China’s enhanced scrutiny of financial leasing likely to drive consolidation and weed out weaker firms, analysts say

China’s enhanced regulatory scrutiny of financial leasing companies could drive out smaller participants and accelerate industry consolidation, according to analysts.

The National Administration of Financial Regulation (NAFR), which oversees the country’s financial industry with a specific remit to look at market risks, said in January that it is soliciting feedback on a draft measure that would revise decade-old rules for financing companies.

A financial leasing company typically acquires concrete assets and sells operating control to another business – the lessee – for a set period of time, during which the leasing company – also known as the lessor – collects rentals and other instalments for the use of that asset to recover acquisition costs, as well as generating additional interest income.

The draft measure, which is open to public consultation until February 5, will raise the total assets and operating income requirements for lessors. It will also increase the minimum shareholding requirement that a major shareholder can take in an asset to at least 51 per cent, up from 30 per cent previously.

In addition, the draft measure will narrow the range of assets that qualify for leasing, and calls for stronger corporate governance and more comprehensive exit mechanisms to prevent financial risks.

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“The new measures, if implemented successfully, should enhance the stand-alone credit profiles (SCPs) of the larger financial leasing companies and are positive for the sector’s long-term development,” analysts at Fitch Ratings wrote in a note.

“However, we do not expect the potential improvement in the Fitch-rated Chinese financial lessors’ SCPs to affect their issuer default ratings, which are derived using a top-down approach and driven by shareholder support,” Fitch analysts said.

SCPs measure a financial institution’s intrinsic creditworthiness without accounting for all external factors, such as government support at times of financial difficulty.

Meanwhile, Fitch said the more stringent rules for financial leasing companies will raise the “regulatory and economic hurdles for operating in the sector, accelerating the exit of weaker and smaller firms, and driving further sector consolidation”.

Drilling down, Fitch wrote “the narrowing of qualifying lease assets mainly to equipment that has clear ownership and economic value and can generate recurring income, will challenge some existing lessors’ balance-sheet expansion, especially [those] with existing large exposure to immovable assets – primarily public infrastructure and public utility assets”.

The Fitch analysts added they expect the regulator to continue to pivot the sector’s focus “towards core leasing products, including direct leases and operating leases, aiming to support the economy by providing financing for manufacturing upgrades, green energy and new infrastructure”.

However, the proposed 51 per cent shareholding requirement is not expected to have significant implications, according to another analyst.

“Since 2014, regulation requires major shareholders to ensure capital adequacy and sufficient liquidity of the leasing company in times of crisis,” said Ying Li, Head of Financial Institutions Ratings at S&P Global (China) Ratings.

“Therefore, this new requirement is consistent with the principle of group support for leasing companies. The majority of mainstream financial leasing companies already have a major shareholder holding over 51 per cent shares,” added S&P’s Li.

“Incumbent financial leasing companies don’t need to meet this new requirement, so it doesn’t affect the incumbent players. For any potential new comers, this 51 per cent requirement won’t be a huge hurdle to cross.”