In spite of the global economic slowdown, the export-oriented feature of the Chinese economy has constantly been reinforced. With the volatility of currency exchange rates, there is a stronger desire for idle domestic capital to be converted into foreign capital. By setting up private funds, domestic, industrial and financial capital takes an active role in cross-border mergers and acquisition, and stimulates industrial integration on both a global and a regional basis.
Compared with foreign-raised private USD funds, the so-called RMB funds have international vision,and operating capability. They integrate profound government and industrial resources, and thus play an important role in transnational investments, and mergersand acquisitions. This article briefly discusses the application of RMB funds in cross-border investment and financing by analyzing some case studies.
Advantages of RMB funds in cross-border investment
For the domestic enterprises participating in cross-border investments for strategic reasons, RMB funds can help them overcome regional, financial, or operational limitations, and reduce the financial, legal and operational risks of cross-border investment.
Firstly, to complete large-scale mergers and acquisitions, domestic enterprises are often under financial pressure. If such enterprises can sign consortium agreements with one or more cross-border equity investment funds to make investments together, the financial risks of the investment can be greatly reduced.
Secondly, domestic enterprises lack practical experience in performing multinational operations and managing invested enterprises. Their lack of familiarity with this territory, as well as their lack of international vision is largely what causes difficulties in the operations after investment. Large RMB funds often focus on the financing, and mergers and acquisitions of specific regions or industries, and know well the operational procedures for making and maintaining investments. They always appoint directors or other senior supervisors to the board of directors, so as to assist the operation and grasp the company’s direction for development. Besides this, based on the principles of maximizing investors’ benefits, equity investment funds often emphasize strategic and financial matters before withdrawal, thus effectively improving corporate performance.
Thirdly, by utilizing standardized operational procedures, professional legal terms, detailed due diligence reports, globalized top-level investment banks, and legal resources, domestic enterprises can introduce RMB funds as strategic investors to effectively control the financial, legal and operating risks during foreign investments.
Fourthly, the supporting policies and supervising conditions for the overseas investment of RMB funds have been greatly improved. In particular, the Chinese government has been vigorously promoting the construction of free trade zones (FTZ) and opening a more effective channel for the overseas investment of RMB funds.
On August 19, 2014, Order No.3 of the Ministry of Commerce, Measures for Overseas Investment Management, established the new management model of "Primarily focusing on filing and secondarily on ratification" to further facilitate overseas investment. Relevant authorities in Shanghai have also formulated Managing Measures for Filing and Documenting the Establishment of Overseas Enterprises and the Managing Measures for Filing and Documenting Overseas Investment Projects for Shanghai’s FTZ. According to the regulations, so long as the overseas investment projects do not involve investments in sensitive countries and regions, and the amount of investment is less than 300 million US dollars, relevant enterprises can directly file an application for currency exchange with the State Administration of Foreign Exchange for overseas development after completing the project filing with relevant departments, such as the management committee of the FTZ.
The supervision of FTZs in the filing of overseas investment projects mainly focuses on technicalities, that is, whether the filing data is complete, whether the legal framework of the overseas investment complies with regulations, how relevant departments ensure supervisions during and after investment, and how to ensure that the exchanged currency flows into the filed projects rather than into other investments beyond the filing. However, the filing departments don't examine the framework and relevant clauses of specific project investments.
At the same time, compared to the previous examination and approval process of cross-border investment projects, the FTZ’s prevailing cross-border investment project filing and currency exchange system greatly simplifies examining procedures and shortens the time, thus facilitating the overseas investments of domestic enterprises and greatly speeding up the development of overseas investments. Based on this, the overseas investments using equity investment funds as a financial intermediary will eliminate supervision problems; more precisely predict the time of establishment and improve the efficiency and certainty of international investments.
Operation and Use of RMB Funds in Cross-border Investment
The financial and industrial logic of the cross-border investment of RMB funds is not different from that of the domestic investments in nature, as the following graph shows:
Simply speaking, one constructs the funding pool domestically and the asset pool beyond domestic borders. Not only should the local properties and legal environment of overseas target assets be taken into consideration, but also the supervising requirements of the flow of international capital. Based on this, the legal arrangements and risk control measures should be considered.
Taking cross-border equity investment as an example, the practical operations are to establish a private fund in China, and complete the filing of overseas investment according to domestic supervision policies, then incorporate a special purpose company in an offshore jurisdiction, and take such a company as the investment subject for purchasing the equity of target enterprises offshore.
Recently, we have directly participated in a case where the controlling shareholder of an overseas listed company was offered RMB funds for financing to complete the privatization, delisting, and spin-off listing of a target listed company. The private financing transactions had the following key points:
Firstly, the actual controller of an overseas listed company established the privatization plan, financing plan and transaction path. (Generally, when the share price is substantially undervalued, the investment banks help the controlling shareholder establish a privatization plan.)
Secondly, the controlling shareholders of the listed company reached agreements with the funds on the terms sheet of the financing plans.
Thirdly, fund managers set up private RMB funds through a public offer according to the financing scale determined in the financing plan in China, and dealt with the filing procedures of overseas investments according to domestic laws and regulations.
Fourthly, when the controlling shareholder increased its shareholding of the target listed company through bridge loans and triggered the fund subscription conditions, several domestic and overseas institutions (including this RMB fund in China) provided controlling shareholders with financing to complete the privatization and delisting by subscribing to the equity of the controlling shareholder's shareholding platform.
Fifthly, after the completion of delisting, the target company will carry out the spin-off and reorganization according to the strategic development objectives of the company, and then list it again on the Hong Kong or US stock market.
Lastly, as a strategic investor, private funds plan to continue to hold the shares of the newly listed company within a certain period after its listing, or to gradually exit. According to the financing arrangement reached by concerned parties, if the target company fails to complete the privatization, breaks the contract, or fails to complete the re-listing within a specified period after the privatization, the RMB fund will exit according to the agreed merger and acquisition contract.
Core terms of RMB fund in cross-border equity investment
The key terms of the investment transaction followed by RMB funds and invested enterprises strictly limit interested relationships, distribution of equity, capital injection conditions, investment supervision, and performance indices between the fund and enterprises. Such terms can be preliminarily classified into the following terms:
Firstly, equity ratio terms: such terms specify the investment amounts invested by the fund on the enterprise, equity procurement price, and corresponding equity ratio in detail. At the same time, to ensure that the equity ratio held by the fund is not diluted, generally we adopt preemptive rights, preemption rights, anti-dilution terms, or equity lockup terms to make sure the equity ratio enjoyed by the fund in the enterprise remains unchanged.
Secondly, corporate governance structure terms: such terms reflect in details the intervention of the fund in the operation and management of the invested enterprise after investment. For example, the funds may enjoy certain board seats, voting rights and decision-making participation rights, or veto power as to the decisions on particular matters specified in the investment agreement.
Thirdly, exit terms: the funds should take a full consideration of the exit mechanism of their investments. The exit methods include listing, transfer of agreement, repurchasing and liquidation. In the investment agreement, terms on repurchasing, repurchasing guarantee and consideration, co-sale rights, drag-along rights, liquidation preferences, and promises of invested enterprise may be arranged to ensure the effective exit of funds.
Besides, theterms sheet of fund investments should also establish particular terms in accordance with the project requirements, including but not limited to: preconditions on investments, arrangement of preferred shares and ordinary shares, share option schemes, and exclusive terms.
Senior partner of Jincheng Tongda & Neal (Shanghai) Law Firm, Senior Trust Finance and M & A lawyer. Master of Finance, Fudan University, Shanghai. Lawyer Xu has served as a member of the Real Estate Research Committee, Fund Research Committee and Trust Research Committee of the Shanghai Bar Association successively. Lawyer Xu is mainly engaged in corporate financial business, real estate financial business and offshore financial business and has been providing legal counsel services for a number of large-scale and medium-sized enterprises for many years.
Liu Dongming graduated from East China University of Political Science and Law with a Bachelor degree, and later received LLM from University of Minnesota in the USA. After joining JT&N in October 2014, Liu Dongming has undertaken various legal affairs on company securities, merger and acquisition, and trust. She also provides long-term legal consulting service for domestic companies.