China: All eyes on the prize

Referring to China as an “emerging” NPL market is a misnomer. The country has an established NPL infrastructure, which dates from 1999 when the Chinese Government set up the original four AMCs for the purposes of acquiring NPLs from the four largest Chinese banks and preparing them for sale to investors. Chinas first NPL cycle ran from 2001 until 2008 and is widely heralded as having been a great success for the country. Although there was strong interest from international banks looking to invest during this cycle, offshore investors ultimately had very limited successmentators widely attribute this to the opaque Chinese legal system, political and strategic issues related to working out state-linked assets, currency controls and a reluctance on the part of Chinese courts to allow foreign investors to restructure businesses where jobs were at stake.

Chinas second NPL cycle commenced in 2015 and the original infrastructure and landscape has now progressed and developed significantly. Infrastructure for online auction processes, OTC trades and securitisation projects has been developed. In addition, there are ongoing legal and structural changes bringing greater legal certainty and the emergence of initiatives such as databases on which asset titles and liens can be checked and verified.

The Chinese Government has also been testing initiatives designed to facilitate offshore investment in NPLs. In , the State Administration of Foreign Exchange (SAFE) launched a pilot programme in Shenzhen for cross-border NPL disposals. In , the Government announced the extension and enhancement of this successful programme, which allows loan till payday Jackson TN AMCs and commercial banks to sell NPLs to foreign investors via a private sale process, rather than through the customary court administered process, provided that certain prescribed criteria are fulfilled.

Similarly, the Shenzhen Qianhai Financial Assets Exchange was established to help streamline sale processes and reduce time and transaction costs for overseas investors. It provides a platform service which can facilitate cross-border payments and transaction settlement, notarisation and execution of NPL sale documentation and cover tax payments including withholding arrangements.

These initiatives come at a time where commentators widely expect Chinas NPL ratio and volumes to rise dramatically. This is largely as a result of Beijings tightening of NPL reporting standards and the China Banking and Insurance Regulatory Commissions (CBIRCs) push towards accurate NPL recognition by banks.

These changes are well documented and commentators expect a 14% rise in NPLs as a result of the change in reporting standards. Some commentators believe that the big four banks will be relatively unaffected by these changes and that 95% of the impact will fall upon the smaller banks within China who have a grace period until 2019 for compliance. Illustratively, in the second quarter of 2018, NPL assets in the countrys rural banking sector grew by 183 billion Yuan according to data from the CBIRC.

Regulatory changes have been introduced targeting the countrys shadow banking sector, including reclassifying all loans overdue for more than 90 days as NPLs

China has also removed limits on foreign ownership of banks and bad debt managers, with the Regulator announcing in August that foreign financial institutions will effectively be treated the same as local companies.

In addition, asset quality has remained stable in line with macro-economic expansion. Average non-performing loan ratios for Chinese commercial banks stood at 1.9% by the end of 2018, up from 1.74% as at the end of 2017, according to data released by the Banking Regulator. All of this represents an opportunity for investors looking to new returns.

Chinas National Banking Regulator also introduced rules in late 2017 forcing the countrys national AMCs to meet core and tier 1 capital thresholds. Whereas the AMCs once needed to maintain an overall capital adequacy ratio of no less than 12.5%, the new rules dictate that core capital should be no lower than 9% and tier 1 capital should be at least 10%. As a result,