On 11 April 2018, the Governor of the People’s Bank of China (“PBoC”), Yi Gang, announced at the Boao Forum for Asia (“BFA”) that the 50% foreign ownership restriction in the life insurance sector is to be lifted to 51% in the first half of 2018. In addition, it was noted that complete liberalization of the life insurance sector (i.e. no foreign ownership restriction) can be expected in three years’ time. On 27 April 2018, the China Banking and Insurance Regulatory Commission (“CBIRC”) issued an announcement on accelerating the implementation of measures regarding opening up the markets of banking and insurance. The CBIRC stated in the announcement that the liberalization of the foreign ownership in the life insurance sector as announced at the BFA would be implemented as soon as possible. Given the scarcity of insurance licenses and the unique attributes of the insurance business, mergers and acquisitions (“M&A”) of insurance companies have always been chased after by the capital.
For the specific M&A rules of insurance companies, in addition to the regulatory requirements for equity-related activities, the CBIRC issued the Measures for the Administration of the Equities of Insurance Companies (Order No. 5  of the CIRC) (“Equity Measures”) (《保险公司股权管理办法》) on 7 March 2018, which provides further guidance and stipulates additional requirements for M&A transactions for insurance companies.
Based on our experience in insurance companies’ M&A transactions and in reference to the Equity Measures, the authors of this article outlined the M&A transaction options and common issues for M&A transactions involving insurance companies:
Approach Selection in the M&A of Insurance Companies
The most common M&A transactions for insurance companies include registered capital increase and equity transfer. Some investors or insurance companies may also, depending on the circumstances and different cases, combine the two approaches (registered capital increase and equity transfer) to achieve their desired outcome from the M&A transaction.
The registered capital increase is when an insurance company issues new shares which are to be subscribed by the investors. The registered capital of the insurance company increases when the investor becomes the shareholder of the insurance company. Equity transfer is when existing shareholders of an insurance company transfer all or part of their equity holding in the insurance company to other investor(s). With the equity transfer, the overall registered capital of the insurance company remains unchanged even though the equity holding structure changes. The investors select different M&A approaches depending on different transaction targets, capital development planning, funding capabilities, and other business demands. The insurance companies adopt different M&A approaches as well, depending on different transaction targets, capital demands, business development, future business planning, etc.
If an insurance company chooses to increase its registered capital, it can strengthen its solvency and receive funds to support its business development. With the equity transfer, the insurance companies can optimize the equity structure or attract some special investors, though the solvency and financial strength of insurance companies may remain the same. Consequently, if insurance companies require more capital to ensure solvency or to have more developing funds, they may choose to increase its registered capital. If the insurance company merely needs to introduce new investors to optimize the equity structure and corporate governance mechanism; or to attract special investors for business synergy to facilitate some strategic targets, they may prefer to undertake equity transfer. For investors, aside from the need for capital of insurance companies, they also take other factors into consideration when deciding on investment methods. For example, registered capital increase may require more capital to be invested than for equity transfer if that investor wishes to achieve a certain percentage of equity holding in an insurance company. However, the equity held by existing shareholders may be subject to transfer restrictions, in which case the investors may prefer subscribing to new shares to increase registered capital.
About two thirds of the M&A transactions of insurance companies we have advised on chose to increase registered capital. This approach strengthens the solvency of insurance companies and provides more capital for business development. The remaining one third of the M&A transactions that adopted equity transfer were results of the need for equity structure adjustment or existing shareholders.
Common Issues in M&A Transactions Involving Insurance Companies
To ensure that the investors in the insurance market are genuine investors who understand the insurance market, the CBIRC has, in recent years, intensified its regulation on equity activities of insurance companies. Thus, the success of M&A transactions involving insurance companies largely depends on the compliance of regulations and the regulatory intent behind them.
Based on our experience in M&A transactions involving insurance companies and with reference to the requirements of the Equity Measures, the authors of this article summarized the major issues in M&A transactions involving insurance companies:
- Understand the Shareholders Qualification Requirements
The Equity Measures provides comprehensive shareholder qualification requirements for insurance companies. Nevertheless, some requirements need further clarification on how it shall be implemented in practice, for example, it is unclear whether a newly established Domestic Limited Partnership (“DLP”) can become a shareholder of an insurance company. The requirement states that the qualification of a DLP is that is must be a “simple structured” DLP; however, it is unclear what ‘simple structured’ means; also, it is unclear whether the investor company must have been established for a period of time to be qualified as a shareholder of an insurance company, or whether the financial indicators requirement for the investors are based on the consolidated accounting statements or the parent company accounting statement, etc.
Based on our recent experience, we understand that depending on circumstances, a newly established DLP may or may not be permitted to become a shareholder of an insurance company. The factors taken into consideration by regulators in deciding whether a DLP qualifies as a shareholder of an insurance company include the DLP’s background and whether the fund is raised in accordance with business practice, etc. With regards to “simple structured” DLP, we understand that the regulator may take deliberate consideration of the qualification of the shareholder if the DLP is multilayered, which means that there are other DLPs in the structure; or if there are some financial institutions such as trust companies and securities companies, whose source of funding is difficult to be unveiled, involved in the structure. Furthermore, we understand that other than the DLPs, investors have to be established for one/two/three year(s) so as to be qualified as certain types of shareholders respectively. We also note that there are no explicit rules on whether the consolidated accounting statements or the parent company accounting statement will apply. In practice, investors shall meet the requirement based on both the consolidated accounting statements and the parent company accounting statement. It is not clear whether such practice may change after the issuance of the Equity Measures.
In addition to the shareholders qualification requirements, the Equity Measures introduces a new qualification criterion of “no serious violation”. For example, if an insurance company would like to establish a new insurance subsidiary, or become the controlling shareholder of another insurance company, the first insurance company must not have “violated the laws or regulations within three years”. Furthermore, the headquarters of such insurance company must have “no serious violation of laws or regulations within one year”. A company that “invested in the insurance market and was responsible for a serious violation of regulations by an insurance company” is not qualified to be a shareholder of an insurance company. Currently, there is no explicit definition of “serious violation”. Nevertheless, the CBIRC has issued the Circular on Issues Concerning the Standards of Serious Administrative Penalty and Serious Violation of Laws and Regulations (“Circular of Serious Violations”), which we understand will help clarify the definition of “serious violation” mentioned in the Equity Measures.
According to the Equity Measures, only relevant provisions therein will apply to the foreign-funded shareholders of insurance companies with more than 25% of ownership. Therefore, as we understand, the above provisions of the Equity Measures regarding the qualification of shareholders may not apply to foreign shareholders of Sino-foreign joint venture insurance companies. However, the Equity Measures will apply to Chinese shareholders in full.
- The funds for capital contributions must meet statutory requirements
To eliminate false capital contribution and strengthen supervision, the Equity Measures specifically deals with “funds for capital contributions”. The funds for capital contribution are always the key point in insurance companies’ M&A. Therefore, both the investors and the insurance companies must ensure that the funds for capital contributions strictly meet supervisory requirements.
The Equity Measures states that the funds for M&A transactions involving insurance companies must satisfy the following requirements:
- an investor shall use lawfully sourced self-owned funds to acquire the equities of an insurance company, and the self-owned funds must not exceed the net assets;
- an investor shall not evade the self-owned funds requirement by adopting a disguised method, such as forming a shareholding institution, transferring expected right to yields of equities and any other ways;
- the CBIRC may, under the principles of penetrating supervision and categorized supervision, retrospectively identify the source of self-owned funds;
- an investor shall make contributions in cash, and not in non-cash forms, such as physical property, intellectual property rights and right to use the land, among others, unless otherwise prescribed by the CBIRC for insurance group (holding) companies;
- an investor shall not directly or indirectly acquire the equities of any insurance company with any of the following capital: (i) borrowings relevant to the insurance company; (ii) capital obtained with deposits or other assets of the insurance company as a guarantee; (iii) capital obtained by inappropriately utilizing the financial influence of the insurance company or inappropriate affiliation relationship with the insurance company; and (iv) capital obtained by means prohibited by the CBIRC; and
- an investor must not misappropriate insurance capital or use capital obtained through an investment trust plan, a privately offered fund, or equity investment of the insurance company to make repeated capital contributions to the insurance company.
The funds for capital contributions must meet the above-mentioned requirements. Based on our recent experience, the CBIRC is strictly scrutinizing the funds for capital contributions and requires investors to confirm the source of the funds for capital contributions specifically and to provide relevant proving materials. In addition, based on our experience and to our knowledge, the above-mentioned regulations apply equally to Chinese and foreign investors.
- Affiliated parties and persons acting in concert to invest in insurance companies are captured
The Equity Measures acts to supervise activities involving insurance companies’ equity, to tighten supervision over shareholders, which also captures persons acting in concert as affiliated parties. The Equity Measures provides that the affiliated parties and persons acting in concert in investing into insurance companies must satisfy the following requirements:
- the shareholding ratio of a shareholder and its affiliates and persons acting in concert shall be calculated on a consolidated basis;
- where the total shares held by affiliated parties and persons acting in concert reach the limit for shareholders of Class-II finance, strategic shareholders or controlling shareholders, the shareholder holding the majority of shares shall meet the corresponding shareholders qualifications;
- an investor together with its affiliated parties and persons acting in concert thereof can only become the controlling shareholder of one insurance company carrying on either life business or property & casualty business;
- an investor together with its affiliated parties and persons acting in concert thereof can only become the controlling shareholder or strategic shareholder of no more than two insurance companies, including the life insurance company and property & casualty insurance company;
- parties that have affiliated relationships within twelve months before the date when the agreement on the investment is signed shall be deemed as affiliated parties; and
- “acting in concert” means the act or fact that an investor works together with other investors through an agreement or any other arrangement to jointly increase the quantity of voting shares under control thereof in a company. Investors acting in concert in relevant equity change activities of an insurance company shall be considered as persons acting in concert with each other. If there is no contrary evidence, an investor falling under any of the following circumstances shall be a person acting in concert: (i) a director or supervisor of an investor, or a major member of its senior executives serves as a director, supervisor or senior executive of another investor concurrently; (ii) an investor acquires relevant equities through the financing arrangements provided by other investors other than banks; or (iii) there is a partnership, cooperation, joint operation and other economic benefit relationships between investors.
Therefore, if an investor intends to invest in an insurance company jointly with its affiliated parties or persons acting in concert, that investor will be subject to the above-mentioned provisions on the affiliated parties and persons acting in concert in investing in insurance companies.
For Sino-foreign joint venture insurance companies, based on our understanding, in addition to the 51% foreign ownership limit for life insurance companies (as when relevant liberalization measures come into effect, the 50% restriction will change to 51%for the life insurance sector), the foreign investor investing in an insurance company jointly with its affiliated parties or persons acting in concert must also meet the above-mentioned requirements.
- Check whether the transferred equity is subject to transfer restrictions
The Equity Measures states that an investor must not transfer any equity held within five years of becoming a controlling shareholder, transfer any equity held within three years of becoming a strategic shareholder, transfer any equity held within two years of becoming a shareholder of Class II finance, or transfer any equity held within one year of becoming a shareholder of Class I finance.
As such, for equity transfer transactions, the investor must first assess whether the relevant equity is subject to any transferring restrictions. During due diligence, the investor must confirm the exact date on which the transferring shareholder became a shareholder of that insurance company and assess whether that equity being transferred is subject to any of the aforementioned transferring restrictions. The investors can adjust the deal arrangements or suspend / terminate the transaction if the desired outcome cannot be achieved.
- Obtain relevant approvals
Under the Insurance Law of the People’s Republic of China (Order No. 26 of the President of the People’s Republic of China) and the Equity Measures, the insurance companies’ change in registered capital must first be approved by the CBIRC. Furthermore, any change to the holding of not less than 5% of equities shall first be approved by the CBIRC and any change to the holding of less than 5% must be reported to the CBIRC.
When an insurance company changes its registered capital or shareholding, its articles of association shall be amended accordingly. In addition to obtaining the approvals from the CBIRC for the changes in registered capital or shareholding, the amendments of articles of associations must also be approved by the CBIRC as well.
According to the Notice of General Office of the CBIRC on Optimizing the Procedures for Approval of Amendments to Articles of Associations of Insurance Companies (《中国保监会办公厅关于优化保险公司章程修改等审批程序的通知》) and Notice of the CBIRC on Issuing the Opinions on Regulating the Articles of Associations of Insurance Companies (《中国保险监督管理委员会关于印发 <关于规范保险公司章程的意见> 的通知》), if a Chinese insurance company only changes its registered capital or shareholding of no less than 5%, it may submit applications for amendments of articles of associations concurrently; if a Chinese insurance company only changes less than 5% of its shareholding, it must submit a separate request for the amendment to its articles of associations. For Sino-foreign joint venture insurance companies, the aforementioned process shall apply mutatis mutandis.
As the supervision policies on activities relating to insurance companies’ equity are becoming more and more strict, the CBIRC is going to adopt stricter scrutiny over insurance companies’ M&A transactions. However, as some of the supervisory requirements have not yet been specified in relevant regulations, it is crucial to maintain an ongoing communication channel with the CBIRC throughout the process for the transaction to close smoothly.