China Special Situations Insight (Volume 2, Issue 7)
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.
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.
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.
For further information, please contact Catherine Miao, Head of Special Situations and Alternative Investment at JunHe LLP: [email protected] or +86-21-22086350.