Due diligence is key for potential private investors in banks
March 07, 2011 | BY
Janice QuInvestment channels widened for private capital
Private capital will have more access to China's domestic banks, but investors need to be wary of hidden liabilities in target financial institutions. Potential investors should conduct comprehensive due diligence on tax and finance aspects of targets, say counsel.
The China Banking Regulatory Commission (CBRC) is committed to expanding channels for private investment into the domestic banking sector, and has raised the proportion of investment in rural financial institutions. Investors are also encouraged to participate in mergers and acquisitions of rural credit cooperatives. More investment avenues are expected to open, but legal specialists say it is difficult to predict exactly what and how.
For those intending to invest in rural banks or credit cooperatives, Beijing-based Dorothy Xing of Concord & Partners cautioned that “the main risks are hidden liabilities of target enterprises”. Examples
of these risks include financial indebtedness, bad loans, government fines, and overdue taxes.
Another danger is that corporate governance in rural enterprises is “relatively weaker” than those in big cities. “A thorough financial and tax due diligence is needed to effectively control these risks,” said Xing. “It is also necessary and important to promptly and effectively communicate with local government.”
Xing also noted a type of “unique liability” in China. It is common to see enterprises in rural areas where individual employees hold company shares. There
is a limit on the percentage of shares
held by the employees in total and typically it should be no more than 20%.
“Those shares could be owned by several hundreds of employees,” said Xing. “However, if you considering an onshore initial public offering as your capital exit, this could become a barrier because the regulator caps the number of individual shareholders to 200.”
Current regulation allows private investors to be shareholders in no more than two banks and they are subject to a lock-up period of five years. They are allowed to purchase a maximum 20% stake in rural credit cooperatives.
However, private investors need to fulfill certain criteria, including having a solid finance standing and a good credit record. They have to be able to show a capacity for capital replenishment in the long term. JQ
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