According to the statistics released by the China Banking and Insurance Regulatory Commission (the “CBIRC”), the balance of non-performing loans (“NPLs”) of commercial banks amounted to RMB 2.41 trillion as of the end of the fourth quarter in 2019, a quarterly increase of RMB 46.3 billion. Meanwhile, there have been many developments in the NPL market this year. In January, further opening-up of domestic NPL market was mentioned in both the historic trade agreement between the U.S. and China (the “Sino-US Agreement”) and a policy document on promoting development of the banking and insurance industries issued by the CBIRC (the “Guiding Opinion”); in February, the U.S. distressed debt giant Oaktree set up a wholly foreign-owned enterprise (“WFOE”) in Beijing; in March, China Galaxy was approved by the CBIRC to become a financial asset management company (“AMC”) and the CBIRC issued the amended licensing rules on such non-bank financial institutions as AMCs (the “Licensing Rules”).

 

Foreign institutions will benefit from setting up AMCs in China and purchasing NPLs from commercial banks on a bulk basis directly, compared with such other ways to engage in NPL business in China.

 

Section IAMC Categorization

 

1. National AMC and Local AMC

 

Category	National AMC	Local AMC
Role	A national AMC is a financial institution that focuses on acquisition, management and disposal of distressed assets and NPLs, and engages in banking, trust, securities, leasing, insurance and other integrated financial services through its wholly owned or controlled financial subsidiaries.	A local AMC engages in bulk acquisition and disposal of NPLs of financial institutions in its home province.
Development Status	China has four national AMCs before China Galaxy became the fifth one, namely China Orient, China Cinda, China Huarong and China Great Wall.	Since 2012, when all provinces were allowed to set up local AMCs respectively, about 60 local AMCs have been set up across the country.
Source of Distressed Assets	Distressed assets and NPLs of both financial and non-financial institutions.	In principle, limited to NPLs of financial institutions.
Business Type	Relatively diversified, including but not limited to (i) leasing or otherwise transferring or restructuring the assets formed by the acquired NPLs; and (ii) debt-to-equity swaps and holding equities in such enterprises.	Originally, only debt restructuring is allowed. Since 2016, it has been allowed to dispose NPLs by means of debt restructuring or transfer to an external party inside or outside its home province.

 

2. AIC with Partially Similar Business

 

A financial asset investment company (the “AIC”) is not an AMC. An AIC refers to a non-bank financial institution approved by the CBIRC to mainly engage in the business of debt-to-equity swap and other supporting business. An AIC shall be initiated and established by a domestic commercial bank as the major shareholder, and an overseas institution is allowed to be a shareholder as well.

 

The AICs are encouraged to implement debt-to-equity swaps through first acquiring creditor’s rights in the enterprises held by the banks and then converting such creditor’s rights to equities. The acquisition price shall be negotiated and determined in accordance with market principles. Where NPLs are involved, it is subject to applicable rules on NPLs.

 

Section IIPolicies on Foreign Investment in AMCs

 

1. National Policy

 

According to the Guiding Opinion, China will realize a higher level of opening-up and introduce renowned international professional institutions, including attracting foreign financial institutions with rich experience in disposal of distressed assets and NPLs to enter the domestic market. Before then, the CBIRC lifted foreign ownership limit in AMCs in 2018.

 

According to the Sino-US Agreement, China should allow U.S. financial institutions to apply for licenses of local AMCs, so that they may directly purchase NPLs from domestic banks, and when China grants new nationwide licenses, domestic and U.S. financial institutions should receive the same treatment. China’s State Council emphasized that other countries will be entitled to the same treatment stipulated in the Sino-US Agreement as the U.S.

 

2. Local Policy

 

For example, Beijing municipal government announced that it will actively strive to attract foreign institutions to invest to local AMCs and engage in disposal of distressed assets and NPLs. Therefore, it may be understandable that Oaktree set up the WFOE in Beijing rather than in other cities.

 

3. Implementation Procedure

 

According to the Sino-US Agreement, China will first allow overseas financial institutions to establish foreign-invested enterprises (including WFOEs) and apply for local AMC licenses. Furthermore, when additional national AMC licenses are granted (e.g., the national AMC license granted to China Galaxy recently) in the future, China shall treat U.S. financial institutions on a non-discriminatory basis with Chinese institutions.

 

Therefore, the major ways for overseas financial institutions to invest in AMCs at the current stage include establishing new local AMCs or acquiring equities in existing local AMCs, or acquiring equities in the five existing national AMCs.

 

Moreover, relevant provisions in the Sino-US Agreement still need to be converted into domestic legislation. As provided in the Sino-US Agreement, unless otherwise provided for in the Sino-US Agreement, both parties shall provide no less than 45 days for public review period for all proposed measures to be taken to implement the Sino-US Agreement.

 

Section IIIThe Advantages of Having an AMC

 

1. Direct Purchase of NPLs from Financial Institutions

 

Overseas institutions cannot purchase NPLs from financial institutions directly through most of available investment channels, and they may need to acquire NPLs indirectly from the AMCs or other platforms. For example, overseas institutions are not acquiring NPLs directly from financial institutions when they invest in NPLs through QFLP program or invest in NPL ABS products traded in the China Interbank Bond Market through QFII/RQFII or CIBM Direct program.

 

There are only a few ways allowing direct purchase of NPLs from financial institutions. For example, the State Administration of Foreign Exchange has been carrying out a pilot program in Shenzhen and Guangdong since 2018 to allow certain transfers of NPLs from banks to overseas institutions, but not on a bulk basis.

 

An AMC can purchase NPLs from financial institutions directly. And it is a regular business of an AMC, rather than a pilot program.

 

2. Bulk Transfer

 

Only AMCs are allowed to purchase NPLs on a bulk basis from financial institutions.

 

Bulk transfer refers to the act of financial enterprises transferring a portfolio of 3 (reduced from 10 to 3 since 2017) or more NPLs to an AMC (including national and local AMC).

 

3. Other Considerations

 

In most of other ways for overseas institutions to engage in NPL business in China, there are other issues to be considered (e.g., governmental formalities, tax, judicial enforcement and etc.). For example, the National Development and Reform Commission (the “NDRC”) has explained that the assignment of any NPL to an overseas investor shall be filed with the NDRC for record. In addition, the relevant formalities for foreign exchange settlement shall be performed.

 

Section IVEligibility Requirements and Approval

 

1. Major Law and Regulations

 

Category	Major Law and Regulations
National AMC	Regulation on Financial Asset Management Companies Licensing Rules
Local AMC	Notice of the China Banking Regulatory Commission on the Qualifications for Local Asset Management Companies to Engage in the Bulk Purchase and Disposal of Distressed Assets of Financial Enterprises and Other Relevant Issues Applicable local regulations

 

2. Approval Authorities

 

Category	Approval Authorities
National AMC	First four AMCs were approved by the State Council and the fifth was approved by the CBIRC. Where an overseas institution intends to hold more than 5% of the equity for the first time by capital increase, equity transfer or other means, it shall report to the CBIRC for approval.
Local AMC	In principle, the establishment shall be approved by a provincial government, with the approval letter sent to the Ministry of Finance and the CBIRC for record at the same time.

 

3. AMC Registered Capital

 

Category	Registered Capital
National AMC	RMB 10 billion
Local AMC	RMB 1 billion, which shall be paid up upon company establishment.

 

4. Foreign Shareholder Qualification

 

Category	Foreign Shareholder Qualification
National AMC	Shall be a financial institution. Its total year-end assets in the latest fiscal year shall generally be no less than USD 10 billion. Good long-term credit rating for the recent two years. Good financial standing and profitable for the recent two fiscal years. Its capital adequacy ratio shall reach the average level for the banking sector at the place of its registration and shall not be lower than 10.5% if it is a commercial bank; or the total amount of its capital shall not be lower than 10% of the total amount of risk-weighted assets if it is a non-banking financial institution. It only uses its own capital to invest, and it is not allowed to invest using entrusted capital or debt capital. The balance of its equity investments shall generally not exceed 50% of its net assets (including the investment in the AMC under contemplation). A major shareholder (i.e., a shareholder who holds more than 5% of the equities or, though less than 5% of the equities of the company, has significant influence on the operation and management of the AMC) shall not transfer the equities it holds within five years as of the date of obtaining the equities (except for special circumstances such as the transfer of equities between different entities under the same control). A major shareholder shall, when necessary, replenish the capital of the national AMC.
Local AMC	There is no qualification requirement for the overseas shareholders, nor are there any restrictions currently. To implement the Sino-US Agreement, we understand that relevant policies are expected to be promulgated in this regard.

 

Section VOutlook

 

According to the data provided by the CBIRC on March 22, 2020, the NPLs disposed of by the banking industry of China totaled CNY 5.8 trillion in the past three years. In addition, due to the COVID-19 pandemic, the NPL ratio of banking institutions increased slightly in late February compared to the beginning of the year by 0.06%. The CBIRC has declared for several times that the banking financial institutions should accelerate the NPLs disposal.

 

Foreign institutions continue to show great interest in China’s growing NPL market. As it was provided in the Guiding Opinion by the CBIRC in early 2020 that overseas financial institutions are welcomed to enter the domestic NPL market, now it is a good time for overseas financial institutions to set up AMCs and participate in the disposal of NPLs in more depth.

 

 

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Please kindly note that this Memo is rendered mainly with respect to relevant laws and regulations of the PRC (for purposes of this Memo only, the PRC does not include Hong Kong, Taiwan or Macau) in effect as of the date of this Memo. This Memo is being furnished solely to you on a confidential basis for your reference purposes only.

 

Jingtian & Gongcheng Investment Funds & Asset Management Group has vast experience with setting up various foreign-invested financial institutions, asset management companies and other regulated entities in the PRC, including but not limited to mutual fund management companies, FMC subsidiaries, private fund management companies, securities companies, wealth management companies and QFLP/QDLP/QDIE fund managers.

 

In September 2019 and March 2020, Jingtian & Gongcheng received international recognition by garnering the China Investment Fund Law Firm of the Year Award from China Law & Practice and Asia Firm of the Year from The Asian Lawyer under leading international legal publishing group ALM, respectively.

 

Should you have any further questions, please feel free to contact Messrs. James Yong Wang and Eric Ye Zou below.