By Yi Zhou
zy@rayyinlawyer.com
Since the 1990s, especially after the Asian financial crisis, the disposal of Non-Performing Loans (NPLs) has been a primary concern for the People's Republic of China (PRC). China's state-owned commercial banks have been the mainstay of the state's financial system and have played an important role in economic development primarily as channels for raising and allocating capital. Prior to the promulgation of the PRC Commercial Banking Law in 1995, state-owned banks operated as organizations specialized in heavily policy-oriented credit business. Factors such as the overheated economy of the early 1990s, the transition to a market- oriented economy, and the absence of effective internal management systems to control loan quality all combined to create a sizeable volume of NPLs. Prior to 1993, the Chinese state-owned banks had not allowed for bad debt provisions and had never written off bad debts, which resulted in a constant accumulation of NPLs and, in turn, financial risks.
China has gradually opened its financial markets, following its commitment to enter the WTO. As a result, state-owned banks have faced tremendous competition since December 11 2006, when business in Rmb was opened to all foreign banks.
Relevant Strategies of NPLs Disposal by Chinese Government
To address the NPL situation, the Chinese government decided to set up Asset Management Companies (AMCs) for integrated management and disposal of the NPLs. Cinda, Huarong, Greatwall and Orient are the four government-authorized AMCs. Recently, these four AMCs have been extremely busy with disposal of NPLs acquired from the state-owned banks, which were seeking to write off bad debts prior to going public. For AMCs, selling to foreign investors or setting up a project-based joint venture with foreign investors is an important option for the disposal of NPLs.
Meanwhile, a number of governmental authorities, including the State Administration of Foreign Exchange (SAFE), Ministry of Commerce, Ministry of Finance and others, promulgated a series of various rules and regulations related to foreign investment in the NPL market in China.
According to the Interim Provisions on Drawing Foreign Capital into the Asset Restructuring and Disposal by Financial Asset Management Companies promulgated by the Ministry of Commerce, Ministry of Finance and the People's Bank of China on October 26 2001, AMCs may restructure and dispose of the assets they possess by drawing on foreign capital. The purpose of this Provision is to draw on foreign capital to activate bad assets, introduce advanced managerial skills, assets and technique, and to conduct technique innovation within the enterprises, to promote the reform of state-owned enterprises and the establishment of a modern enterprise system.
Foreign investors can acquire NPL portfolios through an overseas SPV directly. The SAFE has set out rules in terms of wiring acquisition payment into China and disposal proceeds out of China in its Circular of Relevant Issues on the Control of Foreign Exchanges relating to the Use of Foreign Capital for Non-performing Asset Disposal of Financial Asset Management Companies published on December 17 2004. The People's Bank of China and State Taxation Bureau also issued regulations concerning how an overseas SPV shall open a collection bank account in China, and related taxation issues, in the disposal of NPLs.
Foreign investors are welcome to set up a project-based joint venture company with AMCs in the acquisition and disposal of specific NPL portfolios. However, only the Ministry of Commerce at its headquarters has the power to issue an approval of the establishment of such a joint venture, following the Circular of the General Office of the Ministry of Commerce on Strengthening the Administration of Examination and Approval of Utilizing Foreign Investment for Bad Asset Disposal promulgated on April 29 2005.
Foreign Investors in the Chinese NPLs Market
Since 2001, foreign investment banks such as Merrill Lynch, Morgan Stanley, Goldman Sachs, Deutsche Bank and Citibank have been active in acquiring NPLs in China. Deutsche Bank paid Rmb327 million (US$40 million) for NPLs with an original book value of Rmb1 billion (US$125 million). Afterwards, Goldman Sachs acquired NPLs with an original book value of Rmb1.972 billion (US$250 million). Morgan Stanley has acquired NPLs with an original book value of Rmb10.8 billion (US$1.3 billion). Also, several investment banks have set up equity joint ventures with Chinese AMCs to operate the business of acquiring NPLs.
The NPL business in China is clearly in its early stages and offers an interesting alternative investment option for institutions seeking exposure to the Chinese financial market. As the economy develops and financial and other industries open to the world, subject to China's commitments to the WTO, foreign investors may enjoy better opportunities in Chinese NPL markets in the near future.