JunHe’s Special Situations team led by Catherine Miao has been actively involved in the special situations and alternative investment practice since 1999 and has been at the forefront of providing legal services in this area in China. The team has represented numerous landmark cases in the market such as representing a financial AMC in the first foreign investment in the disposition of non-performing assets in China in 2002, and representing Citigroup Global Markets Asia Limited in the first acquisition by a foreign investor of a NPA portfolio through buyout in China in 2004.
We have advised financial AMCs, local AMCs, investment banks, commercial banks, special situations funds, mezzanine funds, private credit funds, hedge funds, real estate companies, trusts, large private AMC, asset exchanges and large non-financial businesses, on various special situations transactions, including acquisition and disposition of NPLs, acquisition and restructuring of distressed businesses, debt to equity swaps, cross-border acquisition financing, structured financing, leveraged financing, direct lending, acquisition of distressed listed companies, and other investments including turnaround investments, investment in bailout funds, investment in property at court auctions, investment in bankruptcy reorganization, alternative investment, other high-yield investments and the financing of debt and equity in distressed and opportunistic situations. Our representation has involved special situations transactions with an aggregate asset book value of more than RMB 100 billion.
We have been sharing our insight in the special situations market in China on a weekly basis, and this newsletter assembles all articles we published in March 2022 for your easy reference.
I. Foreign Investors Purchasing NPLs in China (I): Direct Acquisition from an AMC as a Traditional Route
(First published on JunHe’s LinkedIn page on 2 March 2022)
With the start of a second wave of foreign investment in China’s NPL market in 2016, NPL opportunities exploded and attracted more foreign investors keen to get in on the action. We are often approached by foreign clients who want to know how to purchase NPLs in China, given that the Chinese government has implemented comprehensive rules to control foreign exchanges. There are many possible routes for foreign investment, and it would be advisable for investors to look into each one in detail to determine the most appropriate course.
We have prepared a series of articles to introduce the four routes that most foreign investors prefer: (i) traditional route– direct acquisition from an AMC; (ii) quick route – transactions through asset exchanges; (iii) flexible route – NPL WFOEs; and (iv) tax-efficient route – the QFLP Pilot Program. There are some other options for foreign investors to participate in China’s NPL market, but we will elaborate on these four routes in this series of articles due to the fact that the other routes may only serve certain transaction structures or may not be profitable to most investors. We will continue this series and cover other options when appropriate.
In this article, we will focus on the direct sales of NPLs between foreign investors and AMCs.
- How do foreign investors directly purchase NPLs from AMCs?
As a traditional and convenient route, foreign investors can use an offshore special purpose vehicle (“Offshore SPV”) to purchase NPLs from the big five AMCs (i.e., China Orient, Great Wall, Cinda, Huarong and Galaxy) directly after completing filings with the National Development and Reform Commission (“NDRC”). In the past, foreign investors had to file with the NDRC and the State Administration of Foreign Exchange (“SAFE”) to acquire NPLs, but from 2015 these SAFE filings were no longer required; now foreign investors only need to assist AMCs to obtain filing certificates from the NDRC to proceed with the purchase of NPLs from AMCs.
The general procedures for the direct acquisition from AMCs are as follows:
(1) The Offshore SPV shall sign an undertaking letter and pay a deposit to the AMC seller in order to launch the due diligence;
(2) If the Offshore SPV is satisfied with the result of the due diligence, it shall participate in the public sale process to bid for the NPLs;
(3) If the Offshore SPV becomes the winner in the public sale process, it shall enter into a creditors’ rights transfer agreement with the AMC ;
(4) The AMC shall submit application documents to the NDRC to complete filings, with the necessary cooperation of the Offshore SPV;
(5) The AMC shall provide a copy to the Offshore SPV upon obtaining the NDRC filing certificate;
(6) The Offshore SPV shall pay the full purchase price to the seller with the auction deposit returned to the Offshore SPV, or the Offshore SPV shall pay the remaining purchase price to the seller with the auction deposit converting into a part of the purchase price;
(7) As soon as the AMC receives the purchase price with the NDRC filing certificate, the Offshore SPV will become the new owner of the NPLs;
(8) The AMC will hand over all the loan documents to the Offshore SPV to close the transaction; and
(9) The AMC and the Offshore SPV will publish a joint announcement in a newspaper with a national or provincial influence, regarding the claims transfer.
- What are the advantages and disadvantages for direct sales with AMCs?
The direct acquisition of NPLs from AMCs is straightforward, quick and tax friendly. The NDRC and SAFE have clear rules for the cross-border transfer of NPLs, pursuant to which a foreign investor can simply designate an Offshore SPV to purchase NPLs in China by participating in a public sale procedure and completing the filing with the NDRC (which in practice would take two to six weeks) if it becomes the highest bidder. Foreign investors may, after completing tax filings, convert all NPL proceeds from RMB into foreign currency and quickly repatriate them to an offshore bank account of the Offshore SPV. Furthermore, the tax burden on the Offshore SPV is low. A withholding tax rate of 10% will be applicable to the profits made from the NPLs, which will not be payable until the aggregate amount of NPL proceeds recovered exceeds the purchase price of the relevant NPL portfolio. However, the traditional route also has some disadvantages:
(1) The NDRC filings will simply convert domestic debt to foreign debt, pursuant to which foreign investors may collect debts or further sell the loans, but investors may not conduct other activities such as debt restructuring to further increase profits.
(2) Although the relevant regulations of NDRC have specified that NPL sellers may be financial institutions, in practice only the big five AMCs may manage to complete NDRC filings for the cross-border transfer of NPLs. If any other financial institution or non-financial creditor wants to sell NPLs, they will need to do a “bridge” transaction with one of the big five AMCs. Please refer to our previous article (Volume 1, Issue 7) for more information regarding these “bridging” issues.
(3) Since only the big five AMCs may complete NDRC filings for the cross-border transfer of NPLs, AMCs must organize a public sale to protect state-owned assets. This is a real risk for NPL investors because the public sale is open to all potential buyers, and there is no guarantee that a particular investor will acquire the NPLs unless it becomes the highest bidder.
II. Foreign Investors Purchasing NPLs in China (II): Transactions Through Asset Exchanges as a Quick Route
(First published on JunHe’s LinkedIn page on 9 March 2022)
In addition to the traditional route explained in our first article (Foreign Investors Purchasing NPLs in China (I): Direct Acquisition from an AMC as a Traditional Route (Volume 2, Issue 7)) where foreign investors may purchase NPLs from the big five AMCs directly after completing filings with the National Development and Reform Commission (“NDRC”), foreign investors also have an option to purchase NPLs through several asset exchanges by virtue of approval from the State Administration of Foreign Exchange (“SAFE”).
In this second article in a series on foreign investment in China’s NPL market, we elaborate on the transaction mode in which the cross-border transfer of NPLs may proceed without NDRC filings through several asset exchanges, such as Shenzhen Qianhai Financial Assets Exchange (“Qianhai Exchange”), Guangdong Financial Asset Exchange (“Guangdong Exchange”), Beijing Financial Assets Exchange (“Beijing Exchange”), and Sanya International Asset Exchange (“Sanya Exchange”).
- How do foreign investors purchase NPLs through asset exchanges?
The cross-border transfer of NPLs through asset exchanges started as a pilot program in Shenzhen in 2017. SAFE issued an official document on 26 May 2017 to grant authority to the Shenzhen branch of SAFE to examine and approve transfers of NPLs to offshore investors. Qianhai Exchange handled a lot of cross-border NPL transactions during this time. When the pilot program in Shenzhen was about to expire, SAFE issued a new notice on 8 May 2018 to allow Qianhai Exchange to operate the program in the long run in Shenzhen. Also in May 2018, SAFE permitted its Guangdong branch to launch a pilot program for the cross-border transfer of NPLs and the Guangdong Exchange was appointed to deal with relevant transactions. In 2020, policies for the cross-border transfer of NPLs emerged in other provinces and cities such as Hainan, Beijing and Shanghai, and they have since set up their own asset exchanges for these transactions.
With this route, when sellers place the distressed bank loans on a competent asset exchange for sale, foreign investors can use an offshore special purpose vehicle (“Offshore SPV”) to purchase the loans. Although some other standard procedures for NPL transfers are similar to those for the traditional route explained in our first article, the general procedures for the cross-border transfer of NPLs in connection with asset exchanges are as follows,:
(1) the Offshore SPV shall pay the auction deposit to a bank account of the asset exchange;
(2) the Offshore SPV participates in the auction of the NPLs on the asset exchange and becomes the winner;
(3) the Offshore SPV and the seller shall sign a creditor’s rights transfer agreement;
(4) the asset exchange shall complete the registrations with the local branch of SAFE;
(5) the Offshore SPV shall pay the remaining purchase price to the seller with the auction deposit converting into part of the purchase price, or the Offshore SPV shall pay full the purchase price to the seller with the auction deposit returned to the Offshore SPV;
(6) as soon as the seller receives the purchase price, the Offshore SPV will become the new owner of the NPLs.
- What are the advantages and disadvantages for transactions made through asset exchanges?
Compared with the traditional route for direct sales with AMCs, the transfer of NPLs through asset exchanges are quick and more flexible. NPL sellers are not limited to the big five AMCs, as banks, trust companies, private institutions or even individuals may sell distressed bank loans to offshore investors through competent asset exchanges. This route does not require mandatory filings with the NDRC before acquiring the NPLs (even though the big five AMCs would still insist on NDRC filings after the closing of transactions simply to be on the safe side), because such a transaction mode is based on another channel set up by SAFE. The local asset exchange usually has a positive connection with the local branch of SAFE, thus examinations on the transfer of NPLs would be finished quickly.
However, the underlying distressed loans for the cross-border transfer are restricted to distressed bank loans only, and trust loans, entrusted loans or private loans may not be sold to offshore investors through asset exchanges. We did observe that Qianhai Exchange managed to transfer a few non-bank loans to offshore buyers years ago with a channel of cross-border RMB, but this was a rare occurrence. Meanwhile, we understand that according to the window guidance of SAFE, if the target is a single credit asset where the borrower is a real estate development company, in practice SAFE may not allow such a loan to be transferred to an offshore buyer. It is also worth noting that asset exchanges only provide convenience for the purchase of NPLs, and other related activities such as debt restructuring would not be permitted with this route.
III. Foreign Investors Purchasing NPLs in China (III): NPL WFOEs as a Flexible Route
(First published on JunHe’s LinkedIn page on 16 March 2022)
In the previous two articles in this series for foreign investment in China’s NPL market, we highlighted the two primary routes foreign investors may use offshore special purpose vehicles to purchase NPLs directly in China. Even though these two routes are simple and reliable, the permitted investment activities and structures have some constraints, whereby investors cannot undertake other arrangements such as debt restructuring or corporate reorganization to maximize profits from NPLs.
Establishing onshore platforms for NPL investments in China is also a noteworthy method because it provides more flexibility for investments under the existing laws to align with various commercial demands. Foreign investors may choose to incorporate a wholly foreign owned enterprise for NPLs (“NPL WFOE”) or a qualified foreign limited partnership for NPLs (“NPL QFLP”). In this article, we begin with NPL WFOEs and we will introduce the NPL QFLP in the next article.
- How do foreign investors establish an NPL WFOE and then purchase NPLs?
The purpose of incorporating an NPL WFOE is to have access to more investment activities and structures, therefore foreign investors should consider expanding the business scope of the NPL WFOE to include asset management, NPL investment, debt restructuring, equity investment and real estate management. If necessary activities are not set out in the business scope, the NPL WFOE may not be able to deploy the paid-up capital for the intended investments, which will make the NPL WFOE meaningless.
In practice, to register the business scope of a company in China, investors need to select activities from a fixed list of censorship-free items; however, such a list apparently does not include the activities that NPL investors would usually need. For this reason, establishing an NPL WFOE is very different from setting up a regular WFOE such as a consulting company. To have all the necessary NPL-related activities as the main business of the NPL WFOE, foreign investors would need to spend a lot of effort in communicating with local authorities, which may include the Finance Administration Bureau, the Administration for Market Regulation and the State Administration of Foreign Exchange, to present their capability and ambition in their NPL investments, and all applications for NPL WFOEs will be examined by the local authorities on a case-by-case basis. Up to now, most investors have chosen Beijing and Shanghai to establish NPL WFOEs.
When all necessary NPL-related activities are registered in the business scope of the NPL WFOE, the foreign investor may push funds down to the NPL WFOE to proceed NPL investments, either by way of capital contributions or shareholder loans (subject to the relevant regulations for foreign debts). Except for the foreign exchange settlement, the procedures to purchase NPLs in China are the same as an NPL WFOE and a regular domestic company, because they are both onshore entities.
- What are the advantages and disadvantages to an NPL WFOE?
Compared with the routes for offshore entities to purchase NPLs directly, incorporating an NPL WFOE shall have the following advantages:
(1) the NPL WFOE may purchase NPLs quickly without any filing with the NDRC or SAFE;
(2) the NPL WFOE may use its own bank account to collect recoveries from NPLs without engaging a collection agent;
(3) the NPLs to be acquired are not limited to distressed bank loans, as the NPL WFOE may also purchase distressed non-bank loans such as trust loans, entrusted loans and private loans;
(4) after acquiring NPLs, the NPL WFOE may arrange debt restructuring or corporate reorganization with the relevant debtors to increase profits from the assets; and
(5) the NPL WFOE only needs to provide simple and standard documents to the courts for participation in legal proceedings to pursue claims.
However, it is important for foreign investors to note that establishing an NPL WFOE requires extensive efforts to communicate and negotiate with the local authorities to get a green light, and enterprise income tax at a rate of 25% will be applicable to the NPL WFOE, although the tax may be managed and reduced to a certain extent by customized transaction structures.
IV. Foreign Investors Purchasing NPLs in China (IV): the QFLP Pilot Program as a Tax-efficient Route
(First published on JunHe’s LinkedIn page on 23 March 2022)
As discussed previously in our third article of the series for foreign investment in China’s NPL market, foreign investors may establish onshore platforms such as a wholly foreign owned enterprise for NPLs (“NPL WFOE”) or a qualified foreign limited partnership for NPLs (“NPL QFLP”) to engage in investments with various transaction structures, without being constrained to fixed patterns of investment. Following the introduction of NPL WFOEs, we now switch to NPL QFLPs in this article, as NPL QFLPs are also very popular among NPL investors.
- How do foreign investors establish a NPL QFLP and engage in NPL investments?
In 2011, Shanghai initiated the first pilot program for Qualified Foreign Limited Partnerships (“QFLP”). Since then, the QFLP pilot program has evolved and improved significantly, with an increase in the number of piloted cities, a more mature management system, and an expanded investment scope. Generally, QFLPs are supposed to serve for equity investments only pursuant to the relevant local policies in most cities, and NPL investments are regarded as irrelevant. However, in response to increasing demands from NPL investors, some authorities would, on a case-by-case examination basis, make exceptions and grant privileges to well-known investors with good reputations for NPL investments with a QFLP. Currently there are more than 20 cities operating QFLP programs in China. According to our experience, authorities in Shanghai and Tianjin have already approved some NPL QFLPs, and authorities in Beijing and Hainan are very positive in attracting investors to set up NPL QFLPs, but all authorities in China are extremely prudent when making decisions with respect to NPL QFLPs.
In practice, there are two circumstances regarding the establishment of NPL QFLPs. Authorities in some cities would agree to specify the NPL-related activities on the internal documents for approval on the establishment of NPL QFLPs, in which case the entire investment would be on the safe side from a regulatory perspective, because the relevant foreign investors may freely push funds down to a NPL QFLP for proposed investment by virtue of the express approvals from authorities. However, authorities in some cities would give only verbal approval for NPL-related activities which would not be specified on any official document, in which case the relevant foreign investors need to have sufficient communications with the custodian banks in advance to ensure that the proposed investment would be proceeded as expected and any returns from the investment would be freely repatriated to an offshore account.
Except for the foreign exchange settlement, the procedures for NPL QFLPs to proceed NPL investments (including the NPLs acquisition and debt restructuring) in China are the same as the procedures for a regular domestic company because they are both onshore entities.
- What are the advantages and disadvantages to an NPL QFLP?
Like an NPL WFOE, compared with the routes for offshore entities to purchase NPLs directly, an NPL QFLP shall have the following advantages:
(1) the NPL QFLP may purchase NPLs quickly without any filing with the NDRC or SAFE;
(2) the NPL QFLP may use its own bank account to collect recoveries from NPLs without engaging a collection agent;
(3) the NPLs to be acquired are not limited to distressed bank loans, as the NPL QFLP may also purchase distressed non-bank loans such as trust loans, entrusted loans and private loans;
(4) after acquiring NPLs, the NPL QFLP may arrange debt restructuring or corporate reorganization with the relevant debtors to increase profits from the assets; and
(5) the NPL QFLP only needs to provide simple and standard documents to the courts for participation in legal proceedings to pursue claims.
Apart from the above, it is worth mentioning that the returns from NPL investments obtained by a NPL QFLP may be subject to a lower tax burden when compared with an NPL WFOE. It is generally considered that NPL QFLPs are exempt from income tax, whilst NPL WFOEs shall be subject to enterprise income tax at a rate of 25%, although the actual tax burden of NPL QFLPs may differ from city to city in practice and foreign investors should seek advice from their tax advisors.
However, every rose has its thorn. The biggest difficulty with NPL QFLPs is that foreign investors need to prepare well and spend some effort to convince local authorities that they are reputable, valuable and experienced investors with true intentions for their NPL investments in China.
For further information, please contact:
ZHU, He (George) , Partner, JunHe
zhuh@junhe.com
