Site icon China Economic Review

New approval hurdles for project finance

After several dismal years, 1996 was a year of change for project finance in China. Several major projects were launched with strong government support and well-publicised promises not to interfere. In 1997, hopes are high that Beijing will allow international project finance on a greater scale, in order to meet its ambitious infrastructure construction targets.

Coping with the unknown
Predictably, one consistent complaint amid the optimism is the lack of a regulatory framework. To date, China has issued regulations which cover some of the components of project financing arrangements, including the provision of loans by the People's Bank of China to foreign investment enterprises, a general law on the granting of security and measures guiding specific guarantee arrangements. There is also one set of guidelines for build-operate-transfer projects — the Notice Concerning Several Issues Relating to the Examination, Approval and Administration of Trial Foreign Investment Concession Projects.

On the ground, however, foreign participants have had to work hard to close the gaps between disparate legislative cues. Often they have been unsuccessful, as Beijing's tinkering with risk distribution has had wholly uncommercial results. During the early 1990s, for example, the government attempted to impose a cap of roughly 12 per cent on the rate of return from projects in China's power sector. The result was transactional gridlock, as foreign investors and financiers alike baulked at so low a return. For several years, only those projects which were small enough to avoid the attentions of the central government ministries had a chance of surviving until signing. Nevertheless, the National People's Congress in '1995 affirmed that China would seek to add roughly 15,000MW of installed capacity to its national grid during each year of the Ninth Five-year Plan (1996-2000). Similar discrepancies exist in other infrastructure sectors.

Signs of change
Despite China's pressing need for further investment in its infrastructure, the government still aims to preserve its control over foreign exchange and other sensitive areas of finance. China appears to be working a change by withdrawing direct commercial controls, such as rate of return caps. It would be wrong to think that the market is now unrestricted. But if Beijing is prepared to offer returns that reflect risk accurately, the investment may be forthcoming. All of the major export credit agencies (ECAs), with the marked exception of US Exim Bank, seem to be accepting the new terms of China's project finance programme since the rate of return issue has been deferred. The willingness of the ECAs to back projects without express guarantees on return is being touted as evidence that a new phase has begun in China's investment programme.

Setting the future pace
New administrative checks are contained in the Provisional Measures on the Administration of International Project Finance. The measures will apply to the whole of the project finance sector, not simply to individual types of projects or select industries.

Some of the checks are built into the definition of project finance. As described in the measures, project finance projects will have the following characteristics:

* lenders shall have no recourse to assets or revenues outside the project
* domestic entities shall not mortgage, charge or use for debt repayment any assets, rights, interests or revenues outside the project
* domestic entities shall not provide any form of guarantee or other security for the financing.

A number of additional items must be included in the feasibility study for any project finance project. They include:

* the qualifications of the principal project investors and parties to project contracts, and the principles of risk allocation
* the method of balancing foreign exchange and the amount required during the operational period
* the basis for setting the price for project products or services and the formula for price adjustments.

In all cases, the project financing conditions will be subject to review by the State Planning Commission and the State Administration of Foreign Exchange (SAFE). Review by SAFE requires a special set of documents, including the financing agreement. Major projects must also be reviewed by the State Council.

Finally, the measures state that once the project is approved and the project company established, the company will be responsible for all activities in connection with the financing. The project financing itself should be completed within one year after the feasibility study report has been approved.

The measures also stipulate that all project finance projects should be competitive in nature. Whether this means that all such projects will need to incorporate formal competitive mechanisms remains to be seen. What is certain is that project developers will need to take special care in drafting their proposed financing arrangements. Loan details will be scrutinised by approval authorities to ensure that the lending terms sought compare with, or are favourable to those common in China and international markets.

It is hoped that such measures do not turn into a backdoor method for reintroducing caps on returns to foreign investment. If they do not, and if the measures do not result in excessive bureaucracy for foreign project investment, China's future infrastructure needs will have a better chance of being fulfilled.

Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For further details, contact Matthew Cosans through its offices in Hong Kong, tel: (852) 2846 3400 or Beijing, tel: (86) 10 6465 4795.

Exit mobile version