Foreign-Invested Leasing Companies: A New Lease on Life?

A look at some of the problems that existed before the promulgation of the Tentative Procedures will help us analyse whether the Tentative Procedures have adequately addressed these problems. Prior to the Tentative Procedures, MOFTEC had, without reference to any specific leasing-related legislation, already approved 40 Sino-foreign leasing companies by simply allowing them to include leasing-related business in their business scope. However, these companies have generally fared poorly. On August 23 2001, a Sino-Japanese joint venture, Shanghai Pacific Leasing Company, was forced to close down – the first foreign-invested leasing company to do so.

First, lessees have routinely defaulted on their lease payments. The State Council was eventually forced, in 1994, to reinstate government guarantees in order to alleviate the plague of overdue lease payments which threatened to push foreign investors out of the China leasing market.

Another problem is that in many Sino-foreign leasing companies, the Chinese party often holds the majority equity interest in such companies, but is unwilling to provide a guarantee or bear financing responsibility in line with its majority shareholder status. Usually, the foreign party takes the responsibility of providing financing, so nearly all risk accrues to the foreign side. As a result, there is little motivation for the foreign party to raise more capital. The prevalence of Chinese majority equity interests might be explained by the fact that financial leasing is listed as Restricted Class B under the Guidelines for Foreign Investment by Industrial Sector, making approvals somewhat more difficult to obtain. An unwritten condition for approval may have been that the Chinese party holds more than 50% equity interest.

A separate problem lay in the weak financial condition and management of the Chinese partners in Sino-foreign leasing companies. The Chinese partners were often state-owned banks or non-bank financial institutions slated for merger or closure as a result of the general reorganization of non-bank financial institutions and reform measures intended to commercialize state-owned banks. The internal problems and restructuring of the Chinese partners may have spilled over to their Sino-foreign leasing companies.

Below, we examine the new rules in detail to see if they answer the problems cited above.

The Tentative Procedures

The Tentative Procedures deal with two types of Sino-foreign¹ joint venture leasing companies, which we will discuss separately. Foreigners are still not permitted to wholly own subsidiaries in China that engage in leasing or financial leasing.

The first type of joint venture leasing companies are those engaging in the financial leasing business (Finance Lease JVs or FLJVs), and the second type are those engaging in other leasing business (Other Lease JVs or OLJVs). All foreign-invested leasing companies, like other foreign investment enterprises (FIEs), are limited liability companies under Chinese law, and can be set up as equity joint ventures or cooperative joint ventures. Under Article 4 of the Tentative Procedures, the parties must “use business and management know-how of advanced leasing companies abroad” in establishing a foreign-invested leasing company.

One key aspect of the distinction between FLJVs and OLJVs is tax-related. Under Chinese tax law, a finance lease is distinguished from an operating lease by the indicia of ownership. If the ownership of the leased property will ultimately pass to the lessee at the end of the lease term, then the lease is a finance lease and the lessor's taxable income on the lease is the net value calculated by deducting the real cost of the leased asset from the total lease payments. If, however, the lease does not involve transfer of ownership, then the total lease payments constitute taxable income to the lessor.

The Lease Committee of the Association of Chinese Foreign-invested Enterprises is, pursuant to Article 18 of the Tentative Procedures, the organization within the industry responsible for the industry management of foreign-invested leasing companies. Under Article 18 of the Tentative Procedures, all foreign-invested leasing companies are encouraged, but not required, to join this committee.

Setting up OLJVs

Under Article 8 of the Tentative Procedures, the requirements for OLJV applicants are as follows:

• The Chinese partner must have had total assets “in the year prior to application” of no less than Rmb100 million. We understand from MOFTEC that this means the Chinese partner's balance sheet from January to December of the year preceding the year of application should show assets of at least Rmb100 million;

• The foreign partner must have total assets of at least US$50 million in the year prior to application; and

• The foreign partner must have had at least three years of experience in the leasing business.

Under Article 9 of the Tentative Procedures, an OLJV itself, as opposed to its investors, must satisfy the following conditions to obtain approval:

• The registered capital of the OLJV must be at least US$5 million;

• The Chinese partner's contribution to the registered capital must be at least 20%;

• The term of operation of the OLJV may not exceed 20 years; and

• The OLJV must have a “competent management”, and its senior officers must have “proper” professional qualifications and at least three years of business experience.

Article 14 provides that with proper approval the business scope of an OLJV may include the following:

• Lease of advanced or appropriate general-purpose equipment obtained from the domestic or foreign market, including equipment for production, communication, medical treatment, research, testing, as well as engineering machines and transportation vehicles;

• Sale or disposal of the residue value of the goods for lease;

• Other business activities approved by MOFTEC.

Setting up FLJVs

Article 6 gives the requirements for FLJV applicants, which are stricter than for OLJVs. The Chinese partner and foreign partner must have total assets of Rmb400 million and US$400 million, respectively, in the year prior to application.

The three-year experience minimum requirement for the foreign partner specified for OLJVs is raised to five years for FLJVs.

Under Article 7 of the Tentative Procedures, the maximum permitted term of operation of an FLJV is 30 years, 10 years longer than for OLJVs, and the minimum registered capital is US$20 million, four times higher than for OLJVs. The other conditions for approval of an FLJV are the same as for those for OLJVs.

Under Article 12 of the Tentative Procedures, with proper approval the business scope of an FLJV may include the following:

• Financial lease business in domestic or foreign currencies such as direct lease, sublease, leaseback, leverage lease, commissioned lease and joint lease of mechanical equipment and related technology purchased from the domestic or foreign market, including various advanced or appropriate equipment for production, communication, medical treatment, research, testing, as well as engineering machines and transportation vehicles (including airplanes, cars and trucks, and ships);

• Purchasing, either domestically or overseas, goods and related technology selected by the lessee to be leased to the lessee;

• Sale or disposal of the residue value of the goods for lease;

• Consulting and security services in connection with lease transactions;

• Other business activities approved by MOFTEC.

Article 13 of the Tentative Procedures provides that if an FLJV engages in financial services other than those listed in Article 12, it must have the approval of MOFTEC, and must also apply for approval by the PBOC. Article 13 thus appears to render the last item of Article 12 meaningless. We assume that the intention is to require both PBOC and MOFTEC approval for any financial services business outside the first four types of business listed in Article 12.

There is also a statutory limit on gearing for FLJVs as a kind of built-in risk protection facility: under Article 16 of the Tentative Procedures, the at-risk assets of an FLJV, including its balance of security, may not exceed 10 times its total capital.

Application Procedures

The procedures for applying for approval of either type of foreign-invested leasing company are similar to those for other FIEs.

The State Administration for Industry and Commerce (SAIC) must first approve the proposed JV's name, and the applicants must then submit the “name approval” to MOFTEC, together with the usual documents such as the JV contract, feasibility study, articles of association, etc.

Other requirements, under Article 10 of the Tentative Procedures, include the need for copies of the incorporation documents or registration certificates of the joint venture partners, copies of the personal IDs of their legal representatives, their credit standing certificates, and their financial reports for the three years prior to application. In addition, the proposed leasing company's senior officers must submit their qualification certificates for inspection.

After receiving approval from MOFTEC, the foreign-invested leasing company has one month to register with the relevant office of the SAIC pursuant to Article 11 of the Tentative Procedures.

The FLC Procedures

An earlier step towards codifying and regulating financial leasing was promulgated in a law by the PBOC on June 30 2000 and came into force on the same date (People's Bank of China, Administration of Lease Financing Companies Procedures, the FLC Procedures). Financial lease companies are, by definition, domestic non-bank financial institutions approved by the PBOC that are engaged primarily in financial leasing operations. At first glance the FLC Procedures appear to cover similar ground as the Tentative Procedures, especially since foreign investment is specifically referred to in the FLC Procedures.

Although the FLC Procedures specifically provide that foreign investors may be shareholders in financial leasing companies, this apparently has not been the case in practice. The PBOC appears to have interpreted the phrase “foreign capital is permitted to enter” which occurs in the text of the FLC Procedures extremely narrowly, allowing foreign investment only in the form of debt, not equity.

Foreign-invested leasing companies are treated differently from domestic non-bank financial institutions. First, whereas the payment of lease amounts payable to financial leasing companies is supervised by the PBOC, this is not the case with foreign-invested leasing companies, which are responsible for raising their own funds and collecting from their lessees. Moreover, foreign-invested leasing companies cannot engage in the lending business, being qualified only for the leasing business.

Conclusion

Reviewing the problems mentioned at the beginning of this article, it appears that the Tentative Procedures resolve very few of them. The Tentative Procedures do clarify the qualifications of Chinese and foreign investors in foreign-invested leasing companies. According to Article 7(2) and 9(2) of the Tentative Procedures, foreign investors are clearly allowed to hold a majority of the registered capital up to a maximum of 80% of the registered capital of foreign-invested leasing companies. However, the Tentative Procedures do not clarify which of the parties to a Sino-foreign leasing company should bear the responsibility for financing, nor make any mention of whether the Chinese party should have to provide guarantees.

Foreign-invested leasing companies will need access to Rmb in large amounts. Although it is expected that the PBOC will issue such guidelines, there are not yet any specific guidelines for domestic banks to issue Rmb loans to foreign-invested leasing companies. In the meantime, there is nothing to stop such loans from being made, but they are technically still restricted by the general rule, applying to all FIEs, that restrict gearing ratios by reference to total investment amount and registered capital.

The success of the lease financing sector in China will not depend solely on how well it is regulated, but on other factors such as management and market conditions. In any case, the scope of the Tentative Procedures appears too narrow and thus they are unlikely to result in any significant improvement in the regulatory regime, other than to give investors the confidence that theirs is a clearly demarcated business sector.

Endnote

1 For the purposes of the Tentative Procedures, “foreign” companies include Taiwan, Hong Kong and Macao firms.

Key Points:

• Sino-foreign leasing companies have already been set up under China's joint venture laws, but until August 2001 China had no specific legislation dealing with leasing companies as foreign-invested enterprises.

• Last year, the People's Bank of China (PBOC) promulgated the People's Bank of China, Administration of Lease Financing Companies Procedures, which provided for domestic non-bank financial institutions to engage in financial leasing. However, it appears that the PBOC has not allowed foreign companies to make equity investments in leasing companies engaging in financial leasing under those measures.

• The Tentative Procedures deal only with the examination and approval of Sino-foreign leasing companies, and set standards for the qualifications of Chinese and foreign investors in such companies. Other regulations will need to be issued by the PBOC, the State Administration of Foreign Enterprise (SAFE), and the State Economic and Trade Commission (SETC), among others, to cover regulatory aspects of leasing not covered by the Tentative Procedures.