Opportunities and Paths for Foreign Investment to Participate in China's NPA Disposal Business under the COVID-19 Outbreak

At the beginning of 2020, COVID-19 disease (the "COVID-19") broke out in Wuhan, China. On January 30 Geneva time, the World Health Organization (WHO) declared that the spread of COVID-19 in China was listed as a " Public Health Emergency of International Concern " (PHEIC) , followed by a global outbreak. Undoubtedly, the COVID-19 pandemic has caused a direct and widespread negative impact on all the industries in China. In this article, we briefly analyze the trends of business of non-performing asset (the "NPA") disposal in China and the opportunities and paths of foreign capital’s participation in the context of the COVID-19 pandemic.

I. The scale of NPA in China will be further expanded due to COVID-19

Affected by the COVID-19 outbreak, all kinds of industries in China have delayed the resumption of work, the production and operation have been stagnated on different level. The operation of enterprises engaged in manufacturing, export, service and tourism in China are nearly freezing and have suffered heavy losses. The suspension of business resulted in the capital chain rupture and further lead to the enterprise's disability to repay the bank loans on time, while the domestic financial investors are also facing the crisis of default payment. Therefore, under the circumstances of the enterprises’ shutdown, the risks of enterprises’ production and operation have transformed into financial risks and affect banks and other financial institutions through the closely connected industrial chain as well as the supply and demand chain, eventually forming non-performing loans and other types of NPA.

Although, in order to prevent financial risks during the COVID-19 outbreak and support the steady development of the real economy, on January 26, 2020, the China Banking and Insurance Regulatory Commission (CBIRC) released Notice on Strengthening Financial Services of Banking and Insurance for Coordinating the Epidemic Prevention and Control of COVID-19 (CBIRC General Office [2020] No.10), states that "With respect to the industries of wholesale and retail, accommodation catering, logistics transportation, cultural tourism which suffered huge impacts of COVID-19, as well as the enterprises with development prospects but temporarily distressed, such loans shall neither be terminated, be interrupted or be stressed absent due cause. The affected enterprises shall be supported to overcome the impact of COVID-19 by means of appropriately lowering loan interest rates, improving policies on arrangements for renewal, increasing credit loans, medium-term and long-term loans." However, the COVID-19 pandemic has exacerbated the deterioration of global economic, both domestic production and foreign trade exports in China have fallen sharply, financial support policies can hardly change the status quo that the global demand market is contracting sharply. It is estimated that the NPA market in China will surge in the coming period of time.


(Source: McKinsey Report)

II. New Opportunities for Foreign Investment in China's NPA Business After the China-U.S. Trade Agreement

In China's growing market of NPA, the current major players are four financial asset management companies(Great Wall, Cinda, Huarong, Orient, together the "Big Four AMCs")and the local financial asset management companies (the "Local AMCs"). Before 2020, foreign financial institutions and foreign asset management companies participated in the business of domestic NPA disposal mainly through the transfer of asset package by domestic asset companies (secondary market), rather than directly transferred and managed NPA packages from Chinese banks and other financial or non-financial institutions through the application and possession of AMC licenses (primary market).

On January 15, 2020, the Chinese government and the U.S. government signed the Economic and Trade Agreement between the Government of the People's Republic of China and the Government of the United States of America (hereinafter referred to as the "Trade Agreement") in Washington, D.C., which provides new opportunities for foreign investment to participate in China's NPA disposal business. Article 4.5 of the Trade Agreement, "Financial Asset Management (Distressed Debt) Services" expressly provides that “ 2. China shall allow U.S. financial services suppliers to apply for asset management company licenses that would permit them to acquire non-performing loans directly from Chinese banks, beginning with provincial licenses. When additional national licenses are granted, China shall treat U.S. financial services suppliers on a non-discriminatory basis with Chinese suppliers, including with respect to the granting of such licenses.” It can be seen that U.S. financial services suppliers are permitted to directly apply for local AMC licenses and participate in the acquisition of non-performing loans of Chinese banks. Moreover, U.S. financial services suppliers are able to apply equally for national AMC licenses. China's NPA market ushered in the "Wolf of Wall Street", the Chinese AMC companies entered into a market-oriented environment that compete fairly with foreign investors.

In fact, as early as in 2018, the CBIRC has issued the Decision of the CBIRC on Abolishing and Amending Certain Rules to abolish the Rules Governing Investment of Foreign Financial Institutions in Chinese Financial Institutions, cleared that the restriction on the shareholding ratio of overseas financial institutions investment in Chinese financial institutions has been abolished. During the period of negotiation between China and the U.S. at the end of 2019, the CBIRC has also issued the Guideline on Promoting the High-Quality Development of Banking and Insurance (CBIRC General Office [2019] No.52), which clearly states that "attract foreign financial institutions in the fields of asset management, NPA disposal, professional factoring, consumer finance, pension insurance, health insurance and other fields to enter the domestic market". A new era has come for foreign investors to participate in the business of China's NPA disposal.

III. Requirements and Paths for Foreign Investment to Participate in China's NPA business

On March 23, 2020, the CBIRC revised the Implementation Rules of CBIRC on Administrative Licensing of Non-bank Institutions (the “Implementation Rules”) to implement the Trade Agreement. Article 117 of the Implementation Rules stipulated the following requirements on a foreign financial institution to be qualified as an investor of an asset management company (the “AMC”):

(1) The total assets as at end of the latest accounting year shall in principle not be less than US$10 billion;
(2) Good long-term credit rating for the past two years;
(3) Good financial standing and consecutively profiting for the past two fiscal years;
(4) The capital adequacy ratio of a commercial bank shall attain the average capital adequacy ratio of the banking industry at the place of registration and shall not be lower than 10.5%; the total capital of a non-bank financial institution shall not be lower than 10% of the total weighted risk assets;
(5) Proper and effective internal control;
(6) The place of registration's regulatory system for financial institutions is proper;
(7) The economic conditions of its country (region) are good;
(8) Investment with its capital funds and entrusted funds, loans or other funds which are not its capital funds shall not be utilized;
(9) The equity investment balance shall in principle not exceed 50% of its net assets (including the current investment amount);
(10) Any other prudential requirements stipulated by the rules of the CBIRC.

A foreign financial institution which meets all above-mentioned requirements may apply for AMC license to establish a national financial asset management company as investor (not strategic investor), directly holds shares in domestic financial asset management companies, and further participate in the primary market business of asset management. On March 5, 2020, the CBIRC issued Approval on the Transformation of Construction and Investment CITIC Asset Management co., ltd. into a financial asset management company(AMC) [2020 No.107.] Since then, the long-lasting Big Four AMCs stage move forward to the Big Five AMCs stage. Base on the Trade Agreement, foreign financial institutions are entitled to apply for AMC licenses equally if the issuance of national AMC licenses becomes actively.

At present, without further opening up of national AMC licenses, foreign financial institutions may first establish local AMCs to participate in NPA disposal business in accordance with local regulations and pilot policies of various provinces, cities, and autonomous regions in China. For example, both Guangdong Provincial Branch of the State Administration of Foreign Exchange and Shenzhen Branch of the State Administration of Foreign Exchange issued Notice on Foreign Exchange Administration Supporting the Development of the Guangdong-Hong Kong-Macao Greater Bay Area and Shenzhen ’s Pilot Demonstration Zone [2020 No. 15] on March 30, 2020, clarifying " the pilot allowing outbound transfer of domestic credit assets. Following the principle of risk control and prudent management, the pilot institutions in the Guangdong-Hong Kong-Macao Greater Bay Area are allowed to transfer non-performing loans and bank trade financing outside of China." On February 7, 2020, Hainan Provincial Bureau of the State Administration of Foreign Exchange issued Notice on Supporting the Construction of a Foreign Exchange Innovative Business Policy for Hainan Free Trade Port promulgates similar policy.

On February 17, 2020, the Beijing Financial Supervision Bureau announced that Oaktree (Beijing) Investment Management Co., Ltd., the wholly-owned subsidiary of Oaktree Capital, a world-renowned investment management company, completed registration with the Beijing Industry and Commerce Bureau. This is widely known as "The first wholly foreign-owned AMC". Therefore, before the Chinese government further liberalizes national AMC licenses, it may be more pragmatic for foreign financial institutions that meet the licensing requirements to apply for local AMC licenses or to operate NPA in pilot areas. However, it is worth noting that, according to the spirit of the original China Banking Regulatory Commission’s Letter on Properly Adjusting the Relevant Policies of Local Asset Management Companies (CBRC [2016] No. 1738), there are maximum two local AMCs within a province, cities or autonomous region in China. Foreign financial institutions are advised to fully understand the latest policies issued by Chinese national and local regulatory authorities before applying for local AMC licenses, and to choose investment location with large NPA stocks.

Conclusion

Under the structure of the co-existence of Big Four AMCs and Local AMCs , China has opened market for foreign investment to directly participate in domestic NPA disposal business. It is predictable that China's domestic NPA disposal business will grow into a competitive market and will bring plenty of new business opportunities for foreign financial institutions.

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