Acquisition financing in China

July 2015  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Six years after the introduction and implementation of the Guidelines on Risk Management of Merger and Acquisition Loans granted by Commercial Banks, the China Banking Regulatory Commission has decided to revise its Guidelines in order to further facilitate the development of the M&A loan market in China.

Banks in China, since the institution of the guidelines, have been unwilling or unable to respond to shifting demands for M&A borrowing from clients within the country. Accordingly, borrowers have been required to look offshore to finance their outbound M&A transactions. Shadow banking in China has also risen to prominence as a means of acquiring funds for transactions.

However, attitudes toward acquisition financing in China are finally shifting, and some of the more stringent qualifications and lending rules under the Commission’s Guidelines are now being revised.

The amended guidelines have been designed to lower a number of lender qualification requirements and permit longer loan tenor and higher loan-to-acquisition price ratios, while continuing the emphasis on risk assessment and internal controls to guard against non-performing loans and fraudulent transactions. The new Guidelines are considerably broader in their application given that they apply to M&A loans provided both by commercial banks as well as policy banks, PRC branches of foreign banks, or finance companies of business groups.

Features of the guidelines

There are four main features of the newly revised Guidelines. First and foremost, the rules now apply not only to commercial banks but also to policy banks, local branches of foreign banks and finance companies of enterprise groups. In addition, two requirements, namely the 100 percent loan loss specific reserve adequacy ratio and the general reserve balance of not less than 1 percent of concurrent loan balance, have been removed from the rules. Accordingly, banks may now provide borrowers with an M&A loan if: (i) the company operates a sound and robust risk management system and has a efficient internal control mechanism; (ii) the borrowers’ capital adequacy ratio is not less than 10 percent; (iii) all the firm’s other regulatory indices meet applicable regulatory requirements; and (iv) it has a professional team responsible for M&A loan due diligence and risk assessment.

Under the Guidelines, the amount of an awarded M&A loan should not exceed 60 percent of the total acquisition price; previously, this figure was 50 percent. This change has been made to reflect the fact that banking facilities are the major source of funding for modern M&A transactions.

Furthermore, the term of the loan should not exceed seven years, an increase from five under the auspices of the previous Guidelines. This change has been made in order to reflect the amount of time it takes for a modern M&A transaction to achieve desired levels of integration as well as the anticipated synergies.

Finally, the security requirements for M&A loans have also been relaxed under the new provisions. Now, they do not have to be more stringent than security for other loans, provided the security is  proportionate to the risks associated with the loan itself.

Risk management

The new Guidelines also set forth the continued importance of administration and information systems, as well as establishing effective internal controls and risk management. The provisions note that banks must have a system in place which is able to statistically analyse M&A loans in accordance with existing regulatory requirements. Banks must also be able to effectively report a number of factors directly to the CBRC or to the Commission’s local bureau regarding the M&A loan limit amounts.

Banks should focus on the concentration limit on a per-borrower, group customer, industrial, national or jurisdictional basis. Banks should also be able to establish the leveraged ratio of M&A loans and ensure reasonable funding by equity contribution.

The Guidelines further serve to strengthen due diligence procedures and after-lending loan management and supervision. They also establish a number of mandatory terms in the loan agreement which protect lenders’ interests, including the lender’s right to take risk control measures upon any material change in the business strategy of the acquired group, and the condition of the security provider or the security assets.

Banking in China has undergone a number of changes in recent years. In 2014, the CBRC approved a pilot program to allow certain technology, manufacturing and services companies to start five new privately-owned banks in Tianjin, Shanghai, Zhejiang and Guangdong. Furthermore, in May news emerged that the Commission planned to ban the substantial and high risk peer to peer lending industry which is so popular in China. The crackdown on p2p lending is expected to enter into force later this year.

In conclusion, given China’s current economic position, and with banking and M&A financing at a pivotal point, the new Guidelines are an important step. Liberalising and simplifying approval procedures in the Chinese banking sector will allow for increased opportunities for lenders and acquiring parties to enter into M&A loans in the country. Though there will be heightened requirements for risk assessment and risk management in connection with M&A loans, these revised Guidelines will present borrowers with myriad opportunities.

© Financier Worldwide

BY

Richard Summerfield