The New CBIRC Regulations on Finance Lease Companies: Tightening up the Control?

Background

The establishment and ongoing activities of Financial Leasing Companies in China (金融租赁公司 in Chinese) is tightly regulated, within a dedicated regulatory regime not unlike that which applies to the banks who typically own them (hence, for convenience, referred in this article as bank-owned financial leasing companies or BFLCs), with oversight from the China Banking and Insurance Regulatory Commission (CBIRC).   

The robust regulatory requirements on BFLCs fall into three categories:

• restrictions around the establishment of BFLCs;
• liquidity support obligations of their promoters/founders and shareholders; and
• risk-management and reporting obligations of BFLCs.

Many aviation banks and financiers who finance BFLCs find comfort in this regulatory oversight, and the regime often forms the basis for credit approvals for transactions involving the BFLCs.

The regulatory oversight over general leasing companies, often known as finance lease companies (FLCs) has recently fallen into a regime that has been less well-defined.

In the past, FLCs were regulated by the Ministry of Commerce. However, in April 2018, all FLCs were brought under the supervision of the CBIRC, leading to much speculation as to a unification of the regulatory oversight of both BFLCs and FLCs. 

On 26 May 2020, the CBIRC issued the Interim Measures for the Supervision and Administration of Finance Lease Companies (the FLC Measures), with immediate effect. The CBIRC has taken this important measure to define more clearly their expectations as to compliance by FLCs with the aim and goal of ensuring the smooth and orderly development of the finance lease business since the supervision function on FLCs was transferred to the CBIRC.

Here, we share insights into Chinese leasing companies, prospective financiers of FLCs and the aviation industry on the potential impact of the new regulation, and draw comparisons to the regulatory regime which apply to the BFLCs as against what is proposed for the FLCs.

It is to be hoped that FLCs may take this opportunity to review their business operations from a future-proof and sustainable perspective.

It is also the authors’ view that these reforms will be unlikely to affect the regime currently applying to the BFLCs, although, conceptually, there may be some convergence over time.

New Measures Are Expected to Bring More Steel to the Balance Sheets of the FLCs

More stringent regulatory indicators introduced

The FLC Measures specify more robust financial supervision indicators, guiding FLCs to focus on their main business and sustainable development, such as:

The ratio between lease assets and total assets: the proportion of finance lease assets and other lease assets of an FLC must not be less than 60% of its total assets. This means that FLCs are explicitly required to take finance lease and other leasing businesses as their core business. FLCs with a ratio lower than 60%, due to higher proportion of non-leasing business, will be asked to clean up their company's main business mix as soon as possible by an accelerated exit from non-core business, and shift their focus to finance leases and other leasing businesses. For “lending dressed up as a leasing” activity, the FLC Measures can also be seen as an encouragement for the finance lease industry to return to its core business.

The ratio between risk capital and net assets: the FLC Measures state that the total risk capital of a leasing company may not exceed eight times its net assets, which significantly deviates from the ten times ratio under the Measures for the Supervision and Management of Finance Lease Enterprises issued by the Ministry of Commerce (MOFCOM) in 2013. We believe this may help to control financial risks, but also have a great impact on the FLCs engaged in aircraft leasing. Given that the Chinese government is considering controlling financial risks of the FLCs, no doubt this will impose greater restrictions on the business development of many FLCs. In order to meet the regulatory requirements, some FLCs will be under pressure to exit certain businesses they are currently engaging in. They may also need to consider increasing their net assets by capital increase or stock issue in order to maintain their existing business scale.

The ratio between investment in fixed income securities and net assets: the FLC Measures stipulate that fixed-income securities investment of an FLC may not exceed 20% of its net assets. We believe the 20% limit will have some impact on those leasing companies with large cash flow, but will not have a significant impact on most leasing companies.

It can be seen from these regulatory requirements that the CBIRC is trying very hard to guide FLCs to concentrate on their core leasing business in an orderly and prudent operation.

In comparison, while BFLCs are not subject to the above financial supervision indicators, they must adopt a more sophisticated system, similar to the classic risk-based loan classification used by commercial banks in China.

Customer concentration and correlation: the FLC Measures require FLCs to strengthen the management of key lessees and control the proportion of a single lessee and related-party lessees to prevent and diversify operational risks. FLCs must comply with the following regulatory indicators:

• single-client financing concentration: the total finance lease balance of a single lessee of an FLC must not exceed 30% of the net assets of that FLC;
• financing concentration of a single-group client: the total finance lease balance of a single-group client of an FLC must not exceed 50% of the latter’s net assets;
• single-customer correlation: the total balance of the finance lease business of a connected party to an FLC may not exceed 30% of the net assets of the latter;
• all correlation: the finance lease balance of all connected parties of an FLC must not exceed 50% of the net assets of the FLC;
• single-shareholder correlation: the finance lease balance of a single shareholder of an FLC and all the connected parties of that shareholder must not exceed the shareholder’s capital contribution to the FLC, and the requirements of single-client correlation under the FLC Measures must also be satisfied.

It should be noted this is the first time that regulatory indicators of business concentration for FLCs have been introduced. Also, the “single-client financing concentration”, “financing concentration of single-group client” and “single-customer correlation” indicators are applicable to BFLCs. Moreover, the CBIRC has introduced more stringent governance rules on related-party transactions to ensure the prudent operation of BFLCs.

We believe this will have a big impact on those aircraft-leasing companies with a high concentration of high-quality airline customers, or those who are overly dependent on their affiliated companies or group companies to grow their business. This is relevant to those captive or quasi-captive leasing companies that mainly serve the needs of their group companies, as such internal service functions will be weakened and they will face more intense market competition. These leasing companies need to review their current customer mix and business concentration percentage, customer correlation ratios, and single-shareholder correlation in their current business operation as soon as possible. It is arguable, though, that the single-client financing concentration ratio only applies to finance lease business, but not to operating lease business. However, those FLCs who focus mainly on operating leasing may not be worse off as a result of the new regulation.

With the FLC Measures now officially promulgated, the affected FLCs should complete their business transformation within the prescribed transition period. It is envisaged that some FLCs could be under pressure to adapt to such change. 

To a certain extent, the regulation will not only bring the motivation and opportunities to explore new markets to leasing companies with a single type of customer, but will impose higher requirements on business development.

Other new requirements and measures

New risk management metrics introduced: the FLC Measures imposed, for the first time, requirements on FLCs to establish proper risk-management systems for the valuation and pricing of leased assets, residual value, credit enhancement, asset disposal, etc.

New prohibited business operation: with regard to business scope, in addition to the existing prohibition of financial services such as illegal fundraising, taking deposits, offering loans, and interbank lending, the FLC Measures specifically state that FLCs are not allowed to seek financings or asset transfers through such channels as online lending intermediaries or private equity funds. It is notable that the officially published text does not seem to restrict FLCs from seeking financings or asset transfers with other market participants. This could give FLCs some reprieve with their financing and asset disposal.

"Shell" company clean-up: the FLC Measures define “uncontactable” and “shell” FLCs as leasing companies with irregular operation and missed regulatory filings for extended periods, thus requiring local financial regulatory authorities to ensure that these irregular or non-compliant leasing companies make rectifications. It is expected that a large number of companies without substantial business operations will be cleaned up or asked to be wound down voluntarily. Such clean-ups and rectifications have been carried out in various other parts of China.

Therefore, FLCs operating as a group company are advised to check the business operations of their subsidiaries, and take the initiative to communicate their business conditions with local market regulatory authorities and financial regulatory authorities to avoid being inadvertently included in the list of "uncontactable" or "shell" companies. Where a group company does have a shell company, it should evaluate the purpose of maintaining such a company as soon as possible, and either re-activate it with live finance lease business or wind it up. However, considering the robust regulation expected in the future, FLC licences may become very valuable; it will be advantageous for the leasing company to make the maximum use of such a scarce resource from a business perspective, and to unlock its commercial value.

Devolved supervision authority and risk allocation: instead of setting a “one-size-fits-all” regulatory standard that is applicable nationwide, and to cater for the need for the development of FLCs in each province (especially in less developed regions), the CBIRC has granted local provincial governments the authority to adopt implementing rules according to their own actual supervision situation. In addition, local deviation from the FLC Measures in matters such as the scope of leased assets, concentration ratio and correlation ratio is permitted as long as it is reported to the CBIRC. However, this could also be seen as a strong signal that the Chinese central government is attempting to “ring-fence” risks associated with FLCs within each province and to shift the responsibility to contain or resolve such risks to local governments.

Transition period arrangement: given that the FLC Measures have introduced many new regulatory requirements, the CBIRC will provide a transition period of up to three years for the implementation of the new regulations. FLCs established prior to the implementation of the FLC Measures must comply with the FLC Measures within the transition period stipulated by the provincial financial regulatory authorities. In addition, provincial governments may extend the transition period beyond the three-year deadline if they deem necessary.

Conclusion

The FLC Measures have demonstrated a trend of robust regulation of the finance lease industry and risk aversion. Compared with the previous Measures for the Supervision and Administration of Finance Lease Enterprises (FLC for Comments) issued by MOFCOM, the FLC Measures have imposed more stringent regulatory requirements for FLCs and their businesses. It is the Chinese government’s preference to use FLCs to help finance SMEs who are otherwise unable to access conventional bank credit.

As previously mentioned, a number of new regulatory indicators are being formulated with reference to those for financial leasing companies established by the banks. However, unlike the BFLCs (where the capital adequacy ratio required of BFLCs is 8%, very similar to a commercial bank), there is no capital adequacy ratio requirement for the FLCs. This shows that FLCs are still treated as junior-league players, whilst BFLCs are regarded as more systematically important.

In the future, regulation of finance lease companies may gradually move closer to the regulatory model of BFLCs when the Chinese central bank and the CBIRC tighten their grip on the banking system.

Early insight and action into legislative trends will not only ensure compliant operation of the FLCs, but will also help them to improve their business management, seize market opportunities, improve their overall quality of business operations, and achieve new market breakthroughs ahead of the potential industry change.