bank in the country, according to data compiled by Bloomberg.

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Founded in 2004, he advised on some of the biggest deals of last year, including handling both sides of the US$15 billion merger between discount site Meituan.com and restaurant-review service Dianping.com. His firm advised Alibaba Group Holding Ltd and Tencent Holdings Ltd in the merger of the Didi and Kuaidi services they had backed separately, establishing a ride-hailing service valued at about US$6 billion at the time.

Bao said Chinese retail investors have been sold tranches of venture capital deals through intermediaries for as little as 50,000 yuan, the equivalent of US$7,632. In the US, venture capital is dominated by professionals whose limited partners typically include investors who can afford to bet in the millions of dollars in an industry that accepts a failure rate of nine out of 10 ventures.

But China's market has become a poorly regulated mess, he said. A plethora of funds have actively sought out individual investors, and are in turn plowing their money into venture capital amid a lack of outsized returns elsewhere, he said.

"The market's become lawless, disorderly and even meaningless. Last year there was an explosion of risk in O2O," he said, referring to on-demand services from food delivery to car-pooling. The problem is confined to the yuan-denominated market, he said. Dollar-backed venture capital is dominated by professional investors and where individuals face a tougher time getting foreign currency.

Unlike listed companies, disclosure in private markets is minimal, he said. "Because there's no obligation, there's no shortage of scams: '3X returns in five years, profit grows 5 times.' This kind of marketing has become ubiquitous." These retail investors don't have any protection built into their investments, like board seats, because middlemen pushing these deals are more interested in making money, he said.

Bao said there is a simple solution.

"The government has to regulate the involvement of retail investors in primary markets. The ones who're issuing structured products - funds, wealth managers, asset managers, trust firms, insurers should come under national supervision, they should be controlled."

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