The biggest Chinese banks have ambitious global lending plans. This is creating borrowing opportunities for Chinese and international companies, and a windfall for major law firms. George W Russell and Robin Weir report
In recent times, the major Chinese banks have undertaken a string of record-breaking initial public offerings. Agricultural Bank of China’s listing in 2010 raised US$22 billion, and Minsheng Bank raised US$3.9 billion in 2009. Since its US$21.9 billion IPO in 2006, the Industrial & Commercial Bank of China (ICBC) has been the world’s largest bank by market value.
The banks have also begun to make strategic acquisitions abroad. In January, ICBC paid US$140 million for 80% of the small US retail network of the Hong Kong-based Bank of East Asia. In 2007, ICBC forked out US$5.6 billion for 20% of South Africa’s Standard Bank, while China Merchants Bank acquired control of Hong Kong’s Wing Lung Bank for US$2.5 billion in 2008 (see Proceeding with caution on page 33).
But while major deals such as these have hit the headlines, Chinese banks are moving forward quietly in another area – international lending – that could alter the global financial landscape. “Chinese banks are happy to deploy their resources internationally, especially loans,” says Alexander Aitken, a Herbert Smith partner in Hong Kong who has advised China Development Bank, ICBC and others.
Chinese banks have been particularly active in emerging markets in Asia, Africa and Latin America. In late December, India’s second-largest mobile telephone operator, Reliance Communications, and sister company Reliance Power, borrowed US$3 billion from a consortium that included China Development Bank. According to media reports, the loans carried a lower rate of interest than Reliance could attain on Indian rupee loans.
China-Latin America business is also burgeoning, underpinned by finance from Chinese banks. “Our experience has been with telecoms, but it is also likely that [Chinese banks] will focus on energy and other infrastructure projects,” says Vicente Lines, a partner with Arias & Muñoz in San José, Costa Rica, who advised Bank of China in a recent project.
And Chinese lending can favour companies in developed markets, too. In January, China Development Bank financed Perilya Canada to the tune of US$100 million in its US$183 million acquisition of Toronto-listed GlobeStar Mining. Perilya Canada’s parent company is listed on the Australian stock exchange and is 52% owned by Shenzhen Zhongjin Lingnan Nonfemet, China’s third largest zinc smelter. GlobeStar operates the Cerro de Maimon copper-gold-silver mine in the Dominican Republic.
To fund their lending spree, China’s biggest banks raised more than US$45 billion in 2010 through rights issues and convertible bond sales to maintain their capital adequacy ratios, according to research by BNP Paribas.
And the Chinese banks are trying to broaden their reach. “Now the banks are looking at a wider spectrum of business sectors and asset classes,” says Nigel Ward, a partner at Norton Rose in Beijing. “The banks have focused on funding the main state-owned enterprises, but we see a trend towards lending to private Chinese companies investing offshore.”
The types of business each bank engages in may largely be driven by what its existing clients require, be it acquisition finance, asset finance, project finance, bilateral or syndicated loans, trade finance or bank-to-bank lending. “Similarly, the sectors in which they are involved will often be influenced by which of their Chinese clients have funding requirements involving jurisdictions outside China,” says Andrew Lockhart, a partner at Baker & McKenzie in Hong Kong.
Across the board, this offers international companies, and Chinese companies venturing overseas, a possible new source of capital. It is also turning Chinese banks into a major client group for international law firms. “All the major international firms with an active financing practice and presence in China have been busy advising China banks on their outbound lending transactions,” says Thomas Ng, a partner at Linklaters in Beijing.
Filling a void?
To some extent, the banks’ move into international lending has occurred as part of their natural growth, boosted by the recent IPOs. It may also have been spurred by government pressure, following Chinese companies abroad as part of the “Go Global” policy. But a major factor has undoubtedly been the downturn in the fortunes of the international banking and financial community caused by the global financial crisis that started in 2008.
“Since the global financial crisis, we have witnessed a significant ramp-up in cross-border lending activities by Chinese banks, no doubt partly to fill up the lending gap left by international banks during the crisis, but also to implement their own international expansion strategies,” says Ng.
Others echo this message. “Undoubtedly, the weakened position of the international banks has helped the Chinese in terms of there being less competition for them in markets traditionally dominated by international banks,” says Lockhart. “We have seen the Chinese banks exploit this market gap quite astutely.” Lockhart says that during some periods since the insolvency of Lehman Brothers in September 2008 “it was really only the Chinese banks lending new money in many markets”.
Allan Yu, a Hong Kong partner at Mayer Brown JSM, agrees. “PRC banks filled the vacuum left behind by the North American and European banks,” he says. “They have completely changed the landscape.” Yu’s firm counts Bank of China, China Construction Bank (CCB) and ICBC among its banking clients.
Other lawyers, such as Ward, emphasize that Chinese banks have been driven overseas by domestic considerations. “That decision was part of the effort China has made to support Chinese business, exports, the growth of its domestic markets through sustained employment and infrastructure development, and the security and diversity of China’s supply of natural resources,” he suggests.
Brett King, a banking and finance partner in the Hong Kong office of Paul Hastings Janofsky & Walker, identifies three stages in the evolution of the Chinese banks into major international lenders. Initially, Chinese banks would participate in loan syndicates arranged by others. “They’ve been doing that for the past five to 10 years,” he notes. The second stage involves lending to Chinese companies going overseas, which the banks have been pursuing for the past few years. The third stage involves Chinese banks in deals that have no Chinese parties involved at all.
Chinese banks, says King, are well into the second stage, with the third stage – which he describes as “the top level of international banking” – well within their grasp over the next five years. “I’m confident that Chinese banks will do this very soon as their learning curve for international banking has been very steep,” he says. “It’s the Korean and Japanese model and I have no doubt they can do it.”
For any company that might consider borrowing, and for that company’s in-house lawyers, does dealing with Chinese banks differ from dealing with their international competitors?
Lawyers say that in their new international business, Chinese banks are using regular international finance structures which are documented in line with international norms. “They have not so far ventured into highly structured or leveraged products,” notes Ward. “They favour full-recourse debt facilities that are supported by parent company or state guarantees. The banks are looking at some limited recourse or project-specific structures, but because demand for their funding has been so strong, they have been slower to widely adopt these international finance techniques.”
As international norms are being followed, English law documentation appears to predominate. “Foreign borrowers are unlikely to accept loan documentation that is governed by Chinese law, and all parties will want a neutral third-party jurisdiction,” says Ng.
Lockhart agrees. “We see mostly English law documentation used for this outbound lending, probably due to a mixture of familiarity and market convention,” he notes. “New York law is used less frequently in our experience, although it is seen on some of the Latin American projects. Hong Kong and other laws are not commonly used for the major cross-border transactions.” (See Hong Kong on page 34)
Ng points out that English law facility agreements in cross-border financing transactions generally follow the templates provided by the Loan Market Association (based in London) or the Asia Pacific Loan Market Association (headquartered in Hong Kong). This provides a level of standardization that is not yet present in China. “Our understanding is that the standardization of loan documentation has not yet happened in China, and each bank has its own loan agreement template,” he says.
Whatever the template used, Ng says that negotiating loan documentation with a Chinese bank is likely to entail the “usual” negotiation points: conditions precedent, the scope of the security package, representations and warranties, undertakings and financial covenants, and events of default.
According to Wang Qi, general manager of the legal and compliance department at Bank of China, BOC has a well-organized legal and compliance regime in place to handle lending to Chinese companies investing overseas. The major legal matters to be taken into account, she says, are “first, relevant laws and regulatory requirements in China; second, the bank’s own strategies and credit products available; third, relevant laws, regulations and policies applicable in the host country; and fourth, the borrower’s credibility”. With regard to risk assessment, she says the bank “would focus on the assessment of potential risks attached to the industry sector and host country the Chinese companies were aiming at, as well as risks related to local laws and regulatory practice”.
But perhaps inevitably, borrowing from Chinese banks can also have its own special characteristics. John Nestel, a partner at Freehills in Sydney, points out that in funding the acquisition or development of mining projects in Australia, Australian (like English) facility documentation focuses on ensuring that the bank has effective security over the underlying assets. “Whilst this is the expectation of Australian, European and US banks, our experience when acting for Chinese on such financings is a different approach to credit assessment and risk mitigation,” he says. “This is often because the bank might effectively be relying on the credit of the Chinese sponsor and its head office relationship with them. In our experience this can be the case whether or not there is a formal parent guarantee.”
Nestel believes it is important for Chinese banks to explain up front to their international lawyers whether the bank intends solely to have recourse to the assets in a project, or is primarily or significantly relying on the credit of the Chinese sponsor. “A number of legal practitioners have expressed concern about spending many hours on legal due diligence and negotiating facility agreement terms to ensure the Chinese bank has effective security, and only later realizing when identifying some particular technical weakness in the security package that the Chinese bank isn’t primarily relying on such security for its credit.”
For the moment, some analysts expect the banks to remain cautious when delving into international market economies. “The Chinese banks have little experience in operating in a competitive market that combines low barriers to entry with market-driven pricing. They are hesitant to make a mistake and over-invest in new markets,” says Michael Werner, senior banking analyst in Hong Kong with the US sell-side research company Sanford C Bernstein & Co.
But the amount of loan capital which Chinese banks have already advanced outside China’s borders and to non-Chinese parties suggests they are already confident. “Perhaps with the return to health of international banks and the narrowing of dollar financing advantages, there will be more Chinese bank involvement in power purchase agreements, private finance initiatives and leveraged structures,” Ward suggests. “The experience of the banks grows every day and they have an impressive ability and willingness to rapidly integrate and absorb best international practices.”
Just as Japanese and Korean banks had close, though often informal, ties with government, Chinese banks – especially the Big Four of Bank of China, CCB, ICBC and Agricultural Bank of China, plus China Development Bank – operate with government blessing. Beijing wants to use the power of the banks to push exports and create employment. This is unlikely to change, lawyers say, but future international lending will have more of a commercial element. “Deals will be driven not by policy but by real credit risk,” says Brett King, a partner at Paul Hastings Janofsky & Walker.
Lending by Chinese banks can benefit from coverage provided by China Export & Credit Insurance Corporation (Sinosure), China’s official export credit and credit insurance agency. Sinosure’s underwriting grew by 128.5% in 2009 to RMB774.9 billion. While Sinosure’s charter does not explicitly say that it is government-backed, it notes that the Ministry of Finance, which owns the agency, supports its budget. Therefore, most observers believe Beijing is ultimately taking the final risk on loans covered by Sinosure.
Sinosure – and the Export-Import Bank of China (China Eximbank), which is 51% owned by China Investment Corporation, the county’s main sovereign wealth fund, and 49% owned by the Ministry of Finance – are both state-owned policy institutions. “They apply a broader range of criteria to determine eligibility of projects and pricing tenor than purely commercial banks would do,” notes Nigel Ward, a partner at Norton Rose.
Some lawyers, however, urge caution when it comes to risk issues. “We think the question of sovereign risk when dealing with Chinese state-owned banks is somewhat sensitive,” says Andrew Lockhart, a partner at Baker & McKenzie. “Clearly a number of foreign counterparties view their exposures as at least ‘quasi-sovereign’ risk [but] it is not clear that the Chinese share this view.”
It is not yet clear what effects the larger Chinese banks’ international IPOs – and the subsequent dilutions of state ownership – will have on their attitude towards risk. King suspects there will be little change. However, there has been a recent move by the China Banking Regulatory Commission to improve risk assessment and the pricing of that risk. Chinese banks have the ability to underwrite and hold much larger commitments than just about any international institution, adds Ward, “but that does not mean they do so without assessing risks and pricing those risks”.
Proceeding with caution
Chinese banks are trying several strategies to broaden their international footprint. Several have set up offices abroad in recent months, while others have acquired stakes in foreign banks, taking advantage of the cheaper asset prices that followed the global economic downturn that began in 2008.
In January, Industrial and Commercial Bank of China (ICBC) opened offices in Paris, Brussels, Amsterdam, Milan and Madrid. ICBC opened an Abu Dhabi branch in November 2010 and is considering branches in Kuwait and Riyadh. In December 2010, China Construction Bank opened a Sydney office while CITIC Bank International set up in Singapore. China Development Bank launched its Moscow office in September 2010.
Law firms are watching the progress of the banks across the globe with interest. “As the Chinese banks grow and establish branches in other jurisdictions, our firm puts a concerted effort into leveraging relationships in China to win assignments elsewhere,” says Li Xiaoming, a Beijing partner and head of the China practice at White & Case.
Meanwhile, the banks are also acquiring units in strategic locations. In January, ICBC paid US$140 million for 80% of Hong Kong-based Bank of East Asia’s small North American network – the first purchase of US retail branches by a Chinese bank. China Merchants Bank acquired control of Hong Kong’s Wing Lung Bank for US$2.5 billion in 2008, and ICBC forked out over US$5.6 billion for 20% of South Africa’s Standard Bank in 2007.
Despite the apparent rush to spread internationally, lawyers and analysts say Chinese banks tend to be cautious outside their home waters. “As far as we can see, Chinese banks are not taking on every global lending opportunity presented to them,” says Baldwin Cheng, a Beijing partner with White & Case. “They have been careful to ensure that their interests are adequately protected and they often focus on providing financing to Chinese companies for their offshore projects or to sectors of strategic importance to China.”
Analysts say Chinese banks have retained memories of foolish foreign investment. China Minsheng Bank posted a US$120 million loss related to its stake in the failed United Commercial Bank in California in November 2009, just prior to its initial public offering.
The banks also recall their forays into US mortgage-backed securities. “This resulted in a significant scale-back of their foreign holdings,” says Michael Werner, senior banking analyst in Hong Kong with the US sell-side research company Sanford C Bernstein & Co.
Hong Kong plays a significant role from a financial institution perspective as it is the home of many branches of mainland Chinese banks. “From Hong Kong we have seen the typical onshore and offshore financing structures as well as financings supported by domestic guarantees and documentary credits,” says Baldwin Cheng, a Beijing partner with White & Case.
Cheng adds that offshore non-recourse financings by Chinese banks are rare as Chinese banks have yet to build the capability to assess risks of this type outside of China. “As a result, they often require some type of credit support in the form of parent guarantee, shareholder undertaking or letter of comfort,” Cheng says. “If there is credit support given by a Chinese sponsor, Chinese banks may agree to limited scope and rigidity of financial covenants.”
But despite Hong Kong’s financial infrastructure, its law remains a minority choice for contract writers. “Hong Kong law is not as robust as English or New York law,” says Brett Walker, a partner at Paul Hastings Janofsky & Walker. “It’s old-fashioned and it’s not updated constantly. It contains very old financial concepts.” As an example, King cites the lack of recognition given to mergers. “Two Hong Kong companies cannot merge.”
Where Hong Kong law firms can excel, says James Lin, a partner with Davis Polk & Wardwell, is in hanging on to Chinese banks after helping them raise money on capital markets. “You can take them public in Hong Kong and retain them as a client,” he says. “The stickiness is in the compliance.” That, he adds, is part of the strategy behind the firm’s hiring in 2010 of partner Bonnie Chan, a former senior vice-president of Hong Kong Exchanges and Clearing, where she led the IPO transactions department.