Life used to be easier for Chinese buyers. They could move capital from balance sheets or bank loans from onshore to off in order to complete M&A transactions. Beijing’s clampdown, however, has scared local banks away from cross-border financing leaving firms looking for a new source of capital. Enter the private debt fund manager.
“If they want to acquire anything offshore, we can provide some degree of financing to them,” says Barry Lau, co-founder and managing director of Chinese alternative credit specialist Adamas Asset Management, which lends to growth companies in China with a consumption angle. It has completed transactions in the education, healthcare and technology sectors.
The cost of the capital controls have been felt by the likes of Dalian Wanda founder Wang Jianlin, who in April blamed them for his company’s failure to acquire Hollywood’s Dick Clark Productions for $1 billion.
Offshore banks can provide a cheaper rate for the loans, but they are unable to act as quickly on requests as private credit funds can. Acquisitions are time-sensitive, and so certainty of financing is crucial to a buyer’s bargaining power.
“What private debt funds can offer is regulatory relief for outbound financing projects in the form of bridge finance. This happens when a private debt fund is confident the buyer has met all the regulatory requirements for the financing and the money is just trapped in SAFE [State Administration of Foreign Exchange] but will eventually come out of China for the intended purpose,” says Jolyon Ellwood-Russell, partner at international law firm Simmons & Simmons.
In addition, private debt funds are more flexible in the underwriting of the loans and are able to extend security beyond traditional collateral.
“By securing these non-corporate assets or even assets of close relatives, it strengthens the borrower’s obligation to honour the contract,” says Vish Ramaswami, managing director at Cambridge Associates.
For example, if the borrower has a property in Hong Kong and a golf course in New York, the contract would be governed in one of those jurisdictions. The borrower would then have to pledge these assets to the lenders as collateral in the contract. This places the loan at a position similar to a senior tranche.
Despite the opportunities for private debt fund managers, challenges remain for groups that lend to certain industries targeted by capital controls. The government’s capital control efforts are meant to ensure that Chinese companies can expand meaningfully in sectors that make strategic sense to them rather than just acquiring trophy assets. Areas such as real estate, hotels, cinemas, the entertainment industry and sports clubs are firmly on the government’s radar.
“If you are talking about a privately-owned-enterprise trying to invest in an area which is not so much aligned with the PRC government policy, you can expect some delays in remittance or even concern about how it could fund the acquisition in the first place,” says Cindy Lo, partner at international law firm Allen & Overy. Private debt fund managers may also find themselves in the Chinese government’s spotlight. The authorities are reportedly requiring banks to provide information on overseas loans made to a few high-profile Chinese overseas assets acquirers: namely, Dalian Wanda Group, Anbang Insurance Group, HNA Group and Fosun International.
To avoid this spotlight, a growing number of offshore private debt funds have started to diversify into wider asset classes where the capital controls don’t bite as hard.
“Although the PRC government wants to control capital outflow, the leadership is aware that China has a genuine need for a lot of things from offshore. They don’t discourage acquisitions of offshore assets as long as they are for legitimate or strategic reasons, such as technology, healthcare and agriculture,” says one private debt fund manager in Hong Kong.
However, when diversifying offshore, private debt investors must be mindful of the purpose of the loans and the repayment ability of the borrowers in China. Market sources point to the size of the borrower as one particular risk.
“Typically, we don’t like to work with small to medium-size companies, just from a risk-reward perspective. Though these companies may be able to offer higher returns, they also carry higher risks, broadly speaking,” the Hong Kong private debt manager points out.
The risk is that the current economic environment in China is making it difficult for many SMEs to survive.
“When we lend, we need to assume that capital control measures will remain in place for a while, and that it will be more difficult or take longer for the borrower to get money from onshore to repay us,” the manager adds. “Hence we prefer to work with borrowers who are able to independently generate sufficient profit and cashflow offshore to repay our loans.”
But despite the difficult economic landscape, other private debt fund managers are more bullish about lending opportunities.
“It has been a difficult six months for Chinese offshore borrowers, but we are actually expecting to see a lot more offshore borrowing because the pricing in China is going up again,” Ellwood-Russell says. He adds that not only are interest rates in China going up, which means a higher cost to borrow onshore, the stabilisation of yuan and the depreciation of the US dollar will encourage borrowers to take out offshore loans.
And it’s not just capital controls that have opened up new opportunities for private debt funds. As Lau says: “There is a combination of reasons and capital control is just one of them. Private debt funds are here because of the banks’ inability to lend in special situations and complex structuring transactions.”
There is clearly opportunity among the chaos in China.