Cross-Border Financing Report 2017: Hong Kong
Jamie Logie and Jonathon Hannah, Sullivan & Cromwell
SECTION 1: Market overview
1.1 Please provide an overview of the cross-border financing market in your jurisdiction.
As an international financial centre Hong Kong enjoys many advantages, not least its strategic geographical position as a major hub and gateway to Mainland China and its well-regarded common law legal system and independent judiciary. Its bank and bond markets are among the deepest, most liquid and most mature in the Asia-Pacific region, and operate under effective and transparent regulations which meet international standards. Bank liquidity through 2016/2017 has remained characteristically strong, with interest rates low, keeping syndicated loan volumes in Hong Kong at healthy levels despite turbulence in the global markets and the general slow-down in pan Asia-Pacific cross-border financing activity.
While the bank term loan market continues in general to feature lower leverage, higher amortisation and tighter maintenance-based covenants than the US term loan B market, practice in this area is gradually converging. US/European-style leveraged finance has also gained popularity, with market participants making increased use of leveraged finance structures such as covenant-lite loans and bridge to high-yield bonds for acquisitions. We have also seen a number of leveraged transactions incorporate LMA-style 'certain funds' (vs. US-style SunGard) terms, even in transactions based in markets more generally familiar with US practice (for example Latin America).
Hong Kong's largest banks in terms of total assets are HSBC and Bank of China (Hong Kong). Bank of China also led the 1H2017 mandated lead arranger tables for Asia (excluding Japan and Australia), with HSBC and DBS Bank taking joint second place.
1.2 What have been the key trends or developments in cross-border financing in your jurisdiction over the past 12 months?
Syndicated loan volumes across Asia-Pacific (excluding Japan) fell to a five-year low of $184 billion in 1H2017, weighed down by the slowdown in Chinese outbound M&A (which was the biggest driver behind the acquisition finance boom in 2016). Although M&A financing activity in Hong Kong was also constrained, an increase in the number of refinancing transactions helped ensure that loan volumes in the territory remained at healthy levels. We expect this trend to continue given estimates which point to high volumes of offshore PRC debt maturing in 2017.
The ever-closer ties between the Hong Kong and Mainland China financial systems and economies was another significant theme, with Hong Kong banks' Mainland China exposure rising to 29.3% of system-wide assets in March 2017 (up from 27.3% in December 2016). Fitch Ratings expects a further increase in lending to the Mainland in 2017 as tightening onshore liquidity conditions add incentives for Chinese companies to borrow offshore. Notably, Moody's Investor Services downgraded Hong Kong's credit rating from Aa1 to Aa2, following Moody's earlier downgrade of Mainland China's rating from A1 to Aa3, reflecting Moody's view that credit trends in Mainland China will continue to have a significant impact on Hong Kong's credit profile.
1.3 Have there been interesting changes in the structure of the banking sector in your jurisdiction?
While traditional banks remain the main providers of loan financings, the investor base is becoming increasingly diverse, particularly in the mezzanine/junior debt market where Chinese private equity sponsors and hedge funds have become regular participants.
On the regulatory side, the Hong Kong Monetary Authority (HKMA) has been designated the 'resolution authority' for Hong Kong's banking sector under the Financial Institutions (Resolution) Ordinance (Firo), which came into force in July 2017. Firo provides for a special resolution regime for systemically important financial institutions and gives the HKMA power to take a range of resolution actions in the event that an institution becomes non-viable.
SECTION 2: Financing structures
2.1 Briefly outline some recent notable transactions involving your jurisdiction, highlighting any interesting aspects in their structures and what they might mean for the market.
Stand-out examples from 2016/2017 include China National Chemical Corp's $12.7 billion bridge loan for the acquisition of Swiss agribusiness Syngenta AG and Tencent's $3.5 billion term loan and revolver for the acquisition of mobile gaming company Supercell Oy.
The Syngenta transaction was the largest ever foreign acquisition by a Chinese company to date. The Tencent transaction attracted oversubscription from a diverse group of lenders, signalling increased market interest in lending to support emerging market companies (for example in the tech sector) which are perceived to be growth companies.
2.2 Have there been any significant developments in the way cross-border financing transactions are structured or in the way borrowers and/or lenders are participating in the market?
We have seen a number of banks add mezzanine debt tranches to transactions where leverage for a senior portion exceeds 6x (up from 4x, the average limit a year ago). This is consistent with an observable increase in Hong Kong banks' willingness to accommodate loans at higher leverage and bullet repayments with minimal amortisation.
In the bond markets, the Hong Kong-China Bond Connect programme launched in July 2017, kicking off a new cross-border regime giving international investors streamlined access to the PRC's $9 trillion inter-bank bond market. Earlier in 2017, the Hong Kong government issued the first 10-year sukuk (Islamic bond) launched by an AAA-rated government, attracting $1.72 billion in orders. Long-term sukuk with a high credit rating is unusual in the international markets and by extending the yield curve to 10 years, Hong Kong set a new pricing benchmark for sukuk bonds (3.132%, or 68 basis points over 10-year US treasuries).
SECTION 3: Legislation and policy
3.1 Describe the key legislation and regulatory bodies that govern cross-border financing in your jurisdiction.
An entity which carries on a banking or deposit-taking business in Hong Kong must obtain a licence and become an authorised institution under the Banking Ordinance. Authorised institutions are regulated by the HKMA.
Any person other than an authorised institution that carries on business as a money lender (or who holds himself out as operating a lending business) must apply to a licensing court for a licence. Several exemptions are available in relation to this requirement, including loans to a company with a paid-up share capital of HKD1 million ($128,000) or more.
3.2 Have there been any recent changes to regulations or regulators that may impact the cross-border financing market and what impact do you expect them to have?
See 1.3 regarding the implementation of Firo in Hong Kong.
In Mainland China, a new nationwide macro-prudential management system for cross-border financings applies. Introduced by the People's Bank of China in May 2016, the rules introduce a new method for capping foreign debt incurred by PRC entities which is based on an assessment of their net value/capital and outstanding borrowings on a risk-weighted basis, rather than by reference to an annual quota issued by China's National Development and Reform Commission. The new regime is generally viewed as a liberalising move, which we expect will contribute to the increasing number of PRC entities accessing debt offshore, particularly in Hong Kong.
3.3 Are there any rules, legislation or policy frameworks under discussion that may impact lenders or borrowers involved in cross-border financing in your jurisdiction?
The Hong Kong Financial Services and the Treasury Bureau is preparing draft instructions for an amendment bill introducing a statutory corporate rescue procedure and insolvent trading provisions into Hong Kong law. The Bureau has indicated that it will introduce the bill to the Legislative Council in late 2017/2018, though the timetable for implementation remains unclear.
SECTION 4: Market idiosyncrasies
4.1 Please describe any common mistakes or misconceptions that exist about the financing market in your jurisdiction.
Since its return to Chinese sovereignty in 1997, Hong Kong has maintained its own independent legal system, protected under the Hong Kong SAR Basic Law, based on English common law and rules of equity. Participants unfamiliar with Hong Kong's One Country, Two Systems constitutional framework are sometimes surprised by the number of differences between Hong Kong and PRC law and practice and the level of independence of Hong Kong's judiciary. One example is in relation to the choice of governing law. Under Hong Kong law, parties to a contract are free to choose the law that governs that agreement (as long as the choice of law is legal, unambiguous, bona-fide and not contrary to public policy) and the Hong Kong courts will generally give effect to and enforce such agreements. Facility documents governed by New York or English law are therefore commonplace in Hong Kong.
4.2 Are there frequently asked questions or often overlooked areas from parties involved in cross-border financings in your jurisdiction?
We are frequently asked to advise on matters relating to the granting and enforcement of security. Common questions include: how security is taken over Hong Kong-incorporated/listed entities (generally by mortgage or charge, though this depends on the type of shares in question and whether they are publicly listed); and whether Mainland Chinese entities can provide security in respect of offshore financings made available to offshore debtors (generally yes, subject to PRC registration/reporting requirements and other restrictions on maximum leverage and use and repatriation of proceeds).
4.3 Are there any classes of assets over which security cannot be taken or regulations specific to your jurisdiction governing the taking of security over certain classes of assets that lenders should be aware of?
In general, security can be taken over any class of asset in Hong Kong. There are a limited number of statutory restrictions (for example in relation to assets of registered occupational retirement schemes).
4.4 What measures should be taken to best prepare for your market idiosyncrasies?
Hong Kong is a mature and highly sophisticated financing market. Participants familiar with UK/European practice should not find the market particularly surprising, though it is still important to obtain local advice, particularly where a transaction involves a PRC nexus. It is also useful to have some knowledge of market conditions and recent comparable transactions in order to secure the best pricing terms (which can vary by institution) and covenant package and to determine the optimal financing structure. Most bank loan documents negotiated in Hong Kong will be based on the standard forms recommended by the Asia Pacific Loan Market Association and/or the UK Loan Market Association, so familiarity with those documents is also beneficial.
SECTION 5: Practical considerations
5.1 Briefly explain the downstream, upstream and cross-stream guarantees available in your jurisdiction, with reference to any specific restrictions or limitations.
A Hong Kong-incorporated company may give upstream, downstream or cross-stream guarantees, provided that it is not restricted by its articles of association from doing so. In addition, it must demonstrate that it has requisite corporate capacity to enter into and derives sufficient corporate benefit from the transaction. For upstream guarantees and other transactions where the benefit to the guarantor is less obvious, it is prudent to obtain both board and shareholder resolutions of the guarantor approving the transaction.
Under the Companies Ordinance, a prohibition on financial assistance applies where a Hong Kong-incorporated company (or its subsidiary) gives financial assistance for the acquisition of its own shares (or those of its Hong Kong-incorporated parent). Part 5 of the Ordinance provides for three principal "whitewash" procedures which apply to both listed and unlisted companies, including one where the giving of financial assistance is approved by written resolution of all members of the company and supported by a solvency statement and resolution of its directors in favour of giving the assistance.
Additional restrictions may also apply to Hong Kong-listed companies under the "connected transactions" provisions of the Hong Kong Listing Rules.
5.2 Are there any specific issues creditors should be mindful of regarding a bankruptcy and restructuring situation?
There is no US Chapter 11-equivalent under Hong Kong law. The main collective winding up process is regulated by the Companies (Winding Up and Miscellaneous Provisions) Ordinance, which applies to solvent, insolvent, members' and creditors' voluntary winding up processes. While restructurings implemented by way of scheme of arrangement under section 669 of the Companies Ordinance are common, creditors should be aware that, in common with other jurisdictions such as the UK, this procedure lacks a moratorium on creditor actions and so is vulnerable to potential challenge from dissenting minorities.
Creditors should also note that a lender may not be able to enforce security for a loan against a defaulting debtor if it is found that the security constitutes a transaction at an undervalue or an unfair preference under the C(WUMP)O. Certain floating charges may also be invalidated under the C(WUMP)O, except to the extent that valuable consideration has been provided. Other restrictions on enforcement of security also apply under the C(WUMP)O and other Hong Kong legislation, including the Bankruptcy Ordinance.
5.3 Do foreign debt quotas apply in your jurisdiction and is offshore financing to domestic entities monitored?
5.4 Describe your jurisdiction's relationship with non-performing loans (NPLs), including volume of outstanding NPLs and techniques/challenges in managing them.
Despite a slight increase in NPL volumes in 2015/2016, the volume of loans overdue by three months or more end-March 2017 remained low at 0.66% of total gross loans according to HKMA statistics. Volumes are not expected to increase significantly in 2017, though a further slowdown in Chinese outbound activity could have implications on Hong Kong banks' asset quality risk, particularly given high average credit-to-GDP ratio and corporate sector leverage on the Mainland.
Credit risk is tightly managed by Hong Kong's banking institutions, who maintain stringent underwriting practices and operate under the close supervision of the HKMA in relation to both their Hong Kong and Mainland lending activities.
SECTION 6: Outlook
6.1 What are your predictions for the next 12 months for cross-border financing in your jurisdiction? How do you expect legal practice to respond?
Consistent with developments over the last 12 months, we expect further a steady growth in lending by Hong Kong's financing sector to Chinese state-owned enterprises, corporates and non-bank borrowers, which should lead to interesting opportunities for the legal profession. In particular, as Beijing's ambitious Belt and Road initiative gains momentum, we predict increased opportunities in 2017/2018 for Hong Kong as a hub for outbound Chinese financing activity in infrastructure and other investments across the Belt and Road regions. Practitioners who are able to provide creative and flexible advice across the full spectrum of financing options are likely to be in high demand, particularly in the infrastructure investment space, where cutting-edge project finance expertise will be of particular relevance.
About the author
Jamieson J Logie
Partner, Sullivan & Cromwell
Hong Kong, China
T: +852 2826 8688
F: +852 2522 2280
Jamie Logie is head of Sullivan & Cromwell's Asia-Pacific projects and English law finance practices, and has significant experience acting for developers, borrowers and lenders in various industries. Logie has more than 30 years of experience in international legal practice, all focused on project, asset and other finance and development work, including acquisition finance and restructurings. Logie's outstanding experience includes advising on the recent TCO $16 billion project financing for the expansion of its upstream operations at the Tengiz supergiant oilfield in Kazakhstan; the 2016 restructuring of Kenmare Resources' project and corporate financings for its Moma titanium project in Mozambique; the refinancing of the Dolphin Energy Project in Qatar/UAE; Australia Pacific LNG's $8.5 billion financing for its LNG facility in Queensland; the BTC pipeline project financing in Azerbaijan/Georgia/Turkey; a number of mining projects in Africa and Asia; several of the first wave of independent power projects (IPPs) in Southeast Asia; and various cross-border corporate financings and restructurings, including LG Philips' $2 billion joint-venture financing in Asia.
Logie has been recognised by numerous legal outlets and is described as "first rate, an excellent all-around advisor" (IFLR1000, UK, 2017).
About the author
Jonathon G Hannah
Special counsel, Sullivan & Cromwell
Hong Kong, China
T: +852 2826 8688
F: +852 2522 2280
Jonathon Hannah is special counsel at Sullivan & Cromwell, practicing in the Hong Kong office. Hannah covers the full breadth of finance work, including project financing, restructuring, corporate lending and acquisition finance. His experience includes financings in the mining, energy, petrochemicals and telecoms sectors in a wide variety of jurisdictions, including Australasia, Africa, the CIS and the Middle East. Hannah has represented developers, sponsors, banks and ECA in relation to some of the most complex and high-profile projects globally.
He is recommended in the 2016 and 2017 editions of IFLR1000 and the 2014 edition of The Legal 500 UK for his project finance expertise in the natural resources sector.