Capital Markets: The Direct approach – an interview with Direct Capital’s Ross George (NZ Herald)

Originally published in the New Zealand Herald

Direct Capital’s Ross George is a pioneering veteran of the New Zealand private equity market. Now, 25 years after raising Direct Capital’s first fund, George is still going strong. He talked with Capital Markets about how he got started here as a 32-year-old, the dynamics of the market and some of his standout transactions.

Herald: You were very young when you came back to New Zealand to raise the first fund for Direct Capital — which you listed.
Why did you make that decision to list and how did you have the confidence to do that at such a young age?

George: I was 32 when I came back. I did come back to raise the first fund for Direct Capital but it didn’t actually work on its first go. That was the early 1990s. New Zealand was quite depressed. There was huge distrust for investment professionals after the party of the 1980s and the private equity industry didn’t exist in New Zealand. There were a couple of venture capital funds including a Government one called Greenstone. We had to educate investors what private equity was. It was called direct investment back then.

I then convinced my varsity mate Mark Hutton to come back from Monaco to join Direct Capital and Bill Kermode, who I knew from school, to do the same. It got off the ground once the three of us teamed up. We were all young but we had confidence because I came from the industry, Mark was in a senior financial position in Monaco and Bill was well known in Wellington where all the institutions were.

The listing was a happenstance. We planned a private fund of $50m which was quite a lot at the time. The listing came about in a funny way actually. I was doing a presentation to about eight people in AMP in Wellington in the middle of which they all started talking amongst themselves and then gradually one by one got up and left. I did the second half of the presentation with a couple of analysts who were over compensating by nodding a lot. Towards the end the big bosses came back in and said “if you can write us a good proposal and agree to list it, we will put $25m in”. That was enticing but it put at risk the only money we did have at the time which was from the Bell South Pension Fund whom I knew from Hong Kong. We actually lost Bell South as a result of the listing decision. But AMP were quite a bell cow for other institutions and we listed with over 10 institutions on board which was a great effort. The other positive of the listing route was we appointed Rob Morrison and Ord Minnett as brokers who did a fantastic job for us.

Herald: In the last few years Direct Capital has transitioned from the three tight partners — Mark Hutton, Bill Kermode and yourself — that ran the fund over the first 20 years. What made you decide to continue after their exit?

George: Yes, it was a great partnership and we are still joined at the hip in a number of investment vehicles.

While Bill left, Mark is still an owner, a director, and on the investment committee. He is not a full time executive but remains actively involved.

It’s actually been a continual succession process since we started through Gavin Lonergan, Tony Batterton, Simon Plowman through to the current owners, Travis Sydney, Heath Kerr, and Andrew Frankham. Hugh Cotterill, our new partner joins in June. We have got very good at succession because we have watched it in a lot in companies we invest in.

I have continued on because I enjoy the work. It is like a university course where continual learning is the norm. You can be dealing with a pharmaceutical company one year, then a logistics company, a retirement village operator, an internet market place and an engineering firm the next. The commonality between them all is growth which is our focus. The rules of growth seem to be the same no matter what industry you are in. The easiest growth we have found to be is in Australia. For the last 20 years about 50 per cent of our revenues have been derived in Australia. Once you know it, it is a very good and successful market to be in.

Herald: Looking back over 25 years, what has been your stand-out performer?

George: We don’t typically highlight individual companies but we’ve listed some of our companies and their performance is public record. Ryman Healthcare has been an obvious highlight. We invested in it in 1996 when it had a small number of South Island retirement villages. The industry wasn’t that understood at the time as it was in its infancy. The people however were the best we had seen. John Ryder and Kevin Hickman had almost all of the bases covered between them. They had different skills but they were good mates and a great business combo. It wasn’t a popular investment at the time as people thought of it as property development. The drivers of this industry are far from it and we think they still are. Building the villages is a short period within a retirement village’s life. It is a people and healthcare industry once it is up and running.

John and Kevin wanted additional capital so they could accelerate what they knew to be a successful business model. It worked almost immediately. Ironically we had trouble listing it and there was reluctance at an institutional level to invest. Fortunately we knew all the institutions at the time and after a series of one-on-one meetings we got a sufficient number on board to proceed. Once it was on the market it didn’t turn into a darling for its first two or three years. We invested at an equity value of $23m! Its market cap hovers around $5 billion to $6b now.

We are very proud of Ryman and to complete the circle John Ryder is now non-executive chairman of Direct Capital, and just to complete another circle, we have re-invested into the retirement village sector alongside John in Qestral Corporation.

Herald: Scales Corporation is absolutely booming. You scooped it up from the South Canterbury Finance receivership in 2011, later listing it on the NZX — which paid off very well. Was that investment always a no-brainer?

George: We knew Scales very well for 5 — 10 years before we got to invest in it. In fact, our offer to invest in 2011 was our fourth attempt. We could never get the (Allan) Hubbard Group over the line.

It was put up for sale through the South Canterbury Finance (SCF) receivership and ironically (again) we absolutely struggled to get into that sales process.

The receiver had high valuation ambitions and Goldman Sachs thought we had insufficient money to buy it. Although that wasn’t completely true we understood their view so teamed up with ACC and NZ Super in a consortium and were then allowed into the process. We knew Scales was not a straight forward investment for anyone unfamiliar with it and we knew it had been tied up in the South Canterbury Finance group which would scare others off.

We didn’t really scoop it up because we think 28 parties were approached and one by one they fell away through the process. Commentators also tend to ignore the high level of debt in the business at the time which we reduced over time. It wasn’t “scooped up” on an enterprise value basis. In any event, we clearly had the most attractive offer at the end which was well financed. I also think we were attractive to Andy Borland and his management team because a number of other bidders only wanted one division of it and our offer was for the whole lot.

Scales is a great company which again has a great group of managers and that is why it’s successful. The investment was in no way a no-brainer in fact it was a very difficult investment to make for all of the reasons above.

Herald: Which company has been the biggest turnaround challenge?

George: It’s one of the most common questions we get asked and we always disappoint by not answering it but the simple truth is that we are always investing into private companies alongside other shareholders, often family groups, and management and our partners are usually quite private individuals. They expect their privacy to be respected and we honour that. In fact, many owners tell us that is the reason they prefer private equity over other options.

But of course very few businesses travel in a straight line of success. Private companies are just as subject to economic and business cycles as anyone. When business gets difficult it is often due to changes in industry structure or risks that do in fact eventuate. Occasionally you have to accept that what you invested in is different to what you thought it was. Thankfully we have delivered very good returns to our investors for 25 years because those situations are the exception, not the norm. When these situations do occur you have to ensure you have the right information to evaluate whether more capital will solve it, or more time. And sometimes it is neither. Investment is rarely a binary “good call or bad call,” it is managing identifiable risks and being patient when required.

One of the reasons private company investment is so successful is the alignment of interest between shareholders and management. In private company investment you invest alongside the owners and management.

Everyone has skin in the game. Both we and they have a vested interest in solving business issues when they arise, rather than management just moving on to the next career assignment. In our view this alignment of interest is one of the most powerful drivers of value in private company investment.

Herald: What have been the lessons you have learnt from an investment that hasn’t gone so well?

George: We invested in a people based company with five owners. We only discovered after we made the investment that only three of them were keen on expanding the partnership to include us.

It was difficult for those five and us but we managed our way through it. It wasn’t a financial success and it shows the value of a harmonious partnership. It’s easier to run a company when all the owners are on the same page.

The lesson out of this was to spend a lot more time with all the owners before investing to find out everyone’s motivations. Nowadays, we ask our prospective partners what their objectives are and we can handle almost every variable we are faced with — ie do they want to stay in the business for ever, do they want out, do they want to be part-time or more flexible, do they want to change roles etc. We can accommodate all of this as long as we know it.

Herald: You hold a retreat every two years where you get all the companies you have invested in together. What’s the rationale behind that?

George: We have held 13 of them and I think they look forward to them as much as we do. Direct Capital doesn’t buy a business, it invests into a company with other shareholder owners so you get quite close to the people you are in business with. Fortunately in a growth company it is also quite good fun and over time you get to like each other and since you have dealt with a myriad of issues in the trenches you know each other really well. The most extraordinary thing is that the people we invested alongside in the early 1990s still come, and they become mates with all the other companies.

Our partners are a group of similar people who enjoy catching up with each other.
We try to make it mostly educational during the day with drinks and dinner and some form of entertainment at night. They never know where they are going and just agree to meet in the morning at a café.

Part of the rationale is that companies we have invested in in the past are our best form of marketing to other company owners. In New Zealand everyone checks each other out and if you don’t check out well you don’t have an enduring business here. They all speak well of us and this conference is also to say thank you for that.

Herald: How has the New Zealand private equity market changed over 25 years?

George: The market has come a long way and is now professionalised with funds being run by experienced and proven management teams. In 1994 it wasn’t really an industry. In addition to the NZ-based managers we see Australian and international funds also active in the New Zealand market.

There’s also been the development of Limited Partners — institutional funds who now allocate capital to the private company market as a matter of course. And it’s not just the evolution of General Partners and Limited Partners — we’ve seen the banking, legal and advisory community grow enormously to service the industry.

And a huge benefit of this is that company owners have also become much more familiar with private equity and understanding of the benefits a financial partner can bring to their business. This was something we used to have to explain to them. Today, a sell down or introduction of a financial partner is a common and accepted (and often preferred) option for business owners thinking about growth or capital.

The operating standards of private equity firms have also advanced through the influence of Limited Partners, who are all part of global networks. Direct Capital operates to international standards in terms of reporting, governance, identifying and managing environmental, social and governance issues (ESG). We were the first New Zealand private equity manager to become a signatory to the United Nations Principles of Responsible Investment (UNPRI).

Herald: You’ve said previously that the private company market is at least 10 times bigger than the listed company market in New Zealand. What does the NZX need to do to build confidence for public listings?

George: We are involved in the Capital Markets 2029 Taskforce currently underway and are very supportive of NZX initiatives to deepen our public markets. We don’t see private equity as a competitor to the NZX.

We are complementary to each other. We have led the IPOs of several of our companies — Ryman, Nobilo Wines, Scales, and New Zealand King Salmon and would expect to list others over time.
I think the first thing to acknowledge is that not every private company can be listed or indeed wants to be listed. As I mentioned, private company owners are often family groups or comprise a small number of shareholders and are quite private people.

Company owners often have strategies that will take several years to execute. When listed there is a natural focus on more immediate performance.  Owners often express a concern about their ability to remain focussed on longer term growth initiatives in a public environment. It’s a common issue in the US and around the world.

Beyond that, a broader market of public market intermediaries would be helpful. We have seen the benefit of that in the private company space and I believe the same would be true for the listed sector.

Herald: What are your predictions for the private equity market over the next five years?

George: We are 25 years old this year and have invested in 75 companies. In the larger mid-market area that we operate in we know there are close to 1000 private companies that are of a size that we could invest into. We’ve barely scratched the surface. Of course those companies need a catalyst to introduce a financial partner — whether it is to fund growth or succession. I think the next five years will be a continuation of the past 25 years.

Capital will continue to accelerate growth. In our 25 years, the benefit of new capital into business has been clear.

Our companies, in aggregate, have grown their employee numbers by 44 per cent and revenue by 64 per cent. Inevitably we will see a cyclical correction — probably sooner than later. But we’ve been through a number of those periods in our 25 years and good businesses with good management teams, and that are well-capitalised will continue to thrive. Indeed, investing in cyclically difficult times has proven to generate the greatest value in our experience.

We’ll see second generation managers emerge and that will be a healthy sign of a continuing maturity in our market. I’d like to think we’ll see more institutional investment into private companies.
KiwiSaver is the obvious elephant in the room for its lack of investment despite the positive international evidence of pension funds in the space and the natural compatibility of the investment timeframes.

KiwiSaver is now at a scale where issues such as the requirement for liquidity and pricing on a daily basis, for example, are not that credible for what would be a small percentage of overall asset allocation.

There is no doubt, New Zealand’s private company sector continues to provide excellent opportunities for experienced managers to accelerate growth and generate investor value. This is confirmed by an array of institutional investors continuing to consider increasing mandates targeting private capital in New Zealand.

Capital Markets: A new role model for growth (NZ Herald)

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Capital Markets: EY monitors record activity (NZ Herald)

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Reflections from MCing the China Business Summit

Newshub Nation Panel: April 13, 2019

China Business: 2019 – a year of challenges (NZ Herald)

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China Business: 2019 – Exchange securing a future (NZ Herald)

Tim McCready talks to James Fok, Head of Group Strategy at the Hong Kong Exchange

Herald: What sets the Hong Kong Exchange apart from other exchanges around the world?

Fok: We’re one of the top several exchanges in terms of market capitalisation in the world. We have been number one in IPOs in six of the last 10 years. In many ways, we have a fantastic business — particularly leaning on mainland China and helping Chinese companies from the 1990s onwards raise capital from international markets. Unlike many other cash equity exchanges around the rest of the world, we have quite a lot of growth in our core business. While in New York you’re seeing the number of listed companies fall year-on-year, we’re seeing the number of listed companies go up.

Going back almost 10 years now, we recognise that mainland China is also changing in the way in which it operates and is structured. The first H-share company [companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange] to IPO on the exchange was Tsingtao Brewery Group in 1993. At that time there wasn’t a lot of capital in China, so if Chinese companies wanted to raise capital they had to come out into international markets, and Hong Kong was a place that enabled them to do that.

Herald: With China opening up over past decades, how has the Exchange’s relationship with China changed?

Fok: Today there is a huge surplus of capital in China — notwithstanding the economy slowing down. There is over US$25 trillion sitting in Chinese deposit accounts that has not been deployed into capital markets. We still see a big opportunity with China, not necessarily with Chinese companies coming out to raise capital — although they are continuing to do that — but to try and find a way for Chinese investors to be able to diversify their investment in international markets.

Chinese financial market needs are also becoming a lot more complex. Chinese companies and individuals are doing a lot more things internationally, and supply chains are such that they are making sure they squeeze every bit of margin out of everything. That means they have to hedge a lot of the input prices such as metals and commodities. China is rich in many ways, but in terms of natural resource commodities it is generally having to import to supplement its own domestic production. On top of that, doing more business internationally means that there is foreign exchange risk, interest rate risk on foreign currencies, etc.

The role Hong Kong needs to play going forward is a much more comprehensive one. Not just the capital formation centre that we have continued to be, but we need to become a wealth management centre and a risk management centre for China as well. International investors coming here continue to come here for the Chinese exposure. They now have the option of going to the mainland directly, but many still find challenges in going directly onshore.

Now, as well as bringing Chinese companies here directly to list, the exchange is helping to provide a channel in which investors on both sides of the border can access each other’s market without the product or company being directly listed there.

We are providing a gateway for people to go in using their broker in Hong Kong — without having to open new accounts onshore — allowing access to the onshore market in as frictionless way as is possible, where we manage the differences in market structure.

Equity is still a large piece of the business, but more and more we have been shifting towards different asset classes as well — the most obvious was our acquisition of the London Metal Exchange in 2012.

Herald: How are new advances in fintech reshaping how you’re operating?

Fok: Stock exchanges are the original fintech businesses. Technology has driven our business for a very long time. But what seems to be happening at the moment in the technology space is that we have a confluence of factors that are forcing a huge acceleration in the pace of change.

That change, in many ways, has been hugely disruptive. You only have to look at retail businesses and what Amazon has done to those to understand that. When you look at stock exchanges and you look at the fundamental business model — providing a centralised place for people to buy and sell securities — generally that model is very efficient. But in every other facet of our business — ranging from clearing and settlement, the ways companies communicate with their investors, through to the day-to-day operational processes — that is now disrupted.

When you look at the ability of robotics and artificial intelligence to replace a lot of fairly menial — and actually relatively sophisticated but process-driven jobs — it’s phenomenal. We have had to, like everyone else, look at how we adopt technology into our business to drive efficiency.

Many businesses do this as a way to cut costs. There is an element to which that is true for us, but actually it goes much beyond that. Because everyone investing in our market has to use us, if we are inefficient as a market and as an infrastructure, it imposes a significant cost on all the market participants which ultimately affects Hong Kong’s competitiveness.

Herald: How is the exchange helping to attract smaller start-ups to Hong Kong?

Fok:  Last year we undertook the largest set of listing reforms we have done in 25 years. We launched three new chapters of our listing rules — all of which were targeted at new economy companies, but two in particular:

We launched a segment of our main board that caters to pre-revenue biotech companies. Many R&D companies when they come to market don’t have revenue, let alone profit. The biotech board allows companies from the biotech sector to come here and list. Prior to these changes companies had to at least have revenue.

The second component is to allow weighted voting rights. These allow founders to maintain control even if they are diluted below 50 per cent of the shareholding of the company. We didn’t offer these kinds of governance structures here, so we saw a lot of Chinese companies in the tech space find themselves in the US market.

We were number one for IPOs last year for the amount of money raised, and 32 per cent of that money raised came from companies listing under the new chapters.

Herald: The Hong Kong Exchange signed a Memorandum of Understanding with the NZX early last year. What was the purpose of this for the HKEX?

Fok: The long-term ambition for us is to develop the product offering in Hong Kong more widely. It is largely an equities market still today, and when you look at trading and market capitalisation, something like 80 per cent of turnover is on mainland Chinese companies. While this is precisely what attracts international investors, as we open up to more direct mainland China investors who already have a lot of China product to invest in onshore, we need to diversify our offering.

New Zealand isn’t the only country we have signed an MoU with.

Of course, on the stock side, New Zealand is not one of the highest priority markets — most Chinese investors looking to diversify will look to the US market. Instead, the purpose is to bring a more diverse range of products to the exchange. New Zealand has done very well in the agricultural milk future space — something that is potentially of relevance to mainland Chinese consumers, particularly given their consumption.

Promoting confidence

The NZX and Hong Kong (HKEX) exchanges signed a Memorandum of Understanding in January 2018 to further promote confidence and co-operation in Asia-Pacific markets. Under the terms of the memorandum, the exchanges seek to promote market development by considering opportunities in a range of areas, including foreign investment, derivatives, depository receipts, listed debt, dual listings and exchange-traded funds.

The NZX says:

  • This global alliance supports NZX’s commitment to increase its international presence, and our desire to expand the reach and connection of the New Zealand market, because growth in New Zealand’s public markets will come from having a wider range of listed products and increased market activity. Global alliances we initiated and are continuing to build with the Hong Kong, Singapore, Shanghai and Nasdaq exchanges support this.
  • NZX and HKEX have continued to work together since the memorandum was signed in January 2018. In April, NZX Regulation recognised the regulatory regimes and requirements for the Hong Kong, Singapore and Toronto exchanges. This allows companies listed on these exchanges to seek a secondary listing on NZX.
  • Seeking new ways to retain and attract customers has been a priority for NZX. It is vital to growing New Zealand’s public markets. Over the past 12 months, we progressed alliances with global peers to ensure that an NZX listing connects New Zealand issuers with the world.
  • Our relationships with the Nasdaq, Singapore, Hong Kong and Shanghai exchanges, and the transformation in our service offering to issuers, ensures we are developing a product that is relevant and competitive.

China Business: Taking a fresh approach (NZ Herald)

http://bit.ly/2FRKzVM

The fresh food e-commerce business is growing in China as Tim McCready reports

Chinese e-commerce giant Alibaba Group launched the sale of fresh produce in 2016 with the introduction of its Hema supermarket chain. These stores have been established as a test bed for what Alibaba calls the “New Retail” concept: the blurring between shopping online and offline.

In order to keep products fresh, Hema’s fresh grocery items are packaged in small quantities — with just enough food portioned out for a small Chinese family.

The supermarket — which doubles as a warehouse and logistics facility — encourages shoppers to buy online using their mobile phones. Alibaba’s smart logistics technology means that as long as the consumer lives within a 3km radius of the store, products will make it into their hands within 30 minutes of ordering.

Last year, Hema supermarkets in Beijing and Shanghai launched a 24-hour delivery service — again with a 30-minute delivery window.

“We found that New Retail doesn’t only merge online with offline, but also connects day with night,” said Hema CEO Hou Yi. The around-the-clock offering includes most items in store, aside from some fresh produce. Cooked meals are available for delivery until 1am.

Hema’s presence in China has expanded rapidly, with the chain now in 80 locations across the country.

Consulting firm iResearch says China’s fresh food e-commerce industry grew by 59.7 per cent in 2017 to 139.1 billion renminbi (NZ$30.13b), noting that fruit is the most popular food item purchased online. Dairy products and vegetables ranked second and third, respectively.

More players are moving into the fresh grocery space. China’s second-largest e-commerce retailer behind Alibaba, JD.com, last year launched its 7Fresh supermarket chain. Like Hema, 7Fresh focuses on fresh food, and promises 30-minute delivery to locations within 3km of a physical store. During its trial period, JD.com said more than 10,000 customers visited the 7Fresh supermarket each day.

JD.com now plans to open 1000 grocery outlets in the next three to five years.

“Our goal is to expand 7Fresh supermarkets into every first and second-tier city and the surrounding areas of those cities,” says Wang Xiaosong, CEO of 7Fresh.

Another fresh produce e-commerce platform, MissFresh, was founded in 2014, and now operates in 20 Chinese cities, specialising in one-hour deliveries of produce.

In September last year, MissFresh completed its Series D fundraise, raising US$450 million (NZ$661 million) from investors that include Goldman Sachs and Tencent Holdings Ltd.

At the time of the raise, founder and CEO Xu Zheng said MissFresh planned to set up 10,000 front-end warehouses in 100 cities around China, which will allow them to provide one-hour deliveries of fresh produce to 100 million families.

The funds from the raise would be used to develop the company’s supply chain, cold chain logistics infrastructure and its smart retail technology.

Food safety, traceability and provenance

Along with a focus on fresh food and fast delivery, supermarkets in China are placing an increased importance on demonstrating food safety and provenance to consumers.

This stems from various food safety incidents in China — most notably the 2008 melamine milk scandal — which have created deep distrust from consumers in food supply chains.

Detail on the origin of products can also help them to stand out as premium products in the minds of the consumer.

Alibaba’s Hema supermarkets encourage customers to scan QR barcodes that accompany every product with their phone. This allows them to receive further information: including how to prepare it, recipe ideas, and its provenance.

Details of the journey of a fresh food item from farm-to-store can include pictures of the distributor’s business licences and food-safety certificates, information on when a particular crop was harvested and the date the item was delivered to the store. For products that need to be kept at a particular temperature — such as meat and fish — the system can provide details on how cold the inside of the delivery truck was during transit.

To further bolster the confidence customers have in its products, Alibaba joined a consortium of four Australian and New Zealand companies last year, to introduce a food traceability system based on blockchain technology.

The consortium — known as the “Food Trust Framework” — includes New Zealand’s dairy giant Fonterra and New Zealand Post, along with Australia’s Blackmores and Australia Post.

A joint statement said of the initiative: “it will use an immutable central ledger to achieve end-to-end supply-chain traceability and transparency throughout the supply chain to enhance consumer confidence and build a trusted environment for cross-border trade.”

The supply chain traceability cross-border trial recently concluded. An Alibaba spokesperson says:

“Following the success of the trial, Alibaba Group will continue to invest in and develop solutions to provide brands and consumers increased confidence and assurance in the supply chain for products sold from New Zealand to Chinese consumers.”

Rural growth

It is estimated that 27 per cent of China’s internet users are based in rural areas, and e-commerce giants are keen to tap into this market, with plans underway for massive development and expansion into inland regions.

Last year, JD.com received approval from China’s Civil Aviation Administration to test a drone delivery network in the northwestern Shaanxi province.  The company also announced plans to build 185 drone airports in Southwest China.

JD.com, which has already been operating drones for deliveries since 2016, says it hopes the new drone airports will allow agricultural products from Sichuan to be delivered anywhere in China within 24 hours. “Due to the high costs of logistics, agricultural products sell at a higher price in cities while industrial products sell at higher prices in rural remote areas,” says CEO Liu Qiangdong.

Alibaba has established a “Rural Taobao” initiative, that aims to sell products to regional customers at urban prices, and create efficient supply chains for rural produce.

As part of the project, Alibaba has established a network of 30,000 e-commerce service centres that enable villagers to purchase products online.

General manager of Rural Taobao Bill Wang says: “We want to improve the living conditions of China’s rural regions. To do so, we need to provide high-quality goods, personalised services, smart logistic solutions and prices comparable to that of the cities.”

These moves from e-commerce giants align with the Chinese Government’s National Strategic Plan for Rural Vitalization from 2018 to 2022, which calls for significant progress in rural rejuvenation. The plan has ambitious goals to close the gap between urban and rural areas, eliminate poverty and improve governance in the countryside.

China Business: Changing landscape (NZ Herald)

http://bit.ly/2YJbnjk

Ye Miao, head of the Asia Team at James & Wells talks to Tim McCready about the foreign investment law passed recently in China.

 Herald: What areas will the new foreign investment law address?

The new Foreign Investment Law, passed by the Chinese National Congress on  March 15, 2019, and coming into force on 1 January 2020, seeks to promote foreign investment into China by further easing market access for foreign businesses and encouraging foreign investment on a government administrative and policy level.

The new law addresses specific areas of concern for foreign businesses looking to invest in China, such as forced technology transfers. It also intends to help strengthen intellectual property (IP) protection and level the playing field in terms of market competition between foreign and domestic businesses.

Herald:  Will the new law allay uncertainty about doing business in China?

It’s important to consider the new law as a framework for the Chinese Government to set out its principles and intentions to further ease market access in China and respond to some of the concerns held by foreign businesses and investors in the China market. It is not necessarily a prescriptive set of rules that govern every eventuality. There is an expectation, however, that it will lead to stronger, more efficient compliance and enforcement.

There are some very promising principles in it.  For instance, Article 22 specifically enunciates the principle of protecting the intellectual property rights of foreign investors and enforcing them against infringing parties, consistent with Chinese intellectual property law.

Importantly for foreign investors, Article 22 also affirms that foreign investors will not be forced into technology transfers as part of their investment into China.

Article 23 also seeks to further protect the trade secrets of foreign investors from being disclosed by government officials and employees.

Other principles set out in the new Foreign Investment Law include:

  • Restriction of investment based on a negative list of specific industries/fields. Outside of these, the Chinese Government will afford the same national treatment to foreign investment.
  • In Government procurement processes, foreign businesses will be given equal treatment as local Chinese businesses.
  • Confirmation that capital invested in China, and profits made by foreign investors may freely be transferred in and out of China.
  • Stronger wording that Government will not seek to impose unwarranted actions that interfere with the business activities of foreign enterprises, and that the Government will fulfil policy and contractual commitments with foreign investors and enterprises.
  • Compensation and complaint mechanisms where commitments are broken and/or the where there is any infringement of the foreign business’ lawful rights.

Some commentators have rightfully noted that the new law still lacks substance in a number of areas, due to its breadth and vagueness.

While this is a cause for concern, it is important to remember that it is not uncommon for Chinese law to be set out as a framework of principles and intentions, necessitating further development and interpretation.

Herald:  How will this impact on the business environment for foreign firms?

This will ultimately depend on interpretation of the new law, and related laws and enforcement of these principles by Chinese authorities.  We hope it will drive a change of business and administrative behaviour in specific areas such as those relating to intellectual property theft or the disclosure of trade secrets, but we cannot expect change to happen overnight.

Overall, China has become a much better and often very lucrative place to invest and do business in over the past two decades.  We are cautiously optimistic that the principles and intentions set out in the new law represent further progress.

Herald: What are the challenges New Zealand businesses face when interacting with the China Trademark Office?

One of the significant challenges facing the Chinese Trademark Office (CTMO) and the Trademark Review and Adjudication Board (TRAB) is the rising volume of trademark applications, oppositions and proceedings.  According to the most recent statistics in China, there are over 18  million trademarks registered in China.

In 2018 alone, the CTMO received almost 7.4 million applications and examined over 8 million.

That represents over 20,000 applications and 22,000  examinations per day.

This puts immense pressure on the CTMO to both process the applications quickly and to act by the book, and has resulted in examiners often taking very conservative positions. Very prescriptive interpretations are taken where there are prior marks that include even minor similarities with the applied for trademark, which means an estimated 50 per cent or more of all applications are now rejected in the first instance. Applicants then have just 15 days to respond.

Therefore, it’s important for a business to consider its options in depth and to engage a trademark professional to assess the examination report and respond to it by the deadline. Often, objections can be overcome at the TRAB appeal level where there is more time for examiners to consider the applications and evidence in support, or through other actions.

Where the TRAB issues an unfavourable decision, an appeal can still be made to the Beijing IP Court. Unfortunately, however, these processes can be time-consuming and costly, so it is worthwhile to have back-up plans and an overall strategy in place. Unfortunately, the high volume of applications can mean that your potential brand (words and logos) may already be taken by someone else. As such, it is wise to consider checking the availability of your brand as trademarks in the development stage of your branding, so that you don’t overcommit on a brand that you may not be able to use or register in your chosen markets.

Herald:  How do you see the long-term outlook for IP protection in China?

China has been updating and improving its intellectual property laws and process over the past decade, and it is continually doing so. For instance, it is currently in the process of updating its patent laws, and has recently had high-level discussions as to its trademark laws and processes. These discussions have involved IP professionals as well as businesses.

While there are still frustrating processes and wait times, the overall goals of the IP authorities are admirable.

They have sought to recruit more examiners to help reduce examination times, set up the Beijing IP court to deal with specific IP matters expediently, and taken drastic steps to reduce trademark squatters.

Herald: Are New Zealand businesses ready to take advantage of the changing opportunities in China?

Some are well-prepared, others less so. In addition to a good product or service, it’s important that New Zealand businesses have a good story, and that they properly assess opportunities in key markets.

We strongly recommend carrying out due diligence in advance of entering China, and engaging someone on the ground with knowledge of your industry or sector.

And of course, we recommend taking early and appropriate steps to protect your IP and trade secrets.

And be mindful of the different cultural forces in play — what works in New Zealand does not necessarily work in other markets like China.

China Business: Cyberport seen as key to success (NZ Herald)

Hong Kong’s Cyberport has a vision to “be the hub for digital technology, creating a key economic driver for Hong Kong”.

Wholly owned by the Hong Kong Government, Cyberport works with start-ups and entrepreneurs to help them  grow in the digital tech industry — which the Government has identified as  a key to success for businesses and an essential economic driver.

Cyberport’s campus — 100,000sq m   of office space  20 minutes from Hong Kong’s centre — is tailor-made for the creative digital community. It is home to over 1000 technology companies and start-ups, consisting of established big names in tech including Microsoft, Lenovo and IBM — as well as fledgling start-ups and aspiring entrepreneurs, and is designed to “foster creativity and innovation,” and provide a platform to connect start-ups and entrepreneurs to investors, academic and industry partners and mentors.

Cyberport says Hong Kong “is well positioned to be a centre of international talent, a gateway for Greater Bay Area cities, and a fintech hub to connect Belt and Road countries to the China mainland and the world”.  With that in mind, it places an emphasis on particular tech sectors — smart living, fintech, and digital entertainment — areas it says are essential for Hong Kong’s digital transformation and new industry development. Alongside these, it focuses on blockchain and AI/big data — platform technologies  applicable across many digital tech areas.

The Hong Kong Government recently allocated HK$100m (NZ$18.7m) to Cyberport, with half to go towards creating a competition venue for large-scale e-sports (video game) tournaments, as Hong Kong plans to become a regional hub for what is expected to be a billion-dollar industry this year and continue to grow rapidly.

“Cyberport was chosen because it has strong network facilities,” said Secretary for Information and Technology Nicholas Yang. “To develop e-sports, to provide live streaming of competitions, we need a strong and stable network — this is something that Cyberport can provide… Our goal is to create a new industry.”

GoGoVan became Cyperport’s — and Hong Kong’s — first unicorn (a term given to privately held start-ups valued at over $1 billion) in 2017. The app-based logistics platform connects van drivers with customers, creating an efficient logistics on demand service for the delivery of freight and goods.

Founded in 2013, in its early days GoGoVan received HK$100,000 (NZ$18,750) in seed funding from the Cyberport Creative Micro Fund, then joined the Cyberport Incubation Programme to develop its business further. It went on to secure funding from Alibaba and other investors, and now has a presence across Hong Kong, Singapore, South Korea, Mainland China, Taiwan and India.

Several New Zealand companies have  made use of Cyberport’s facilities to springboard into Asia. Just Service is one example — a fintech company that provides support applications for independent financial advisers, insurance companies, and banks.

Chief executive Phil Neilson established the business in 2014, starting with a workstation at Cyberport.

He says Cyberport provides a low-cost solution for start-ups with facilities “like you would imagine at Google in the US,” along with access to support services and a network of start-ups and other young, successful companies.