China’s leasing industry is like a rough diamond, it requires a skilled craftsman to cut and polish it to turn it into a shiny gem. There are a lot of rough diamonds waiting to be mined in China. The potential leasing market is huge. With a leasing penetration rate at less than 3%, there is a lot of room for foreign lessors to grow in China.

According to the China National Bureau of Statistics (NBS), in 2006, 24% of China’s fixed asset investment of US$1.4 trillion was related to equipment investment. This translates into a potential of leaseable assets of US$335 billion. China’s fixed assets investment was up another 25.5% in the first four months of 2007. At this growth rate, leaseable assets in China should exceed US$500 billion by 2008. On the other hand, only 18.3% of China’s fixed assets investment was funded by domestic bank loans, according to NBS, while 62% was financed by self-raised funds.

In addition, leasing is also one of the few remaining financial services industries in China that is allowed 100% foreign ownership and a market you can enter without paying a big premium. Today, Chinese banks are trading at a hefty premium of three times book value and with a maximum foreign ownership of 25%.

Like any developing market, there are opportunities as well as challenges. Having worked in the Chinese leasing market since 1994, I have witnessed many improvements over the years. The best comfort is that Chinese government officials in various ministries have recognized the problems facing the leasing industry.

Over the past few years, these Chinese ministries have actively worked with the National People’s Congress (NPC) to draft the first Chinese leasing law. They made a lot of efforts, particularly in areas that most concern foreign lessors, such as equipment title registration, repossession and enforcement, without having to go through lengthy court proceedings.

The leasing law is expected to be passed in 2008. After more than a decade of debate, China also passed the Property Right Law on March 16, 2007. This law recognizes the ownership right of individuals and companies. The new Property Right Law and the Bankruptcy Law, which became effective in August 2006, are enhancing the protection of lessors’ rights regarding equipment.

China is a big country, but it can move much faster than an elephant. I believe the China leasing market will quickly catch up with those markets in the U.S. and Europe. For example, a few years ago every major international financial paper and journal frequently referred to the bad debt problems of Chinese banks, which were confronted with up to 40% non-performing loans.

During this same period, many smart foreign strategic investors like Goldman Sachs and Bank of America had quietly negotiated to buy a piece of these Chinese banks. Their billion dollars of investments have more than doubled as Chinese banks are now trading close to three times book value. Warren Buffet more than tripled his billion dollars of investment in Petrol China in just a few years.

The major perceived barriers for non-Chinese financial services companies providing leasing in China are:

General Lack of Leasing Knowledge by the Lessee
It is a fact even recognized by Chinese banks that financing to Chinese SMBs, traditionally targeted customers for lessors, is regarded as considerably riskier because of rudimentary and often unreliable accounting records and doctored financial records. But there are many potential good lessees in China that are currently not served by the lessors.

In Asia, particularly in China, the interest of good credit companies in leasing has been low in the past. This is due to the fact that new fixed assets investment was controlled by the state, the management of state-owned enterprises was appointed by the state and a companies’ financial performance was not the most important criterion in assessing the effectiveness of the management.

But now China is transforming itself into a market economy as proofed by the recent listings of all major Chinese companies in banking, energy, telecom, petroleum and so forth on the international capital markets. And this means an opportunity for leasing. As listed Chinese companies are now accountable to shareholders for their financial performance and management becomes interested in using different financial tools to improve their companies financial position, they begin to fully appreciate the flexibility leasing offers to deploy their assets.

Currently, a high proportion of Chinese management still perceives leasing companies as a “second-class bank,” and very few recognize the flexibility and benefits that leasing provides. Investment in time and effort towards lease education will result in a big payoff for the lessors.

Lack of Credit Information
One of the main barriers to the development of China’s leasing industry is the absence of borrowers’ historic credit data. Credit information, such as past lending activities of enterprises and general business performance information, is almost non-existent.

To address this deficiency, a credit information databank targeting all Chinese companies was launched on a trial basis in early 2006 and became fully operational by the end of the year. A credit information databank targeting individuals has been up and running since January 1, 2006. The individuals’ databank includes the records of all personal guarantees provided by the major shareholders.

It is the intention of the Chinese government to expand this databank with records of utilities and phone payments, tax filings and travel information. The data will be retained for ten years. Implemented earlier this year, a three-month delinquency in phone payment by a person will be reflected in the individuals’ databank.

As the borrowers are now aware that their credit records, including all outstanding loans balance and payment history, will be kept for ten years, they feel a strong incentive to pay back the loan. The newly introduced credit information databank should reduce the lending risks to SMBs, which are the traditional bread-and-butter customers of lessors.

Enforcement
The biggest complaint from Chinese lessors in doing business in China is the legal enforcement, particularly at the municipality court level. Chinese mayors, in my opinion, are the most commercial of government officials. Their key mandate is the economic development of the city and to provide jobs for local residents.

As many foreign managers doing business in China have experienced, the local Chinese partners will solicit the cooperation of local government officials to support their projects. During the negotiation phase, the fancy “get to know you” dinners with the local mayors and plenty of Chinese wine is a standard protocol. It works the other way when a project goes downhill. Repossession of assets will be difficult to enforce against the lessee, as the local government will try to avoid the bankruptcy of the company in an attempt to protect local jobs.

Central China’s government has recognized this issue and initiated many directive measures to alleviate the problem. For example, China Export Credit Insurance Corporation, a wholly owned subsidiary of China’s Ministry of Finance, has rolled out an investment credit insurance program for foreign investors against the enforcement risks arising from protectionism and unfair practices of local government.

Recently, the Chinese government has also initiated some high-profile cases against the questionable decisions made by local judges. Once the pending China Leasing Law is passed as a national law, this will provide further protection to the leasing companies as many local courts will be less likely to challenge an industry that is governed by national law. In the latest draft of the pending leasing law, there is a provision to allow lessors to repossess without going through the lengthy court procedures.

Equipment Title Registration
Today, there is no uniform equipment title registration process in China as each municipality adopts different procedures. The pending China Leasing Law will unify the registration procedures and protect the lessor against a “good-faith” third-party claim if the leased assets are registered in the lessor’s name.

Geographic Coverage and Regional Differences
China has 23 provinces, five autonomous regions and four municipalities (Beijing, Shanghai, Chongqing and Tianjin) with an area of 9.6 million sq. km. The average flight time between major cities is about two hours. The official Chinese spoken language is Mandarin. Regional dialects like Shanghainese, Cantonese and Sichuanese are widely used as day-to-day spoken languages. For example, more than 100 million people in China speak Sichuanese.

Officially, there are no language barriers among Chinese people as Mandarin is taught throughout and there is only one set of Chinese characters. However, a sales person from a different spoken-dialect region may not be as effective as a local sales person speaking the same dialect. Travel time and associated cost for cross-region sales coverage are neither efficient nor cost effective. Being in Beijing or in Shanghai does not necessary mean full coverage in China.

China’s GDP for 2006 at the official exchange rate was US$2.5 trillion. More than 13 out of the 32 provinces (comprised of 23 provinces, five autonomous regions and four municipalities), regions and municipalities had a GDP more than US$100 billion. The 2006 GDP of Guangzhou province alone was the same as Hong Kong (US$187 billion) and Singapore (US$138 billion) combined. With the regional differences that exist and a cut-off of GDP US$100 billion, it literally means that operating across China is similar to doing business in 13 different countries.

In 2006, the GDP of Shanghai was exceeding the GDP of Malaysia of US$131 billion. To be a major successful player in China, non-Chinese lessors need to plan for national coverage in order to be competitive both in market coverage and cost.

Staffing
There is a well-stocked pool of available people at the entry professional level with some working knowledge of English. The development of China’s financial services industry is still in its infancy and the market has only recently opened up to foreign financial services institutions like banking, insurance, investment banks, asset management and security. Consequently, there is a strong demand for middle-level and senior management people with a good knowledge of Chinese and international financial markets. Not only do foreign lessors have to compete among their peers but also other financial institutions like banks.

Citibank announced recently it would add 1,000 staff to its China operation in the near future. It is not so much a problem at the senior management level because candidates can be easily seconded from HQ as an expatriate for three to five years. The critical hiring is the second level of management like CFO, head of risk and head of sales. These people are acting as the interface between the functional bosses at HQ and their local team.

“Lost in translation” is the common factor for losing good local staff because they have to spend so much of their time translating local documents into English. This can be a difficult and frustrating task for many Chinese staff and, as a result, very little effort is being spent in sales and marketing. Not only is it frustrating for the local staff, it is also unproductive for the non-Chinese lessors. A good middle-level management team will minimize the need for local teams to have to interface directly with HQ and will also enhance productivity as communications and directives will then mainly be conducted in Chinese.

Patience Required
Many foreign companies doing business in China have substantially underestimated the administrative burden for routine administrative compliance with various government ministries and the Tax Bureau. It is like waiting in a taxi queue on a rainy day. There is nothing you can do except wait — but with the comfort that eventually you will get a taxi. The best solution is to outsource administrative tasks to companies that have experience in dealing with the bureaucy. A lack of understanding from HQ for the slow progress on small tasks may result in local management being seen to be ineffective whereas, in reality, such things will be out of their control.

It must also be recognized and appreciated that there are many basic custom and cultural differences between China and many foreign countries when it comes to doing business and in working methods or practices at the workplace. Simply trying to apply foreign domestic practices can easily result in bad communication and misunderstanding about the real intention and can lead to entirely different results than expected. Conducting discussions to reach common levels of understanding may also require a great deal more time than expected. Foreign entities coming to do business in China must be prepared to spend time and effort learning how to combine their instinctive home-country ways with those in China to maximize effectiveness.

In summary, it is easy to find excuses for not being in China. In my opinion, perceived risks are higher than real-market risks. This is understandable with the bad track record in the 1980s suffered by many Japanese lessors with joint ventures in China and the underdevelopment in the area of legal enforcement. The fact that the Chinese government is recognizing those barriers that are hindering the development of its leasing industry and is proactive in removing those barriers is a major step forward for a healthy expansion of the Chinese leasing industry.

Despite many newly established foreign wholly owned lessors, the combined capital of all Chinese and non-Chinese lessors is less than US$2 billion. Under Chinese leasing regulations, a leasing entity can finance up to ten times its registered capital. This generates a leasing capacity of less than US$20 billion. As projected, leasable assets will reach US$500 billion by 2008. The current leasing capacity based on current capitalization level will only satisfy 4% of the equipment investment.

With the pending new China Leasing Law, newly introduced credit information databanks, government initiatives and the demand for lease solutions by listed Chinese companies, there is considerable room to increase the lease penetration rate. Here’s a point to consider: A 1% increase in lease penetration rate will generate an incremental US$5 billion of lease volume.

Don Chan recently joined Fortis Lease Group with more than 18 years of experience in global leasing in the U.S., Pan Asia and China. As the CFO of AT&T Capital, Asia Pacific and later as the president of AT&T Capital, North Asia, Chan took a leading role in the execution of AT&T Capital’s Asia Pacific strategies and expansion into Hong Kong, Taiwan, Singapore, Malaysia, Australia and New Zealand, successfully implementing tough strategies to navigate through the Asia Economic Crisis of 1997/98.

Chan led the start-up of CIT China and built it into one of the successful foreign financial services joint ventures in China. He was also responsible for establishing and managing Dell Financial Services to support and enhance Dell’s Asia Pacific sales.

He is a CPA in the U.S., and received a Bachelor’s degree from Baruch College as well as a Master’s degree in Business Administration from New York University.