Guidelines for Risk Management by Commercial Banks of Loans Extended for Mergers and Acquisitions

We have formulated the Guidelines for Risk Management by Commercial Banks of Loans Extended for Mergers and Acquisitions in order to regulate the extension by banks of loans for mergers and acquisitions (M&A Loans), enhance banks' capacity to manage the risks attaching to M&A Loans, strengthen the support given by the banking sector to adjusting the economic structure and optimising the allocation of resources, maintain steady and relatively rapid economic growth and promote sectoral integration and industry upgrading. We hereby issue the Guidelines to you and notify you concerning relevant matters as follows:

1. Commercial banks with legal personality that satisfy the following conditions shall be permitted to engage in the M&A Loan business:

(1) sound risk management and effective internal control mechanisms;

(2) an adequacy ratio of not less than 100% for the reserve dedicated for loan loss;

(3) a capital adequacy ratio of not less than 10%;

(4) a general reserve balance of not less than 1% of the balance of loans during the same period; and

(5) a dedicated team for conducting M&A Loan-related due diligence investigations and risk assessments.

Before launching its M&A Loan business, a commercial bank that satisfies the foregoing conditions shall, in accordance with the Guidelines for Risk Management by Commercial Banks of Loans Extended for Mergers and Acquisitions, formulate appropriate M&A Loan business procedures and internal control systems and implement the same after submission to the regulatory authority.

If, after the launch of its M&A Loan business, a circumstance arises that prevents a commercial bank from continuing to satisfy the conditions set forth above, it shall cease to handle new M&A Loan business.

2. A commercial bank shall intensively and thoroughly put in place an objective development outlook, actively and soundly engage in the M&A Loan business in line with the principles of lawfulness, compliance, prudent operations, controllable risk and commercial sustainability, and satisfy reasonable merger and acquisition financing demand on the basis of building a comprehensive framework for managing M&A Loan risks and the effective control of loan risks.

3. CBRC agencies at every level shall strengthen their oversight of the M&A Loan business of commercial banks, regularly conduct onsite inspections and offsite oversight and if a commercial bank is found not to satisfy the conditions for engaging in the M&A Loan business, to have violated relevant provisions of the Guidelines for Risk Management by Commercial Banks of Loans Extended for Mergers and Acquisitions or to not be able to effectively control M&A Loan risks, they may, in accordance with relevant laws and regulations, take regulatory measures such as ordering such commercial bank to suspend its M&A Loan business.

Banking regulatory bureaux are asked to transmit this Circular to urban commercial banks, rural commercial banks, wholly foreign-owned banks and Sino-foreign equity joint venture banks in their jurisdictions.

Guidelines for Risk Management by Commercial Banks of Loans Extended for Mergers and Acquisitions

PART ONE: GENERAL PROVISIONS

Article 1: These Guidelines have been formulated pursuant to laws and regulations such as the PRC Banking Regulation Law and the PRC Commercial Banking Law in order to regulate the M&A Loan business of commercial banks, enhance the capacity of commercial banks to manage M&A Loan risks, promote fair competition in the banking sector, enhance the competitiveness of the banking sector and safeguard the lawful and sound operation of the banking sector.

Article 2: For the purposes of these Guidelines, the term “commercial bank” means a commercial bank with legal personality established in accordance with the PRC Commercial Banking Law.

Article 3: For the purposes of these Guidelines, the term “mergers and acquisitions” means transactions wherein the acquiring enterprises in China effect a merger or obtain de facto control of an established and operating target enterprise by way of an acquisition of existing equity, subscription for additional equity, acquisition of assets, assumption of liabilities, etc.

A merger or acquisition may be effected by an acquiring party through a wholly-owned or controlled subsidiary (Subsidiary) that is established expressly for the purpose of the merger or acquisition and that engages in no other business activities.

Article 4: For the purposes of these Guidelines, the term “M&A Loan” means a loan extended by a commercial bank to an acquiring party or its Subsidiary for the purpose of paying the moneys for the merger or acquisition transaction.

Article 5: A commercial bank engaging in the M&A Loan business shall comply with the principles of lawfulness, compliance, prudent operations, controllable risk and commercial sustainability.

Article 6: A commercial bank shall formulate an M&A Loan business development strategy, which shall include but not be limited to setting forth the objective of development of the M&A Loan business, the scope of the client base for its M&A Loan business and its main risk features and the bearable limit on the risks attaching to the M&A Loan business.

Article 7: A commercial bank shall, in line with the principle of management intensity greater than that for other types of loans, establish appropriate M&A Loan management systems and a management information system and ensure that the business procedures, internal control systems and management information system can effectively identify, weigh, monitor and control M&A Loan risks.

PART TWO: RISK ASSESSMENT

Article 8: A commercial bank shall assess M&A Loan risks on the basis of a comprehensive analysis of the various risks attaching to mergers and acquisitions, such as strategic risks, legal and compliance risks, integration risks, business risks and financial risks.

If a merger or acquisition involves a cross-border transaction, the commercial bank shall additionally analyse the country risks, exchange rate risks and the risks inherent when funds cross borders.

Article 9: When assessing strategic risks, a commercial bank shall, from the perspective of the industry prospects, market structure, business strategies, management teams, corporate cultures and shareholder support of the parties to the merger or acquisition, analyse, without limitation, the following:

(1) the degree of complementarity of the industries of and the degree of correlation in the strategies of the parties to the merger or acquisition, as well as the synergies that may arise;

(2) the chances that the parties to the merger or acquisition may derive additional returns from their strategies, management, technologies and market integration, etc.;

(3) the anticipated strategic successes and the source of the dynamism for corporate value increase after the merger or acquisition;

(4) the probability that the new management team will achieve its strategic objectives after the merger or acquisition;

(5) the speculative nature of the merger or acquisition and countermeasures for controlling the attendant risks; and

(6) if the synergies are not realised, the risk control measures or withdrawal strategies that the acquiring party may take.

Article 10: When assessing the legal and compliance risks, a commercial bank shall analyse, without limitation, the following:

(1) whether the parties to the merger or acquisition have the qualifications to be entities to merger and acquisition transactions;

(2) whether, based on relevant provisions, the merger or acquisition transaction has been or will be approved, and whether registration, announcement and other such necessary procedures have been or will be carried out;

(3) whether laws and regulations place restrictions on the source of funds for the merger or acquisition transaction;

(4) whether the legal structure of the security is lawful and valid and whether the necessary statutory procedures have been carried out;

(5) whether the borrower's control of the cash flow for repayment is lawful and compliant;

(6) whether the lender's rights are accorded effective legal protection; and

(7) other compliance aspects relating to the merger or acquisition or the financing or legal structure of the merger or acquisition.

Article 11: When assessing the integration risks, a commercial bank shall, without limitation, analyse whether the parties to the merger or acquisition have the capacity to realise synergies through the integration of the following:

(1) their development strategies;

(2) organisations;

(3) assets;

(4) business; and

(5) human resources and cultures.

Article 12: When assessing business and financial risks, a commercial bank shall, without limitation, analyse the following:

(1) the major business risks that the enterprise will face after the merger or acquisition, e.g. whether industry development and market share will remain stable or experience growth, whether corporate governance will be effective, whether the management team will be stable and whether it has sufficient capabilities, whether the technology is mature and can enhance corporate competitiveness and whether financial management will be effective, etc.;

(2) the future cash flow of the parties to the merger or acquisition and the degree of stability thereof;

(3) the risk that the pricing of the target equity (assets) is higher than the rationally-estimated value of the equity (or assets) of the target enterprise;

(4) the dividend distribution strategies of the parties to the merger or acquisition and the impact that they have on the source of the funds to be used to repay the M&A Loan;

(5) the fixed-return instruments used in the merger or acquisition and the impact that they have on the source of the funds to be used to repay the M&A Loan; and

(6) the impact of changes in factors such as exchange rate and interest rate on the source of the funds to be used to repay the M&A Loan.

Article 13: On the basis of a comprehensive analysis of the various risks attaching to an merger or acquisition, a commercial bank shall establish a prudent financial model, and estimate the M&A Transaction parties' future financial data and the key financial leverage and debt service capacity indicators that will have a material impact on the M&A Loan risks.

Article 14: On the basis of the financial model estimates, the commercial bank shall fully consider the impact of various adverse circumstances on M&A Loan risks.

The aforementioned adverse circumstances shall include but not be limited to the following:

(1) during the repayment period, the business performance of the parties to the merger or acquisition (including cash flow) fails to remain stable or show a growth trend;

(2) the governance structure of the parties to the merger or acquisition is unsound, or their management teams are unstable or incompetent;

(3) after the merger or acquisition, the synergies between the acquiring party and the target enterprise fail to materialise; or

(4) an affiliated relationship exists between the acquiring party and the target enterprise, in particular, the acquiring party and the target enterprise are both controlled by the same de facto controller.

Article 15: On the basis of a comprehensive assessment of the M&A Loan risks, a commercial bank shall arrive at an overall determination of whether the borrower's source of funds for repayment is sufficient, whether there is a match between the repayment source and the repayment schedule, whether the borrower is capable of paying the loan interest and principal in accordance with the contract, etc., propose countermeasures or a withdrawal strategy that it can take in the event that the quality of the M&A Loan declines, and come up with a loan assessment report.

PART THREE: RISK MANAGEMENT

Article 16: The balance of all the M&A Loans of a commercial bank shall not account for more than 50% of its core net capital for the same period.

Article 17: A commercial bank shall, on the basis of its M&A Loan business development strategy, establish an appropriate limit control system for M&A Loan concentration classified respectively by individual borrower, enterprise group and industry category.

The balance of a commercial bank's M&A Loans to one borrower shall not account for more than 5% of its core net capital during the same period.

Article 18: M&A Loans shall not account for more than 50% of the fund sources for a merger or acquisition.

Article 19: In general, the term of an M&A Loan shall not exceed five years.

Article 20: A commercial bank shall have a sufficient number of professional personnel familiar with relevant legal, financial, industry and other such knowledge that is appropriate to the scale and the degree of complexity of its M&A Loan business.

Article 21: A commercial bank shall strengthen professional management and control at each of the main stages of its M&A Loan business, including business acceptance, due diligence investigation, risk assessment, execution of contracts, loan disbursement, post-loan management, etc., and in its internal control system.

Article 22: The M&A Loan applications accepted by a commercial bank shall satisfy the following basic conditions:

(1) the acquiring party is operating lawfully and compliantly, has a good credit position and does not have a record of credit default, evasion of bank liabilities, etc.;

(2) the merger or acquisition transaction is lawful and compliant and, if matters such as state industrial policy, industry access, anti-monopoly considerations, state-owned asset transfer, etc. have a bearing thereon or are involved, the approval of the relevant authorities has been obtained and the relevant procedures have been carried out in accordance with applicable laws, regulations and policy requirements; and

(3) there is a relatively high degree of complementarity of the industries of or a relatively high degree of correlation in the strategies of the acquiring party and the target enterprise, and the acquiring party, through the merger or acquisition, will be able to acquire the target enterprise's research and development capabilities, key technologies and processes, trademarks, franchises, supply or distribution network and other such strategic resources in order to strengthen its core competitiveness.

Article 23: A commercial bank shall internally arrange for the formation of a dedicated team for due diligence investigation and risk assessment of M&A Loans to investigate, analyse and assess the information specified in Articles 9 to 15 hereof and produce written reports thereon.

The person in charge of the dedicated team mentioned in the preceding paragraph shall have at least three years' experience in mergers and acquisitions, and the members of the team shall include but not be limited to merger and acquisition experts, credit experts, industry experts, legal experts and financial experts.

Article 24: A commercial bank may, depending on the complexity, specialised nature and technical nature of a merger or acquisition transaction, engage an intermediary firm to conduct the relevant investigation and use such intermediary firm's investigation report when carrying out its risk assessment.

If the circumstance specified in the preceding paragraph applies, the commercial bank shall establish an appropriate intermediary firm management system and specify the intermediary firm's legal liability in a written contract.

Article 25: A commercial bank shall require a borrower to provide security, including but not limited to an asset mortgage, equity pledge, third party guarantee or other legally compliant form of security, sufficient to cover the M&A Loan risks.

In principle, the security conditions that a commercial bank attaches to an M&A Loan shall be more stringent than those attached to other types of loans. If security is provided in the form of a pledge of the target enterprise's equity, the commercial bank shall adopt a more prudent method to assess the value of its equity and determine the pledge ratio.

Article 26: A commercial bank shall prudently determine basic terms of the loan contract such as the loan amount, term, interest rate, repayment schedule and security method on the basis of the outcome of its risk assessment of the M&A Loan.

Article 27: The key terms that a commercial bank sets forth in a loan contract to protect the lender's interests shall include but not be limited to:

(1) terms constraining the major financial indicators of the borrower or the post-merger or acquisition enterprise;

(2) mandatory terms obliging the borrower to apply any additional cash flow obtained by it under specific circumstances to prepaying the loan;

(3) terms on monitoring the main or dedicated account(s) of the borrower or post-merger or acquisition enterprise; and

(4) undertakings by the borrower to ensure the lender's right to be informed of or approve material matters.

Article 28: A commercial bank shall, through the key terms specified in Article 27 hereof, specify the risk control measures it can take if any of the following circumstances should come to apply to the M&A Transaction parties:

(1) a change in a major shareholder;

(2) a change in a major investment project;

(3) an irregular change in operating costs;

(4) a material adverse change in brand, customers, market channels, etc.;

(5) the arising of a new material liability or security provided for a third party;

(6) a sale of material assets;

(7) a material change in the profit sharing strategy; or

(8) another material matter that affects the enterprise as an ongoing concern.

Article 29: In the loan contract, the commercial bank shall specify the drawdown conditions and terms relating to the payment and use of the loan. The drawdown conditions shall, at minimum, include conditions such as the full and successful raising of the funds that were to be raised by the acquiring party itself and the satisfaction of the compliance conditions of the merger or acquisition.

Article 30: A commercial bank shall specify in the loan contract that the borrower is under obligation, during the term of the loan, to regularly submit the financial statements of the parties to the merger or acquisition and the guarantor and other relevant information required by the lender.

Article 31: During the life of a loan, the commercial bank shall regularly assess the predictability and stability of the future cash flow of the parties to the merger or acquisition and regularly assess whether there is a match between the borrower's repayment schedule and source of funds for repayment.

Article 32: During the life of a loan, the commercial bank shall pay close attention to the performance of the key terms of the loan contract.

Article 33: A commercial bank shall carry out a risk classification and make provisions for M&A Loans at a frequency and at rates no lower than those for other types of loans.

Article 34: When an M&A Loan becomes non-performing, a commercial bank shall, in a timely manner, take risk control measures such as loan recall, preservation measures, disposal of the thing mortgaged (pledged) and taking over in accordance with the law the operations of the enterprise.

Article 35: A commercial bank shall specify the contents of, pathway for and frequency of internal M&A Loan business reports and conduct internal inspections and independent internal audits of the compliance of its M&A Loan business and change in asset values at least once per year and carry out a comprehensive assessment of its risk position.

In the event of a trend toward high concentration and down-grading of risk categories, etc. of M&A Loans, a commercial bank shall increase the frequency of internal reports, inspections and assessments.

Article 36: When the ratio of non-performing M&A Loans is on the rise, a commercial bank shall strengthen its reporting, inspection and assessment of the following:

(1) the method, constitution and loan principal and interest coverage of security provided for M&A Loans;

(2) the recall and preservation measures taken in respect of bad loans;

(3) disposal of pledged equity;

(4) the taking over of the operations of enterprises in accordance with the law; and

(5) the writing-off of non-performing M&A Loans.

PART FOUR: SUPPLEMENTARY PROVISIONS

Article 37: For the purposes of these Guidelines, the term “parties to a merger or acquisition” means the acquiring party and the target enterprise.

Article 38: The China Banking Regulatory Commission is in charge of interpreting these Guidelines.

Article 39: These Guidelines shall be effective as of the date of issuance.