Guest comment by Sam Tai and Kevin Song
Private credit is booming, despite a slowdown in deal activity in the first quarter of 2022, with 201 private credit deals worldwide worth a combined $54.8 billion, compared with 400 transactions with a combined transaction value of $63.3 billion in the previous quarter in 2021. Yet, private credit in Asia-Pacific remains a nascent asset class, despite promising growth signs having more than doubled to $59 billion in the three years to 2020.
The unique challenge in Asia is that banks remain the dominant lenders. Today, with banks facing intensified regulatory oversight, the prospect of higher interest rates and high lending criteria, the funding gap for SMEs and mid-cap companies will be impossible for banks to meet alone. It highlights the need for more flexible credit options to fuel growth that in turn represents the exciting opportunity for private credit managers to build their investments in the region.
Private credit managers, however, must understand the complexities and be prepared for the challenges that are well documented in Asia and which are highlighted in a report by the Alternative Credit Council that points out the following:
The patchy/complex regulatory regimes in Asia comprising more than 40 countries, each with its own legal framework and regime
The complexities of Asian borrowers’ assets across multiple jurisdictions; and, for non-Asia private credit funds, facing regulatory restrictions in their home jurisdiction
The type and form of collateral the fund can take onshore and/or offshore and capital control restrictions, among other things.
Lack of creditor protection
Non-bank lenders may also face an uphill battle in Asia when it comes to managing risk and returns, even in some of the most developed “creditor-friendly” markets, such as Hong Kong and Singapore. The enforcement regimes are being strengthened, yet the balance of power between debtors and creditors remains in favour of borrowers.
Over time, the lack of remedies to protect the rights of creditors, or clear and appropriate legal recourse when it comes to restructuring, will sap the confidence of investors who can provide the much-needed flexible capital that will finance the region’s growth and recovery.
While some progress has been seen in key jurisdictions, successful private credit investment comes largely from high-net-worth individuals or family offices and established asset managers that understand the local jurisdictions, implement early due diligence on investment opportunities and have the right on-the-ground network of experts with robust strategies.
Despite market challenges, many private investors still actively seek and find investment opportunities in mainland China. The scale of opportunity is hard to ignore. Although the enthusiasm of foreign direct investment is not at the same level it was 10 years ago and the number of private equity deals have been stymied by the pandemic, Kroll’s restructuring team in China has seen noticeable improvements in the judicial system that supports the recovery of investments and more robust bankruptcy procedures that support investors and lenders.
One such improvement is the Recognition Pilot Program between the Supreme People’s Court of the People’s Republic of China and the Department of Justice of Hong Kong SAR, signed on 14 May 2021. The programme has established a co-operation arrangement for mutual recognition of, and assistance to, cross-border corporate insolvency and debt restructuring proceedings between mainland China and Hong Kong.
While still in its infancy, the Hong Kong liquidation of Samson Paper Company Limited provides a good example of how liquidators gained recognition and assistance from a Mainland Chinese court to deal with Samson’s material assets, principally located in Shenzhen, including equity investment, real estate and accounts receivable.
In September 2021, the Hong Kong liquidators applied to the Shenzhen Court for recognition of the Hong Kong liquidation of Samson and to allow the liquidators to perform their duties in Mainland China. The Shenzhen Court’s decision was the first recognition granted by a Mainland court in accordance with the co-operation arrangement and provided the Hong Kong liquidators with the necessary recognition, assistance and definitive powers in Mainland China.
In September 2021, the Hong Kong court, also for the first time, granted an order for recognition of, and assistance to, the reorganisation proceedings of HNA Group Co Limited, a company headquartered in Hainan, Mainland China. The court also permitted the administrators to employ professional advisers in Hong Kong for the purpose of assisting them in the execution of their powers and duties; and to bring legal proceedings before it on behalf of, and for the benefit of, the company.
All of these are typical powers given to Hong Kong liquidators in either compulsory or voluntary liquidation.
The way forward
The promulgation of the co-operation arrangement is a significant and helpful step for both Mainland Chinese bankruptcy administrators and Hong Kong liquidators. It provides a clear path for bankruptcy recognition and assistance between the two jurisdictions. This is especially important in light of the very frequent economic exchanges between the Mainland and Hong Kong and the increasing trend of cross-border insolvency. That said, the pilot scheme is only applicable to three Mainland Chinese cities.
While the co-operation arrangement is being tested in the pilot areas of Shanghai, Xiamen and Shenzhen, we look forward to ongoing communication and co-operation between the courts in Mainland China and Hong Kong on matters relating to mutual recognition and assistance in bankruptcy proceedings in the two jurisdictions.
There is hope that the private credit markets continue to develop through the implementation of reliable enforcement regimes to protect investors. These will facilitate the development of private credit markets in Greater China and more broadly in Asia, and support demand for the numerous opportunities for SMEs and corporates that need to fulfil their capital growth needs.
Sam Tai and Kevin Song are managing directors and co-heads of restructuring for China at Kroll, the risk, governance and growth specialist