REGULATIONS
Leasing Opportunities in China
April 20, 2006
Derek Soper, Principal, The Alta Group

The leasing market in China is not fully developed but is moving rapidly. The rate of growth means it is a market that cannot be ignored, but the key decision for new entrants to the market is choosing a quality Chinese partner.

Pace of Change in China's Regulatory Environment
China's gross domestic product is one of the fastest growing globally and the country's accession to the World Trade Organisation is one of the focal points for the development of the legal, regulatory and business environment that will enable the development of leasing. The pace of change in China is exciting great interest among vendors of all types of equipment. The emerging leasing market is now setting out its stall to serve those vendors. Additionally, the major Chinese manufacturers of equipment, now selling into the rest of the world, will need support for sales financing. The leasing potential is enormous.

In China, legal changes and revisions continue at a pace, catching up with practices that the Western world has lived with and developed over many years in order to govern the increasing sophistication of our financial markets. At the end of 2004 there was an announcement that securities houses would be allowed to use stock as collateral for loans - a change in the law that has been required to allow growth, but one which has been in existence for some time in Western economies.

Just to demonstrate how difficult these matters are to handle and the complexity of decision making, the announcement came from no fewer than three governing bodies in a joint statement - the People's Bank of China, the China Banking Regulatory Commission and the China Securities Regulatory Commission. Even then, the new regulations carry some severe health warnings of dos and don'ts.

What this serves to show is that the financial markets, including leasing, are not yet fully developed but are, nevertheless, moving quickly. Interest among Western lessors has, and is, primarily driven by customer pressure, particularly vendors of equipment. They reason that if they give good quality profitable business to a financial partner in America or Europe, then they expect that partner to support them in some of the more difficult but growing markets in the rest of the world. Not an unreasonable request, one might say. The two main markets where we have seen these pressures in recent times are Russia and China, both huge growth markets with their own difficulties, but very different.

Interest in China manifested itself among American leasing companies in a recent trade mission to China arranged by the US Equipment Leasing Association. Ten companies were represented and they visited Beijing, Shanghai and Hong Kong. They had a gruelling schedule and met with government agencies, local leasing associations and the normal American ports of call such as the US Embassy and the American Chamber of Commerce. Overall, the general consensus was that the Chinese leasing market is sufficiently complex that taking the time to learn the rules will pay in the long term.

Those companies that have decided to enter the market are doing so with a mixture of Western and local management. Local recruiting is becoming more difficult as there is a shortage of experienced staff. Some movement of leasing professionals from Hong Kong and Singapore is boosting the market and confirms the importance that entrants are placing on their comfort levels with local management.

A saying that underlined much of the caution came from a recent European entrant to the market. He said: "Our contribution to the joint venture is the sourcing of good quality vendor business and our Chinese partner's contribution is the knowledge of whether we can collect our rentals or not." Much of the leasing growth is being driven by leasing companies who are following their major vendor relationships, as well as vendors either with or without local partners.

Domestic and Foreign Leasing Companies
There are two types of domestic leasing companies. The first are the financial leasing companies approved by the People's Bank of China. Their businesses are mainly in the areas of capital finance and medical and aircraft leasing. The other types of leasing companies are those that do not need the approval of the PBOC and can engage in financial or operating leasing. Most have concentrated on capital finance but are now moving into operating leasing.

There are also two types of foreign leasing companies: foreign leasing joint ventures, which need to be approved by the Ministry of Commerce, whose foreign investors are mainly from America, Europe and Japan; and wholly foreign-owned enterprises.

China is currently subject to a double regulation system with the following regulatory bodies:

• The China Banking Regulatory Commission, which regulates the banking industry and non-bank financial institutions. Financial leasing companies organised as non-bank financial institutions are therefore regulated by the CBRC.
• The Ministry of Commerce. Foreign invested leasing companies are established with the approval of, and are regulated by, the ministry.

Legislation is currently being drafted to regulate financial leasing and put it under the control of the Ministry of Commerce. When implemented, probably around 2007, the law will be the first covering the industry. Currently, China's Contract Law has some provisions about financial leasing but that is insufficient to keep up with the rapidly growing leasing industry.

Under new rules, which took effect on 5 March 2005, foreign investors are permitted to set up fully owned renting or leasing companies in China. Before that date they had to establish joint venture or co-operatives with Chinese counterparts. The capital threshold for financial leasing for foreign investors has been lowered from a minimum registered capital of $20m to $10m, which has to be fully paid up at the commencement of operations.

Success in China is dependent on steering the correct course among the cultural differences that exist between the joint venture partners. Importantly, Western lessors' dependence on balance sheet strength and borrowing ratios is not paramount in China. Important factors to note are that the use of corporate or personal guarantees is virtually unknown; the law is unclear on ownership and repossession; enforcement is a major issue; it is difficult to assess credit; and information on residual values is deficient.

New entrants who may wish to take a cautious approach to entry into the China market should consider a company such as Daye International Leasing Co. (Daye Leasing), a joint venture leasing company in Beijing, which offers a leasing platform. Daye Leasing will underwrite the deal on behalf of leasing companies and subsequently discount it on a non-recourse basis. In this way, Daye Leasing becomes a virtual leasing company in China for those seeking to enter the market. Joint name marketing can take place, the injection of one or two staff, the ring fencing of a portfolio; in short, all the ingredients for establishing a leasing company in the future when comfort levels have been achieved.

Critical mass is important. For those companies seeking to have a vendor programme in China, Daye Leasing will only consider portfolio sizes of a minimum of around $20m. Minimum size average deals should be in the range $120,000 to $150,000.

Where Chinese manufacturers are looking for sales financing to export their products, opportunities are arising for the establishment of joint ventures in America and Europe. Transaction size is not an issue for vendors seeking to import Chinese goods.

For investors considering dipping their toes in this exciting market, the important advice is: find a quality Chinese partner, take your time and get to know them well. Make the investment, not only in cash terms, but also in recruitment and training and proceed with caution. The sheer scale of the opportunities means that China cannot be ignored and, regardless of the various hurdles, presents an irresistible opportunity. Those companies that take the plunge today will be ahead of the pack and for the sceptics; a change of heart in a few years time will be a costly exercise.

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