On December 6, the China Banking Regulatory Commission (CBRC) issued the Guidelines on the Risk Management of M&A Loans Extended by Commercial Banks, the Guidelines), which came into effect on their date of issuance. The Guidelines expand the lending business scope of commercial banks by allowing them to offer M&A loans to domestic companies. At the same time, the Guidelines establish requirements and risk management rules that commercial banks must adhere to in conducting such transactions. CBRC officials have explained that the purpose of these Guidelines is threefold:
- To promote the country’s economy and industry upgrade;
- To provide assistance to domestic companies for their acquisitions abroad; and
- To regulate the operation of acquisition loans offered by commercial banks and improve these banks’ ability to manage the risks of such loans.
The Guidelines are applicable only to legal person commercial banks that have been established in accordance with the Commercial Bank Law of the PRC. Hence, unless a foreign bank incorporates its operations under PRC law, its domestic branch is not allowed to offer M&A loans to domestic companies.
The Guidelines define the term “acquisition” as a transaction in which a domestic acquiring company merges or actually controls an existing and operating target company through, among other means, the purchase of existing equities, the subscription of newly added equities, the acquisition of assets or the assumption of debt owed by the target company. The term “acquisition loan” is defined under the Guidelines as a loan that is extended by a commercial bank to the acquiring party or its subsidiary to pay for the acquisition price.
The CBRC issued the Guidelines in a circular (the Circular). In the introductory part of the Circular, CBRC specifies that a commercial bank may carry out M&A loan transactions as long as it has:
- a comprehensive risk management system and an effective internal control system;
- a loan loss provision reserve adequacy ration of no less than 100 percent;
- a capital adequacy ratio of no less than 10 percent;
- a general loan loss provision reserve of no less than 1 percent of the loan balance of the same period; and
- a designated team of specialists responsible for completing due diligence and risk assessment for the bank’s M&A loan transactions.
According to the Guidelines, a commercial bank’s management of its M&A loans must be more stringent than that of its other types of loans. An integral component of the commercial bank’s management of such loans is their risk assessment, for which the bank is required to take into account strategic risks, legal and compliance risks, integration risks, and operational and financial risks among others.
With respect to the risk management of M&A loan transactions, the Guidelines specify that a commercial bank must comply with the following requirements:
- The total amount of M&A loans that it has extended may not exceed 50 percent of its net core capital of the same period;
- It must set up credit-line control systems corresponding to the individual borrower, corporate group borrower, and industry (the M&A loan extended to an individual borrower may not exceed 5 percent of its net core capital for the same period);
- The amount of its M&A loan may not exceed 50 percent of the total funds for the M&A;
- The term of an M&A loan generally may not exceed five years; and
- It must call for adequate security for the M&A loan;
- It must have specialists with relevant legal, financial and industrial knowledge to carry out the management of the transaction.
Additionally, the Guidelines also spell out the basic terms and conditions that must be included in the loan documents provided by the borrower, in order to protect the interests of the lenders.
The Guidelines are significant because they partly remove the prohibition stipulated in the General Principles of Loans from the Bank of China that prohibits PRC banks from financing equity investments. The new Guidelines allow domestic companies to use loans extended from commercial banks to make such investments in certain M&A transactions. If implemented effectively, the Guidelines will further develop the M&A market in China.