Mezzanine finance is a flexible financing method which is widely adopted in Europe and the United States. Due to its flexibility, the risk and return of mezzanine investment which are structured in between senior debt and equity financing, and the fact that mezzanine finance is able to provide longer financing term, it is often used in the financing of leveraged buyout, M&A, Business expansion, debt restructuring, recapitalization and refinancing. From the industry perspective, mezzanine investment is mainly used in infrastructure, commercial and industrial projects.
Mezzanine finance is still relatively new to China. China has now become the world’s second largest economy. However, the financial market in China is still under-developed compared with the industrial economy and as such, the application of mezzanine finance as a new type of financing method, has encountered various restrictions. For many Chinese enterprises, typically, their shares will be diluted once they bring in outside shareholders and it is often difficult for them to obtain sufficient loan from banks. Mezzanine finance could solve this dilemma and assist enterprises to improve their financial structure, expand the scale of company and strengthen their capacity of mergers, acquisitions and listing. Therefore, mezzanine finance has started to play a positive role in practice and showed good prospects for development in the areas of real estate, energy, infrastructure and high tech. The analysis in the legal environment of mezzanine finance is based on the case of mineral project finance as below:
In 2006, Jinchuan Group Co., Ltd. of Gansu Province (“Jinchuan”) and Australia Allegiance Mining NL (“Allegiance”) have reached an agreement in developing Avebury Nickel Mine Project in which Jinchuan invested in Allegiance by the way of private equity and appointed directors to the restructured board of directors of Allegiance in accordance to the proportion of shares it holds in the company (warrants of a certain amount and duration were attached to the initial investment); both parties shared the capital expenditure of the development; Jinchuan possessed exclusive selling rights of concentrated nickel mine in the term of Avebury Nickel Mine Project; Allegiance should repay the project finance amount plus interests in installments at the delivery of the products. Jinchuan was also entitled with profit dividends and the rights of share appreciation of Allegiance, as well as the pre-emptive rights of access and purchase of other projects apart from Avebury. In October 2006, Jinchuan invested AUD7 million to exercise the warrant of 25 million shares and the proportion of its investment was 3.73% and later in 2007, Jinchuan has become the major shareholder of Allegiance with the proportion increased to 11.1% by another two additional investments. In 2008, under the pre-condition that the exclusive distribution agreement remains effective, Jinchuan has obtained AUD30 million as the profit of its equity investment by selling the shares of Allegiance to Zinifex Company (an Australian company).
The financing approach taken by Jinchuan is a fusion of debt financing and equity financing, i.e. mezzanine finance. Although no specific provisions of mezzanine finance can be found in the legislation of China, a certain number of regulations have been adopted in relation to project finance as the number of outbound projects invested by Chinese enterprises has been increased tremendously with the support of “Going-Global” strategy. The specific laws and regulations include:
- Basic Laws
Corporation Law, Law on Commercial Banks, Securities Law, Guarantee Law, Contract Law, Tax Law etc.
Regulations on the management of investment, foreign exchange and capital
- Decision of the State Council on Investment System Reform and its appendix-the Catalogue of Investment Projects Ratified by the Governments (2004);
- Interim Measures for Approval of Enterprise-invested Projects (2004), Interim Administrative Measures for the Verification and Approval of Foreign Investment Projects (2004), Notice of Guiding Opinions on Implementing Filing System to Enterprises Investment Projects(2004), Measures on Improving and Perfecting the Measures for the Administration of Reporting Investment Projects to the State Council for Examination and Approval or Verification(2005), and Notice of the National Development and Reform Commission on Issues Concerning Improvement of the Administration of Overseas Investment Projects (2009) promulgated by The National Development and Reform Commission.
- Notice of the National Development and Reform Commission and the China Development Bank on the Relevant Issues Concerning Further Strengthening Financing Support to Key Overseas Investment Projects (2005);
- Procedures on the Administration of Borrowing of International Commercial Loans by Institutions within Chinese Territory (1997), Notice of the State Administration of Foreign Exchange on the Administration of Foreign Exchange Involved in Financing and Return on Investment Conducted by Residents in China via Special-Purpose Companies (2005), Notice of the State Administration of Foreign Exchange on Issues Related to Foreign Exchange Administration in Domestic Individuals' Participation in Equity Incentive Plans of Companies Listed Abroad (2012) promulgated by the State Administration of Foreign Exchange.
- Interim Measures for Administration of Working Capital Loans, Interim Measures for the Administration of Fixed Asset Loans, Notice of the China Banking Regulatory Commission on Printing and Distributing the "Guidelines for Project Financing Business" (2009) promulgated by China Banking Regulatory Commission.
Despite of the existence of basic legal support and standards provided by above-mentioned laws and regulations for projects investment and financing, mezzanine finance still encounters many obstacles due to the under-developed financial market. Firstly, the concept of preferred stock is not accepted in Chinese legal system. Secondly, according to relevant articles of the Law on Commercial Banks, there is no legal basis for Chinese commercial banks to run mezzanine finance business because of the Separated Operation Policy. Nevertheless, Article 43 of the Law on Commercial Banks was amended with an addition of the wording: “except where otherwise provided for in the regulations of the State” and thus provided more space for the development of mezzanine finance. Furthermore, it should be noticed the characteristics of trust are well connected with the transactional structure of mezzanine finance. Although mezzanine finance business can only be attached to a specific project under current legal system, the functions of trust companies as an important role in financial market will be extended due to the promulgation of laws on industrial funds and limited partnership etc. Trust companies can then establish specific funds of mezzanine investment and then select investment projects of which the benefits and risks are suitable for the funds.
In terms of legal prospective, no specific regulations of mezzanine finance have been issued in China. However the relevant regulatory authorities have come to the consensus on the enrichment of financial tools and financial innovation as required by the improvement of financial market during the process of economic development. With the revision of the laws such as Company Law and Guarantee Law and the issuance of pertinent regulations, the legal mechanism about mezzanine finance will be improved and mezzanine finance will play a more significant role in the financial market. On March 13, 2013, Mr. Ouyang Zehua, the director of the supervision department of listed companies, China Securities Regulatory Commission (CSRC) said that CSRC will be market-oriented in pushing forward merger and acquisition of corporations to cross ownerships and regions, and that “CSRC is now considering taking further steps on enriching the tools for mergers, providing more convenience to corporations in using tools such as mezzanine finance, bridge loan, financing and other stocks or warrants, and facilitating the marketization of the prices for merger and acquisition”. With the support and encouragement on industrial merger and financial innovation applied in the macro-policy of the State, the following laws and regulations have already been put on the schedule of revision: Securities Law, Regulations on the Supervision and Administration of Listed Companies, Measures for the Administration on Acquisition of listed Companies, and Measures for the Administration of Major Asset Reorganization of Listed Companies. Meanwhile, during the process of Chinese corporations’ overseas investment, financial institutions like banks or trust companies have obtained useful experience of mezzanine finance which could be a good reference for the inland development of mezzanine finance. This can also enrich the merger and acquisition tools and improve financial market.