In order to regulate the fixed assets loans and project finance business of the commercial banks, China Banking Regulatory Commission (“CBRC”) released the Guidelines for Project Finance Business (《项目融资业务指引》) (Yinjianfa [2009] No.71) on July 18, 2009, and the Provisional Measures on the Administration of Fixed Assets Loans (《固定资产贷款管理暂行办法》) (CBRC Order [2009] No.2) on July 23, 2009. Both of the regulations apply to all banking institutions and will come into force three months after the date of its promulgation.

Provisional Measures on Administration of Fixed Assets Loans (“Provisional Measures”)

The “fixed assets loans” mentioned in the Provisional Measures refers to loans granted by the lender to an enterprise legal person (institutional person) or any other entity which is qualified as borrower under the PRC law to finance the borrower’s fixed assets investment, in RMB or in foreign currency.

The Provisional Measures require the lender to carry out an independent and comprehensive risk appraisal of the loans, taking into consideration factors such as the borrower, the project sponsors, the compliance of the project with applicable laws and regulations, the technical and financial feasibility of the project, the market of the products to be produced under the project, the financing scheme of the project, reliability of repayment sources of the loans, security, insurance, etc.

For those lenders who violate the Provisional Measures, penalties will be imposed according to the Provisional Measures. At the same time, the Provisional Measures also require the lenders to prepare their own administrative rules and operation procedures for fixed assets loans based on the provisions of the Provisional Measures.

The Provisional Measures also set forth some new requirements, including:

(a)Out of concern over the risks that could be brought to loans by the deficiency in capital investments in project, the regulator now expressly requires the followings to be included as conditions for drawdown: (i) the capital of the project proportionate to such drawdown has been paid up and the actual progress of the project corresponds to the amount invested; and (ii) if the amount actually invested has exceeded the estimated investment amount and additional loans are required for the project, the sponsors shall increase their capital investment accordingly to maintain the proportion of its capital investment in the total investment of the project and shall provide relevant additional security.

(b)Despite the fact that account control mechanism is from time to time seen in project financing cases, it is the first time for the regulator to make it a mandatory requirement that, (i) control over the Borrower’s accounts are provided for in the loan contract; and (ii) where the contract has specified a repayment reserve account, the lender shall request a certain proportion of the cash flow generated by the fixed assets investment project or from the borrower’s income to be paid to such account, and maintain a specific average balance in such account.

(c)The Provisional Measures have a separate chapter dedicated to administration of drawdown and payments of the loan proceeds, which expressly requires the proceeds of any drawdown in excess of 5% of the aggregate investment amount of the project or over RMB5,000,000 to be paid by the lender on trust for the borrower, that is, the lender will, based on the borrower’s payment authorization and upon its drawdown request, directly pay the loan proceeds to the relevant counterparty of the borrower in accordance with the purpose stipulated in the loan contract. Where the loan proceeds is not paid by the lender on trust for the borrower, the lender shall require the borrower to submit regular reports to the lender in respect of the payment of the loan proceeds, and shall verify whether the proceeds are applied towards the agreed purpose by way of account analysis, examination of certificates and site inspection, etc..

The supervision on the utilization of loan proceeds is an old topic, and has also been an issue under close scrutiny of the regulators for a long time. In practice, a lot of borrowers misappropriate the loan proceeds and apply it for purposes other than those agreed, which brings great risks to the banks’ rights and interests as creditors. Now the Provisional Measures once again tightened up supervision over the use of loan proceeds, this time with specific measures.

(d)The Provisional Measures require the lenders to have a particular department and specific positions in place responsible for due diligence investigation on the projects, and to incorporate the findings of such due diligence investigation into a written due diligence report. The person who carries out the due diligence investigation shall ensure such due diligence report being true, complete and valid.

Guidelines for Project Finance Business (“Guidelines”)

The “project finance” referred to in the Guidelines means a loan with the following characteristics: (1) the purpose of the loan is to finance the construction of one or a set of large-scale manufacturing equipment(s), infrastructure, real estate development projects or other projects, including refinance of the projects in construction or any completed projects; (2) the borrower will usually be an enterprise established for the construction, operation or finance of such project; and (3) repayment relies on the incomes deriving from the sale of products, subsidies or other incomes of the project, and there will usually exist no other source of funds for repayment of loans.

The Guidelines expressly recognize the Provisional Measures as one of its basis of legislation, and the procedural management and payment management of the loans under project finance are required to be carried out in accordance with the provisions of the Provisional Measures. Based on the rules of the Provisional Measures, the Guidelines shed more light on the characteristics of the project finance, for which the Guidelines provide corresponding rules.

As a conclusion, the Provisional Measures and the Guidelines reflects the efforts by the regulator to enhance supervision of large amount loans. Banks thus need to make more detailed risk control internal policies in terms of loan documentation and disbursement procedures. At the same time, banks also need to consider how to implement some of the requirements in the Provisional Measures and the Guidelines, such as ensuring the truthfulness and completeness of due diligence reports and how to accommodate the “pay on trust of the borrower” rule with the various funding demands of borrowers.

Contacts

For further information on the matters covered in this newsletter, please contact:

BEIJING OFFICE
Zhigang LIU
King & Wood
40th Floor Office Tower A,
Beijing Fortune Plaza
7 Dongsanhuan Zhonglu,
Chaoyang District, Beijing, China
Tel: +86 10 5878 5126
Fax: +86 10 5878 5599
Email: liuzhigang@kingandwood.com

SHANGHAI OFFICE
Jack WANG
King & Wood
28-30/F, Huai Hai Plaza
1045 Huai Hai Road (M)
Shanghai 200031, China
Tel: +86 21 2412 6051
Fax: +86 21 2412 6250/6251
Email: jackwang@kingandwood.com