The China Banking Regulatory Commission (CBRC) issued the “Guidelines for Risk Management of Merger and Acquisition Loans by Commercial Banks” (Guidelines) on December 9, 2008. They went into effect that same day. The Guidelines allow qualified Chinese commercial banks to provide commercial loans to acquirers to finance merger and acquisition (M&A) deals. Until issuance of the Guidelines, financial institutions had been prohibited from directly financing acquisitions. Issuance of the Guidelines marks a major step forward from past prohibitions on leveraged acquisitions.
The M&A transactions covered by the Guidelines include equity acquisitions, subscriptions for new equity issuances, asset acquisitions, assumptions of liabilities and other transactions which enable one entity to merge with or to obtain control of another entity (Article 3 par. 1). Acquisitions can be effected through existing operating companies or special purpose vehicles (Article 3 par. 2). Loans may be used for cross-border transactions (Article 8 par. 2).
The Guidelines are targeted to support strategic M&A deals in China to encourage industry restructuring. Article 22(3) requires that both the acquirer and the target company be in a closely or strategically-related industry, which may bar access by many private equity and venture capital entities to these loans, and that the acquirer have the capability to deploy research, key technology or skills, trademarks, concessions, supply or distribution channels, or other strategic resources to raise core competitiveness after completion of the deal. Additionally, the Guidelines require that the acquirer be creditworthy and the transaction comply with all legal requirements. Approvals must be obtained from relevant authorities to the extent that industrial development policies, anti-monopoly law, and state-owned assets transfer regulations require (Article 22(2) and (3)). The term of the loan generally may not exceed five years (Article 19).
In order to control risks in providing M&A loans, the CBRC incorporates several risk management requirements in the Guidelines. Banks are required to establish more rigorous loan monitoring procedures for M&A loans than for other loans (Article 7). Banks are required to conduct a full-scale risk evaluation including evaluation of strategic risks, legal and compliance risks, integration risks, operational risks and financial risks before extending loans (Articles 8 par. 1 and 9-12). The CBRC also requires that the banks’ total M&A loans balance not exceed 50% of their Tier One capital (Article 16) and loans to a single borrower not exceed 5% of their Tier One capital (Article 17). M&A loans may not exceed 50% of the transaction’s consideration (Article 18). The loans must be secured to a greater extent than required for other type of loans (Article 25 par. 2). The Guidelines do not indicate whether acquired assets or equity may be used for security, but that presumably is permitted. The loan contract must include certain mandatory provisions to protect the borrower’s interest, e.g., restrictive provisions on key financial norms of the acquirer or the target company post-acquisition, the acquirer’s ability to obtain additional cash flow to repay loans in advance, provisions to monitor key bank accounts of the acquirer and the target company post-acquisition, and commitments by the acquirer to notify the lender with respect to material conditions (Articles 12 and 27).
The Guidelines refer to the acquirer in Article 3 as a “domestic acquisition enterprise” (境内并购方企业) which would include foreign-invested enterprises (FIEs), which are themselves Chinese companies, even though there is still no clear interpretation by the CBRC in this regard. Chinese banks, upon inquiry, have stated that FIEs would be eligible.
On January 6, 2009, Industrial and Commercial Bank of China’s (ICBC) Beijing Branch, China Beijing Equity Exchange and Beijing Capital Co., Ltd. (Beijing Capital) signed a cooperation agreement regarding M&A loans, under which ICBC agreed to provide M&A loans to Beijing Capital through the China Beijing Equity Exchange’s platform to finance Beijing Capital’s several water treatment M&A deals. This is the first such commercial bank M&A loan. On February 19, 2009, ICBC’s Shanghai Branch entered into an M&A Loan Agreement with Bailian Group, a large state-owned retail enterprise in Shanghai, to provide RMB 400 million to finance its acquisition of 100% of the equity of Shanghai Industrial Commercial Network Co., Ltd. This is the first M&A loan provided to entities under the Guidelines. Starting with large state-owned enterprises, we expect the loans under the Guidelines to be gradually extended to other enterprises including medium and small-scale private companies and FIEs.
