By Li Liming
Published: 2008-04-09

From News, page 6  issue no. 362, April 7, 2008
Translated by Ren Jie
Original article: [Chinese]

After three months of tense negotiation, China Investment Corporation has signed a deal with JC Flowers and Co. to jointly establish a 4 billion dollar fund for overseas investments.

The EO has learned that JC Flowers won the deal because it provided the CIC more favorable terms than Texas Pacific Group (TPG). The source believed the CIC gained experience in foreign investment from deals with Black Stone and Morgan Stanley, and has learned to negotiate harder as a result.

Squeezing Favorable Terms
Last September, not long after the CIC was founded, it was preparing to entrust one billion dollars to a foreign private equity company for investments abroad. One source told the EO that the CIC's original choice was TPG and that both parties had already begun negotiations on the deal's specifics. TPG's affiliate, Newbridge Capital, bought a 17.8 percent share in the Shenzhen Development Bank in 2004.

The EO also learned that the CIC realized that to introduce competition would help it win more favorable terms. So JC Flowers became an alternative in the end of November 2007.

JC Flowers, the world's largest private equity firm focusing on financial investments, was founded by former Goldman Sachs banker Christopher Flowers.

After over three months' worth of negotiation, CIC insisted that the entrusted party contribute capital to the fund. TPG withdrew because it could not satisfy that condition. CIC singed a trust agreement with JC Flowers at the end of last month.

Sources said CIC insisted on the condition that of the 800 million dollars remaining after it contributed 3.2 billion, half would be contributed by the entrusted party's other funds and related institutions, and another half should come from the entrusted party's general partner. This point could not accepted by TPG.

Besides this point, JC Flowers also conceded to other CIC terms. Especially on distribution of profits and management fees, JC Flowers made concessions that surpassed industry norms. According to such norms, 20% of the profits of this kind of investment should go to JC Flowers and 80% to the CIC. The former would also receive 1.5 to 2% fund management fees.

The CIC retained the right to intervene and make stipulations on investments, for example, choosing geography or specific projects to go forward with.

The EO also learned that Christopher Flowers, JC Flowers' founder and CEO, felt that such low profit distribution and management fees for his firm were unacceptable at first, because it would influence JC Flowers' income and make affiliated limited partners of other funds unhappy. But managing director Xuan Cangneng believed it was a wonderful chance for JC Flowers, which was not famous, to become well-known in China.

This deal was JC Flower's first foray in China. Sources said, Gao Xiqing, CIC's general manager and chief investment officer, was active throughout the negotiation process; Lou Jiwei participated in decision making, and Li Yingru, who was in charge of private equity within the CIC's alternative investment department, answered for specific items. Flowers took part in the negotiation in person, and aside from JC Flowers' Chinese managing director Xuan Changneng, an attorney was also present in the negotiation.

A Practical Choice
Finance professor Chen Zhiwu of Yale University pointed out that the CIC should seize on the opportunity created by the sub-prime lending crisis to buy shares in international financial institutions which were starved for capital injections. November 29, 2007, Lou Jiwei said that if other sovereign wealth funds (SWF) inject capital in battered international financial institutions in this way, the CIC would also look into it.

However, as an SWF, the CIC's investing in outside financial markets has been a sensitive topic. Its deal with Blackstone drew the attention of the US congress, and resulted in new legislation. This has influenced the CIC's decision to invest abroad through intermediary institutions.

JC Flowers had anther advantage: that if objects of investment were US banks, JC Flowers could hold more than 25% stocks. This is because according to US law, PE companies which did not specialize in investing in financial institutions could not hold a share over 25%.

CIC - Background
The CIC was founded on September 29 2007 after approval by the State Council, with registered capital of 200 billion dollars. Lou Jiwei would serve as its director, Gao Xiqing as general manager and Hu Huaibang as chief supervisor.

In October, the CIC bought the Central Huijin Investment Company from the State Administration of Foreign Exchange at the price of 67 billion dollars. Huijin holds stocks of commercial bank of China, Construction bank and bank of China valued at over 350 billion US dollars.

On January 5, 2008, CIC fielded bids to be its foreign investment managers. Over 200 companies applied, of whom around ten were selected. As foreign investment managers for the CIC, they would be required to make investments with annual yields at least 200 base points beyond the standard financial rate of returns for the same period.

On February 29, the CIC's first interest payment came due. It must pay 4.3 percent, 12.9 billion yuan in interest, each year for the 600 billion yuan in special bonds issued to fund it.