CITIC’s mezzanine initiative still veiled in secrecy

Industry participants searched for confirmation on what, if true, would be China’s first-ever mezzanine vehicle.Little information has been forthcoming. The fact that CITIC Private Equity was even planning a fund of this nature only leaked out when Zhonghong Real Estate disclosed in a filing with the Shenzhen Stock Exchange that it would invest RMB100 million in the vehicle.

The information void has been filled by speculation. One private equity source tells AVCJ that the introduction of mezzanine financing – which some dub “sandwich financing” because it falls between a senior loan and an investment’s equity – could “signify the Chinese government’s wider vision of developing a new loan system.”

There is clearly demand for such services. Concerned about consumer and asset price inflation, China has tightened credit supply in recent months, focusing on real estate in particular. According to the country’s central bank, domestic lenders issued RMB551.6 billion in new loans in May, down from RMB739.6 billion in April. Mezzanine players could feasibly meet the needs of developers struggling to raise capital to complete construction projects. They have played much the same role in Australia, Singapore and Japan.

 “CLSA MezzAsia has done a number of transactions in China, mostly through dual onshore-offshore structures, in light of the prevailing lending restrictions,” says Stephane Delatte, managing director of CLSA Capital Partners’ Mezzanine Fund. He adds that formal onshore mezzanine finance is still a new to China,  but it could gain traction as funds rush to supplement existing offshore vehicles.

Regulatory restrictions

Although a number of mezzanine funds – managed by firms such as CLSA, Asia Mezzanine Capital Group, Darby Asia and Development Partners – are active in the market, direct mezzanine finance in real estate investment is prohibited in China. Instead, funds must be channeled through a joint venture structure that is part onshore and part offshore.
A similar approach is taken to China’s ban on intercompany loans.

According to Joel Rothstein, partner at Paul Hastings, a bank acts as an intermediary between two companies and the loan is packaged as an entrustment loan. Rothstein believes that, through careful structuring, mezzanine lenders could expand their role. For example, a mezzanine fund could lend money through the acquisition of shares in the borrower; the transaction is linked to a put option that requires either the company or an alternative entity to buy back the shares that the mezzanine company acquired.

“The pricing of the shares can build in a return of principal plus a specified return, which is basically interest,” says Rothstein.

This system would open a new liquidity channel for local financiers and investors, but it isn’t likely to create inroads for offshore mezzanine specialists. Joseph Ferrigno III, managing partner of the AMCG Partners, says more should be done in this respect, especially given the scarcity of bank credit, rising interest rates and limited access to public equity markets in China and abroad “Mezzanine financing is a highly effective solution to obtaining growth and buyout capital for Chinese businesses,” he says.

Onshore vs. offshore

The principal obstacle is that the absence of a transparent and legally watertight mechanism for issuing debt offshore to companies whose assets are within mainland China. Fix that and Rothstein expects a flurry of deals. “We have a number of clients who would like to make short-term bridge loans and other strategic investments via debt in Chinese projects, but the regulatory environment for such cross-border investment in real estate is too prohibitive at this time,” he says.

As it stands, CITIC’s purported mezzanine fund is far too veiled in secrecy to give concrete indications of how – and how quickly – the industry might develop. If and when it emerges, it could be bound up by such a tight investment mandate that it doesn’t operate as a mezzanine fund in the traditional sense. Alternatively, it could be a one-off effort devised by a manager who has identified a niche.
“China has simply too much money, so raising a renminbi fund is easy no matter what the fund type,” one LP concludes. 

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• Topics
• Regulation
• Financing
• Greater China
• Mezzanine
• CLSA Capital Partners
• Darby Asia Investors