Legal Avenues for Foreign Investors to China’s NPL Market（II）

3 AMCs Establish Equity or Contractual Joint Ventures with Foreign Investors with NPL Portfolios as Contribution
There are two basic models for adopting this methods of utilizing foreign capital to dispose of NPL: (1) the AMC will contribute the NPL portfolio as its capital contribution or conditions for cooperation, and the foreign investors will use cash as its capital contribution; both parties will establish either an equity joint venture or a contractual joint venture to dispose of the NPL portfolio; and (2) the AMC will transfer a part of the interests of the NPL portfolio to foreign investors and the remaining interests are still held by the AMC; both parties will use their portion of interests from the NPL portfolio as their capital contribution or conditions for cooperation to jointly establish either an equity joint venture or a contractual joint venture which will enjoy all of the interests from the NPL portfolio and have the right to dispose of the NPL portfolio.
The Notice of the Ministry of Commerce on Strengthening the Approval Management of Foreign Investment of Disposal of Non-performing Asset (Shang Zi Zi [2005] No.37) clearly states that due to strong policy consideration, high sensitivity, and wide influence of the foreign investment in NPL areas, the Ministry of Commerce requires strict scrutiny in the approval procedure; and that the establishment of equity or contractual joint ventures shall be subject to approval of the Ministry of Commerce, and the administrative authority of commerce at local or national economic and technology development areas levels shall not have the authority to approve the establishment of such equity or contractual joint ventures themselves.
In practice, the Ministry of Commerce generally requires this type of foreign-invested joint ventures to only dispose of the NPL Portfolios which are used as capital contribution by their domestic and/or foreign shareholders and restricts them from continuing acquisition and management of other NPL portfolios. Accordingly, the terms of operation for these foreign-invested joint ventures is subject to the time needed for disposal of the NPL portfolios used as contribution, and the nature of these companies is usually sino-foreign contractual joint ventures. For example, in a case where we provided services for an asset management company jointly established by Orient and a foreign party, the term of operation for the asset management company in the form of contractual joint venture was only four years, which was the estimated period for disposal of the NPL portfolio contributed by both parties. Though the Ministry of Commerce has ever approved the establishment of foreign-invested asset management company in the form of equity joint venture, such as Huarong Rongde Asset Management Company Limited, which was established by Huarong, Deutsche Bank AG and other international financial investors jointly as the first asset management company in the form of sino-foreign equity joint venture with perpetual business operation term, if compared to those sino-foreign contractual joint ventures, the number of the sino-foreign equity joint ventures is very small. We understand that this is mainly because the equity joint ventures have capacities to continuously operate and acquire new NPL portfolios, unlike the contractual joint ventures that are restricted to dispose of the NPL portfolios contributed as cooperative conditions and/or capital contribution by shareholders only. This may lead to potential competition of these equity joint ventures with the four major state-owned AMCs. In practice, the establishment of sino-foreign equity joint ventures is under strict and cautious scrutiny by the examination and approval authority and therefore applications for establishment of sino-foreign equity joint ventures to some degree may not be pursuable.
Furthermore, in some projects, in order to maximize their advantages in disposing of NPL, the AMCs and foreign investors may simultaneously apply to establish foreign-invested service-provider company to provide debt collection services when incorporating the foreign-invested asset management company. In a case where we were assisting in the project of establishing a sino-foreign cooperative asset management company, the Chinese and foreign parties also established a sino-foreign equity joint venture as a service provider which provided not only debt clearing, debt reorganization and asset management services for the sino-foreign asset management company holding the NPL Portfolio, but also continued to provide other asset management and debt recover services within its scope of business. This type of service-provider company is not restricted to providing services to the specific foreign-invested asset management company regarding the NPL portfolios it holds, but may run as an independent and perpetual company and based on its approved scope of business extend its services to both domestic and foreign investors holding NPL portfolios in China in the areas including NPL clearing, debt reorganization and management services, which entitles it to a huge market and prosperous future. Certainly the establishment of foreign-invested enterprises conducting NPL disposal activities, including debt reorganization and debt recovery, shall be subject to the approval by the Ministry of Commerce. As per the Notice of the Ministry of Commerce on Strengthening the Approval Management of Foreign Investment of Disposal of Non-performing Asset, the Ministry of Commerce in principle will not approve debt-collection companies or quasi-debt collection companies; when examining and approving the establishment of foreign-invested enterprises providing services of enterprise economic trusteeship, commercial agency, management consultancy, financial consultancy and asset consultancy, the Ministry of Commerce shall require these companies to guarantee in writing that they shall not provide NPL disposal activities including debt reorganization and debt recovery. Therefore, it may be hard to obtain from the Ministry of Commerce the approval to establish this type of asset management services enterprise.
In the past, we have provided legal services assisting AMCs in establishing three sino-foreign contractual asset management companies and one foreign-invested services-provider company. However, after researching the public information registered with the administration for industrial and commerce of the four major AMCs, the total number of these types of sino-foreign contractual joint ventures and equity joint ventures successfully established is very low. Due to difficulty in obtaining the approval for establishment of foreign-invested asset management companies and services-provider companies, in practice, we did come across some foreign-invested enterprises with the approved scope of business of consultancy and investment services that are actually and primarily carrying out the business in acquiring and disposing of NPL without the approval from the Ministry of Commerce. We understand that based on the above-mentioned notice of the Ministry of Commerce, strictly speaking, the operation models of these companies have serious compliance issues.
4 Foreign Investors Establish Private Equity Investment Funds to Acquire NPL in China
According to the Interim Measures on Supervision and Administration of Private Equity Investment Fund implemented on June 30, 2014, private equity investment funds refer to the investment funds within China raising capital from investors via non-public methods; and investment of private equity investment fund assets refers to the sale and purchase of stocks, equities, bonds, futures, options and fund contributions and other investment objects agreed to in the investment contracts. Therefore, creditors’ rights to NPL can be used as the object of investment in private equity investment fund assets.
Currently, in the market there are products of private equity fund asset objects of which include NPL. For example, special opportunity fund of China Orient Qianhai Asset Management Limited Company under the Orient has completed the I period marketized fund-raising of 490 million in August 2015, and started its operation. Furthermore, in October 2015, Zhejiang Oriental Asset Management Limited Company established the first sunshine private equity fund of quasi-fixed-interest-rate investing in bank NPL and further issued four private equity funds focusing on disposal of NPL, with a total value of 100 million RMB. The current operating methods for private equity funds is usually a private equity fund product established for one NPL portfolio, with a term of one year and rights to extend another year and after two years, such fund shall be cleared whether or not all the distressed debts in the portfolio have been recovered.
As of this writing, we have not encountered any private equity fund products with investment objects of NPL and with participation of foreign investment, but since there is no restriction against foreign investment in establishing private equity investment funds and private equity fund management organizations, nor restriction on investing in NPL by private equity investment funds established by foreign investors set out in the relevant regulations of private equity investment funds of China, we are of the view that the foreign investors may consider investing in NPL in China through the establishment of private equity investment funds. With further reform and application of Will-depended Settlement System of Capital Project by the State Administration of Foreign Exchange, in the foreseeable future, foreign-invested private equity funds will have more involvement and presence in the NPL investment field.
Given the situation of NPL rates of Chinese commercial banks steadily increasing and government authorities requiring the strengthening and improvement of participation and efficiency of NPL disposal, the NPL market has huge potential and it is foreseeable that foreign investors’ participation in Chinese NPL disposal will continue to be encouraged. Still compared with previous rounds of NPL market, there are new features concerning China’s current economic situation, legal environment and NPL market, which naturally require the relevant parties based on their previous experience to adopt different disposal methods of NPL depending on new situations in a flexible, innovative and efficient manner, and to achieve a win-win situation among the domestic holders of NPL, foreign investment and other related parties.