This article was written by Zhou Jie, Anne-Marie Neagle, Andrew Fei, Richard Mazzochi and Wang Xiaoxue (Stella).

Nearly 21 years after China established the big four national asset management companies (AMCs) to acquire, manage and dispose of non-performing loans (NPLs), the Chinese government has approved the establishment of a fifth national AMC.  This is a significant milestone for China's growing NPL market which will have significant implications for market participants and, ultimately, for foreign investors looking for Chinese NPL-related opportunities. 

On 5 March 2020, the China Banking and Insurance Regulatory Commission (CBIRC) announced its approval for Beijing-based Jiantou Citic Asset Management Co., Ltd (Jiantou Citic) to be converted into a national AMC and renamed China Galaxy Asset Management Co., Ltd. (China Galaxy AMC).  China Galaxy AMC must complete its conversion into a national AMC within six months of the CBIRC's approval.  Currently, China Galaxy AMC is approximately 70% owned by state-owned investment company Central Huijin Investment Ltd. (which is a shareholder of many major Chinese state-owned banks, securities firms and other financial institutions) and approximately 30% owned by Citic Securities Co., Ltd. (which is one of China's largest securities firms). 

KWM is acting for Jiantou Citic (soon to become China Galaxy AMC) in connection with its conversion into a national AMC and is very honored to have participated in this historic transaction in China's financial services sector.

In this article, we explore the significance and potential business opportunities presented by the establishment of the fifth national AMC in China.  However, to better understand its implications, we begin with a high-level overview of the existing macroeconomic and regulatory landscape surrounding China's NPL market.  For those who are already familiar with the background, please refer directly to Part II of this article further below. 

Part I:   Background on China's NPL market

Macroeconomic context

As China's economy enters the "new normal" and undergoes significant transformations and reforms, Chinese companies – both private enterprises and state-owned enterprises – are experiencing rising debt levels.  As a result, both official statistics and unofficial estimates indicate that the amount of NPLs held by Chinese financial institutions and corporations are on the rise. 

China classifies loans into five risk-based categories: normal, special-mention, substandard, doubtful and loss, with loans falling within the bottom three categories being referred to as NPLs.  According to the CBIRC, as at the end of February 2020, Chinese banks held RMB 3.30 trillion of NPLs (resulting in an NPL ratio of 2.08%), and RMB 5.80 trillion of special-mention loans, which are one notch above NPLs in China's risk-based classification.   

Given uncertainties currently surrounding the regional and global economy, the trend of rising NPL levels is expected to continue in 2020, if not accelerate.  As NPLs have a countercyclical component, we expect they will continue to be of interest to investors notwithstanding recent economic headwinds.  

As part of its efforts to address the NPL issue and maintain financial and economic stability, the Chinese government continues to open up China's growing NPL market to foreign investors through a number of channels. 

Key players in China's NPL market

Despite the fact that new channels for foreign investors to participate in China's NPL market are emerging, the market continues to be dominated by the state-owned national AMCs. 

The four existing national AMCs were established in 1999 with an original mandate to purchase NPLs from the big four state-owned Chinese commercial banks and to manage and dispose of these NPLs.  The four existing national AMCs and their original corresponding commercial banks are as follows:

  • China Cinda Asset Management Co., Ltd. – China Construction Bank
  • China Great Wall Asset Management Co., Ltd. – Agricultural Bank of China
  • China Huarong Asset Management Co., Ltd. – Industrial and Commercial Bank of China
  • China Orient Asset Management Co., Ltd. – Bank of China

Since their establishment nearly 21 years ago, the four existing national AMCs have evolved to become diversified financial holding companies engaged in a broad range of banking, securities, insurance and other financial services.  However, their core business continues to be the acquisition, management and disposal of NPLs, and a number of them are in the process of spinning off their non-core businesses.

The Administration Measures on Bulk-transfer of NPLs by Financial Enterprises (Cai Jin [2012] No.6) issued by the Ministry of Finance (MOF) and the then China Banking Regulatory Commission (CBRC) on January 18, 2012 (2012 Measures) established the regulatory framework for Chinese banks and other financial institutions to transfer NPLs to national AMCs on a "bulk" basis (currently defined as transferring three or more NPLs).  For the purposes of this article, the term "NPL portfolio" refers to a portfolio of more than three NPLs such that the transfer of an NPL portfolio necessarily involves a bulk transfer for Chinese regulatory purposes. 

The 2012 Measures also allowed provinces in China to establish local AMCs that can acquire NPL portfolios directly from financial institutions in their home province.  In 2016, regulations governing local AMCs were relaxed by the then CBRC and local AMCs are now generally allowed to transfer NPLs they have acquired to entities outside their home province.

Although China Galaxy AMC is the first national AMC to be approved in nearly 21 years, nearly 60 local AMCs have been approved to date and we expect more approvals in the future.  In some provinces, local AMCs play an increasingly important role in acquiring NPLs from local commercial banks.

Transactions in China's NPL market are divided into Primary Market Transactions and Secondary Market Transactions

Generally, only AMCs are allowed to purchase NPLs on a bulk basis from Chinese banks.  The acquisition of NPL portfolios directly from Chinese banks and other Chinese financial institutions is referred to as a Primary Market Transaction

The acquisition of NPL portfolios from AMCs by investors (both domestic and foreign) and subsequent transfers of NPL portfolios among investors are referred to as Secondary Market Transactions.

Channels for foreign investors to participate in China's NPL market

Over the past several years, new channels for foreign investors to access China's NPL market have emerged while existing channels are becoming more streamlined and investor-friendly.

The key existing access channels are summarised below.  For further information, please refer to our earlier publication on China's NPL market.

Purchasing NPL portfolios from AMCs

National AMCs:  Foreign investors can purchase NPL portfolios from national AMCs through a competitive bidding process.  This is a well-established channel for foreign investors to acquire NPLs and has been available since 2001.  Over the years, the process for obtaining Chinese regulatory approval in connection with a national AMC's transfer of NPLs to foreign investors has become simplified and more streamlined.

Local AMCs:  There remains uncertainty regarding whether foreign investors can purchase NPL portfolios from local AMCs, because the relevant regulations are not clear on this point. 

Purchasing NPLs (on a non-bulk basis) from Chinese commercial banks (including pursuant to the Shenzhen NPL Pilot Program)

Generally, foreign investors cannot purchase NPLs in bulk directly from Chinese commercial banks. However, foreign investors may discuss the types of NPLs they are interested in acquiring with AMCs and the AMCs can help source NPL portfolios from Chinese commercial banks.  In these types of arrangements, the AMC would essentially act as a conduit that first acquires an NPL portfolio from Chinese commercial banks, and then on-sells the NPL portfolio to foreign investors via a competitive process.  An alternative is for a Chinese commercial bank to issue NPL-asset-backed securities (see below).

In 2017, a cross-border NPL pilot program (Shenzhen NPL Pilot Program) was set up by China's foreign exchange regulator, the State Administration of Foreign Exchange (SAFE).  In essence, the Shenzhen NPL Pilot Program allows foreign investors to directly purchase NPLs on a non-bulk basis from Chinese banks and branches in Shenzhen.  The pilot program also allows foreign investors to purchase NPLs on a bulk basis from AMCs that list NPL portfolios on the Qianhai Financial Assets Exchange (QEX) and other local exchanges.  The QEX operates one of China's largest NPL trading platforms and has, since the establishment of the NPL Pilot Program, handled a large number of cross-border NPL transactions.  Similar pilot programs have begun in other Chinese cities and provinces. 

 Investing in NPL securitizations

In 2016, Chinese regulators established a pilot program for qualifying financial institutions to restart the NPL ABS market in China.  So far, a dozen Chinese commercial banks have issued NPL asset-backed securities (ABS) in China's institutional bond market, the China Interbank Bond Market (CIBM).  In November 2019, the Chinese regulators further expanded the list of Chinese financial institutions that are eligible to participate in the NPL ABS pilot program. 

Qualifying foreign institutional investors can invest in these NPL ABS via established channels such as the Qualified Foreign Institutional Investor (QFII) and RMB Qualified Foreign Institutional Investor (RQFII) schemes, the CIBM Direct Access Scheme and Bond Connect.

Entering into joint ventures with national AMCs

Foreign investors can, and have, entered into joint ventures with national AMCs for the purpose of acquiring and managing NPL portfolios.

Using QFLP / RQFLP structures

Some foreign investors have relied on the Qualified Foreign Limited Partner (QFLP) or RMB Qualified Foreign Limited Partner (RQFLP) pilot programs established in certain Chinese cities to form private equity funds that invest in NPL portfolios.  The features of each QFLP / RQFLP pilot program are different, resulting in different regulatory requirements and procedures associated with pursuing this access channel, depending on the particular pilot program on which a foreign investor is seeking to rely. 

Establishing wholly foreign-owned "non-licensed" AMCs

Part II: Potential implications of the fifth national AMC

Potential changes to the national AMC landscape

China Galaxy AMC is the first national AMC to be approved in nearly 21 years.  This represents a milestone in China's NPL market and signals further diversification of market players at the national level.  The establishment of a fifth national AMC may, over time, alter the competitive landscape and present more opportunities for domestic and foreign investors seeking to participate in China's NPL market.  It might also open the door for further national AMCs to be established in the future as the NPL market continues to grow and mature.

Compared to the four existing national AMCs, China Galaxy AMC's background in the securities sector and the fact that its minority shareholder is one of China's leading securities firms could mean that China Galaxy may focus on non-performing assets arising from capital markets and securities activities.  As bond defaults continue to rise in China, China Galaxy's familiarity with the Chinese capital markets may also enable it to play an important role in this space.  However, we wait to see which particular business areas China Galaxy AMC will focus on over the coming years.

National AMCs and Article 4.5(2) of the China-U.S. Phase One Trade Deal

Foreign investors continue to show strong interest in accessing China's growing NPL market.  So much so that the recent China-U.S. Phase One Trade Deal (formal title: Economic and Trade Agreement between the Government of the United States of America and the Government of the People's Republic of China) includes a commitment by China to further open up its NPL market to U.S. firms.  Specifically, under Article 4.5(2) of the Phase One Trade Deal, China has agreed to allow U.S. financial services firms to apply for local (and eventually national) AMC licenses, which would allow them to acquire NPL portfolios directly from Chinese banks. 

Please refer to our earlier publication for further discussion on the potential implications of Article 4.5(2) of the Phase One Trade Deal.  As far as national AMC licenses are concerned, Article 4.5(2) states that "when additional national [AMC] licenses are granted, China shall treat U.S. financial services suppliers on a non-discriminatory basis with Chinese suppliers, including with respect to the granting of such licenses."

In other words, Article 4.5(2) provides that, if and when China opens up its national AMC market to domestic firms, U.S. financial services firms may be able to, over time, obtain national AMC licenses on the same basis as their Chinese counterparts, and participate in the national NPL market on the same footing.  The CBIRC's decision to approve the establishment of a fifth national AMC represents the first step in the gradual opening-up of China's national AMC market. 

Article 4.5(2) itself does not contain much detail.  Overtime, it is hoped that relevant Chinese regulators will publish policies and guidelines to clarify the eligibility criteria, requirements, procedure and timeline for U.S. financial services firms to obtain local (and eventually national) AMC licenses as well as the scope of permitted business activities for these foreign-owned AMCs.  For example, market participants want to know if foreign-owned AMCs may engage in the same activities as domestic AMCs.  The existing CBIRC rules on the establishment and business scope of non-bank financial institutions do not shed light on this question.  To the extent that Chinese-owned AMCs are permitted to engage in a broader range of activities in the future, foreign-owned AMCs may also benefit from such regulatory relaxation.

These policies and guidelines may come from either the relevant provincial governments (in the case of local AMCs) or the CBIRC, which is the main regulator overseeing China's banking sector and financial institution NPL market.                                                                                                   

Looking ahead

The establishment of a fifth national AMC symbolizes the further opening-up of China's NPL market to both domestic and foreign market participants, which presents new business opportunities for foreign financial institutions and investors.  Overtime, the further opening-up of China's NPL market will result in greater foreign participation in China's financial markets and financial services sector, and lead to greater competition, more innovation and better quality of service. 

While Chinese regulators have taken, and will continue to take, steps to further open up the country's financial markets and financial sector (including the NPL market), ensuring financial stability will continue to be their paramount policy consideration.  Accordingly, we can expect China to continue to adopt a gradual and incremental approach to reforming and opening up its NPL market and emphasize strict compliance with regulatory requirements in order to prevent systemic risks. The flip-side of national treatment of foreign investors and financial institutions in China is that they are expected to fully adhere to Chinese laws, regulations and policies in the same manner as their Chinese counterparts. 

King & Wood Mallesons has decades of experience in successfully helping foreign companies establish and expand their operations in China, obtain financial services licenses, enter into joint ventures with Chinese financial institutions, invest in the Chinese financial services sector and comply with applicable Chinese laws and regulations.  We have also been active in China's NPL market since its inception in 2000.  We regularly act for AMCs, foreign and domestic investors and other participants in all types of domestic and cross-border NPL transactions. 

Should you wish to discuss what the developments outlined in this article mean for you or your business, please contact a member of our cross-border team.

In the meantime, we will continue to keep you updated on important Chinese financial regulatory developments through our regular client alerts and in-depth analysis.

Originally published May 15, 2020.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.