Foreign Strategic Investment in a PRC Domestic Bank

A 25% foreign shareholding has long been a threshold between domestic companies and foreign-invested companies , though this may be changing. In some industries like banking, being a foreign-invested company means limited licence of business, at least before China opens its market according to its WTO commitments.

A limited license may be detrimental to the fundamental interests of both the target domestic bank and the foreign investor. Furthermore, in practice, there has been no precedent in which a domestic bank has been approved to convert into a foreign-invested bank. Therefore, currently a 25% shareholding seems to be the ceiling for foreign equity participation in a domestic bank.

Exit

Although strategic investment is supposed to be a long-term investment, foreign investors often need to have necessary protection for exit of investment. A put option is often chosen as a contractual exit mechanism. It gives the foreign investor the right to sell its equity interest in certain events to a pre-agreed party, which can be the domestic bank itself, a shareholder or another third party. If the party obligated to purchase is a shareholder or another third party, the purchase constitutes a share transfer subject to verification by the People's Bank of China (PBOC) on the capacity and qualification of the transferee at the time of exercise of the put option. If it is the domestic bank that undertakes to redeem the equity interest, the redemption is limited by more legal constraints. Under the Company Law, redemption of shares is allowed only in two circumstances: reduction of registered capital and merger with another company, both having to comply with all the requirements for public announcements and consent of creditors. Therefore, redemption of shares under a put option would mean reduction of registered capital. For a domestic bank, this would be subject to the PBOC's approval at the time of exercise of the put option. It would be more difficult to obtain such approval where the redemption may cause the bank's capital adequacy ratio to fall below the statutorily required level.

Shareholder Information Disclosure and Takeover Rules Compliance

If the target domestic bank is a listed company, the foreign investment may trigger the CSRC requirement to file a report for shareholder. If the investment is large enough to give the foreign investor actual control in the listed domestic bank, it would constitute takeover under recent CSRC's takeover rules. Although a shareholding of less than 30% would not trigger the obligation to give a tender offer for overall takeover, the investor is required to file a detailed takeover report with the CSRC and the relevant stock exchange, and to make public announcements of the report and the takeover.

Regulatory Approvals

Foreign investment in a domestic bank is subject to the approval of the PBOC. Such approval is on a case-by-case basis since current PBOC rules still prohibit foreign investment in domestic banks in general. In practice, approval or consent by the State Council is also needed although no written approval or consent can be issued to the relevant parties to the transaction. If the investment involves transfer of state-owned shares, approval from the Ministry of Finance is needed, and independent evaluation of the shares to be transferred shall be made except for listed companies. The transaction would go to the CSRC for approval if the investment were in a listed bank, although the current laws and regulations do not require the CSRC's approval for transfer of shares in a listed company. It's interesting that currently MOFTEC seems to have no involvement in such kind of transaction, although according to a recent notice MOFTEC's approval shall be obtained even where the foreign shareholding is below 25%. This may be due to the specific nature of the banking industry. However, whether and how MOFTEC will be involved in foreign investment in a domestic bank after the said notice becomes effective is still subject to clarification of the relevant governmental authorities.

By David Liu and Richard Nie

Llinks Law Office

Shanghai