Advisory Board

  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Peter Clarke
  • Barry Diller
  • IAC/InterActiveCorp
  • Fu Chengyu
  • China National Petrochemical Corporation (Sinopec Group)
  • Richard J. Gnodde
  • Goldman Sachs International
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V.
  • Jiang Jianqing
  • Industrial and Commercial Bank of China, Ltd. (ICBC)
  • Handel Lee
  • King & Wood Mallesons
  • Richard Li
  • PCCW Limited
  • Pacific Century Group
  • Liew Mun Leong
  • Changi Airport Group
  • Martin Lipton
  • New York University
  • Wachtell, Lipton, Rosen & Katz
  • Liu Mingkang
  • China Banking Regulatory Commission (CBRC)
  • Dinesh C. Paliwal
  • Harman International Industries
  • Leon Pasternak
  • BCC Partners
  • Tim Payne
  • Brunswick Group
  • Joseph R. Perella
  • Perella Weinberg Partners
  • Baron David de Rothschild
  • N M Rothschild & Sons Limited
  • Dilhan Pillay Sandrasegara
  • Temasek International Pte. Ltd.
  • Shao Ning
  • State-owned Assets Supervision and Administration Commission of the State Council of China (SASAC)
  • John W. Snow
  • Cerberus Capital Management, L.P.
  • Former U.S. Secretary of Treasury
  • Bharat Vasani
  • Tata Group
  • Wang Junfeng
  • King & Wood Mallesons
  • Wang Kejin
  • China Banking Regulatory Commission (CBRC)
  • Wei Jiafu
  • Kazakhstan Potash Corporation Limited
  • Yang Chao
  • China Life Insurance Co. Ltd.
  • Zhu Min
  • International Monetary Fund

Legal Roundtable

  • Dimitry Afanasiev
  • Egorov Puginsky Afanasiev and Partners (Moscow)
  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Johan Aalto
  • Hannes Snellman Attorneys Ltd (Finland)
  • Nigel P. G. Boardman
  • Slaughter and May (London)
  • Willem J.L. Calkoen
  • NautaDutilh N.V. (Rotterdam)
  • Peter Callens
  • Loyens & Loeff (Brussels)
  • Bertrand Cardi
  • Darrois Villey Maillot & Brochier (Paris)
  • Santiago Carregal
  • Marval, O’Farrell & Mairal (Buenos Aires)
  • Martín Carrizosa
  • Philippi Prietocarrizosa & Uría (Bogotá)
  • Carlos G. Cordero G.
  • Aleman, Cordero, Galindo & Lee (Panama)
  • Ewen Crouch
  • Allens (Sydney)
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Rachel Eng
  • WongPartnership (Singapore)
  • Sergio Erede
  • BonelliErede (Milan)
  • Kenichi Fujinawa
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Manuel Galicia Romero
  • Galicia Abogados (Mexico City)
  • Danny Gilbert
  • Gilbert + Tobin (Sydney)
  • Vladimíra Glatzová
  • Glatzová & Co. (Prague)
  • Juan Miguel Goenechea
  • Uría Menéndez (Madrid)
  • Andrey A. Goltsblat
  • Goltsblat BLP (Moscow)
  • Juan Francisco Gutiérrez I.
  • Philippi Prietocarrizosa & Uría (Santiago)
  • Fang He
  • Jun He Law Offices (Beijing)
  • Christian Herbst
  • Schönherr (Vienna)
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V. (Amsterdam)
  • Hein Hooghoudt
  • NautaDutilh N.V. (Amsterdam)
  • Sameer Huda
  • Hadef & Partners (Dubai)
  • Masakazu Iwakura
  • TMI Associates (Tokyo)
  • Christof Jäckle
  • Hengeler Mueller (Frankfurt)
  • Michael Mervyn Katz
  • Edward Nathan Sonnenbergs (Johannesburg)
  • Handel Lee
  • King & Wood Mallesons (Beijing)
  • Martin Lipton
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Alain Maillot
  • Darrois Villey Maillot Brochier (Paris)
  • Antônio Corrêa Meyer
  • Machado, Meyer, Sendacz e Opice (São Paulo)
  • Sergio Michelsen Jaramillo
  • Brigard & Urrutia (Bogotá)
  • Zia Mody
  • AZB & Partners (Mumbai)
  • Christopher Murray
  • Osler (Toronto)
  • Francisco Antunes Maciel Müssnich
  • Barbosa, Müssnich & Aragão (Rio de Janeiro)
  • I. Berl Nadler
  • Davies Ward Phillips & Vineberg LLP (Toronto)
  • Umberto Nicodano
  • BonelliErede (Milan)
  • Brian O'Gorman
  • Arthur Cox (Dublin)
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Sang-Yeol Park
  • Park & Partners (Seoul)
  • José Antonio Payet Puccio
  • Payet Rey Cauvi (Lima)
  • Kees Peijster
  • COFRA Holding AG (Zug)
  • Juan Martín Perrotto
  • Uría & Menéndez (Madrid/Beijing)
  • Philip Podzebenko
  • Herbert Smith Freehills (Sydney)
  • Geert Potjewijd
  • De Brauw Blackstone Westbroek (Amsterdam/Beijing)
  • Qi Adam Li
  • Jun He Law Offices (Shanghai)
  • Biörn Riese
  • Jurie Advokat AB (Sweden)
  • Mark Rigotti
  • Herbert Smith Freehills (Sydney)
  • Rafael Robles Miaja
  • Robles Miaja (Mexico City)
  • Alberto Saravalle
  • BonelliErede (Milan)
  • Maximilian Schiessl
  • Hengeler Mueller (Düsseldorf)
  • Cyril S. Shroff
  • Cyril Amarchand Mangaldas (Mumbai)
  • Shardul S. Shroff
  • Shardul Amarchand Mangaldas & Co.(New Delhi)
  • Klaus Søgaard
  • Gorrissen Federspiel (Denmark)
  • Ezekiel Solomon
  • Allens (Sydney)
  • Emanuel P. Strehle
  • Hengeler Mueller (Munich)
  • David E. Tadmor
  • Tadmor & Co. (Tel Aviv)
  • Kevin J. Thomson
  • Barrick Gold Corporation (Toronto)
  • Yu Wakae
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Wang Junfeng
  • King & Wood Mallesons (Beijing)
  • Tomasz Wardynski
  • Wardynski & Partners (Warsaw)
  • Xiao Wei
  • Jun He Law Offices (Beijing)
  • Xu Ping
  • King & Wood Mallesons (Beijing)
  • Shuji Yanase
  • OK Corporation (Tokyo)
  • Alvin Yeo
  • WongPartnership LLP (Singapore)

Founding Directors

  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz
  • Nigel P.G. Boardman
  • Slaughter and May
  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz
  • Peter Williamson
  • Cambridge Judge Business School
  • Franny Yao
  • Ernst & Young

Sectors

CHINESE UPDATE – The Future of Automotive JVs under the New Policy of Opening Up the Automotive Industry in China

Contributed by: Adam Li (Li Qi), Jun He Law Offices (Shanghai)

Editors’ Note: Contributed by Adam Li, a partner at JunHe and a member of XBMA’s Legal Roundtable. Mr. Li is a leading expert in international mergers & acquisitions, capital markets and international financial transactions involving Chinese companies. This article was authored by Mr. Michael Weng, and Mr. Daniel He, both partners at JunHe. Mr. Weng has broad experience dealing with complicated foreign direct investment and cross-border M&A transactions, and Mr. He is specialized in merger and acquisition projects, joint venture transactions, and strategic investment projects in various industries.

Summary

There are numerous examples of Automotive JVs that have been operating successfully and profitably in China for more than a decade. With the imminent removal of the shareholding cap on foreign investment in automotive manufacturing, there will be opportunities for Chinese and foreign parties to alter their equity holdings, including being able to buy out the JV partner or exit in part or completely. It is our assessment that Chinese and foreign parties are unlikely to immediately implement any major changes. Rather, we expect them to maintain the status quo for a considerable period of time, until larger commercial incentives trigger a withdrawal of one of the joint venture partners.

 

Main Article

At the recent Boao Forum for Asia Annual Conference 2018, the Chinese President Mr. Xi Jinping announced that “China will remain unchanged in its adherence to reforming and opening up, and will continue to launch new major measures to pursue further opening up.”  Since then, both the National Development and Reform Commission (“NDRC”) and the Ministry of Industry and Information Technology in their respective Answers to Reporters’ Questions have committed to gradually opening up automotive manufacturing to foreign investment before 2022 by removing the shareholding limit for foreign investors and also the restriction on foreign investors being allowed to invest in no more than two automotive joint ventures. The reforms and their implications for the future are of great relevance to the many long-standing, active Sino-foreign automotive joint ventures (“Automotive JVs”). In this article, we will discuss several possible development paths for Automotive JVs, and some of the issues arising from the reforms.

 

I.       Possible Development Paths for Automotive JVs

 

1.   Chinese Partner Acquires All or Part of the Equity Held by Foreign Investor

Thanks to the massive growth in demand in the Chinese automotive market, many of the Automotive JVs have been highly profitable. The Chinese partners of those Automotive JVs have primarily been very large central or local state-owned enterprises (“SOEs”) with solid foundations and extensive connections, enabling them to make a vital contribution to Automotive JVs’ swift localization and expansion within the Chinese market. It may be that these Chinese partners will hope to acquire the equity interest held by their Automotive JV foreign partners in order to further strengthen their control within the Automotive JV and to improve their profit earnings. However, Automotive JVs are still largely reliant upon their foreign partners for business resources including branding, new ideas, technology and equipment, and the auto groups to which the foreign partners belong are unlikely to willingly give up the substantial revenue and profits generated by the Automotive JVs. Hence, it will likely prove difficult, at least in the short run, for the Chinese partners of any successful Automotive JV to disrupt the structural balance by acquiring all or part of their foreign partner’s equity.

However, for an Automotive JV that is struggling and not profitable, it is possible that the Chinese partner may be able to acquire their foreign partner’s equity. Indeed, it may well be that a foreign partner in such unsuccessful Automotive JV has already been contemplating an exit. The gradual removal of restrictions on foreign investment in automotive manufacturing presents the opportunity for foreign partners to leave an unsuccessful Automotive JV and set up their own entity. However, before making such a decision, a foreign partner should first make a full assessment of its ability to operate the business independently.  Success in the Chinese market requires not only branding, technology and management expertise, but also access to and control of sales channels and an in-depth understanding of local consumers and markets.

 

2.  Foreign Partner Acquires All or Part of the Equity Held by Chinese Partner

Removing the shareholding cap of foreign investments in automotive manufacturing has eliminated the legal barrier preventing foreign partners from acquiring the equity held by their Chinese partners, but is of course dependent upon the willingness of both sides to pursue this option. It seems highly unlikely that a Chinese partner would be inclined to relinquish its equity interest in a profitable Automotive JV. Moreover, from a strategic perspective, a Chinese partner aiming to build up its own brands may use the leverage of its involvement in an Automotive JV, which brings with it indirect support in the expansion and influence of the Chinese partner’s own independent brands, by having access to the Automotive JV’s upgraded products and technologies, and skills development. In addition, with only very limited licenses to manufacture traditional fuel vehicles, it is highly unlikely that any newly established automotive manufacturer would be able to attain the necessary regulatory approval. Ultimately, the Chinese partner is highly unlikely to hand over control of the Automotive JV with the required manufacturing license. For an under-performing Automotive JV, while the acquisition of a Chinese partner’s equity may not bring immediate financial benefits, the foreign partner could use the existing manufacturing approval, production lines and personnel to start production right away. Provided the acquisition price of the Chinese partner’s equity is reasonable, this could be an effective shortcut for a foreign brand seeking to obtain production capacity and operate independently.

 

3.  Maintain the Status Quo

After the NDRC released its information on easing restrictions on foreign investment in automotive manufacturing, some of the foreign partners of existing Automotive JVs were quick to confirm their intention to continue to support the development of their respective current joint ventures in China. It is our assessment that both the Chinese and foreign parties should take a pragmatic approach to the new policy and, at least in the short-term, focus on maintaining the current structure. It seems unlikely — at least until the expiry of the operation term of the existing joint venture contract — that the Chinese and foreign parties of most of Automotive JVs automakers will initiate a change in the balance of ownership by seeking to acquire all or part of the equity held by their partner.

 

II.      Key Factors Influencing the Possible Development Path

Once the shareholding limits for foreign investors in automotive manufacturing have been phased out, a variety of factors will determine whether foreign automakers choose to remain with their Chinese partners or to make their own way. Some of the key factors for consideration are listed below.

 

1.  Continuing Product Upgrade

At present, many of the Automotive JVs’ products are based upon foreign brands’ original overseas car models. The production of core components, such as vehicle engines and gearboxes, is primarily based upon foreign partner’s technology. Therefore, the prosperity of the Chinese automobile market driven by the Automotive JVs is essentially attributable to foreign automakers’ products. The continuing survival and success of Automotive JVs is at least in part dependent upon foreign partners providing access to upgraded products and technologies. The growing sophistication of Chinese consumers and the emergence of local automotive brands builders means that Automotive JVs are facing an ever more demanding and competitive market. Only those Automotive JVs that continuously innovate will survive. The removal of the shareholder cap means that a foreign automaker with strong product R&D and upgrade capabilities and whose Chinese partners lack product input capabilities may be able to use their relative strength to persuade their Chinese partner to transfer some of their equity. If a foreign automaker is able to obtain continuing regulatory approval to manufacture on their own (as mentioned above, the possibility of obtaining new licenses is very slim), it may be possible for the foreign automaker to set aside the existing Automotive JV in order to establish a separate company, manufacturing and selling their own automobiles in a wholly-owned company.

 

2.  The Trend toward New Energy Vehicles

The growth in purchases of traditional fuel vehicles has slowed down in recent years. In the meantime, sales of new energy vehicles are increasing, attributable at least to some extent to Chinese government efforts to promote these upgraded, clean energy automobiles. Nowadays the vast majority of Automotive JVs’ production is traditional fuel vehicles. However, this is likely to change, with declined growth in demand for fuel vehicles, the implementation of government policy incentives for new energy vehicles, and preemptive dominance of the new energy car market by the Chinese traditional and new automakers. Given that the first shareholding cap to be eliminated will be on new energy car manufacturers, in 2018, foreign automakers will need to decide how they intend to manufacture new energy vehicles in China, whether by taking advantage of a current Automotive JV to apply for cross-category production of new energy vehicles, or by establishing a new wholly-owned subsidiary to undertake this task. The Measures for the Parallel Administration of the Average Fuel Consumption and New Energy Vehicle Points of Passenger Vehicle Enterprises (“Points Administration Policy”) that have been implemented since April 1, 2018, require foreign automakers to take into account the impact on the production of fuel vehicles by the existing JV automaker in their overall production plans. Starting from 2019, according to the Points Administration Policy, there will be a points system under which Automotive JVs will be subject to production limits for fuel vehicles. When this limit is reached, they will be required to produce a certain proportion of new energy vehicles in order to be permitted to continue the production of fuel vehicles. Points will be accrued for the manufacture of new energy vehicles by Automotive JVs and additionally will be available for purchase, through an official platform, from third parties with surplus points. As it stands, the simplest way for foreign automakers to satisfy the new energy vehicle points requirements and to continue production of fuel vehicles is to maintain their current Automotive JV, while introducing new energy vehicle models.

 

Influences of the Tariff Cut

On May 22, 2018, the Customs Tariff Commission of the State Council issued an announcement stating that, effective from July 1, 2018, there will be a reduction of tariffs on imported vehicles and car parts. Tariff rates on vehicles will be reduced from their current levels of 20% and 25%, down to 15%. Even after the adjustment, tariffs will remain higher than in developed countries such as Europe, the United States and Japan. Moreover, the final price of imported cars will also be subject to VAT, consumption tax, dealer profits, and other factors. While the tariff cuts may initially have a short-term stimulating effect on sales of imported vehicles, their impact is not forecasted to be significant in the long run. In an environment where foreign investment restrictions are gradually being lifted, foreign automakers seeking to become more competitive will need to take into consideration the relative costs and factors – economic and non-economic – of establishing or acquiring a wholly-owned local automaker compared with the option of exporting vehicles to China under a lower tariff regime.

 

3.  Difficulties in Going Solo

One of the Chinese government’s original intentions in formulating the automotive joint venture policy was a “market-for-technology” strategy. In return for providing their technology, foreign automakers have gained Chinese market share through their partnerships with China’s central and local SOEs and large-scale private enterprises. In addition, the foreign automakers have obtained special support and benefits in aspects such as regulatory approvals, land acquisition and factory construction, fiscal subsidy and tax preferential treatment, and so on, without which their foreign automotive products might not even have been brought into China. If, after removal of the foreign shareholding cap, a foreign automaker chooses to operate completely independently and without the support of Chinese partners, there is no certainty that they will continue to enjoy such special benefits. Specifically, approvals for new energy vehicle manufacturing are currently on hold and there are unlikely to be many more licenses issued to manufacture traditional fuel vehicles. While it is anticipated that the approval process for new energy vehicles will recommence soon, it seems likely that entry thresholds will rise substantially. Against this background, it may be unwise for foreign automakers to abandon their current joint ventures and start over on their own. Building an automobile sales and after-sales network is a costly and time-consuming process, further complicated by the range of differing local business environments around China. Without Chinese partners to help navigate local markets, foreign automakers will likely face barriers to a quick set-up and roll out of sales and after-sales networks, particularly on dealing with the existing dealers of the JV Automakers and balancing their relationships and interests.

 

*     *     *     *     *

 

In the decades since Automotive JVs were first established, there have been numerous reforms to the legal environment as well as changes in the range of products offered, fluctuating market conditions, the introduction of new domestic brands, increases in labor and other production costs, a shifting international business environment, and the emergence of new energy cars. As is so often the case in China, the only constant is change itself.

 

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

 

MEXICAN UPDATE – Mexico’s Landmark Energy Reform is Enacted

Contributed by: Manuel Galicia Romero and Juan Pablo Cervantes, Galicia Abogados, S.C. (Mexico City)

Editors’ Note: Manuel Galicia Romero is a founding partner of Galicia Abogados and a member of XBMA’s Legal Roundtable. Mr. Galicia, who was involved in the negotiation of the North American Free Trade Agreement (NAFTA), is a leading expert in international transactions in Mexico.  Juan Pablo Cervantes is a member of Galicia Abogados and an international business lawyer actively involved in the promotion of trade and investment between Mexico and numerous countries, particularly from Asia.

Highlights:

  • Considering the Constitutional amendments enacted late last year, resulting in the opening of the energy industry to private investment, especially oil and gas, among other laws, the Federal Executive published the Hydrocarbons Act (“HA”) earlier last month.  The HA reaffirms the newly revised principle enshrined in the Mexican Constitution that all hydrocarbons underground belong to the State and its rights thereto may not be transferred or encumbered.
  • The HA gives the Ministry of Energy the power to award assignments to Petróleos Mexicanos (including its subsidiaries) or any other productive state enterprises (“PSEs”) to perform the recognition and superficial exploration, and the exploration and production of hydrocarbons (“E&P”), with the prior favorable opinion of the National Hydrocarbons Commission (the “CNH”), on round zero and on an exceptional basis thereon, as well as to amend them.
  • The Mexican State may enter into contracts for E&P activities through the CNH with (i) Pemex, (ii) other PSEs or (iii) companies organized under Mexican law, or with consortiums entered into by any of these companies. Such contracts shall be awarded after a public tender process. The aforementioned joint ventures shall be governed by general commercial law and shall not be deemed public-private partnerships.
  • The Energy Reform gave way to a new Law of the Electrical Industry, which establishes an entirely new regulatory framework for the power industry in Mexico where the Mexican state reserves exclusivity over certain strategic areas and otherwise permits the participation of private investment in all other areas that make up the power industry in the country, including the generation and open-market marketing of electricity.

MAIN ARTICLE

  • Energy Reform:  Secondary Legislation.

On August 11, 2014, several new laws and amendments to existing legislation were published in the Federal Official Gazette (“DOF”) in order to implement the constitutional amendments related to the energy industry that were published in the DOF on December 20, 2013.

 

In the notes linked below we analyze the new Hydrocarbons Act and the new Law of the Electrical Industry, as well as other relevant legislation that was enacted or amended as part of this reform.

  • New Hydrocarbons Act (Ley de Hidrocarburos).

As a result of the opening of the energy industry to private investment, especially oil and gas in the amendments to Articles 25, 27 and 28 of the Mexican Constitution, published on December 20, 2013, the Federal Executive published the Hydrocarbons Act, which is effective as of August 12, 2014, and repeals the Regulatory Act for Article 27 of the Constitution for the Petroleum Industry (Ley Reglamentaria del Artículo 27 Constitucional en Materia de Petróleo). The most relevant aspects of this law include the ability of the private sector to enter into exploration and extraction contracts with the state (under new schemes, namely, licenses, and production or profit sharing agreements), and to pursue activities such as refining, transportation, distribution and storage of hydrocarbons, as well as the importation and retail of gasoline and diesel.  For a brief summary of Hydrocarbons Act, click here.

  • New Law of the Electrical Industry (Ley de la Industria Eléctrica).

The new Law of the Electrical Industry (Ley de la Industria Eléctrica) repeals the former Law on the Electricity Public Service (Ley del Servicio Público de Energía Eléctrica), in effect since 1975, and establishes an entirely new regulatory framework for the power industry in Mexico, where the Mexican State reserves exclusivity over certain strategic areas and otherwise permits the participation of private investment in all other areas that make up the power industry in the country, including the generation and open-market marketing of electricity.  For a brief summary of the Law of the Electrical Industry, click here.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

SPANISH UPDATE – New Opportunities For Foreign Investors In The Real Estate Sector

Editors’ Note: This paper was contributed by Juan Miguel Goenechea, a partner at Uría Menéndez in Madrid and a member of XBMA’s Legal Roundtable.  As one of Spain’s leading M&A experts, Mr. Goenechea has broad expertise in corporate, banking, finance and securities transactions at the top end of the market. This paper was authored by Uría Menéndez senior associates Pedro Ravina and Diego Montoya.

Highlights

  • The newly-created Spanish “bad bank” (SAREB) has been transferred a EUR 50.8 billion pool of loans and real estate assets from Spanish credit entities that were totally or partially nationalized, as well as the legal mandate to liquidate the entire portfolio in 15 years.
  • A legal framework has been enacted to facilitate the divestment process. In particular, a new type of investment vehicle with a privileged tax regime has been implemented to attract investment by non-Spanish resident investors. The vehicle is taxed at a 1% CIT rate and income obtained by non-resident investors (including residents in tax havens) will be tax exempt in Spain.
  • SAREB already announced divestitures in 2013 and the pipeline for new projects is extensive and appears to have attracted the attention of the largest international real estate firms as a result of the significant price discounts and the efficiency of the investment structure.
  • Amid the generally improved outlook of the Spanish economy and the increased stability in the Eurozone, the Spanish real estate market appears to be taking off after multiple years of significantly reduced activity.

Main Article:

Background

In the context of the EUR 100 billion external financial assistance requested by the Spanish Government with the aim of facilitating the restructuring and recapitalization of the Spanish banking sector, a memorandum of understanding (MOU) was agreed in July 2012 by and between the Spanish Government and certain European Union authorities (with the participation of the International Monetary Fund) by virtue of which specific political and financial-related conditions were imposed on Spain.

Key elements of the roadmap provided under the MOU included: (i) the identification of the individual capital needs by each of the Spanish banks by means of a “bottom-up” stress test (as well as a determination of which banks would need public support to complete the necessary recapitalization); and (ii) the segregation of the impaired assets of banks under public control or receiving public assistance and their transfer to a “bad bank”.

As a result of the stress test undertaken by Oliver Wyman and released in September 2012, the Spanish banking sector was divided into four groups: group 1 (comprising banks already nationalized, such as Bankia); group 2 (banks with capital needs that would likely lead to the bank requiring public assistance); group 3 (with lower capital needs and no expectation of public intervention); and group 4 (without further capital needs).

In November 2012, legislation enacted in consultation with the European Commission, the European Central Bank, the European Stability Mechanism and the International Monetary Fund provided for the creation of the Spanish “bad bank” (denominated the Sociedad de Gestion de Activos Procedentes de la Restructuracion Bancaria, or SAREB) and the establishment of a specific legal and tax framework applicable to the bank.

Creation and main features of SAREB

SAREB is a for-profit corporation which overarching objective is the management and, ultimately, the divestiture of the assets received from the contributing banks within a period of no more than 15 years.

The contributing banks are those financial institutions included under groups 1 and 2.  Assets transferred to SAREB between December 2012 and February 2013 were primarily: (i) foreclosed real estate assets with a net book value exceeding EUR 100,000; (ii) (not necessarily non-performing) loans to real estate developers with a net book value exceeding EUR 250,000; and (iii) controlling shareholdings in real estate companies. Assets for an aggregate value of approximately EUR 50.8 billion have been transferred to SAREB, which price reflects an average haircut over gross book value of approximately 63% for foreclosed assets and 45% for loans. As consideration, SAREB issued state-guaranteed senior debt securities in favor of the participating banks. The securities have been structured to meet all requirements to be accepted as collateral for purposes of European Central Bank financing.

In order to fund operational needs, SAREB has raised equity for an aggregate amount of EUR 4.8 billion (25% share capital and 75% subordinated debt). A public-controlled fund for the restructuring of the Spanish financial sector (FROB) is the major shareholder with 45% of the equity holdings, while the remaining equity (55%) is held by a number of Spanish and foreign financial institutions (including Spanish banks under groups 3 and 4), insurance companies, and leading industrial corporations.

Divestment alternatives: Banking Assets Funds

Although SAREB may decide to refinance or further develop some of the assets received in order to maximize their value, the ultimate objective is the profitable liquidation of the entire pool of assets within the 15-year statutory deadline, either through the full collection of the principal of the loan (where feasible) or, most likely, by transferring the asset.

While the discounted price at which SAREB acquired the assets is itself an incentive for transfers, an ad hoc structure was created by law to facilitate the acquisition by foreign institutional investors of SAREB assets in tax-advantageous conditions.

In short, SAREB is able to divest the assets by incorporating insolvency-remote vehicles (denominated Banking Assets Funds, or BAFs) that provide structural flexibility and a favorable tax regime for investors and the BAFs themselves, subject to the condition that either SAREB or the FROB retain a stake.

BAFs can therefore be featured as joint ventures between investors and SAREB, and can be used to repackage different types of assets. Furthermore, BAFs’ liabilities can include loans, debt securities, quasi-equity instruments, several types of credit enhancement instruments or a combination of several. As a result, investors will have the flexibility to invest or co-invest in one or multiple tranches of BAFs whose assets were previously cherry-picked by investors (or “put on sale” by SAREB). Although the representation and management of the BAFs is legally reserved to regulated Spanish entities (securitization funds management companies), there is an expectation that, and experience has already shown, the leading role when it comes to material decisions (e.g., the sale of an asset allocated in a BAF) will be placed in the hands of investors or an asset manager appointed by them.

Nevertheless, in general, the main benefit of investing in SAREB assets through a stake in a BAF, as opposed to a direct acquisition of the relevant assets by the institutional investor or a subsidiary of the same, is tax-related. While the BAF itself enjoys a privilege treatment (for instance, a 1% corporate income tax rate as opposed to 30% for regular Spanish corporation), the key element of the scheme is the privileged tax regime applicable to the BAF’s stakeholders, particularly non-resident holders: non-resident entities without a permanent establishment in Spain investing in BAFs, including those domiciled in tax havens, will benefit from a full Non-Resident Income Tax exemption on income (interest, distributions) and gains (transfers) deriving from their BAFs’ stakes. Thus, from a tax standpoint, investment in real estate assets using a BAF would be the optimal option in contrast to using a regular corporation for the same objective (which would imply 30% CIT and, if not properly structured, Spanish taxation on income received from the vehicle).The privileged tax regime will only apply as long as SAREB or the FROB remains exposed to the BAF with, in principle, a stake of at least 5%.

Although the resulting outcome of the BAF joint structure is that SAREB will only partially dispose of the assets (as it would still have indirect exposure to them through its stake in the BAF), these assets will now be managed by specialist investors and SAREB will likely benefit from some portion of the upside upon exit.

Debut transactions and prospects

Following the completion of the process to group all assets transferred from the contributing banks and a comprehensive internal commercial and legal due diligence, SAREB has started to test the waters with a number of projects involving diverse types of assets.

Transparency and competitiveness have been key elements in all divestment processes. SAREB has proactively put specific groups of assets “in play” (perhaps after perceiving specific interest in the marketplace) and, with the assistance of corporate and real estate advisors, have organized auctions general open to bidders. The improved outlook of the Spanish economy, the increased stability in the Eurozone and the attractive features of the potential transactions (both in terms of price and tax-efficiency) have incentivized some of the largest international private equity and real estate investment houses to submit bids in these auctions.

Bull Project, whose EUR 100 million portfolio included real estate developments located in eight different Spanish regions, was the first auction completed last August. The selected buyer was H.I.G. Capital (through its affiliate Bayside Capital) and the transaction was structured through a BAF which will be held by H.I.G (with a 51% stake) and SAREB (with a 49% stake). Prestigious funds such Lone Star, Apollo, Colony, Centerbridge and Cerberus were reportedly among the other bidders in the auction.

As of July 2013, SAREB had sold 1,800 retail residential assets through the participating banks’ branch network. That figure increased to around 6,400 real estate assets as of November 2013. In addition, a portfolio of stakes in syndicated loans granted to Spanish listed real estate companies (Metrovacesa and Colonial, for approximately EUR 1.2 billion) have also been transferred to an undisclosed investor and Burlington, respectively. Other transactions in SAREB’s pipeline (including urban and rural land, luxury homes, shopping malls, office projects and additional stakes in loans to Spanish listed real estate companies), are expected to be announced before the end of the year or in the first quarter of 2014.

The general perception that the Spanish economy and real estate market have bottomed out and that prices now reflect the fair market value of the real estate assets is also contributing to a significant activation of the Spanish real estate M&A sector after several years of dramatic downturn. Some of the 2012 and 2013 deals included the acquisitions by TPG, Cerberus and a consortium of Kennedy Wilson and Varde of the Caixabank, Bankia and Catalunya Bank’s real estate portfolio management companies, respectively (and Grupo Santander and Banco Popular are also in the process of selling their recovery units). In all the cases of these sales of servicing companies by healthy banks, the managed assets are not transferred, but retained by the transferor. Other recent highlights include the purchase of Aktua (the former customer collection company within the Santander group) by Centerbridge, the approximately EUR 200 million sale by the Madrid regional government of a group of 3,000 subsidized apartments to a Goldman Sachs affiliate, and the pool of 1,860 rent-controlled properties sold by the City of Madrid to Blackstone for EUR 125 million.

Furthermore, all signs seem to indicate that the Spanish real estate market will continue to provide attractive opportunities for international funds in future months. SAREB projects will continue to fuel the activity, as SAREB’s business plan contemplates the divestiture of half of its portfolio during its first five years of existence. Additionally, most of the Spanish banks within groups 3 and 4 created their own “bad banks” in late 2012, into which they transferred all foreclosed assets as well as those acquired through debt-to-asset transactions. As the banks try to refocus on their core business, most of these “bad banks” (some of which became major Spanish real estate companies in terms of volume of assets) are up for sale, attracting the attention of the international investors.

For investors in distressed assets, undertaking appropriate servicing actions is a key element in their long-term plans to recover value on acquired bad debts. The offsetting up of local teams and the acquisition of Spanish collection platforms and real estate management companies by the largest international funds suggests that the investors are here to stay (at least for a while).

Nevertheless, there is no hope, or fear, of a new construction “boom” in Spain, as the main indicators on new construction, construction employment and cement consumption have remained weak. Conversely, experts consider that Spain is living in a period of price correction and reordering of the real estate existing stock which will produce attractive yields to those who are able to anticipate and invest at these valuation levels.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

ISRAELI UPDATE – Public Investment in Hi-Tech Companies

Editor’s Note:  David E. Tadmor is a member of XBMA’s Legal Roundtable and the Managing Partner of Tadmor & Co.  Mr. Tadmor is recognized as a leading expert in the area of Israeli competition law.  He served as the Director General of the Israel Antitrust Authority (IAA) from 1997 to 2001.  Yoel Neeman is the head of Tadmor & Co.’s Corporate and M&A groups with extensive experience in cross-border transactions. This update is written by Yaniv Aronowich, a partner at Tadmor & Co.’s corporate group.

Executive Summary: The Committee for Encouragement of Investments in Public Companies Engaged in R&D, formed by the Israeli Securities Authority, has recommended adopting three main solutions aimed at encouraging public funding of hi-tech companies: promoting IPOs of relatively large hi-tech companies; facilitating the establishment of publicly-traded venture capital funds and encouraging the establishment of publicly traded R&D partnerships.  The Committee also recommends establishing two extra-stock exchange funding routes for seed-stage hi-tech companies:  crowd-funding, and investor clubs.  The article below details some specific recommendations made by the Committee.

Main Article:

Israel has set a goal of promoting and developing the hi-tech sector, which is the industry of the future and one of Israel’s primary growth engines.  However, so far, the Tel Aviv Stock Exchange (“TASE”) has failed to present an efficient alternative for raising public funds for companies in this sector.  In order to investigate ways of encouraging such investment in hi-tech companies via capital markets, the chairman of the Israeli Securities Authority (the “ISA”) appointed a Committee for Encouragement of Investments in Public Companies Engaged in R&D (the “Committee”).  On 4 June 2013, the Committee issued its interim report and recommendations.

Among the issues explored by the Committee aimed at facilitating public fund raising for hi-tech companies, were the adjustment of prospectus and ongoing disclosure requirements; determination of specific rules of trade and the establishment of a designated trade list; encouragement of analysis; facilitating access of foreign investors and companies to the TASE; encouragement of institutional investment in hi-tech companies; issues of structure and corporate governance; investor tax benefits.

In its interim report, the Committee recommends adopting three main solutions aimed at encouraging public funding of hi-tech companies: promoting IPOs of relatively large hi-tech companies; facilitating the establishment of publicly-traded venture capital funds and encouraging the establishment of publicly traded R&D partnerships.  The Committee also recommends establishing two extra-stock exchange funding routes for seed-stage hi-tech companies:  crowd-funding, and investor clubs.  In the following paragraphs, we have highlighted some specific recommendations made by the Committee.

IPOs: the Committee recommends enabling growth-stage companies (generally, with a post-IPO market cap of at least ILS 250 million, or sales of at least ILS 80 million per annum and a market cap of at least ILS 185 million) to go public on a designated trade list, to be known as “Tech Elite”.  The Committee also recommends looking at ways to incentivize the creation of derivative markets for Tech Elite securities.  The Committee further recommends that for a limited period of time and subject to additional conditions, investments of up to ILS 5 million in IPOs of Tech Elite companies may be written off and regarded and recognized as a capital loss in the year in which they were made.

Disclosure: the Committee recommends relieving Tech Elite companies from some of the more stringent disclosure requirements, during the first few years after listing.  For example, such companies will be able to enjoy the reporting and disclosure benefits of small-cap companies.  They will also be permitted to do their financial reporting according to GAAP (rather than IFRS), and will not be required to file quarterly management reports.  The ISA will be authorized to allow further extenuations, depending on circumstances.

Corporate governance: Elite Tech companies will be permitted – during the first few years following listing – to implement less stringent corporate governance controls.  For instance, they will not have to appoint a financial reports committee, their chief executive officer may also act as the chairman of the board, their compensation controls may be less strict, and they may simplify certain mechanisms for the approval of interested party transactions.

Delaware entities; language of reports: in order to encourage hi-tech companies incorporated in Delaware to list their securities in Israel, the Committee suggests permitting such entities to report in English (alongside a general recommendation to permit Tech Elite companies to file in English).

Listed VCs; R&D Partnerships: the Committee envisages two forms of publicly-traded VCs, which shall both act as mutual investment funds (under the applicable Israeli legislation): limited-period funds (of up to 15 years), and evergreen funds (whose duration may be terminated by resolution of the interestholders).  These VCs will be permitted to invest up to 30% of their proceeds in Israeli, or Israeli-oriented, unlisted hi-tech companies.  R&D partnerships are VCs that are co-managed by unaffiliated strategic investors (in the relevant field of investment) and financial investors (who will act as joint general partners), who will each have to hold a significant stake in the partnership.  R&D partnerships will have durations of no more than 15 years.

Crowdfunding: following on the US JOBS Act, the Committee recommends excluding certain crowdfunding activities from the scope of securities regulation and provide safe harbour for crowdfunding financing.  Funds raised by crowdfunding will be limited to ILS 2 million (approximately US$550,000) during each 12-month period.  Generally, an investor will be permitted to invest up to ILS 20,000 (approximately US$5,500) during any 12-month period, with each investment limited to ILS 10,000 (approximately US$ 2,750).

Sophisticated investor clubs: the investor club model would enable companies to raise higher amounts of funding compared to crowdfunding, from fewer and more sophisticated investors.  Contingent upon prescreening of such investors, so as to make sure they meet the “eligible investor” threshold set forth in Israeli security regulations, investments made through such clubs will also be exempt of stringent security regulation.

Assuming adoption of the Committee’s recommendations into law, these are set to revolutionize the ways in which hi-tech, bio-tech, bio-med and other R&D companies may raise funds in Israel.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

GLOBAL UPDATE – Global Capital Confidence Barometer: Real Estate, Hospitality and Construction

Editors’ Note:  Franny Yao (Yao Fang), who contributed this article, is a Partner & Leader at Ernst & Young in Beijing, responsible for Key Accounts and Government Relations in China. She is a founding director of XBMA and has broad expertise in cross-border M&A, representing major Chinese companies in their global expansion and other strategic drives. This report was produced by Ernst & Young’s Real Estate, Hospitality and Construction practice group.

Executive Summary:

The Global Capital Confidence Barometer is a regular survey of senior executives from large companies around the world, conducted by the Economist Intelligence Unit (EIU) of Ernst & Young. This snapshot of findings gauges corporate confidence in the economic outlook, and identifies boardroom trends and practices in the way companies manage their capital agenda:

  • Nearly half (47%) of real estate, hospitality and construction companies surveyed see the global economy declining, compared to 39% that see the economy improving.
  • The economic environment for transactions remains challenging, with executives continuing to grow their companies organically and focusing on stability.

For the results of the survey, click here.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

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