China approves acquisition loans to further stimulate economy – Cuatrecasas Goncalves Pereira

The gloomy economic situation not only urges the furthering of China’s industrial upgrading and restructuring, but also the advancement of its banking industry. On January 20, 2009, the China Development Bank signed a contract for an acquisition loan with Zhongxin Guoan (Group) for RMB 1.63 billion (€176m). This was followed shortly by another two loan contracts that the Industry and Commerce Bank of China and the Construction Bank of China signed with clients for hundreds of millions of RMB.

These loans ended the 13-year prohibition on banks granting loans for acquisitions, as banned under Article 20 of the 1996 Lending General Provisions issued by the People’s Bank of China, the Central Bank of China. This has been possible only because of the new Guidelines on Risk Management of Acquisition Loans of Commercial Banks (the Guidelines), issued by the China Banking Regulatory Commission (CBRC) on December 6, 2008, which now allow Chinese banks to grant loans for acquisition activities to companies incorporated in China (foreign-funded or domestic).

The Guidelines, issued one month after the announcement of the central government’s RMB 4 trillion (€433bn) stimulus budget, help boost a declining economy by introducing a new financing option to the market to mitigate the impact of the global financial crisis. 

Summary

The Guidelines comprise 39 articles in four chapters, with most articles focusing on risk assessment and management. Following the fundamental principle of meeting market demand and diversifying loan options on the one hand, while containing the risks of acquisition loans on the other, the Guidelines achieve equilibrium betwe+en meeting market demand and risk control.

The Guidelines do not establish tough market-entry standards for Chinese banks and locally incorporated subsidiaries of foreign banks, but instead require banks to establish higher levels of internal risk-control systems for acquisition loans than other types of loans. This is achieved through comprehensive provisions on risk assessment in Chapter Two and risk management in Chapter Three. An integrated report on the internal risk-control system must be submitted to the CBRC for review before commencing this loan business.  

Risk assessment

Chapter Two stipulates a mandatory risk analysis, which breaks down all the risks that banks must analyse before granting an acquisition loan, including analysis of strategic risks; legal, compliance and regulatory risks; enterprise-integration risks; and operation and financial risks. Risks concerning cross-jurisdictions, exchange rates and cross-border payments must also be analysed for foreign acquisitions. 

The strategic risks analysis in which banks consider “the industrial and strategic correlation between a buyer and a seller” is particularly interesting. The correlation requires the businesses of the buyer and the seller to be very similar so that in its daily business the buyer can effectively use the R&D capacity, technology and know how, trademarks, supply and distribution channels, and other business resources it obtains from the seller. 

It is also important to consider whether an acquisition can affect the buyer’s business development and increase the value of its enterprise. These loans must only be granted to borrowers seeking to upgrade and develop their businesses, not to borrowers seeking loans to invest in asset management, which is driven more by speculation.  

Risk management

The risk-management provisions in Chapter Three require banks to establish stricter risk-management systems, which can be exemplified as follows: 

• Higher levels of guarantees must be established
• Specific risk-management measures must be stipulated in contracts for acquisition loans to cover special events and circumstances, including changes of shareholders, large investments, abnormal changes in operation costs and expenses, material changes harmful to the corporate brand, client base and market channels, large debts, and purchase or sale of valuable assets
• Both borrowers and guarantors must regularly provide tax reports to banks for review
• Acquisition loans must not be valid for more than five years, as opposed to 10 years for other types of loans
• The leverage ratio of acquisition loans must be a maximum of 50% (ie the buyer must pay at least 50%).  

Good news for M&A activity in China

Given the financial struggle that companies worldwide are facing, it is good news that the Chinese government has lifted some of its banking restrictions, easing financing of M&A activity in China for China-incorporated enterprises, including foreign-invested ones, which may see the coming of the Guidelines with more interest and enthusiasm, given the increasing difficulties of getting loans from their home countries.  

We expect the Chinese government to continue opening up its banking system, which, along with other economic policies already in place, will no doubt have a positive influence on both the Chinese and global economies.  

Omar Puertas is the managing lawyer of the Cuatrecasas Goncalves Pereira office in Shanghai. He can be reached via omar.puertas@cuatrecasas.com.