New rules that make it easier for Chinese companies to use onshore assets as security for offshore loans are unlikely to spark a wave of lending. The rules were issued by China’s State Administration of Foreign Exchange (Safe) on June 1, but restrictions over remitting the proceeds back onshore has dampened initial enthusiasm.
The dominance of state-owned enterprises in China’s bank lending market has typically made it difficult for private-sector businesses to find affordable funding. Safe’s new rules were seen as a move to encourage offshore lending into the private sector, while also providing additional security for lenders and investors amid growing concern over regional banks’ exposure to Chinese debt. The Hong Kong Monetary Authority has expressed concerns over banks’ exposure to mainland debt and Taiwanese lenders have been cutting back on lending to Chinese companies, according to reports.
Under the new rules, mainland companies can provide guarantees and security for an offshore entity without the need to obtain any approval or quota from Safe, which regulates currency flows in and out of China.
Previously, Chinese companies needed Safe approval and quota — and typically only large state-owned enterprises such as Cnooc had such access. The lack of onshore security and subordination risk is a key concern among lenders.
However, Chinese companies are restricted from remitting the proceeds back home or even to refinance existing debt taken for investment into mainland entities. They are also unable to use it to buy shares in an offshore company that has more than 50% of its assets in China, which means that take-private transactions such as Focus Media and Giant Interactive will still have to use the traditional holdco structure.
Such restrictions mean that few firms will find any use for the new rules.
“Due to the restrictions on remitting money back to China, it is likely that only certain companies will use it for certain purposes — such as companies with sizeable operations overseas or who want to make offshore acquisitions,” said Eugene Man, partner at White & Case.
Offshore acquisitions are often secured by shares of the target but under the new rules Chinese companies can finance loans with onshore assets. “Most companies prefer to finance acquisitions that are backed by shares and/or assets of the target, but if the target is a weaker credit, it could be easier to obtain financing for an acquisition backed by the acquirer’s credit,” said Man.
However, Chinese law still applies, which means that companies in a restricted industry such as telecoms or banking will not be able to use onshore assets to secure loans.
Credit tightening onshore
Japanese companies have been funding an offshore acquisition spree with cheap local credit for the past few years, but specialists warn against expecting a repeat in China.
“Many Japanese companies have chosen to take corporate loans to fund offshore acquisitions rather than leveraged buyouts due to the availability of cheap domestic financing,” said John Hartley, head of White & Case’s banking, capital markets and restructuring practice in Asia. “However, the availability of such financing is currently lessening in China so we expect Chinese companies to look at alternative ways to fund overseas acquisitions.”
Potentially, the new Safe rules could see more mainland banks issuing standby letters of credits (SBLCs) for offshore loans or bonds. In the past, Chinese lenders had a quota to issue such SBLCs but that quota has been abolished under the new rules. Large companies such as Cnooc that previously issued US dollar bonds backed by the parent onshore will no longer be subject to a quota and merely need to register with Safe within 15 days of signing a deal.
The rule changes mean that privately owned companies that previously would have found it difficult to get quotas for onshore guarantees or security are now able to provide onshore security. However, lenders will still have questions over their ability to enforce their claim over onshore assets.
“The practicality of enforcing security is still an issue in China,” said Man. “A lender may have a claim to the secured assets but whether they will be able to get their hands on it in practice is another question.”
Chinese authorities are reportedly investigating if traders in Qingdao used metal stocks to secure multiple loans, which has done little to inspire confidence among foreign lenders.
According to one Hong Kong-based loans banker, the market is still digesting the new rules.
“It takes time to understand what you can and can’t do,” he said. “It’s a step in the right direction in terms of liberalising China’s lending, but what it means from the practical perspective is something the market is still working out.”