Changing M&A regulations in supply chain finance

By Mark Wang, East & Concord Partners
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Supply chain finance has been growing in importance in recent years. In September 2020, eight state ministries and commissions, including the People’s Bank of China, issued the Opinions on Standardising the Development of Supply Chain Finance to Support the Stable Circulation and Upgrading of the Industry Chain of Supply Chain Finance, raising the importance of this area of economic activity to the national level.

Changing M&A regulations in supply chain finance Mark Wang
Mark Wang
Partner
East & Concord Partners

As prominent legal entities engaged in supply chain finance, commercial factoring companies, or factors, are allowed to directly participate in core supply chain finance transactions by means of accounts receivable financing. Factors differ from banks and other financial institutions by having a low establishment threshold and a high degree of business flexibility.

In addition, the Civil Code stipulates the factoring contract as a “nominate contract”, providing a systemic and legal basis for the factoring business. It can be expected that factors will gradally demonstrate their significance and that they will increasingly become targets of M&A transactions. The regulatory issues related to M&A of factors – including cross-border deals – will therefore be of interest.

Regulatory evolution

The regulatory authority of commercial factoring companies has changed from the Ministry of Commerce (Mofcom) to the China Banking and Insurance Regulatory Commission (CBIRC). In 2012, Mofcom authorised Tianjin and Shanghai to set up pilot factors, followed by a nationwide push. Over the years, factors developed at a rapid pace, with an explosion in their number, but this also raised a series of issues, such as those surrounding shell companies.

In May 2018, Mofcom issued a notice transferring the administrative responsibilities for factors to the CBIRC, eventually forming a regulatory system where the commission is responsible for the formulation of laws and regulations, while local governments and financial regulators are responsible for supervising the daily operation of factors.

With the change of authority, the regulatory approach to factors also shifted from loose to tight, before turning to moderate. When regulated by Mofcom and local commercial departments, the threshold for setting up a factor was not high due to the more relaxed policies, and investors intending to engage in factoring could enter the market by directly setting up a new factor. Further, there were generally no regulatory barriers for matters such as change of shareholder and change of actual controller in factor M&A.

However, after the regulatory responsibilities were transferred to the CBIRC, in order to clean up the use of shell companies as well as solving other problems, the regulatory authority stopped approving all equity changes for two years, except for equity transfer between affiliated companies, resulting in a virtual halt to factor M&A.

Recently, since those strict regulatory policies and the reformation of related industries have achieved intended results, some local financial regulators have restarted approvals for changes in the shareholding of factors, and M&A of factors also re-emerged.

However, the resumption of regulation does not mean that policy has gone back to its former loose state. At this stage, the local financial regulators are still moderately cautious about the M&A of factoring companies.

Equity transfer

For M&A transactions with the equity or actual control of factors as targets, with very few exceptions, all equity changes are required to be examined and approved by the local financial regulators, and such examination and approval should be substantive, adopting criteria close to those for newly established companies. For simple illustration, the author classifies them as “formal” requirements and “substantive” requirements.

First of all, the acquirer must meet the regulatory requirements for shareholders of factors. In practice, it should be noted that the market entry criteria and threshold for shareholders may vary depending on the place of incorporation, and the specific entry threshold is subject to the local laws and regulations of the place of incorporation.

In the M&A transaction, the acquirer’s proposed shareholding entity is required to comply with the threshold requirements of the local laws and regulations for the shareholders of factoring companies. In conjunction with relevant local regulations, the acquirer’s shareholders generally must meet relevant criteria in relation to credit standing, financial and profit position, actual controller, availability of senior management with experience in the financial industry and source of funds. The aforementioned criteria, basic entry requirements for acquirers, are considered “formal” requirements.

Moreover, in the Notice on Strengthening the Supervision and Administration of Commercial Factoring Enterprises, the general office of the CBIRC required local financial regulators to strengthen review of background strength, motivation for equity participation and the source of equity capital of new shareholders of factors.

On the basis of the relatively rigid “formal” requirements, local financial regulators will also examine whether the acquirer meets “substantive” requirements for becoming an investor of a factor. The substantive requirements are in place mainly to ensure that the new investor is qualified for and capable of operating the factor, and that its operations are in compliance with regulations (both before and after approval).

In the absence of written laws and regulations in this regard, local financial regulators in practice have a certain discretion in determining whether these “substantive” requirements are met.

M&A transactions

In view of the current regulatory characteristics of factors, the author believes that we should focus on the following issues in factor-centred M&A transactions:

    • Determine the arrangement of transaction structure according to the qualifications of the acquirer’s investors in advance. As mentioned earlier, regulators have set thresholds and requirements for new shareholders of factors, and regulations and regulatory approaches vary from place to place. Before making the acquisition, investors should make proper preparations according to their own qualifications, to ensure compliance as a new shareholder.
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      Be knowledgeable about the approval documents of the target company and conduct due diligence on its operational compliance. In practice, regulators will also examine the prior compliance status of the factor, and if any instance of non-compliance is discovered, the acquirer may encounter obstacles with approval.

    • The contract terms should include a withdrawal mechanism in case approval for equity change is not obtained.

Mark Wang is a partner at East & Concord Partners

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East & Concord Partners
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