Accessing Chinese solutions for mining clients

Accessing Chinese solutions for mining clients financial institutions ENERGY infrastructure AND COMMODITIES Transport technology

Accessing Chinese solutions for mining clients A NORTON ROSE GROUP GUIDE NOVEMBER 2010

Accessing Chinese solutions for mining clients

Contents 06 Introduction 07 China Export & Credit Insurance Corporation (SINOSURE) 10 Accessing Chinese bank/eca facilities 15 Resource M&A transactions involving Chinese investors 24 Enforcement issues when dealing with Chinese counterparties 35 Observations on dealing with Chinese entities 46 Norton Rose Group: track record 53 Contacts

Accessing Chinese solutions for mining clients Introduction Norton Rose Group has been regarded for many years as having one of the leading legal practices servicing the mining sector. The mining sector was one of the hardest hit by the credit crunch. Share prices of corporates plummeted as a result of a mixture of drops in commodity prices and the absence of debt for further mine developments. As is usual in such situations the market has simply adapted. We have seen a massive increase in the number of export credit agency (ECA) financings supported by Chinese banks. Further we are now seeing a real increase in the number of acquisitions of existing mining businesses or stakes therein by Chinese State Owned Enterprises. Given the fact that we have one of the leading China practices this has led to a huge increase in the number of China mining mandates. We are delighted to say that we have a dedicated China mining team. Not only do we act for multinationals on China related matters but we also act for the Chinese counterparts on international deals. This we believe gives us a particular insight into the new world. The scale of our China mining practice has expanded when Deacons Australia joined us, from 1 January 2010. Our combined teams will offer our clients added insight and expertise. At the request of clients and contacts we have pulled together a series of articles intended to provide a framework within which to assess options for non-chinese clients. Again we believe it is the only guide of its kind focused on accessing Chinese capital for mining. In tandem with this guide we have provided a seminar on this topic. For those that feel they would benefit from further information we are happy to offer discrete training on all matters related to mining and accessing Chinese finance. 06 Norton Rose Group November 2010

China Export & Credit Insurance Corporation (SINOSURE) China Export & Credit Insurance Corporation (SINOSURE) SINOSURE is the official export credit agency of the People s Republic of China (PRC). It was established in 2001 and took over roles previously filled by People s Insurance Company of China and The Export-Import Bank of China (C-EXIM). C-EXIM still has a significant role however, it is not an official ECA, but is regarded as a policy bank providing support (in the form of direct funding) to the economic/political policies of the PRC. It was not until 2003 that SINOSURE began writing policies covering classic ECA export risks commercial credit risk and political risk. Like many ECAs the bulk of SINOSURE s business is in short term support for Chinese exports, however its medium and long term underwriting has grown substantially over the years and exponentially over the last 12 months all very much in line with the Chinese government s stimulus package for the economy. SINOSURE has representative offices and branches across China and it is to the local office that the Chinese exporter will usually address its initial request for cover. A foreign project company seeking SINOSURE support for its project due to, for example, the involvement of a Chinese equipment supplier/epc contractor, will need to access SINOSURE through its financial adviser or the relevant Chinese equipment supplier/ EPC contractor the foreign project company will not itself have direct access. This application process is typical of access to other ECA cover. Requests for medium and long term SINOSURE cover are processed through the head office in Beijing and are subject to approval by the Ministry of Commerce (MOFCOM) for cover in excess of USD30 million and by the State Council for cover in excess of USD100 million. Discussions with SINOSURE are usually begun by the Chinese equipment supplier/ EPC contractor and taken up by the bank arranging the credit facility. There is usually little or no contact with the foreign entity. China is not a participant in the OECD gentlemen s agreement on official support for export credits (the Consensus) but SINOSURE is nonetheless represented at the Berne Union and complies with the Consensus. Norton Rose Group November 2010 07

Accessing Chinese solutions for mining clients SINOSURE provides up to 95 per cent cover for political risks and has traditionally limited commercial risk cover to 50 per cent, however in the current market there is now some flexibility in the level of cover for commercial risks. The percentage of cover is run against the amount of the contract value which SINOSURE is able to support ie, up to 85 per cent of the total contract value, in common with other ECAs. SINOSURE cover is available for both Chinese and foreign banks who meet certain criteria (including a track record in export credits), although the foreign bank must have a branch in PRC (a representative office is not sufficient). As with all export cover SINOSURE cover is only available in support of exports of the host country ie, Chinese goods and services. This can be a flexible concept but the Chinese content should be at least 70 per cent of the value of the export contract/project. The greater the Chinese connection to the project (in terms of economic interest for the PRC), the better the chance of obtaining cover and MOFCOM/State Council approval. It is preferable for the purposes of obtaining SINOSURE cover that the export contract/project should generate a supply of strategically interesting products or natural resources for China. However, we should note that the existence of a Chinese offtaker would not typically by itself satisfy the conditions for SINOSURE cover of debt into a project, irrespective of the value of that offtake contract the cover is really in place to assist export of goods/services from China. However, assuming the requisite level of goods/services were supplied into a project, such an offtake would no doubt assist the likelihood that SINOSURE will be interested in providing cover in relation to such a project. Further, SINOSURE may be more willing to provide cover in relation to a project if there is an element of Chinese equity investment involved, in view of the stated policy of the PRC to promote and ensure acquisitions of interests in foreign assets, particularly strategic resource assets. It is important to appreciate the global strategic interests of the PRC and the relative position of any contractor and any export contract/project in the hierarchy of those interests. 08 Norton Rose Group November 2010

China Export & Credit Insurance Corporation (SINOSURE) Although obtaining an initial response on underwriting from SINOSURE can be relatively quick within a week of SINOSURE receiving a complete file the full process can get very bogged down as the underwriting request is processed through MOFCOM, and even more so if it has to go to the State Council. The process can take between 3 and 6 months to complete. The length and relative opacity of the process form the basis of negative comments about dealing with SINOSURE. However, SINOSURE has made significant progress in both transparency and turn around times (barring the MOFCOM/State Council process). As a state policy institution SINOSURE is subject to directions given to it by MOFCOM. New directions apply to cover which SINOSURE has conditionally approved but which have not become the subject of binding policies, and can also apply retrospectively. Late last year SINOSURE began to require that all buyer credits be supported by a guarantee preferably a state guarantee and for private sector buyers a parent company guarantee. More recently (April 2009) MOFCOM has required that Chinese banks should hold a majority of any funding supported by SINOSURE. In current market conditions accessing either SINOSURE cover or C-EXIM funding is a possibility that few can ignore. SINOSURE has significantly expanded its capacity to underwrite transactions and has upgraded its country risk analysis and its country limits. Moreover it has experienced a huge surge in demand for its services and it struggles to keep pace. Norton Rose Group November 2010 09

Accessing Chinese solutions for mining clients Accessing Chinese bank/eca facilities We have set out below a generic set of questions and answers, which address some of the key issues that sponsors may focus on in seeking to understand their ability to access Chinese bank/eca support for a mining project. Clearly this article provides only a summary overview of these points and further issues/detail may need to be investigated or discussed in relation to any specific transactions. Although we refer to The Export-Import Bank of China (C-EXIM) as an ECA, we should clarify that C-EXIM is not strictly an ECA but a state owned policy bank through which official support is provided on terms that closely follow the OECD guidelines on export credits; SINOSURE is the only official Chinese ECA. 1. What level of Chinese bank/eca facilities are offered? Is there any limit? Can a commercial loan amount be larger than the portion covered by an ECA guarantee? Chinese commercial banks are willing to provide both covered and uncovered facilities, although typically Chinese funding of commercial loans (particularly from a single lender) on a single project will be either ECA covered in full or fully uncovered, rather than partially covered and partially uncovered. There is no absolute fixed limit to the facility amount when accessing funds from Chinese institutions. However, there are certain limitations on the amount of cover which can be obtained from Chinese ECAs. In common with all other ECAs, Chinese ECA cover is limited to an amount equal to 85 per cent of the relevant export contract value, and the 15 per cent contribution/down-payment from the project company is typically required as a condition precedent to loan disbursement/ guarantee provision. This 85 per cent threshold is set by the OECD guidelines on export credits, although currently there are many temporary 10 Norton Rose Group November 2010

Accessing Chinese bank/eca facilities rules in place that have allowed ECAs to cover higher percentages and broader categories of eligible goods. Although the level of guarantee cover provided by ECAs usually varies between 90-100 per cent (of both political and commercial risk), for single asset project finance SINOSURE can only provide up to 50 per cent commercial risk cover (although for corporate transactions it can also provide up to 95 per cent political risk cover). These percentages of cover are calculated against the amount of the contact value which SINOSURE is able to support ie, up to 85 per cent of the total contract value. However as more and more ECAs take measures to increase the percentage of cover that they can offer, we would expect SINOSURE to follow suit and become a much more influential source of cover in this respect this is certainly the mandate from the Chinese State as it seeks to develop its strategic macro-economic interests. For deals over a certain size (and the thresholds are both increased from time to time as the state widens SINOSURE s mandate, and are also to varying degrees relaxed depending on the strategic importance of the project to be financed), SINOSURE requires separate approval from the Ministry of Commerce (MOFCOM) and/or the State Council. These approvals can take a long time to be issued, however the SINOSURE underwriting department is capable of giving a qualified response (subject to such approvals) within a week of receiving a complete submission. 2. What might one expect as the debt/equity ratio? 80:20 is a typical debt:equity ratio. 3. In what currency will the loan be denominated? What is the base cost of funds? Loans from Chinese institutions may be denominated in any currency. Domestic lending is denominated in renminbi (RMB) but almost no cross- border lending has been done in RMB (although the possibility of cross-border RMB trade settlements and funding has recently become available). The vast majority of cross-border lending is in US$, based on a LIBOR base rate. Norton Rose Group November 2010 11

Accessing Chinese solutions for mining clients C-EXIM direct funding to suppliers is typically tied to the currency of the relevant export contract (typically US$). 4. In what currency will the supplier/contractor be paid? As noted above, in cross-border transactions, the supplier/contractor will typically be paid in the currency of the relevant supply/epc contract (whether through commercial bank or C-EXIM funding). For domestic transactions, RMB may be used unless the relevant supplier/contractor is a foreign entity requiring payment in foreign currency. 5. Is the supplier/contractor paid directly by the Chinese bank? Typically Chinese bank funding will be made available direct to the supplier/contractor (following a drawdown request by the borrower), unless it is to be used to re-fund the borrower for payments already paid to the contractors/suppliers. Drawings require a supplier s/contractor s disbursement request to support a borrower s drawdown request. 6. Must all deals have a Chinese offtaker? If there is no Chinese offtaker what security is required? Do Chinese banks look for onshore security over mining rights/charges over payment accounts? In what instances might a parent company guarantee be required? It is not strictly necessary to have a Chinese offtaker, although the State banks prefer (and the ECAs require) some form of Chinese component to the deal, whether this be a Chinese offtaker, equipment supplier or EPC contractor. The security requirements of Chinese banks are much softer than typical Western bank financing, as Chinese banks often take the view that, particularly in relation to emerging economies, there is very limited value to onshore security, due to enforcement hurdles. Asset security is typically not required for any ECA covered portion of the debt. Typically a project company parent company guarantee will be required, although this can be negotiable. 12 Norton Rose Group November 2010

Accessing Chinese bank/eca facilities 7. Is it traditional for Chinese banks to look for hedging of commodities? Unlike typical international financings of mining projects, Chinese banks do not usually require any commodity hedging. 8. Is there a standard form of facility documentation? Is it LMA based? There is no official standard form documentation which Chinese banks work to, however each bank tends to have its own standard form which is an LMA based form. The documentation is becoming ever more Westernised /LMA based, particularly on international syndicated transactions as China becomes more involved in international crossborder transactions. Indeed, we are currently building a precedent for China Development Bank (CDB) using Asia Pacific Loan Market Association (APLMA) precedent wording. SINOSURE policies have become standardised they have general terms and a schedule that sets out the specifics of the transaction that is covered although some negotiation is possible. International syndicated loans may be governed by English or other foreign law, however large bilateral deals tend to be documented under Chinese law. SINOSURE requires arbitration as the dispute resolution forum. 9. Are loans structured on the basis of a payment cascade as per international project finance? No. Loans are structured on more simple corporate lending terms. 10. Will Chinese banks instruct their own technical adviser or is all technical due diligence done in-house? Are the usual pre-feasibility and feasibility reports required for Chinese finance into a mine? Typically the level of technical due diligence required by Chinese banks is more limited than that carried out by Western banks, and is done in-house rather than by appointing external advisers. Often the banks internal personnel will visit the relevant mine and agree the commercial deal as the technical due diligence is carried out on-site. Legal documentation may also be drafted and negotiated simultaneously Norton Rose Group November 2010 13

Accessing Chinese solutions for mining clients with this site visit. Full pre-feasibility and feasibility reports are not typically required the Chinese banks adopt more of a high-level approach to the technical due diligence. 11. What Chinese approvals are required? Other than internal authorisations (eg, credit committee/board approval), the relevant approvals for enabling Chinese bank/eca funds to be injected into projects are (depending on the size of the facility) MOFCOM and State Council approvals. 14 Norton Rose Group November 2010

Resource M&A transactions involving Chinese investors Resource M&A transactions involving Chinese investors The surge in overseas investment by Chinese companies (both state owned enterprises (SOEs) and, increasingly, private companies) looks set to increase again. The total amount invested by Chinese companies offshore in 2008 reached US$52.15 billion, and the Chinese government s recent confirmation on 21 July 2009 of its intention to use China s huge foreign exchange reserves to support and accelerate overseas expansion and acquisitions by Chinese companies means that this year outward investment could exceed inward investment for the first time. In particular, SOEs in the oil and natural resources sector have accelerated their search for overseas investment opportunities to take advantage of depressed share and commodity prices around the world. This is in keeping with Chinese officials views that the deployment of foreign exchange reserves should focus on the natural resource sector in order to fuel China s domestic growth. Non-Chinese mining companies will be aware of the current opportunity to raise money through Chinese investors, and this article looks at some of the issues which they will be faced with when trying to secure PRC equity funding. An understanding of the issues involved, including the increased significance of due diligence for SOEs and the regulatory framework within which the parties must operate, will increase the likelihood of successfully completing a deal. Due diligence The prevalence of Chinese SOEs in the resources sector means that resource companies seeking to secure a Chinese investment should be prepared for a substantial due diligence process. Whereas the ready availability of cheap government finance, and the drive to secure resources, can mean that SOEs will be more willing to commit to the broad terms of the agreement at an early stage, they will almost certainly be obliged to present a comprehensive study of the investment to the Chinese governmental authorities when they seek approval for the investment and when they arrange their finance through Chinese banks. Norton Rose Group November 2010 15

Accessing Chinese solutions for mining clients Resource transactions are often complex in nature and will involve a broad range of legal issues, including local mining regulations. Therefore, in order to assist a potential investor in understanding the key features of the target s business and the legal framework in which it operates, the target should anticipate the areas in which the potential investor is likely to be interested, and make initial preparations that will allow it to respond with the required information in a timely and rational manner. Many SOEs will appoint investment banks and legal advisers to assist them with: investment analysis and modelling issues tax issues structuring advice project implementation and completion and due diligence. Given the complexity of dealing with SOEs, these teams require significant diplomatic, legal, analytical and commercial skills to bring a transaction to a successful conclusion. Preparatory due diligence issues At the initial preparatory stage, the target should, in conjunction with its advisers: prepare a comprehensive virtual data room draft an introductory memorandum on the project and relevant documentation (including details regarding the history of the project/ target and background/reputation of the management teams) 16 Norton Rose Group November 2010

Resource M&A transactions involving Chinese investors be prepared for significant Q&A put in place a comprehensive confidentiality agreement and ensure all documents can be disclosed prepare a summary of local applicable mining laws and have mining data and analysis ready for scrutiny. Legislation mining law One of the primary areas of concern for a potential investor, and an area in which it is unlikely to have prior knowledge, is in relation to the local mining regulations of the jurisdiction in which the target conducts its mining operations. Building a team of advisers who can distil the applicable regulations and present them in a clear manner will be important for satisfying the requirements of the potential investor. The most efficient way to do this is perhaps for the principal legal advisers to engage local lawyers and other technical advisers, while retaining oversight of the entire due diligence process. This will ensure that the relevant local expertise is used and that it is harnessed and presented in a manner that will assist the potential investor in making its assessment of whether to invest in the target. Key issues for the local lawyers to address will include matters such as the precise ownership of the minerals, whether the State has a free carried interest in the target, whether there are any restrictions on the sale of the minerals and what approvals are required for granting mining rights. In addition to those matters, the potential purchaser will also be concerned with the specific mining regulations which provide the detail of the procedures regulating the local mining sector, such as the licences involved, financing issues, registration systems and environmental laws. Legislation relating to surface rights, foreign investment codes, state corporations, company law, localisation/empowerment laws, employment law, competition law and planning law will also need to be analysed. There is clearly potential for a vast amount of legislation to be drawn into the due diligence process for a resource M&A transaction. Norton Rose Group November 2010 17

Accessing Chinese solutions for mining clients The experience of the target s advisers is therefore invaluable as it will allow the most important areas to be anticipated so that information and responses can be provided as soon as practicable. The target will want to ensure that it does all that it can to progress the transaction as speedily as possible as the complexity of China s legal environment (discussed below) often slows the pace of cross-border M&A transactions with Chinese companies. An additional factor which can delay completion of the investment is the probable requirement of the key Chinese authorities that all of the conditions precedent to the investment being made, other than regulatory approval, are satisfied before they will even begin to seriously consider the investor s application for approval. Further, there may well be special legislation or policies that govern investments by SOEs in the target s own jurisdiction (eg, the Foreign Investment Review Board in Australia), so it is important for the target to ascertain the nature of the prospective investor at an early stage. These issues may well take time to resolve and must be considered in both the scope and timelines for the conditions precedent. Mining projects are generally subject to a significant number of contractual and statutory requirements, including mining tenement conditions, farm-in agreements, joint venture agreements and royalty agreements. On a mining transaction the most significant documents in due diligence will be the mining leases/licences. The forms of mining leases/licences will differ between jurisdictions in some jurisdictions most of the provisions are set out in the law, while in others the contract contains the bulk of the terms. In any event, the potential investor will need to be informed of certain matters such as the nature of the rights granted (whether this is a concession, a licence or some other right), what it entitles the holder to do, what its terms are and under what circumstances they may be terminated. Other agreements made by the target, such as management agreements, offtake agreements, refining agreements, contractor agreements, insurance and employment 18 Norton Rose Group November 2010

Resource M&A transactions involving Chinese investors agreements will all be of significance to the potential investor. The ability of the target to have accurate information available immediately upon request and in an orderly fashion will again assist in the speed and success of the due diligence process. It is clear that there is potential for the due diligence process to become a time-consuming matter for the target. One method of sharing the responsibility in this regard is to offer that legal opinions from the local law advisers be provided to the potential investor. This will mean that the matters covered by the opinions do not need to be addressed in due diligence. There will obviously be a limit on the range of issues which can be dealt with in this manner, however corporate issues such as the target s valid incorporation, good standing and share capital history, as well as confirming the validity of the mining licences involved, may be dealt with by the legal opinions. This can be a useful tool in reducing the scope of the due diligence process and should be considered at the outset of the transaction. The due diligence process will evidently be a significant issue for both the potential investor and the target. The potential investor, who in the context of the Chinese mining sector will most likely be a SOE, will need to conduct a thorough due diligence process, and the target will want to ensure that it does all it can to provide a smooth and speedy process in which the potential investor is equipped with the information it needs to gain the necessary approvals and make an investment in the target company. However, there will be other factors beyond the due diligence process which relate to the nature of transacting with a Chinese counterparty in this sector that will be an issue to the target, and which the target will need to be prepared for in order to promote the success of the transaction. Norton Rose Group November 2010 19

Accessing Chinese solutions for mining clients Approval procedures for Chinese companies investing overseas Virtually all overseas investments by Chinese enterprises will require government approval in China before they are able to be completed. The level and extent of those approvals is largely governed by the level of the investor if, as is often the case with significant investments in the resources sector, the investor is a SOE, and by the value of the investment. Further approvals may be required according to the particular circumstances of the investment. For example, an investment in a uranium mining company may need additional approvals from the Ministry of Science and Technology. Often the key factor is not whether a particular investment will be approved, but rather how long that approval might take, and what conditions may be imposed upon the approval. The target company needs to be pro-active in understanding the impact of the Chinese approval regime on a prospective investment. There is nothing to be gained by relying on the investor or its advisers to include these approvals in the conditions precedent. Regardless of the contractual legal rights of the parties, the Chinese investor cannot, nor will it, proceed without all the necessary approvals. China s best known international enterprises, such as Sinopec, Sinosteel, Baosteel, Minmetals and CNOOC, are all under the supervision of the State Assets Supervision and Administration Commission (SASAC). SASAC was established to hold the Government s interest in those enterprises and operates, in effect, in the manner of the majority shareholder in listed companies elsewhere. It does not generally interfere in the daily operations of the enterprise, nor make commercial decisions for them, but it does have the power to hire and fire the enterprises senior executives, and it does monitor major investments. As a matter of prudence, we would usually include SASAC approval as a specific condition precedent in any significant investment by a major Chinese enterprise. Interestingly, the Chairman of SASAC, Li Rong Rong, recently described legal risk as the single most important challenge for Chinese enterprises investing overseas. We have been invited by Deputy Chairman Li Wei to present a series of training seminars to SASAC s managers and enterprises on managing legal risk in difficult jurisdictions. 20 Norton Rose Group November 2010

Resource M&A transactions involving Chinese investors The approval of the National Development and Reform Commission (NDRC) is usually the determining factor in satisfying Chinese government requirements. If NDRC gives its approval, then the other Chinese authorities are likely to follow. Enterprises will usually lodge preliminary applications with NDRC, and will often engage in lengthy discussions with the enterprise, but as a rule NDRC will not make a final decision until all government and other approvals in the target s jurisdiction have been granted. The target should factor in a delay of at least three months for NDRC approval. Ministry of Commerce (MOFCOM) approval is also usually required. Recent amendments to MOFCOM regulations have eased the burden of approvals somewhat, but it remains a necessary step in the case of most investments. Detailed information is available on this process in the article accessed via the address below. http://www.nortonrose.com/knowledge/publications/2009/pub20434.aspx MOFCOM is becoming increasingly interested in reviewing both inbound investment into China and outbound investment from China, particularly in the context of the recent changes to the anti-monopoly regime in China. Further detail can be accessed via the address below. http://www.nortonrose.com/knowledge/publications/2008/pub17463.aspx Finally, approval from the State Administration of Foreign Exchange (SAFE) will be required for the transmission of foreign currency funds out of China by the investor. This is usually the last step in the approval chain. There are no clear criteria for obtaining SAFE approval, although our experience is that if a full set of approvals has been obtained from NDRC, MOFCOM and SASAC then it is a straightforward process to obtain SAFE approval. Further detail can be seen in the article accessed via the address below. http://www.nortonrose.com/knowledge/publications/2009/pub22209.aspx Norton Rose Group November 2010 21