On 12 May 2014, the State Administration of Foreign Exchange (“SAFE”) issued the Rules on Foreign Exchange Administration for Cross-Border Security (“Rules”) which became effective on 1 June 2014. The Rules relax government control of capital and simplify cross-border guarantee of loans and investment requirements in and out of the People’s Republic of China (“PRC”).
Under the new Rules, pre-approval by SAFE and quota management for giving cross-border security and guarantee are replaced by post-execution registration making it less costly for PRC companies to arrange cross-border funding and there is now more certainty in structuring such funding.
The Rules define 3 categories of cross-border security and guarantee and provisions applicable to financial institutions and non-financial institutions are different. For the purpose of this article, we are concerned with non-financial institutions provisions only.
1. Security/guarantee by onshore entity to secure loans by offshore lender to offshore debtor (Nei Bao Wai Dai)
A PRC entity (“Onshore Guarantor”) can provide cross-border security and guarantee to an offshore lender for lending to an offshore borrower. Unlike previously when the guarantor has to be the shareholder of the borrower, under the Rules, the Onshore Guarantor and the borrower can now be unrelated parties. If the Onshore Guarantor is a non-financial institution, it will only be necessary for it to apply for registration of the security/guarantee with SAFE within 15 working days of execution and only a procedural review of the above application will be involved. The effectiveness of the security/guarantee is no longer conditional on the registration with SAFE.
The above provisions also apply to PRC nationals, so that they can freely give security/guarantee to offshore lenders from now on.
There are however restrictions on the use of the funds from Nei Bao Wai Dai in that the offshore borrower must use the funds in its ordinary course of business and must not directly or indirectly repatriate the funds into China for any use domestically eg investing in any entities registered in China. Otherwise, special approval from SAFE will be required.
When the guarantee is called, the Onshore Guarantor can arrange for payment to the offshore lender through domestic banks by providing the relevant guarantee registration documents. Thereafter, the Onshore Guarantor will become the creditor of the offshore borrower by subrogation and will need to register with SAFE the resulting cross-border debt owed to it by the offshore borrower within 15 working days.
Unless approved by SAFE, the Onshore Guarantor is not permitted to enter into any further Nei Bao Wai Dai arrangement until the existing foreign debt has been repaid.
2. Security/guarantee provided by offshore entity to secure loans granted by onshore lender to onshore debtor (Wai Bao Nei Dai)
An offshore entity (“Offshore Guarantor”) may provide cross-border security/guarantee to an onshore lender for lending to an onshore borrower. The lender should be a registered financial institution in China and the borrower should be a non-financial institution registered and carries on operations in China. For instance, an offshore company may provide security/guarantee to a PRC bank to secure the lending (in Renminbi or foreign currency) from the bank to a PRC borrower (who may or may not be the subsidiary of the security provider as there is no longer such shareholding requirement now).
There is no need for the onshore borrower to register the security/guarantee contract with SAFE. Only the lending bank (onshore lender) will need to report and supply the relevant data to SAFE.
When the guarantee is called against the Offshore Guarantor, the lending bank can receive payments in China directly from the Offshore Guarantor.
Upon payment by the Offshore Guarantor under the guarantee, the onshore borrower should, within 15 working days of the above payment, complete the procedures and related filing for short-term foreign debt registration with the local branch of SAFE.
The onshore borrower is not permitted to enter into any further Wai Bao Nei Dai arrangement until the above foreign debt has been repaid.
Pursuant to the relevant provisions of the Rules for Wai Bao Nei Dai, the total outstanding amount of foreign debt of the onshore borrower should not be more than 100% of its audited net assets. It is noted that this cap has been increased compared to before the commencement of the Rules.
3. Other cross-border securities/guarantees
The third category includes all cross-border securities/guarantees other than Nei Bao Wai Dai and Wai Bao Nei Dai.
Examples include an onshore guarantor providing security/guarantee to offshore lender for loans to an onshore borrower and an onshore guarantor providing security/guarantee to onshore lender for loans to an offshore borrower.
Unless otherwise specifically required by SAFE, no registration or filing is necessary for this category of cross-border security/guarantee but all relevant domestic and overseas laws and regulations must be complied with.
The Rules are seen as a relaxation of PRC’s foreign exchange control policy and will undoubtedly ease and facilitate cross-border security and international capital fund raising. Subject to any practical implementation difficulties, the Rules are much welcomed by PRC companies.
If you have any questions on the above or other issues on doing business in Mainland China, experienced lawyers in our China Business Department will be happy to assist you.