Local Govt as Venture Capital
The Hefei Model
Tom Hancock at Bloomberg last year wrote a very good piece How China’s communist officials became venture capitalists (via the Times of India, so it’s free):
Hefei has pioneered a shift in Chinese capitalism over recent years in which local governments are increasingly taking minority stakes in private companies. Since the 1950s, Hefei has been a hub of scientific research, but today its shrewd investments have transformed it from a relative backwater to a bustling metropolis of about 5 million people. In terms of economic growth, what Chinese media call the “Hefei model” appears to work. In the decade to 2020, Hefei was China’s fastest-growing city in terms of gross domestic product.
Hefei made its first winning bet on BOE Technology Group Co., an electronic display maker founded in 1993. When BOE was in trouble after the 2008 financial crisis, the city canceled plans for its first subway line and instead plowed billions of yuan into the company on the condition it would build a local plant. BOE built a state-of-the-art liquid-crystal display (LCD) screen plant, and by 2011 Hefei owned an 18% stake. The city agreed to vote with management on key decisions, according to company filings.
Over the following years, Hefei continued to invest in BOE, helping it build new plants and extracting profits. The company brought tens of thousands of jobs to Hefei and anchors a display-industry manufacturing cluster that makes products worth more than 100 billion yuan annually, including for foreign companies such as Corning Inc. In 2021, BOE overtook South Korea’s Samsung Electronics Co. as the world’s top manufacturer of LCD screens used in flatscreen TVs, helping end China’s dependence on foreign suppliers.
By all accounts, Hefei’s bold experiment was a success - if just a unique one. Some Chinese cities sent officials to Hefei to find out why. Visitors from the municipal authorities of Luoyang, a city in nearby Henan province, wrote a report examining how Hefei succeeded and what lessons can be learned from Hefei.
Below is an abridged translation of the report. But before we get there, I’m sure the word on many readers’ minds is “state capitalism,” as Hancock reported
The US and other Western governments have long been wary of the economic power of China’s “state capitalism,” fueled by giant state-owned companies and an industrial policy driven by subsidies and government mandates. But policymakers need to pay more attention to what’s really propelling China’s growth: private firms with minority government-linked investments. “The distinction between state-owned and private has been important for policymakers outside China and for analyzing the Chinese economy,” says Meg Rithmire, a professor at Harvard Business School who specializes in comparative political development in Asia and China. “That boundary is eroding.”
Are Chinese firms with majority stakes from the private sector and minority stakes from local Chinese government vehicles “state-owned” or “private” companies? What if there is strong evidence that the local govt doesn’t interfere with the company’s businesses?
Also, in the case of the companies in Hefei, as you will read below, the Hefei local government planned at the very beginning of its investment that its state capital would pull out after a few years and had no intention of retaining a stake permanently.
If you have access to the fantastic research papers from Gavekal Research, the Rise Of The Hybrid Firm published in September is an original study and very informative:
Today, 48% of onshore listed companies, representing 67% of market capitalization, have a mixed bag of major shareholders from the private and state sectors. While many of those companies are still clearly controlled by either state or private shareholders, a large and significant group of firms occupies an intermediate position that is harder to characterize.
by Policy Research Office, Communist Party of China Luoyang Municipal Committee
Summary, inspiration, and advice from Hefei’s industrial investment and financing model
In recent years, Hefei has been running on the road of industrial investment and financing by increasing its investment in BOE, joining hands with others to invest in ChangXin Memory Technologies, and (also) investing in NIO…To learn from the success of the "Hefei Model" and help Luoyang's industrial development, we summarized Hefei's industrial investment and financing model, combined them with Luoyang city's actual situation, and put forward advice.
The core of the so-called "Hefei Model" of industrial investment and financing is to give full play to the 引导 guiding role of state capital and to promote high-quality industrial development. The key is to focus on its positioning of industrial development, identify key enterprises in the key links of the industrial chain, 带动 spur non-government capital to invest alongside state capital, and jointly cultivate and develop industrial projects. When the projects mature, the state capital will exit safely in market means and switch to other industrial projects to continuously extend and expand the local industrial chain.
1.1 Accurately focus and scientifically determine industrial projects
1.1.1 To find out the development direction of the industry.
First, ascertain the direction of its industry. Hefei was established as the provincial capital (of Anhui) in 1952, but due to its weak foundation and poor conditions, it has never matched its political status as a provincial capital. Around 2006, Hefei proposed that only by developing industry could it realize 跨越式发展 "leapfrog development" and determined the strategy of 工业立市 "establishing the city by industries."
At that time, Hefei could hardly cultivate a competitive industry by itself, but it could bypass the arduous process of building from scratch with the help of the emerging opportunities of the global supply chain. Hefei seized that strategic opportunity of the migration of industries from the eastern coastal areas to the inland, the national strategy of 中部崛起 the “Rise of Central China,” focused on the key links in the supply chain of the home appliance industry, introduced major projects, and built up its first industry.
Only five years later, Hefei has developed into the country's largest home appliance production base, with the output value of the home appliance industry exceeding 100 billion yuan for the first time, forming an industrial agglomeration and economies of scale summarized as "Made in Hefei.”
Subsequently, Hefei's industrial development basically followed this logic, always looking for emerging industries around the upstream and downstream of the industrial chain - first introducing key enterprises through government investment and financing and then spurring other enterprises in the industrial chain to enter Hefei. They did go there one after another.
In recent years, Hefei has introduced and nurtured leading enterprises such as BOE, Iflytek, ChangXin Memory Technologies, and NIO. Hefei has gradually built up dozens of industrial chains spearheaded by 芯屏汽合 “chips, displays, automobiles, and others in coordination” (a wordplay of Chinese characters which sounds the same as the nice Chinese proverb 心平气和 meaning peaceful) and 集终生智 “semiconductor, terminals, bioscience, and smart technology” (another wordplay of Chinese characters which sounds the same as the nice Chinese proverb 急中生智 meaning wisdom in a hurry).
Second, to be able to get on the same page with enterprises, Hefei city leaders and civil servants in charge of investment promotion have been studying and researching various industry-related information such as higher-level industrial investment and financing policies, industry development reports, publicly-listed companies' share offerings, etc. A junior-level civil servant in investment promotion is typically knowledgeable about an entire industrial chain.
In addition, through the regular exchange of personnel between government agencies and universities at temporary positions, a number of professional talents have also been trained in business promotion and investment. For example, a cadre from a municipal government agency worked as a project manager for seven years at the Institute of Advanced Technology, University of Science and Technology of China (USTC), and the cadre’s main task was to help scientific researchers sort out patents and link them with the market. The nature of his work requires him to be proficient in professional knowledge before he can put forward constructive suggestions, such as whether a patent is infringing someone else’s intellectual property rights and the market prospect of a patent. He must be proficient in various policies and negotiation skills before effectively communicating with people in different fields, such as civil servants in different government departments, venture capitalists, and professionals in private enterprises.
Through these means, Hefei has built a "team of investment bankers in government" who understand the industry, communicate policies effectively, are familiar with the market and good at negotiation, and are good at investment banking.
Third, precisely study industrial investment promotion. Focusing on the development direction of Hefei's main industries in a new era, the city has compiled accurate investment promotion catalogs and maps for key industries, sorted out the leading enterprises, the headquarters, the “unicorns,” the champions, and the emerging key enterprises in the entire chain of the main industries where Hefei is determined to develop.
For example, Hefei's Investment Promotion Guide for Key Industries is different from the typical Chinese investment promotion brochures, which usually present local conditions and humanities. Hefei’s Investment Promotion Guide focuses on key industries such as integrated circuits, new displays, and intelligent home appliances based on consolidating a large amount of relevant literature and industry reports. Hefei’s Investment Promotion Guide provides detailed information on industry trends, market layout, industrial policies, industrial chain overview, specific enterprises, and Hefei’s suitable industry platforms in 24 sub-sectors, such as compound semiconductors and micro-electromechanical systems. It is rich in text, data, and charts.
（2020 Investment Promotion Guidelines for Key Industries in Hefei. Source: some file-sharing webpage)
Fourth, rigorous procedures before extending support. For the key industrial projects to be invested, Hefei’s government group leading industry development, which is the predecessor of the current "industrial chain chiefs," took the lead and jointly conducted scientific evaluations such as comprehensive due diligence and market prospect estimation together with investors and professionals in the market from the aspects of industry direction, competitive environment, and development space.
For example, before Hefei decided to invest in NIO, it inspected NIO through "four fronts." First, it actively conducted research and judgment on NIO's technology, supply chain, and market with professional investors such as State Development & Investment Corporation. The second is to pay close attention to the support of national policy. The third is to entrust professional legal and financial advisors to conduct comprehensive due diligence on the enterprise. The fourth is to conduct detailed, careful, and rigorous business negotiations with the enterprises. The fifth is to establish a scientific decision-making system.
Hefei has established a scientific decision-making system for major projects. The municipal Party Committee and government are not the only decision-makers for major project decisions. After the government makes the decision to introduce the project, it first reports to the municipal financial and economic committee of the local legislature. When approval is obtained, the investment proposal is reported to the leaders of the executive leadership of the local legislature, after which it is submitted to the local legislature and, finally, shared with the local political advisory body. All proposed investment projects must go through this decision-making process before the investment is finally determined.
1.2 State capital leads in innovating the investment and financing model
The first is to improve the participation of government funds. To give full play to the guiding role of government funds in industrial development, Hefei integrated various types of government funds in 2014 and made significant adjustments in its investment.
On the one hand, the former 撒胡椒面 "sprinkle pepper noodles"/spread-the-money-evenly style of investment has been changed to heavy investment in certain key industrial areas and projects.
On the other hand, Hefei abolished 事后奖补 monetary compensation after investments and put the funds into profit-seeking, market-oriented investments.。。
The new investment method helped the private companies meet their funding needs in the early and mid-term of the industrial projects and implemented market-oriented investment and financing. Hefei changed grants to investments and monetary aid to professional funds. The limited government funds have now focused more on Hefei's major and strategic emerging industries.
The second is to set up specialized state capital platforms. In 2015, Hefei reorganized and integrated the state-owned assets operating companies and formed three major state-owned investment and financing platforms. One of them targets new energy vehicles, modern tourism, transportation, etc. Another targets guiding high-quality development of industries. And another one, the Hefei Xingtai Financial Holdings, became a local financial holding platform. Currently, the investment and financing of Hefei's state capital are mainly conducted via the three platforms.
At the same time, more than 40 regulations, such as on investment, financing, guarantee, property right transaction, and loss cancellation, were introduced or revised to regulate Hefei’s state-owned enterprises’ operations. For example, because of the high debt risk pressure of on Hefei’s SOEs, especially the platforms, Hefei’s local State-owned Assets Supervision and Administration Commission reined in the asset-liability ratio and debt levels via enforcing strict budget requirements. Hefei reduced financing costs through the issuance of 企业债 corporate bonds (via the platforms), Medium Term Notes, and other means, strove for more channels to raise funds, and improved the structure of assets and liabilities to ensure the safety of its platforms’ “capital chain.”
Third, leverage more non-governmental capital. Cultivating an industry from the very beginning requires more government funding. But once the industry has risen to a certain level, it is possible to guide non-governmental capital to participate in industrial development.
Hefei has given full play to the leveraging role of the state capital, and has effectively introduced more financial and non-governmental capital. Up to now, Hefei has established a collective of funds worth more than 100 billion yuan (13.7 billion USD), which has spurred non-governmental investment in the amount of nearly 400 billion yuan.
Among them, to support start-ups and small and medium-sized enterprises, a total of 5.92 billion yuan of venture guidance funds, industry guidance funds, and angel funds were set up, which spurred more than 200 billion yuan of investment from non-governmental capital.
Hefei set up an investment fund of nearly 30 billion yuan dedicated to screens and chips, all directed to the upstream and downstream industrial chains of integrated circuits and flat-panel displays. For the 10.5-Generation production line at BOE alone, 7.945 billion yuan of non-governmental funds were spurred (to co-invest with the fund). More non-governmental capital flow into Hefei as a result of the marketization of state capital.
The fourth is to construct the exit mechanism for state capital. After many years of exploration and practice, Hefei has formed an industrial development mode of "introducing the projects → state investment to spur non-governmental investment → landing the projects → state capital quits via selling its stakes → go into new projects."
At the beginning of relevant industrial projects, Hefei plans a safe exit channel for the state capital. When the state investment reaches a pre-determined age or the agreed exit conditions, the state capital operators will exit safely through marke means such as public listing, equity transfer, and share buybacks in accordance with regulations.
In this way, the state capital not only fulfills the mission of cultivating and introducing industrial projects but also maintains and increases their value, making it bigger and stronger.
Up to 2020, the total asset-liability ratio of state-owned companies within the jurisdiction of Hefei’s State-owned Assets Supervision and Administration Commission was 59.8%. The total assets of those companies were nearly 800 billion yuan, and the net assets were nearly 300 billion yuan. Through reinvestment of state capital, Hefei's industry has been vigorously promoted.
1.3 Optimizing govenrment services to create an excellent "industrial ecosystem."
First, improve the policy support system. In 2014, Hefei was the first in the country to make major adjustments to its industrial support policies, forming a "1+3+5+N" policy framework. "1" refers to the programmatic document "Some Provisions on Hefei's Policies to Support Industrial Development (for Trial Implementation)." "3" refers to 3 policies on its fund management. "5" refers to the supporting policies for the five major industries... "N" refers to the specific implementation measures that each industrial policy implementation department can tailor following relevant regulations.
The second is to optimize the talent recruitment and cultivation environment. Hefei vigorously recruited and trained industrial and technological talents to focus on eight strategic emerging industries, such as electronic information, energy conservation, environmental protection, and new materials. Hefei had successively issued "20 policies on talents" and "8 new policies on talents" and formulated 34 detailed implementation rules…forming a relatively complete talent policy system.
Hefei started an “international talent zone” and a human resources industrial park, and created a comprehensive service platform. Hefei also gave preferential policies to entrepreneurs, issuing “green cards” that afford preferential treatment in tax, household registration, medical care, education, etc. The Hefei government also led the construction and management of apartments for talents…
The third is to create an innovation incubation platform. Hefei government built four innovation platforms: a platform for resource gathering represented by the Hefei 大科学装置公司 company dedicated to the large-scale scientific facility, a platform for collaborations representative by Hefei 创新院 Institute of Technology Innovation, a major scientific and technological achievements transformation platform represented by Hefei’s Ionic Medical Center, and an independent research and development innovation platform represented by ChangXin Memory Technologies, to help transform scientific and technical achievements and upgrade industries.
The success of Hefei's industrial investment and financing was not just a matter of luck. It is more due to finding the right industrial 风口 "emergence," optimizing the investment decision-making system…and making good use of government policy funds, seizing investment opportunities, attracting and developing a number of key enterprises, and setting up industrial clusters and realizing scaled-up development.
First, industrial investment and financing of a certain region must be precisely oriented. The key to industrial development is to determine the development orientation, identify the key links and sub-sector of the industrial chain, and then concentrate funding continuously. After establishing the strategy of 工业强市 "strengthening the city by industries," and combining it with its advantages, Hefei has always focused on the key links of the industrial chain and the high-end links of the value chain.
For example, ChangXin Memory Technologies was established in cooperation with GD32 based on the judgment that the integrated circuit industry has a large market and slow process iteration speed. Hefei has precisely selected DRAM-type memory chips as a key sub-sector. Changxin successfully mass-produced 8Gb domestic DDR4 memory, which not only broke the decades-long monopoly of foreign manufacturers in the DRAM industry but also attracted a large number of semiconductor enterprises to settle in Hefei, and capital such as the 国家集成电路产业基金 National Integrated Circuit Industry Fund and 湖北小米长江产业基金 Hubei Xiaomi Changjiang Industry Fund came to Hefei for investment.
Second, industrial investment and financing must build a professional talent recruitment system. Only by relying on various kinds of professionals can we accurately grasp the development direction of the industry, determine valuable investment projects, and select knowledgeable and reliable companies. One of the important reasons why Hefei can successfully invest in strategic emerging industries is to build a strong talent recruitment system by training local talent recruitment teams and relying on external talent. Hefei's government investment promotion team can be described as investment-oriented and professional, from its leaders to the grass-roots level. 其他地市与合肥相比，根本不在一个数量级 Compared with Hefei, other cities are not at the same level regarding professionalism.
In addition, Hefei has secured many well-known entrepreneurs as investment advisers to help the government attract investment through personal bonds and business interests. For all leading industries, a database of the world's top experts in this field was established, and top experts in this field will be invited to evaluate potential projects. By relying on these professionals, Hefei successfully introduced, nurtured, and hosted one after another industrial project.
Third, a scientific decision-making system must be established for industrial investment and financing. The establishment of a scientific decision-making system is the basis. Unlike other places, after scientific and rigorous estimation, Hefei would still need the permission of the local legislature’s Finance and Economics Committee, the executive leadership of the local legislature, the local legislature, and the local political advisory body. This is because the local legislature and political advisory body are capable of mobilizing a large number of people with different professional backgrounds, such as governmental departments, universities, research institutes, finance, and industries. Through the process, they can bring together constructive suggestions from all sides and better ensure the scientific rationality of investment decisions.
In conclusion, the scientific evaluation and decision-making system of Hefei’s major industrial project investments ensure the rationality of investment decisions to the greatest extent. They minimize investment risks and maximize investment success rate. Meanwhile, detailed and in-depth due diligence has also been part of Hefei’s comparative advantage in attracting leading projects.
Fourth, industrial investment and financing must genuinely make good use of government funds. If the “tradecraft”(术) of the Hefei Model is to find industries that are of investment value, the combination of a facilitating government and an effective market is the “fundamental method”(“道”) of Hefei’s industrial leap.
When new industries have yet to break ground, it’s difficult for them to depend entirely on a market-oriented approach. Especially when major investment is needed, market-oriented funds are hardly likely to participate due to considerations of short-term return. Therefore, it is necessary that governmental funds accompany the growth of enterprises and industries for a relatively long period of time.
To make greater use of governmental funds, Hefei through establishing the guiding funds to “spur non-governmental investment through state capital investment”（“以投带引”) and levering (“撬动”) the non-governmental capital to invest. Hefei realized the win-win of the flourishing of strategic emerging industries and the preservation and appreciation of state capital.
But unlike common venture capital investment, the purpose of government investment and financing does not aim for high returns; instead, it aims to promote better development of local industries by attracting high-quality industrial projects. Therefore, in the investments of BOE, Visionox, ChangXin Memory Technologies, O-Film, and others, Hefei’s state capital investment always followed the path of “not seeking a controlling stake, exiting promptly when the industries show positive development and then turning to the next project.”
With a more facilitating government 有为政府 promoting a more effective market 有小政府, Hefei has been called the “Best Governmental Investment Bank.”
Fifth, industrial investment and financing must focus on the marketization of scientific and technological achievements. Innovation is the source of driving force for industrial development. In recent years, another enlightenment brought by Hefei’s rapid economic growth is the focus on turning scientific research advantages to industrial development advantages.
Rich scientific research resources do not automatically translate into local development advantages. Hefei has three armies: the one led by the Hefei-based University of Science and Technology of China, the one led by China Electronics Technology Group (whose No.16 and No. 38 institutes are based in Hefei), and the one led by local universities (Hefei University of Technology, Anhui University, etc.)…At present, there are more than 60 new research and development institutions, such as the “Anhui Innovation Pavilion,” the USTC’s Institute of Advanced Technology, CAS’s Hefei Institute of Technology Innovation engineering, THU’s Hefei Institute for Public Safety Research, and others.
Through these new research and development institutions, various scientific and technological innovation resources have been translated into the driving force of industrial development, which has strongly promoted the rapid and high-quality development of Hefei’s industries.
The "Hefei Model" of Industrial investment and financing, based on specific conditions, has its uniqueness, and it is not rare that some cities have failed to copy such a model.
Therefore, what we need to learn from Hefei is not only its courage and insight to gamble at high stakes, but more importantly, to find the right developing path that suits us, bring our advantage into full play, make up for the shortcomings, boost the success rate of investment, cultivate a group of high-growth enterprises that support a wide industrial base, and form the unique competitiveness of industrial innovation and development in Luoyang.
First, the government needs to enhance its market-oriented mindset. It is a must to emancipate the mind, change the administrative mode of thinking, and make good use of the market-oriented mindset and measures to operate and develop industries. For example, change the investment and financing mode of state-owned capital from primarily “set discounts for the land and lower or exempt the taxes” 土地优惠，税收减免 to primarily “operate in line with capital market rules and support with funds”资本运作，基金支持…For example, the operation of government industrial investment funds should highlight professional management and market operation, introduce market-oriented professional investors to jointly form fund management teams (with the government), develop innovative fund management mechanisms, and improve the efficiency in the use of funds. For example, accelerate the establishment and improvement of the factor markets needed by the development of industries, such as those of land, talent, capital, technology, data, etc.
Second, make precise investments in emerging industries with huge potential (风口产业) and key links in the industry chain…
Third, establish and cultivate a team of professional talents in recruitment and investment who are specialized in industries. Through methods such as secondment postings 挂职交流, studies in other places, and training on special topics, cultivate as soon as possible a group of talents who know industrial policies and markets well and are good at commercial negotiations and capital operations to work at foreign offices, economic municipal units, and municipal state-owned enterprises. Take advantage of the fact that there are many colleges and universities, research institutes, and centrally-managed state-owned enterprises in our city, and take into consideration the need for industrial development, recruit a group of professors and entrepreneurs who understand the industry to be on secondment in municipal units. Accelerate the construction of youth-friendly cities, gather the urgent needs of Luoyang’s industrial development, build an effective policy system of attracting and retaining talents 引才、留才, and recruit and retain more professional talents for Luoyang…
Fourth, establish a scientific decision-making mechanism for industrial investment and financing. Form an industrial development committee, and reinforce the overall coordination of industrial development in Luoyang. Recompose our major investment list around the whole chain of leading industries, as well as the repertoire and mapping of precise investments of major industries…Put effort into constructing a mechanism of investment project evaluation and decision-making with the participation of the government, experts, and market. Improve the follow-up mechanism on major projects, and evaluate projects and estimations of performance regularly.
Fifth, construct a market-oriented model of investment and financing of the state capital that enables investment, exit, and another investment…
Sixth, actively construct an innovation platform for industrial technology. Deepen the reform of the local system of science and technology development, fully mobilize the researchers in colleges, universities, and institutions, and accelerate the industrialization of the research outcomes… (The report in Chinese is written by Liu Linna and Wang Zezhong for the Policy Research Office, Communist Party of China Luoyang Municipal Committee.)