PACL.L Regulatory News (PACL)

28 September 2011

Pacific Alliance China Land Limited

('PACL' or the 'Company')

Unaudited Interim Results for the six months ended 30 June 2011

Pacific Alliance China Land Limited ('PACL' or the 'Company'), an AIM-traded, closed-end investment company with a portfolio of investments including existing properties, new developments, distressed projects and real estate companies in Greater China, has today announced its financial results for the six months to 30 June 2011.

Financial Highlights

·; Net asset value as at 30 June 2011 was US$253 million, representing US$1.81 per share, a 3.6 per cent increase on the prior six months to 31 December 2010 (US$242 million, representing US$1.75 per share) and an annualised increase of 18 per cent since the Company's inception.

·; The Company's share price closed at US$1.215 on 30 June 2011, representing a 46 per cent year-on-year increase. PACL's share price has consistently outperformed major benchmark indices including the FTSE 350 Real Estate Index and the FTSE AIM All-Share index.

Portfolio and Fund Developments

·; During the first quarter of 2011, PACL sold its remaining indirect interest in HNA Airport for a total of US$14.5 million which, together with previous partial realisations, brings total consideration of HNA Airport to US$27.4 million in cash of which US$13.6 million is attributable to PACL. This represents a 1.3x gross cash multiple. As part of the sale, the Company received options in HNA Airport, exercisable subject to a number of conditions, which could potentially provide significant future upside for PACL.

·; In June 2011, the Company exercised its put option to sell its 40 per cent interest in Project Blue Bird back to its JV partner, Vanke, for a total of RMB125 million, of which RMB62 million is attributable to PACL. This represents a net IRR of 16 per cent and a net cash multiple of 1.3x.

According to Patrick Boot, Managing Director, Pacific Alliance Real Estate Limited, the Company's strong focus and weighting on the China commercial property sectors is driving PACL's growth.

"As the residential property sector in China continues to be affected by tight monetary policy and strict government regulation, commercial real estate continues to benefit from rising wages and increased consumption, which is driving returns for our portfolio. We are also seeing increased demand and new opportunities for alternative lending, including bridge financing and co-developments, from developers with solid projects and prospects that have been negatively impacted by stricter onshore bank lending policies," he said.

"Given this situation we will continue to monitor the price corrections in the residential sector closely over the next 12 months; as developers become more cashflow constrained there will likely be some good buying opportunities for PACL".

For further information please contact:

Notes to Editors:

About Pacific Alliance China Land Limited

Pacific Alliance China Land Limited ("PACL") (AIM: PACL) is a closed-end investment company that was admitted to trading on the AIM Market of the London Stock Exchange in November 2007. PACL is focused on investing in a portfolio of existing properties, new developments, distressed projects and real estate companies in Greater China.

For more information about PACL, please visit: www.pacl-fund.com

Pacific Alliance China Land Limited is a member of PAG (formerly known as Pacific Alliance Group), which is one of the region's largest Asia-focussed alternative investment managers, with funds under management across Private Equity, Real Estate and Absolute Returns strategies.

Founded in 2002, PAG now has a presence across Asia with over 270 staff working in the region.

For more information about PAG, please visit: www.pagasia.com

Chairperson's Statement

Pacific Alliance China Land Limited ("the Company") delivered a solid performance during the first half of 2011. The Company's net asset value (NAV) was US$253 million or US$1.81 per share as of 30 June 2011, a 3.65 per cent increase from 31 December 2010 and a 2 per cent increase from 30 June 2010. The performance can be attributed to the Company's continued commitment to a combination of defensive and growth investment strategies which has delivered significant value to shareholders.

The outlook for the property sector in China continues to be dominated by the Chinese government's focus on inflation and tightening monetary policy. In the first six months of 2011, The People's Bank of China twice raised the deposit reserve requirement ratio, bringing it to an historic high of 21.5 per cent as of June 2011, yet the upward trend in the consumer price index continues. As such, the government is likely to remain committed to policies to slow growth in the residential property sector.

The impact of these policies is starting to be felt in some areas. Residential sales volumes in some tier 1 and tier 2 cities have decreased and prices have decreased slightly, particularly for projects located in city outskirts. However, in many of the stronger tier 3 cities where government policy has not been as strictly applied, sales volumes and prices have held steady. Irrespective, onshore bank borrowing has continued to become even more difficult and many developers have begun seeking funds offshore or via alternative domestic financing options. It is this flight to alternative financing which is generating new opportunities for our business, particularly in bridge financing and co-development deals with preferred returns.

To date, our focus on the commercial property sector has insulated the Company from much of the volatility in the residential property sector, while at the same time allowing the Company to capitalize on the strong growth of the office/retail property market driven by rising wages and increased consumption.

In the first half of 2011, the Company successfully exited two projects: Hainan Airport and Project Bluebird and will continue to look for further exit opportunities at attractive pricing which can be accretive to the Company's NAV.

The Board of Directors and the Investment Manager would like to take this opportunity to thank you for your continued support. We are confident that our opportunistic multi-strategy investment approach will continue to deliver attractive risk-adjusted returns to shareholders despite the challenging current macro environment.

Margaret Brooke

Chair

Investment Manager's Report

Portfolio Performance

As at 30 June 2011, the Company's unaudited total net asset value ("NAV") was US$253 million, at US$1.81 per share. This is a 3.65 per cent increase from the NAV in the Company's 2010 audited financial statements and an annualized increase of 18 per cent since inception. Independent valuations are currently undertaken on a quarterly basis by recognized international valuation firms and real estate appraisers.

On 30 June 2011, the Company's share price closed at US$1.215, a 46 per cent increase year-on-year and a 33 per cent discount to the unaudited NAV per ordinary share. PACL's share price has outperformed major benchmark indices including the FTSE 350 Real Estate Index and the FTSE AIM All-Share Index on a consistent basis.

Portfolio Summary

As at 30 June 2011, the Company held investments with a cost of approximately US$148 million and fair value of US$345 million. The Company's portfolio is diversified across five strategies including bridge financing, co-development, pre-IPO financing, platform investment and asset acquisition.

Breakdown of Investments by Strategy

(1) The allocation by strategy as per the Investment Manager's report differs from the unaudited financial statement investment schedule. The cost of the loans receivable disclosed in the unaudited financial statement schedule represents the cost of investments for accounting purposes, which are higher than the respective cost of the loans according to the terms under the loan agreements. Collection/repayment of loans receivable is calculated based upon the effective interest method in the unaudited financial statement schedule, whereas in the Investment Manager's report and newsletter, in accordance with the legal agreements, the cost is reduced prior to a reduction of interest.

(2) The investment value includes an amount attributable to the PACL II shareholders.

Investment Strategy

During the first half of 2011, credit tightening, purchase limits and increasing inflationary pressure significantly impacted the residential property market. Despite this, the Manager believes that residential markets still offer attractive opportunities for returns from investments with good fundamentals and an absence of purchase limits. The Company will continue to look for opportunities in tier 1 and 2 cities where purchase limits are applied, but has introduced more stringent underwriting standards in assessing these investments.

Conversely, the office and retail property sectors continue to enjoy more favorable market conditions without the inflationary and subsequent regulatory pressures that impact the residential sector. According to recent Jones Lang/PWC/Colliers research, sales prices and rental rates have increased in most tier 1 and 2 cities, and vacancy rates have dropped to below 10 per cent for Grade A offices in all major tier markets for the first time since the 2008 global financial crisis.

This is good for our portfolio which is over 70 per cent weighted in the office, retail and leisure sectors which means our existing investment portfolio has limited exposure to the Chinese government's policy measures directed at reducing speculative demand in the major residential property markets. Furthermore, commercial propertiesrepresent an efficient and effective inflation hedge, as rents correlate positively with inflation due to rising land and building costs.

Looking ahead, we have two key focus areas for the second half of 2011. First, we will continue to focus onimproving the operations of our existing investments and maximizing the net asset value of each investment. Second, we anticipate growing demand for capital from small-to-medium size developers and some large listed developers as monetary policy continues to tighten and reduce market liquidity. We will look for new opportunities in alternative lending at attractive margins.  

Defensive Strategies

Bridge Financing

Continued credit tightening is generating new demand for bridge financing from small-to-medium size developers. The Company's bridge financing solutions provide developers with cash critical to the completion of the development process. Projects must have sound real estate fundamentals, reasonable business foundations and borrowers must have good development track records.

Co-Developments with Preferred Returns

Residential inventories are rising due to purchase limits, bank interest rate hikes and credit tightening. Accordingly, the Company expects to see attractive opportunities for co-developments with preferred returns as domestic financing channels continue to shrink and developers experience reduced cash flow.

Growth Strategies

Value-Added Asset Acquisitions

In contrast with residential markets, where prices have softened slightly, existing or nearly completed retail/commercial properties with poor lease-up and/or ineffective management represent high value-add opportunities. We are actively exploring this investment sector and working closely with asset management service providers to identify various value creation opportunities.

Platform Investment and Pre-IPO Financing

Financing channels for developments are becoming increasingly restricted due to government cooling measures. As a result, some developers on track for an IPO may now be forced to consider strategic pre-IPO financing at a corporate and/or project level for additional funds. We expect this will open up new pre-IPO and platform opportunities. The Manager will pursue opportunities with quality companies with proven track records and high-quality land banks.

Distribution Policy

On 7 February 2011, the Company's distribution policy was modified to match distributions to shareholders with ordinary course realizations to maximize returns, instead of liquidating an investment primarily to fund distributions. The modified policy will also require that each distribution represent 50 per cent of the Company's net realized profit of the fully realized investment, with the returned principal plus the balance of the net realized profit available for reinvestment.

Conclusion

China's property market continues to face a challenging outlook, with residential markets in particular facing further cooling measures including rising interest rates, more restricted lending practices and purchase limits.

The Company's investment focus on commercial property has taken advantage of the upward movement in the commercial property market while maintaining minimum exposure towards the residential market. The Manager believes the Company will continue to capitalize on attractive investment opportunities during the current downturn while avoiding most residential property sector risk.

CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

AS AT 30 JUNE 2011

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED SCHEDULE OF INVESTMENTS

AS AT 30 JUNE 2011

1 The principal above represents the principal calculated according to the Fund's accounting purpose, which is different from the loan principal calculated in accordance with the legal agreements whereby the cost is paid prior to the repayment of interest component.

 The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE PERIOD ENDED 30 JUNE 2011

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

FOR THE PERIOD ENDED 30 JUNE 2011

The accompanying notes are an integral part of these consolidated financial statements.

CONSOLIDATED STATEMENT OF CASH FLOWS

FOR THE PERIOD ENDED 30 JUNE 2011

Non-cash transactions

See Note 11(a) for the restructuring of the Company.

The accompanying notes are an integral part of these consolidated financial statements.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE PERIOD ENDED 30 JUNE 2011

1 Organization

Pacific Alliance China Land Limited (the "Company") was incorporated on 5 September 2007 in the Cayman Islands. It is a closed-end Cayman Islands registered, exempted company. The address of its registered office is PO Box 472, 2nd Floor, Harbour Place, Grand Cayman, KY1-1106, Cayman Islands. The Company can raise additional capital up to the authorized share capital as described in Note 8 below.

The Company's ordinary shares are traded on the AIM Market of the London Stock Exchange.

The principal investment objective of the Company is to provide shareholders with capital growth and a regular level of income from investments in existing properties, new developments, distressed projects and real estate companies in Greater China.

The Company's investment activities are managed by the Investment Manager, Pacific Alliance Real Estate Limited ("PARE"). The Company has appointed Sanne Trust Company Limited to act as Custodian, Administrator and Registrar pursuant to the custodian agreement and fund administration services agreement respectively.

The consolidated financial statements were approved by the Board of Directors on 27 September 2011.

2 Summary of significant accounting policies

The following significant accounting policies are in conformity with accounting principles generally accepted in the United States of America. The Company applies the provisions of FASB ASC 946-10, Financial Services - Investment Companies (formerly the AICPA Audit and Accounting Guide for Investment Companies) (the "Guide"). Such policies are consistently followed by the Company in the preparation of its consolidated financial statements.

(a) Principles of consolidation

These consolidated financial statements include the financial statements of the Company and its subsidiaries (collectively, the "Fund"). Subsidiaries are fully consolidated from the date on which control is transferred to the Fund and deconsolidated from the date that control ceases. Inter-company transactions between group companies are eliminated upon consolidation. 

The Fund uses wholly and partially owned special purpose vehicles ("SPVs") to hold and transact in certain investments. The Fund's policy is to consolidate, as appropriate, those SPVs in which the Fund has control over significant operating, financial or investing decisions of the entity.

Except when an operating company provides services to the Fund, investment in an operating company is carried at fair value (refer to Note 2(c) below for fair value measurement).

(b) Use of estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the Fund's management to make estimates and assumptions that affect the reported value of assets and liabilities and disclosures of contingent assets and liabilities as of 30 June 2011 and the reported amounts of income and expenses for the year then ended. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the financial statements are disclosed in Notes 2(c) and 2(g).

(c) Investments

The Fund holds investment securities which are unlisted and have limited marketability. The Fund engages in secured lending transactions consisting of repurchase agreements and other secured borrowings.

(i) Recognition and derecognition

Regular purchase and sale of investments are accounted for on the trade date, the date the trade is executed. Costs used in determining realized gains and losses on the disposal of investments are based on the specific identification method for unlisted or unquoted investments. Cost includes legal and due diligence fees associated with the acquisition of investments.

Transfer of investments is accounted for as a sale when the Fund has relinquished control over the transferred assets. Any realized gains and losses from investments are recognized in the consolidated statement of operations.

(ii) Fair value measurement

The Fund is an investment company under the Guide. As a result, the Fund records and re-measures its investments on the consolidated statement of assets and liabilities at fair value, with unrealized gains and losses resulting from changes in fair value recognized in the consolidated statement of operations.

Fair value is the amount that would be received to dispose of the investments in an orderly transaction between market participants at the measurement date, i.e. the exit price. Fair value of investments is determined by the Valuation Committee, which is established by the Investment Manager and the Board of Directors.

The fair value of unlisted or unquoted securities is based on the Fund's valuation models, including earnings multiples (based on the budgeted earnings or historical earnings of the issuer and earnings multiples of comparable listed companies) and discounted cash flows. The Valuation Committee also considers the relevant developments since acquisition of the investments, the original transaction price, recent transactions in the same or similar instruments, completed third-party transactions in comparable instruments, reliable indicative offers from potential buyers and rights in connection with realization. It adjusts the model as necessary for factors such as non-maintainable earnings, tax risk, growth stage, and cash traps. Cross-checks of primary techniques are made against other secondary valuation techniques.

In determining fair value of certain unlisted securities, the Valuation Committee uses as reference valuations made by independent valuers which rely on the financial data of investees and on estimates made by the management of the investee companies as to the effect of future developments. The independent valuers also assist in the selection of valuation techniques and models. However, there are inherent limitations in any valuation technique due to the lack of observable inputs. Estimated fair value may differ significantly from the value that would have been used had a readily available market for such investments existed and these differences could be material to the financial statements. Additional information about the level of market observability associated with investments carried at fair value are disclosed in Note 4 below.

The Fund enters into secured lending transactions which are reported as operating activities in these consolidated financial statements. Loans receivable are recorded at fair value in accordance with the guidance set forth in Note 4. The valuation techniques applied usually takes into account the estimated future cash flows, liquidity, credit, market and interest rate factors.

(d) Cash and cash equivalents

Cash represents cash at banks and does not include restricted cash such as fixed deposits pledged as security for bank loans. Cash equivalents are defined as those instruments which mature within three months or less of the date of purchase.

(e) Bank loans

Bank loans are initially recognized at fair value, net of transaction costs incurred and subsequently stated at amortized cost. Any difference between the proceeds (net of transaction costs) and the redemption value is recognized in the consolidated statement of operations over the period of the borrowing using the effective interest method.

(f) Foreign currency translation

The books and records of the Fund are maintained in United States Dollars ("US$"), which is also the functional currency. Assets and liabilities, both monetary and non-monetary, denominated in foreign currencies are translated into US$ at period-end exchange rates, while income and expenses are translated at the exchange rates in effect during the period.

Gains and losses attributed to changes in the value of foreign currencies for investments, cash balances and other assets and liabilities are reported as foreign exchange gain and loss.

(g) Income taxes

Under the current laws of the Cayman Islands, the Fund had no income taxes payables in that jurisdiction. The Fund may be subject to taxes imposed in other countries in which it invests. Such taxes are generally based on income and gains earned. Taxes are accrued on investment income, realized gains, and unrealized gains, as appropriate, when the income and gains are earned. The Fund accrues for liabilities relating to uncertain tax positions only when such liabilities are probable and can be reasonably estimated in accordance with the authoritative guidance contained in ASC 740 described in Note 9. Such income and gains are recorded gross of taxes in the consolidated statement of operations and taxes are shown as a separate item in the consolidated statement of operations.

The Fund files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. The Fund uses the asset and liability method to provide for income taxes on all transactions recorded in the consolidated financial statements. This method requires that income taxes reflect the expected future tax consequences of temporary differences between carrying amounts of assets or liabilities for book and tax purposes. Accordingly, a deferred tax asset or liability for each temporary difference is determined based on the tax rates that the Fund expects to be in effect when the underlying items of income and expense are realized.

(h) Recognition of income and expenses

Interest income on bank balances is accrued as earned using the effective interest method. 

Dividend income is recognized on the ex-dividend date and is recorded net of withholding taxes where applicable.

Expenses are recorded on an accrual basis. 

(i) Subsequent events

In accordance with FASB ASC 855-10, "Subsequent Events", (formerly FAS165), the Fund discloses events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. See Note 14, Subsequent Events, for further discussion.

(j) Critical accounting estimate and assumptions

Estimates and judgements are continuously evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are addressed below.

(i) Income taxes 

The Fund is subject to income taxes in the jurisdictions in which it operates. Significant judgement is required in determining the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain. The Fund recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the current and deferred income tax assets and liabilities in the period in which such determination is made.

3 Concentration of risks

(a) Market risk

Market risk represents the potential loss in value of financial instruments caused by movements in market variables, such as equity prices. 

Investments are made with a focus on Greater China. Political or economic conditions and the possible imposition of adverse laws or currency exchange restrictions in that region could cause the Fund's investments and the respective markets to become less liquid and also the prices to become more volatile.

The Fund's investments may be concentrated in a particular industry or sector and performance of that particular industry or sector may have a significant impact on the Fund. The Fund's concentration of investments in a particular industry or sector is presented on the consolidated schedule of investments.

The Fund's investments may also be subject to the risk associated with investing in private equity securities. Investments in private equity securities may be illiquid and subject to various restrictions on resale and there can be no assurance the Fund will be able to realize the value of such investments in a timely manner.

See Note 4 below for a discussion on the inputs in fair value measurement of the Fund's investments.

(b) Interest rate risk

Interest rate risk arises from the fluctuations in the prevailing levels of market interest rates which affect the fair value of financial assets and liabilities and future cash flows. The Fund has bank accounts, restricted cash, loans receivable and bank loans that expose the Fund to interest rate risk. The Fund has direct exposure to interest rate changes in respect of the valuation and cash flows of its interest bearing assets and liabilities. The Fund may also be indirectly affected by interest rate changes in respect of the earnings of certain companies in which it invests.

(c) Currency risk 

The Fund has assets and liabilities denominated in currencies other than the US$, the functional currency. The Fund is therefore exposed to currency risk as the value of assets and liabilities denominated in other currencies may fluctuate due to changes in exchange rates. The net assets of the Fund are denominated in the following currencies:

(d) Credit risk

The Fund is exposed to default risk by the counterparties of the loans receivable. Whilst the loans receivable are structured to provide the Fund with adequate collateral in the event of default, enforcement may be subject to the legal system of the countries where the relevant agreements are entered. Even where the contract is enforced, the collateral may not be sufficient to fully compensate the Fund for default losses. In an attempt to mitigate losses, the Fund, where possible, obtains independent valuations of the collateral on a regular basis and monitors the fair value of collateral relative to the loan amounts plus accrued interest and where necessary, requires additional cash or collateral from the borrower to manage its exposure. However, these valuations do not guarantee the ultimate realizable value of the collateral.

The legal system of the countries in which the Fund invests vary widely in their development, degree of sophistication, attitude, and policies towards bankruptcy, insolvency, liquidation, receivership, default and treatment of creditors and debtors. Furthermore, the effectiveness of the judicial system of the countries in which the Fund invests varies, thus the Fund (or any entity in which the Fund holds a direct or secondary interest) may have difficulty in successfully pursuing claims in the courts of such countries. To the extent the Fund or an entity in which the Fund holds a direct or secondary interest has obtained a judgement but is required to seek its enforcement in the courts of the countries in which the Fund invests, there can be no assurance the court will enforce such judgement.

As at 30 June 2011, investments in loans receivables and bonds of US$63,921,703 (year ended 31 December 2010: US$62,885,693) were borrowed/issued by counterparties which are currently unrated by any rating agency.

(e) Liquidity risk

As the Company is closed-end, it is not exposed to redemptions of shares by its shareholders.

The Fund is exposed to liquidity risk as the majority of the investments of the Fund are illiquid and certain of the Fund's liabilities have short maturity. Details of the maturity analysis on loans receivable are set out in Note 5 below. Illiquid investments include all securities and instruments which are not actively traded on any major securities market or for which no established secondary market exists where the investments can be readily converted into cash. Reduced liquidity resulting from the absence of an established secondary market may have an adverse effect on the prices of the Fund's investments and the Fund's ability to dispose of them where necessary to meet liquidity requirements. The liquidity risk and the liability level of the Fund is closely monitored by the Investment Manager. All current bank loans are fully collateralized with cash. The Fund has distributed $49,989,521 (year ended 31 December 2010: US$23,286,109) to PACL II for the period ended 30 June 2011.

China currently has foreign exchange controls that restrict the repatriation of funds. Any unexpected foreign exchange control in China may cause difficulties in the repatriation of funds. The Fund invests in China and may be unable to repatriate funds out of China on a timely basis to meet its obligations. See Note 3(c) above for exposure to Renminbi.

The Fund has the ability to borrow in the short term and this is subject to certain limitations on such borrowings, including a limit on the total amount of all borrowings outstanding at any time which shall not exceed 50% of the Fund's total assets at such time.

4 Investments

In accordance with Financial Accounting Standards Board ("FASB") ASC 820-10, Fair Value Measurements and Disclosures, (formerly Statement of Financial Accounting Standards ("SFAS") No. 157), the Fund discloses the fair value of its investments in a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to valuations based upon unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to valuations based upon unobservable inputs that are significant to the valuation (Level 3 measurements). FASB ASC 820-10-35-39 to 55 provides three levels of the fair value hierarchy as follows:

Level 1

Inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities that the Fund has the ability to access at the measurement date;

Level 2

Inputs other than quoted prices included within Level 1 that are observable for the asset or liability either directly or indirectly, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not considered to be active, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived principally from or corroborated by observable market data by correlation or other means;

Level 3

Unobservable inputs based on the best information available in the circumstances, to the extent observable inputs are not available (including the Fund's own assumptions used in determining the fair value of investments).

Inputs to measure fair values broadly refer to the assumptions that market participants use to make valuation decisions, including assumptions about risk. Inputs may include price information, volatility statistics, specific and broad credit data, liquidity statistics and other factors. An asset or a liability's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes "observable" requires significant judgment. The Valuation Committee considers observable data to be such market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary and provided by multiple, independent sources that are actively involved in the relevant market. The categorization of an asset or a liability within the hierarchy is based upon the pricing transparency of the asset or liability and does not necessarily correspond to the Valuation Committee's perceived risk of that asset or liability.

In determining an instrument's placement within the hierarchy, the Valuation committee follows the following:

Level 1

Investments in listed stocks and derivatives that are valued using quoted prices in active markets and are therefore classified within Level 1 of the fair value hierarchy. 

As at 30 June 2011, the Fund did not have any investments that were categorized as Level 1 within the fair value hierarchy (year ended 31 December 2010: Nil).

Level 2

Investments in listed stocks for which trading is restricted for a certain period of time and for which the restriction is applicable to market participants in general (for example, legal person shares containing lock-up periods) are valued using the last traded prices of the listed stocks after factoring in discounts for liquidity. Such investments are generally classified within Level 2 of the fair value hierarchy. The discounts for restrictions are estimated by the Valuation Committee by analyzing the length of the restriction period and are as follows:

As at 30 June 2011, the Fund did not have any investments that were categorized as Level 2 within the fair value hierarchy (2010: Nil).

Level 3

Assets are classified within Level 3 of the fair value hierarchy if they are traded infrequently and therefore have little or no price transparency. Such assets include investments in unlisted stocks and bonds and loans receivable. Investments classified within Level 3 have significant unobservable inputs, as they trade infrequently or not at all. Level 3 instruments include illiquid listed equity, private equity, real estate investments, certain bank loans and bridge loans, less liquid corporate debt securities (including distressed debt instruments), collateralized debt obligations, less liquid convertible debt securities, and investments in closed-end funds. When observable prices are not available for these securities, the Valuation Committee uses one or more valuation techniques (e.g., the market approach or the income approach) for which sufficient and reliable data is available. Within Level 3, the use of the market approach generally consists of using comparable market transactions, while the income approach generally consists of the net present value of estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors.

The inputs used by the Valuation Committee in estimating the value of Level 3 investments include the original transaction price, recent transactions in the same or similar instruments, completed or pending third-party transactions in the underlying investment or comparable issuers, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and changes in financial ratios or cash flows. Valuation of Level 3 investments may also be adjusted to reflect illiquidity and/or non-transferability with the amount of such discount estimated by the Valuation Committee in the absence of market information.

The fair value measurement of Level 3 investments does not include transaction costs that may have been capitalized as part of the security's cost basis. Assumptions used by the Valuation Committee due to the lack of observable inputs may significantly impact the resulting fair value and therefore the Fund's results of operations.

All of the Company's investments are categorized as Level 3 investments within the fair value hierarchy. The following table summarizes the changes in fair value of the Fund's Level 3 instruments by captions:

As at 30 June 2011, investments of US$280,370,025 (year ended 31 December 2010: US$258,365,492) were held directly by the Fund, and investments of US$65,118,380 (year ended 31 December 2010: US$77,385,693) were held through jointly controlled entities with Pacific Alliance Asia Opportunity Fund L.P. ("PAX L.P."), an investment fund managed by Pacific Alliance Investment Management Limited, a fellow subsidiary of the Investment Manager.

The following table summarizes the changes in fair value of the Fund's Level 3 instruments.

Total net change in unrealized gains on Level 3 instruments as shown above are presented in the consolidated statement of operations.

5 Investments - loans receivable and bonds

As at 30 June 2011, the Fund had loans receivable from unaffiliated parties amounting to US$14,963,957 (year ended 31 December 2010: US$13,927,948). The loans will mature in the next 12 months. The interest rates charged on the loans is 15 per cent per annum (year ended 31 December 2010: 10 per cent to 35 per cent per annum). 

For the period ended 30 June 2011, total realized gains recognized on these loans amounted to US$ Nil (year ended 31 December 2010: US$12,508,536) and net change in unrealized losses for loans receivable amounted to US$1,036,010 (year ended 31 December 2010: unrealized losses of US$9,110,895).

The loans are categorized into the following types by structure:

As at 30 June 2011, the Fund had a bond investment from an unaffiliated party amounting to US$48,957,746 (year ended 31 December 2010: US$48,957,746) which will mature in the next 12 months. The Fund held collateral on the bond investment in the form of assets of the bond issuer and its subsidiaries. The fair value of the investment is determined by the Valuation Committee. For the period ended 30 June 2011, total unrealized gains recognized on the bond amounted to US$ Nil (year ended 31 December 2010: US$3,981,220).

6 Investments - derivatives

The buyer of an option has the right to purchase a specified quantity of a specific financial instrument at a specified price prior to or on a specified expiration date. The maximum loss exposure of a call option is the premium, if any, paid by the buyer.

As at 30 June 2011, the Fund had an investment of US$1,196,677 in the form of options on equity shares that were categorized as Level 3 within the fair value hierarchy (year ended 31 December 2010: Nil).

7 Bank loans

In order to finance the investment projects and facilitate distributions in different currencies, the Fund may from time to time enter into loan agreements with banks which are fully secured by deposits in currencies other than the denomination of the loans held directly by the Fund or related entities. In the event that amounts under the loan agreements are due and not paid, the banks are entitled to receive an amount of the deposits equal to the unpaid amount.

As at 31 July 2009, a bank loan was drawn from Xiamen International Bank Limited which amounted to US$12,000,000. The loan was repaid on 4 January 2010. The interest rate charged on the loan was LIBOR plus 1 per cent per annum with fixed deposits of US$12,000,000 pledged to the bank.

As at 30 June 2011 a bank loan was drawn amounting to USD38,121,000, with a fixed deposit of RMB273,000 fully pledged to the bank. The interest charged on the loan is LIBOR plus 2.5 per cent per annum. The purpose of the loan was to facilitate a US dollar distribution to PACL II. The RMB securing the loan was allocated from the PACL II cash balance, of which all unrealized foreign exchange gains and losses arising on the bank loan and associated fixed deposits as at the period end was allocated to PACL II.

For the period ended 30 June 2011, total interest expense incurred on bank loans by the Fund amounted to US$ Nil (year ended 31 December 2010: US$1,283).

8 Share capital, share premium, capital surplus and tendered shares

At 30 June 2011, the total authorized number of ordinary shares was 10,000,000,000 (year ended 31 December 2010: 10,000,000,000) with par value of US$0.01 (year ended 31 December 2010: US$0.01) per share.

In March 2009, the Company repurchased 180,166,107 shares at US$1.01 per share and cancelled these shares as part of the restructuring of the Company. See Note 11(a) below for details.

As at 1 January 2009, the number of tendered shares was 29,960,000. In July 2009, the Company further repurchased 8,031,849 shares at US$1.09 per share through a wholly-owned subsidiary, PACL Trading Limited, and held these shares as tendered shares. As at 31 December 2010, the number of tendered shares increased to 51,677,033 of which 6,970,762 shares at US$1.12 per share were repurchased in January 2010, and 6,714,422 shares at US$1.43 per share were repurchased in August 2010.On 30 June 2011, the Company transferred 1,719,857 tendered shares at US$1.7939 per share to the Investment Manager to settle its obligation in respect of the share portion of the 2010 performance fee.

As at 30 June 2011, the Company had 189,833,893 (year ended 31 December 2010: 189,833,893) ordinary shares in issue, of which 49,957,176 (year ended 31 December 2010: 51,677,033) were held as tendered shares.

9 Taxation

The Fund adopted the authoritative guidance contained in FASB ASC 740 on accounting for and disclosure of uncertainty in tax positions, which required the directors to determine whether a tax position of the Fund is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For tax positions meeting the more likely than not threshold, the tax amount recognized in the financial statements is reduced by the largest benefit that has a greater than 50 per cent likelihood of being realized upon ultimate settlement with the relevant taxing authority.

The uncertain tax positions identified by the directors mainly include:

(a) Whether any of the Fund and its offshore SPVs would be deemed as a China Tax Resident Enterprise ("TRE") under the China Corporate Income Tax ("CIT") Law. If an offshore entity is deemed as a China TRE, its income would be subject to China corporate income tax at 25 per cent.

(b) Whether any of the Fund and its offshore SPVs that may derive income would be deemed as having an establishment or place of business in China. If an offshore entity has an establishment or place of business in China, income derived by the offshore entity that is derived from China by the establishment or place of business or income that is effectively connected to the establishment or place of business would be subject to China corporate income tax at 25 per cent.

(c) Whether any of the Fund and its offshore SPVs is subject to Hong Kong profits tax. An entity would be subject to Hong Kong profits tax if (i) the entity carries on a trade, profession or business in Hong Kong; (ii) profits are derived from that trade, profession or business carried on in Hong Kong (excluding gains of a capital nature); and (iii) the profits arise in or are derived from Hong Kong, i.e. have a Hong Kong source.

The directors assessed that the Fund and its offshore SPVs are not TREs in China and do not have an establishment or place of business in China. 

Gains from disposal of investments in China by the Fund or its SPVs may be subject to China withholding tax at 10 per cent without considering the potential relief that may be available under any tax treaty between the tax jurisdiction of the transferor and China. In addition, where Chinese equity investments are held via an offshore intermediate holding company, exit of Chinese equity investment via disposal of shares in the offshore intermediate holding company could be regarded as an indirect transfer of the Chinese equity investment. According to the General Anti Avoidance Rules under the China CIT Law, if arrangement of adopting the above investment holding structure and exiting via indirect transfer do not have a reasonable commercial purpose, the Chinese tax authority is empowered to disregard such arrangement and impose withholding tax on the gains from the indirect transfer. The directors have reviewed the structure of the investment portfolio and assessed the potential withholding tax implications and have determined that adequate provision to China tax has been made on the Fund's financial statements.

As at 30 June 2011, provision for current tax and deferred tax amounted to US$327,674 (from 1 January to 30 June 2010: US$2,718,761) and US$55,955,527 (from 1 January to 30 June 2010: US$22,567,473), respectively.

However, given the uncertainty of China tax, the Investment Manager would like to highlight that there is a possibility that some or all of the tax provided as at 30 June 2011 will not be payable and may be released. The Investment Manager is regularly monitoring the position.

The Investment Manger has reviewed the structure of the Fund's investment portfolio and considered the Fund's exposure to Hong Kong Profits tax has been properly reflected in the Fund's consolidated financial statements.

Under current Cayman Islands legislation applicable to an exempted company, there is no income tax, capital gains or withholding tax, estate duty, or inheritance tax payable by the Fund.

10 Management fees and performance fees

Pursuant to the Investment Management Agreement dated 20 November 2007, the Investment Manager was appointed to manage the investments of the Fund. The Investment Manager will receive an aggregate management fee of 2 per cent per annum of the quarterly Net Asset Value ("NAV"). The management fee is paid quarterly in advance based on the NAV at the first day of each fiscal quarter. For the period ended 30 June 2011, total management fees amounted to US$2,400,389 (from 1 January 2010 to 30 June 2010: US$1,879,810).

The Investment Manager is also entitled to receive performance fees from the Fund in the event that the year-end NAV is greater than (a) the year-end NAV for the last year in which a performance fee was payable ("High Water Mark"), and (b) the year-end NAV for the last year in which a performance fee was payable increased by an annual hurdle rate of 8 per cent ("Hurdle").

The performance fee will be calculated as follows:

·; 0 per cent of the relevant increase in the year-end NAV if the year-end NAV is at or below the Hurdle;

·; 100 per cent of the relevant increase in the year-end NAV above the Hurdle up to 10 per cent (the "Catch-up"); and

·; 20 per cent of the relevant increase in the year-end NAV above the Catch-up.

For the period ended 30 June 2011, total performance fees from PACL amounted to US$2,211,051 (from 1 January 2010 to 30 June 2010: US$624,809).

Under the Investment Management Agreement, the performance fee shall be paid 75 per cent in cash and 25 per cent in the Company's ordinary shares ("share portion"). The Company may elect to meet its share obligation either by issuing new shares at NAV or purchasing the equivalent number of shares in the market.

During the period ended 30 June 2011, the Investment Manager agreed to receive 1,719,857 tendered shares from the Fund to settle its obligation in respect of the share portion of the 2010 performance fee of US$3,085,252 (year ended 31 December 2010: the Fund received cash totalling US$2,396,374 to settle the share portion of 2009 performance fees of US$3,606,249), and a gain of US$1,342,005 was recognised by the Fund as share premium in the consolidated statement of assets and liabilities (year ended 31 December 2010: a gain of US$1,209,875 recognised as other income in the consolidated statement of operations). Had the Fund opted for issuing new shares at NAV to settle the outstanding performance fee payable as at 30 June 2011, the Company's total number of issued shares would have increased by 1,719,857 (year ended 31 December 2010: 2,594,424).

The Investment Manager received 1,719,857 shares from the Fund to settle the share portion of the 2010 performance fee.

11 Related-party transactions

The Fund had the following significant related-party transactions.

(a) Restructuring with PACL II Limited

On 2 March 2009, the Company held an extraordinary general meeting to approve a tender offer that allowed shareholders to exchange all or part of their shares for shares in PACL II Limited ("PACL II"), a Cayman Islands private vehicle that will be used to realize and distribute cash from exited investments based on the investment and asset positions held by the Fund as at 31 December 2008 ("Tender Offer Portfolio"). PACL II is also managed by the Investment Manager. It will, without any further action on the part of its shareholders, automatically wind up and dissolve in 3 years upon when its ordinary shares were first issued. The duration of PACL II may be extended by 1 year upon written election by the Investment Manager.

As part of this restructuring, the Company repurchased 180,166,107 shares at a tender price of US$1.01 per share in exchange for holders of these shares receiving the same number of shares in PACL II. Under the terms of the tender offer, PACL II is entitled to receive 50.33 per cent of the proceeds from the Tender Offer Portfolio, which reflects a 5 per cent discount of its proportionate share of the Tender Offer Portfolio. As such, the amount due to PACL II is recorded as a payable by the Fund, adjusted at each period end based on the movement in the fair value of the underlying assets and the income and expense attributable to the Tender Offer Portfolio. The amount is unsecured and non-interest bearing.

The following table summarizes the changes in payable to PACL II.

For the period from 1 January to 30 June 2011, the Fund distributed US$45,874,691 (year ended 31 December 2010: US$23,286,109) of realization proceeds from the Tender Offer Portfolio to shareholders of PACL II and a net increase in payable to PACL II from gains attributable to PACL II of US$1,284,361 (year ended 31 December 2010: US$9,403,257) was recognized as a gain as a result of the increase in value of the Tender Offer Portfolio.

(b) Management fees and performance fees to the Investment Manager

The Fund pays management fees and performance fees to the Investment Manager. See Note 10 above for details.

(c) Directors' remuneration

The Company pays each of its directors annual fees of US$30,000. If a director is a member of the Valuation Committee or Audit Committee, the director also receives an additional fee of US$10,000, or US$5,000 if they serve as Chairman of either Committee. During the year, Chris Gradel and Horst Geicke agreed to waive their directors' fees, and Chris Gradel has also agreed to waive his committee fee for the period ended 30 June 2010 and 2011.

12 Financial highlights

Net asset value per share at the end of the year is as follows:

The following represents the ratios to average net assets and other supplemental information:

(1) Total return represents the change in NAV (before and after performance fees), adjusted for cash flows in relation to capital transactions for the year/period.

(2) Average net assets is derived from the beginning and ending NAV, adjusted for cash flows in relation to capital transactions for the year/period. For the period ended 30 June 2011, the average net assets amounted to US$245,493,863 (from 1 January 2010 to 30 June 2010: US$202,144,089).

13 Commitment and contingency

In the normal course of business, the Fund may enter into arrangements that contain a variety of representations and warranties that provide general indemnification under certain circumstances. The Fund's maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Fund and which have not yet occurred. However, based on experience, the directors expect the risk of loss to be remote, and, therefore, no provision has been recorded.

14 Subsequent events

Management has performed a subsequent events review from 1 July 2011 through to 27 September 2011, being the date that the financial statements were issued, and has determined that there were no subsequent events requiring adjustment or disclosure in the financial statements.