China and Chinese financial institutions have quickly become one of the largest sources of financing for African countries, with approximately $148 billion in loans committed by Chinese lenders between 2000 and 2018.
China's first official international loan was to Guinea in 1960. After adopting the 'Going Out' strategy in 1999, which sought to deploy quickly accumulating foreign exchange reserves outside of China to minimise inflationary and currency pressures, China and Chinese financial institutions quickly became one of the largest sources of financing for African countries.
In July 2020, the Mexican foreign ministry announced that China plans to provide a $1bn loan to make its coronavirus vaccine accessible for countries across Latin America and the Caribbean once it becomes available, following the conclusion of a virtual meeting of ministers from China and certain Latin American and Caribbean nations. This announcement follows other actions by China, such as the $500 million urgent loan from the China Development Bank (CDB) to Sri Lanka in response to the Covid-19 pandemic in March 2020, and is the latest in a number of loans announced by China in 2020.
Chinese financing can be broadly categorised into three types:
- interest free loans;
- subsidised concessional loans; and
- commercial loans.
Buyer's credit loans, which are used to finance purchases of goods and services from China, can be provided on concessional or commercial terms.
The London Interbank Offered Rate (LIBOR) is in the process of being phased out as a global reference rate, but LIBOR has historically been widely used by Chinese lenders for USD transactions and is continuing to receive support from Chinese lenders. As far as we are aware, there is currently no clear guidance or consensus as to what arrangements will be made to replace LIBOR on Chinese USD loans; or whether the Secured Overnight Financing Rate (SOFR), which is an alternative to LIBOR proposed by the US Federal Reserve Bank, will gain wide acceptance.
Interest-free loans
Interest-free loans are provided by China's Ministry of Commerce (MOFCOM) through "economic and technical assistance agreements" in the form of foreign aid. The terms of these loans are typically extremely generous, with no requirement for matching counterpart funding to be provided by the borrower.
Interest-free loans are not widely available, making up less than 5% of all Chinese loan commitments. However, their relative rarity makes it easier for China to work with distressed borrowers. Historically, China has a clear tradition of forgiving interest-free loans made to heavily-indebted developing nations that have diplomatic relations with China, including those in Africa.
Between 2000 and 2019, Chinese lenders cancelled approximately $3.4bn worth of loans, according to a report by the China-Africa Research Initiative of Johns Hopkins University (CARI). It also restructured approximately $7.5bn worth of loans and refinanced another $7.5bn worth of loans over the same period. China has also confirmed that, by the first quarter of 2009, 150 interest-free loans owed by 32 African countries were cancelled.
CEXIM concessional and preferential loans
Concessional and preferential loans are available from CEXIM, China's export bank, to sovereign borrowers at interest rates subsidised by the Chinese government. These loans come in the form of:
- concessional loans; or
- preferential buyer's credit.
CEXIM also offers buyer's credit on market terms.
Concessional loans and preferential buyer's credit are subsidised from different budgets. As a result, concessional loans are denominated in RMB and preferential buyer's credit loans are denominated in USD. The two products also have different counterparty funding arrangements. Concessional loans are able to fund 100% of project costs, while preferential buyer's credit can only fund up to 85% of project costs.
Both products are typically priced around 1%-3% fixed interest rate - generally around 2% - with a five year grace period and tenor of up to 20 years. Generally speaking, comparable concessional loans tend to provide more favourable pricing and terms than preferential buyer's credit. By way of comparison, a study published by the Centre for Global Development (CGD) in April 2020 found that the World Bank's loans to developing countries come with a 1.54% fixed interest rate, 10 year grace period and 40 year maturity.
Concessional loans are generally governed by Chinese law with dispute resolution in China, with limited scope for documentary negotiation. More flexibility is available for documenting preferential buyer's credit. Where the parties agree to resolve disputes through arbitration, in most cases arbitration with the China International Economic and Trade Arbitration Commission (CIETAC) in Beijing will be the default position.
Due to availability, and as concessional loans do not require counterparty funding, CEXIM will sometimes provide concessional loans alongside preferential buyer's credit as a way for the borrower to manage its funding requirements. In such cases, the covenants for the two facilities will typically be aligned.
Concessional loans and preferential buyer's credit tend to take considerably longer to reach signing and disbursement when compared to commercial loans.
Chinese commercial loans
As the name suggests, commercial loans are commercial in nature and are structured, priced and documented in accordance with prevailing market conditions and practice. Qualifying loans may benefit from political and commercial insurance from the China Export and Credit Insurance Corporation (Sinosure), which helps to streamline the credit approval process; but Sinosure's involvement is neither automatic nor always a requirement.
According to the CGD, commercial loans and commercial buyer's credit facilities from Chinese financial institutions are typically priced on a benchmark plus margin basis. In our experience, an interest period of six months is typically favoured for regulatory and administrative reasons.
The margin for commercial loans is typically market and credit driven and can have a large variance, but in limited cases can also have concessionary features. For example, the US$500 million COVID-19 facility provided by CDB to Sri-Lanka mentioned earlier is described by China's Ministry of Foreign Affairs, the US$500 million COVID-19 facility has a tenor of 10 years, a 3-year grace period and a floating interest rate linked to 6-months LIBOR.
According to CARI, the lowest margin to date was 30 basis points charged by the Industrial and Commercial Bank of China for a rural electrification project in Ghana, while the highest margin was 450 basis points from CDB for a road project in Africa. This is consistent with our experience where most infrastructure commercial loans had margins in the range of between 250 and 400 basis points.
Historically, the maturity for some loans can be over 15 years, but more recently loans with a tenor of more than 10 years are becoming rare. To put things in perspective, World Bank's market-based loans are generally priced at six-month LIBOR plus on average 205 basis points, with maturities of around 18 to 20 years.
Standard facility agreement documentation from the Loan Market Association (LMA) in London or its Hong Kong affiliate, the Asia Pacific Loan Market Association (APLMA), are widely accepted by Chinese lenders. However, many Chinese lenders will require substantial changes to reflect their institutional requirements due to different approaches on the Foreign Account Tax Compliance Act (FATCA), withholding risk, sanctions, anti-corruption and other considerations.
Waiver of sovereign immunity in respect of both jurisdiction and enforcement is standard on loans involving sovereigns, supported by sovereigns or involving state-owned enterprises. This is consistent with international lending practices.
US-style documentation and New York governing law are generally not preferred by Chinese lenders, with some lenders now having strict policies against agreeing to New York or any other US governing law or US dispute resolution clauses. Most Chinese lenders will accept the choice of English or Hong Kong law as the governing law of the loan agreement and English or Hong Kong courts for dispute resolution, although in recent years international arbitration has gained considerable popularity.
We have seen Chinese lenders agree to arbitration using the rules of most major institutions including the International Court of Arbitration of the International Chamber of Commerce (ICC), the London Court of International Arbitration (LCIA), the Hong Kong International Arbitration Centre (HKIAC) and the Singapore International Arbitration Centre (SIAC). However, most Chinese lenders will focus more on the seat of arbitration. In this respect, Hong Kong and Singapore are generally considered to be equivalent, with London as a distant third option. In practice negotiations often involve the borrower proposing its own capital or London as the seat; lenders proposing Beijing or Hong Kong; and the parties ultimately agreeing on Singapore.
Debt relief and restructuring
As reported by CGD, prior to 2012 rescheduling and restructuring of Chinese lending averaged US$52 million per case, but after the commodity price collapse in 2015, the average jumped to US$1 billion per case. To date, the largest is the $7.5 billion refinancing of Angola's state-owned enterprise Sonangol. In addition to CDB's restructuring of Sonangol, there are a large number of other well documented instances of Chinese loans being restructured, including loans involving Mozambique, Cameroon, Zimbabwe, Niger, Ethiopia, Republic of Congo, Djibouti, Benin, Sudan and Chad.
China has a tradition of cancelling zero-interest loans but these make up less than five percent of China's lending activities. For the other types of loans extended by Chinese lenders, including concessional/preferential and commercial loans, the practice is to either restructure or refinance. These loans tend to involve much larger sums than MOFCOM zero-interest loans, and can be provided by a variety of lenders.
Where a loan benefits from Sinosure insurance, Sinosure could potentially provide up to 95% of cover for losses incurred by paying unpaid scheduled payment obligations. In such cases, Sinosure will be subrogated to the rights of the lenders and their approval must be obtained in relation to any restructuring or refinancing discussions.
Unlike zero-interest loans from MOFCOM, loans provided by other Chinese lenders are not funded from government budget and any failure to pay will directly impact on their balance sheet. Individual Chinese bankers can also be personally disciplined for defaulted loans. As a result, as far as we are aware Chinese lenders have never agreed to outright debt cancellations and these loans must be either restructured or re-financed.
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