Covering the bases in financing via corporate debt instruments

In order to guard against risks, the central government requires local governments to control and oversee the scale of issued debt, but relevant information shows that the issuance of debt by local governments and enterprises has not been markedly affected by this. For qualified enterprises, financing through the issuance of debt remains the low-cost fundraising method of first choice. The types of enterprise financing available include super and short-term commercial paper, small and medium enterprise collective notes, short-term financing bills, medium-term notes, directional instruments, asset-backed notes, project revenue notes as well as financial bonds issued by financial institutions. This column will mainly discuss corporate bond financing and related issues that require particular attention in terms of law, such as information disclosure.

Innovation in financing methods

The project revenue notes introduced by the National Association of Financial Market Institutional Investors have created the conditions for the financing of single projects. The term “project revenue note” means a debt financing instrument offered on the interbank bond market by non-financial enterprises, the proceeds of which are used for project construction and the operational cash flow derived from the project serving as the main source of funds to repay the debt.

As compared to traditional debt financing instruments, the mechanism design of project revenue notes adopts several innovations. The product design, based on the project itself, creates a good financing environment for the financing of the project company. The product offer period covers the entire life of the project from construction to operation and reaping of the benefits, fully considers the matching with the project cash flow recovery schedule, thereby smoothing out, with the aid of the financial market, the mismatch between the revenue and expenditure periods of urban construction projects and allowing the enterprise to formulate a reasonable repayment plan based on the project schedule.

Project revenue notes can effectively guard against the fiscal and financial risks that come with the traditional financing platform model, having a positive effect on progressively channelling and neutralising existing hidden financing platforms or local government debts. In order to further increase the debt financing product types available to non-financial enterprises, consideration could, in future, be given to expanding project revenue note issuers from urban construction enterprises to other enterprises in general industries, and using such instruments to support the construction of projects that have sustainable and stable non-fiscal operating revenues, e.g. transportation junction projects, toll roads, bridges and tunnels, hydropower and gas projects, etc. The note term could cover the entire life of the project, and the cash flow generated by the operations of the project itself could serve as the main source for repaying the debt.

Bond issuance practice

In 2014, the National Association of Financial Market Institutional Investors issued the Business Guidelines for Non-Financial Enterprise Project Revenue Notes on the Interbank Bond Market, and formally commenced accepting the registration of the project revenue notes issued by enterprises on the interbank bond market. On the very day the guidelines were issued, the association accepted registration of the project revenue notes of Zhengzhou Jiaotou Dikun Industrial in the amount of RMB1.2 billion (US$195 million), with a proposed initial offering of RMB500 million.

From this it can be seen that many enterprises are actively developing financing channels, and in keeping a close watch on the policy directions of the policy authorities can successfully raise funds. In the face of the development trends in international bond markets, the central government should, while protecting the interests of investors, actively innovate in bond products. The issuance of rules and regulations by relevant authorities, such as Announcement [2014] No. 8 of the People’s Bank of China and the China Banking Regulatory Commission, have had a positive impact on the issuance of financial bonds.

Complying with requirements

With respect to an issuer issuing short-term financing bills, if lawyers fail to duly perform their verification obligations during the early due diligence of the issuer, or in issuing their legal opinions, the association may deal with the firms and personnel that breached the self-regulation rules by taking such measures against them as giving a warning, calling them for an admonitory lecture, publicly censuring them, etc. When assisting an enterprise in its financing efforts, special attention should usually be paid to the enterprise’s repayment capacity and, to guard against the possibility of the occurrence of an event that could have a material impact on the issuer’s repayment capacity, relevant undertakings should be put in place in strict accordance with the requirements of the investor protection mechanism.

Where a financial institution is issuing financial bonds, its capital adequacy ratio, single customer financing concentration, single group customer financing concentration, single customer degree of connection, entire degree of connection, single shareholder degree of connection, interbank lending ratio and fixed return securities investment ratio should be in compliance with regulatory requirements.

Other matters

Likewise, the lawyers should review the qualifications of the credit rating agency and accounting firm engaged by the issuer, and check whether the service personnel of the intermediary firms have been subjected to relevant penalties. Other material legal matters relating to the issuance of short-term financing bills include: the balance of the issuer’s financing bills to be repaid; the purpose of the proceeds of the current offering; details of the governance of the issuer; details of the issuer’s business operations; details of the issuer’s encumbered assets (bank loans, details of the issuer’s mortgaged assets and details of the issuer’s pledged assets); contingent matters of the issuer (details of security provided by the issuer for connected parties and details of security provided by the issuer for third parties); the issuer’s pending lawsuits (arbitration), material undertakings and other contingent matters; details of any material restructuring of the issuer’s assets; details of the enhancement of the issuer’s credit and other issues requiring explanation. Lawyers should appropriately investigate the same to avoid legal risks.

Li Yunhai is a partner at Zhonglun W&D Law Firm