Robert here, writing from sunny Sunny Isles Beach, Florida, where my wife and I call home when I am not traveling in Asia and the Middle East. After being abroad 10 of 12 weeks, it is nice to be here.

I would like to take this opportunity to briefly introduce our readers to a recent and important development in the China M&A market. In the midst of all the doom and gloom in Asia, with the global downturn most definitely reaching the Asia shores in the past few months, there has been a very positive development in China M&A regulations, a development that could dramatically increase M&A activity in the not too distant future.

Although M&A activity in China has seen a big surge over the past decade, government regulations have prevented M&A numbers in China from reaching the full potential in the market. However, on Dec. 6, the China Banking Regulatory Commission (CBRC) took steps to correct some significant limitations, by issuing the Guidelines on Risk Management of Acquisition Loans of Commercial Banks. These allow for the first time commercial banks incorporated under PRC law to make loans to companies for the purpose of M&A transactions, including equity and assets of target companies. This potentially opens the door to leveraged buyouts in China. These new guidelines, in large part, reverses the General Principles of Loans, put into effect in 1996, which forbid onshore banks to provide loans for purposes of a borrower’s equity investments in acquisition transactions.

However, only “strong” commercial banks, defined as those with at least 10 percent capital adequacy, will be able to make such loans. Among other requirements, the CBRC will also require such M&A loans to not have terms of more than 5 years; M&A loans cannot be more than 50% of the net core capital of the bank; a good risk management and internal control mechanism; and adequacy ration of loan loss provision being 100%; and the buyer and the target company must be highly related in business and strategy.

These new guidelines will likely not lead to a surge in leveraged buyouts in China in the very near future, but it is an important step, in that companies can now take loans for M&A activity within a legal structure, rather than doing such in a gray area.

According to Zhan Xin, partner of Global Law Office, quoted in a recent article by Chinalawandpractice.com, “This is a groundbreaking rule and should be listed as one of the most important rules issued by CBRC to date. It opens the door to a new banking area and will have a tremendous impetus to the structuring and execution of M&A deals.”

However, the CBRC’s guidelines do not contain specific regulations and thus banks may move cautiously on such new M&A loans, at least until there is more specific guidance from China. According to Paul Hastings’ Maurice Hoo, quoted in a recent ALB article, “The [guidelines] are less formal than ‘measures’ or ‘regulations’, but given who CBRC is, banks are not inclined to test what might happen to them if they violate the guidelines. As such, various compliance officers of Chinese banks have indicated to us banks won’t be rushing out to make M&A loans until there is some form of reconciliation between the PBOC [People’s Bank of China] principles and CBRC’s guidelines… Still, these guidelines signal that the Chinese government is keen to move China in line with the rest of the world in M&A. It won’t mean an overnight move into leveraged buyouts, but given that companies have less access to capital markets these days, loans can provide the capital that a company will need to build itself into an industry leader. The Chinese government has always been focused on domestic consolidation and creating national leaders, so these guidelines will give [domestic] companies an important tool.”

Although it is not yet clear on lending for the purpose of overseas acquisitions, the CBRC has stated that M&A lending would be overhauled to support overseas acquisitions if the number of outbound M&A transactions by Chinese companies grows.

Many experts believe that commercial banks in China will be able to play a more significant role in the market once they feel comfortable taking advantage of these new CBRC guidelines. Further, companies in China, especially state owned, will be able to pursue consolidation and undergo international expansion.

In a future posts, we will get back to you with a much more detailed analysis of the potential and actual affect of these guidelines. However, it appears from initial conversations we have had with a handful of senior M&A US attorneys, based in China, there is a lot of cautious optimism.

As China’s government takes steps to curb the slowing economy there, many in the legal industry are cautiously optimistic that there will be a continued loosening of various restrictions that have been in place on deal flow in China, which could of course bode very well for the market when the economy picks up again.