(a) Is it more usual for the financing needs of these types of corporates to be satisfied out of capital (equity) raisings; retained earnings; or external borrowings?

It depends. It can be any of the above, although equity raisings and corporate borrowings are more frequently used. During market upturns, financing would generally be through a combination of equity raisings and external borrowings; during market downturns, as at present, through external borrowings.

(b) What are the main sources for borrowing for these types of corporates?

Banks, not capital markets, including arrangements of syndication loans, FRNs, FRCDs, overdrafts, and installment loans.

(c) Is there significant competition among lenders and significant choice of sources for borrowing available to these types of corporates?

The amount of competition is related to the economic cycle. At the top of the cycle - during strong economic times - there is much competition and much lending. At such times, some medium-sized companies have even borrowed up to HK$1,000,000,000 from as many as 20 to 25 banks, although the norm would involve much lower amounts from between 5 to 10 banks.

During market downturns, many of the banks withdraw from the market and competition diminishes; there is a flight to quality and only the stronger companies can borrow. At present, Hong Kong, China is experiencing a severe credit contraction.

(d)What is the present average rate of interest payable in respect of unsecured and secured debt?

The interest rate is a result of many factors and as several bankers noted, differed from client to client and was market driven. However there was agreement that the spread margins are roughly 2 to 4 times what they were a year ago. One banker noted that for premier companies, at present the interest rate formula would be based on Hibor, plus a big risk premium; and for medium/small companies, on Prime, plus a big risk premium. At some banks, the availability of collateral does not reduce the risk premium and has little effect on the pricing differential; at others, greater security protection is tied to lower interest rates.

(e) Is finance generally available for long, medium and short-term borrowings?

Most financing is in the form of short- or medium-term (roughly 3 years) borrowings. Short-term borrowings are usually dictated by the trade necessities of the companies. However, during bull markets, some Hong Kong, China companies have attempted to use short-term borrowings for long-term needs, such as investing in the property and equity markets.

During strong economic times, many banks are less concerned about security and frequently issue unsecured debt on a pari passu basis with other banks.

(a) What part does the central bank of this economy play in the regulation of the banking and finance sector?

The HKMA plays a major role. It has expressed its support for the Guidelines on Corporate Difficulties (Circular No. S/98/067 (April 1998)) that were issued by the Hong Kong Association of Banks on 3 April 1998. These formal, but non-statutory, guidelines cover how banks should deal with borrowers in financial difficulties that have borrowed from multiple banks. These guidelines provide that banks should cooperate to achieve a workout and that they should abide by a standstill: 'They should not withdraw facilities or hastily put the company into receivership, or issue . . . writs demanding repayment.' (para 2(a).)

Would it intervene or seek to influence the outcome or course of events if, for example a large corporate with debt exposure to a number of banks was in financial difficulty?

The HKMA would be reluctant to step in to save a company unless such action was clearly in the public interest. The burden is high - recently, even Peregrine was unsuccessful in its bid for intervention by the HKMA.

(b) Is there any tradition in this economy for a 'main' or 'house' or 'lead' bank to become involved as a chief negotiator or leader in the case of the financial difficulty or insolvency of a large corporate borrower with debt exposure to a number of banks?

This would be the norm. Hongkong Bank might well serve as lead bank in roughly 75-80% of the cases.

(a) Is assessment or analysis of lending risk widely practised in this economy?

Yes, assessment or lending risk is widely practiced.

(b) If so, does the average lending bank make adequate assessment of risk analysis when contemplating lending to a corporate borrower?

There is general agreement that such analysis in Hong Kong, China is better than elsewhere in the region, but is not up to Western standards. Some bankers were more critical of the overall standard of the assessment in Hong Kong, China than others. For example, some bankers stressed that there was still too much reliance on name lending or on guarantees. In addition, there was agreement that banks are often provided with much more information at the time they try to collect an overdue debt than at the time a loan is made. There was also agreement that many medium-sized local banks continue to emphasise asset protection rather than cash flow analysis.

(c) Would it be usual or common for a lending bank to regularly monitor the financial performance of a corporate borrower?

Monitoring is common, but again, there was concern that it is of uneven quality and it was noted that breaches frequently do occur. One banker observed that foreign banks that have done balance sheet lending might be somewhat more vigilant in monitoring the financial situation of the borrower. Monitoring often consists of quarterly reviews of the corporate borrower's payment record and accounts and an annual review that involves a review of the financial statements submitted by the corporate borrower.

The financial performance of corporate borrowers throughout Hong Kong, China has been deteriorating across the board.

(d) Would it be usual or common for a lending bank to be regularly supplied with copies of the financial statements of a corporate borrower?

Yes, this would be the common practice, although the frequency and standard of the reporting is often less than in many Western countries. Public companies normally provide their bankers with basic Profit and Loss statements every six months, but some private companies can take up to two years to supply the statements. In addition, many of the companies supply consolidated statements that make it difficult, if not impossible, to assess the performance of the corporate borrower (or guarantor) within the overall corporate family.

In the discussions of bank lending, Hongkong Bank and Standard Chartered Bank are considered local banks.

(a) Is there a significant source of foreign bank lending in this economy?

Yes.

(b) If so, is it usual for this funding to be provided by the foreign bank/s alone or in combination with funding from local or domestic bank/s?

Both, but the norm would be for there to be a combination of funding from foreign and local banks, and usually in HK$ or US$. The foreign banks generally concentrate their lending to the premier- and middle-tier market, but not to the lower-tier. Local banks generally loan across the spectrum, with some banks concentrating on the middle- to upper-tiers. There is some competition at the top tier between the foreign and local banks but, as noted by one banker, the foreign banks generally add value to the existing relationships. Much of the competition at the medium-tier level is between medium-sized local banks.

(c) Are you able to detect whether there are significant differences in approach and funding terms when a foreign bank is involved in the lending (as compared with a purely local or domestic funding)?

Yes, there are differences in approach that are based on differences in style between Asian and non-Asian banks, as well as between domestic and foreign perspectives.

(d) If so, what are the main differences?

First, many of the local and Asian banks are more likely to rely more on asset and guarantee protection unlike their counterparts from Western countries that rely more on cash flow tests. Second, local banks often have greater liquidity than their foreign counterparts. For example, many foreign banks rely on swapped cross-border funding. This causes a liquidity crunch at times such as the present because Hong Kong, China exposure is lumped with total Asian exposure. Third, foreign banks often lend primarily to middle-and upper-tier companies and not to lower-tier companies. Fourth, some of the foreign banks are somewhat more aggressive than their local counterparts when negotiating contractual terms. Fifth, many of the local banks have longer standing relationships with their clients that they wish to preserve and that might lead to a greater willingness to avoid forcing a corporate borrower into receivership or liquidation. A sixth difference arises in the context of the strength of the commitment to the Hong Kong, China market. There is some concern that some banks from other jurisdictions - Japan, Taipei,China, and France, were noted - get skittish during market downturns and decide to pull out of Hong Kong, China which, in turn, exacerbates the overall economic problems. The data bears this out this last observation. Economists at the Bank for International Settlements have noted that '[a]s the Japanese economy has fallen into recession banks there have been forced to trim their overseas operations.' Sheel Kohli, HK loan growth fall slows, South China Morning Post (Business Post), 1 December 1998, p 1.

(a) Is 'related' or 'exclusive' lending (ie where a corporate borrower and a bank have an established commercial relationship such that only that lender is looked to as the source of borrowing by the corporate borrower) common in this economy?

From the corporate lenders' perspective, of course, exclusive lending is the preferred option. However, such relationships are rare, except when dealing with smaller companies. For a middle- or upper-tier company (which is more established), it would be more common to have a 'stable' of five or six banks to which it turns for funding. Large companies are primarily the domain of the larger local banks, with the foreign banks generally adding value to the existing banking relationships between Hong Kong, China companies and their Hong Kong, China bankers (eg, by participating in syndication).

(b) If no, what effect does this have if the corporate borrower is in financial difficulty or is insolvent?

There will usually be a multi-bank situation in which the goal is to achieve a workout. In practice, when confronted with the need for a group solution, most banks are committed to working together. This cooperative approach will be better facilitated by the recently issued Guidelines on Corporate Difficulties.

(a) Is 'syndicated' lending (ie where a group of banks or financial institutions join together to provide funding for a corporate borrower) common in this economy?

Yes.

(b) If so:

(i) does a lead bank perform the role of 'agent' on behalf of all the lenders; and/or

Yes, with the role often performed by Hongkong Bank.

(ii) is the concept of a 'trustee' (or similar) for a syndicate of banks (ie where the 'trustee' holds any security for the syndicated funding on trust for the syndicate of banks) known and/or practised in this economy?

That concept does exist in Hong Kong, China, but it was noted that 'trustee' lending is not practiced on a large scale.

(iii) if the corporate borrower is in financial difficulty or is insolvent what function does the 'agent' or 'trustee' perform?

The agent will serve as the lead bank. However, it was noted that the role of an 'agent' in Hong Kong, China is not as formalized as elsewhere. For example, in some Western countries the 'agent' might well have litigation liability if it doe not manage well - but that would be an unlikely occurrence in Hong Kong, China. Rather, in Hong Kong, China the agent generally performs the role of a clearinghouse for information.

(a) Is the concept known as 'debt subordination' (ie, a contractual arrangement between lenders in which there are 'layers' of 'senior' and 'junior' debt and which has the effect of postponing repayment of the 'junior' debt until payment has been made of the 'senior' debt) recognised and practised in this economy?

Yes, the concept of debt subordination does exist in Hong Kong, China, although the lender frequently does not get paid a premium for accepting subordination. Some banks refuse to lend money on a subordinated basis in which they will have to take a junior position.

One banker noted that given the complicated corporate structure in Hong Kong, China, at times when lending to a company within a group, the bank may not realize the true extent to which its debt is subordinated to other banks with borrowings to other companies in the group.

(b) If so, is debt subordination recognised and/or enforced under the insolvency regime of this economy?

Yes, valid debt subordination may be achieved through the use of a 'complex trust structure.' Consultation Paper on the Winding-up Provisions of the Companies Ordinance, supra, para 32.1 at 199 (citing the submission of the HKAB). This approach has been adopted because of the historical reluctance of the common law to allow parties to contract out of the pari passu principle. See British Eagle International Airlines Ltd v Compagne Nationale Air France [1975] 2 All ER. However, recently debt subordination has been allowed in some contexts. See Re Maxwell Communications Corp plc (No. 3) [1993] BCC 369. In its recent Consultation Paper, the Sub-Committee on Insolvency recommended that debt subordination 'should be allowed so long as the subordination of debt agreement does not affect the rights of third parties.' Supra, para 32.2 at 199. Implicit in this statement is that the agreement should not 'adversely' affect the rights of third parties.

(a) Is it permissible for banks to own equity in a corporate borrower?

It is possible, but remains uncommon.

(b) If so, is it permissible for a bank to convert debt to equity?

Yes, in both an 'informal workout' and in a formal Section 166 scheme.

(c) Are there instances where this has in fact occurred, particularly in the context of either:

(i) in the context of an 'informal work out' as a result of the insolvency or approaching insolvency of a corporate borrower; or

The workout in Asia Commercial Holdings Ltd was noted.

(ii) in the context of a formal insolvency administration of a corporate borrower?

No examples come to mind.

(d) In such a case, is it usual for the bank to be then represented on the management or board of the corporate borrower?

This would not be usual in Hong Kong, China.

(a) Is there a market for 'debt trading' (ie, where a bank might sell or trade the debt owed to it by a corporate borrower) in this economy?

Yes, there is a market for 'debt trading,' although the FRN market has recently dried up.

(b) If so, is debt trading common in this economy, particularly where the corporate borrower is insolvent or near insolvent?

Debt trading certainly occurs, but not as frequently as in many Western countries. Where the borrower is insolvent or near insolvent, debt trading is very uncommon. With the recent arrival of a few global investment banks that are trumpeting the benefits of 'insolvent debt trading,' such practices are now entering a nascent phase in Hong Kong, China. In many Western countries, the investment banks have created secondary markets for debt trading. Those markets do not yet exist in Hong Kong, China. Thus, in the few instances where the investment banks have purchased the debts of a company near insolvency or in insolvency, they have done so pursuant to longer-term goals (rather than for short-term trading). The investment banks claim that they are participating in such workouts as a strategic investor trying to maximize recovery.

(a) Is the concept of a third party 'guarantee' (as distinct from a security over property) to support corporate borrowing known and practised in this economy?

Yes. One commentator noted that in practice the common form of a guarantee often provides that the liability of the surety (guarantor) is primary rather than secondary.

(b) Is there a law which regulates the power to take or give a guarantee?

Yes. There is no separate ordinance regarding guarantees, although some legislative provisions are pertinent. For example, if a bank seeks a guarantee from a partner on behalf of a partnership, Sections 7 and 20 of the Partnership Ordinance (cap 38) should be consulted, and when seeking a guarantee from a company director, Section 157H of the Companies Ordinance is relevant.

Most matters involving guarantees will be resolved by contract law and the well-developed case law.

And in the corporate context, the bank should ensure that a company's memorandum and articles provide a company with the power to provide a guarantee.

(c) Is it common or usual for corporate borrowing to be supported by guarantee/s?

It would be common for borrowing from unlisted companies to be supported by guarantees, but rare from listed companies (except perhaps from public holding companies). Reliance on guarantees is usually less common for foreign banks than for local banks.

(d) If so, are these guarantees usually taken from owners/directors of the corporate borrower; from other corporates associated with the corporate borrower (eg subsidiaries or holding company); or from unrelated third parties?

Guarantees will normally be sought from controlling shareholders/directors and from associated companies. In the corporate context, downstream guarantees are much more common than upstream guarantees. Guarantees from spouses of shareholders/directors are less common unless they too are involved in the company. Guarantees from unrelated third parties would at times be used by some of the medium-sized local banks, but would be rare at the large Hong Kong, China banks or at the foreign banks.

Another way (albeit, less desirable) of gaining protection when lending to a corporate borrower in a group is to include a cross-default clause, although this is less practicable where the subsidiaries are public companies. Non-payment by the corporate borrower might thus trigger problems for other entities in the group, including rating losses.

(e) Is there a law which regulates the enforcement of guarantees?

Yes, contract law. Relevant issues might well involve the law undue influence, misrepresentation, discharge, etc.

(f) Is it easy or difficult in practice to enforce guarantee obligations?

In most cases, it is easy and efficient to enforce the guarantee, but often only after the banks have been forced to threaten litigation. Lawsuits commenced by local banks against guarantors are not uncommon. To make it easier to enforce a guarantee, it is not uncommon for the local form to provide that the surety (guarantor) is primarily, rather than secondarily, liable.

(g) Is it usual to require that a guarantor should give security over the property of the guarantor as an additional comfort to the lender?

The bank will ask for security over the property of the guarantor where such property exists. Some banks would generally not require the security as a condition of accepting the guarantee; others would.

(h) Does the insolvency of a corporate borrower have any effect on the enforcement of a guarantee?

The insolvency of a corporate borrower does not have any legal effect on the enforcement of the guarantee but, of course, whether or not the enforcement of the guarantee is difficult often depends on the financial position of the guarantor. In some cases, the insolvency of the corporate borrower may well have a domino effect - the triggering of the guarantee could lead to the bankruptcy of the guarantor (where the guarantor is an individual) or the winding up of the guarantor (where the guarantor is a company).