On 22 January 2016, China’s central bank promulgated a notice entitled the PBOC Circular Regarding the Expansion of the Pilot Program of Prudent Macro Management of Cross-border Financing (“PBOC Circular”). According to the PBOC Circular, a new unified cross border financing management regime will be implemented as of 25 January 2016 in China’s four free trade zones, including Shanghai Free Trade Zone, Guangdong Free Trade Zone, Tianjin Free Trade Zone and Fujian Free Trade Zone.

In this regulatory alert, we will analyze the key features of the new cross border financing management regime contemplated by the PBOC Circular.

1. Scope of Application

The new cross border financing management regime is expressly applicable to both RMB and FX denominated cross border financing borrowed by the pilot companies and the pilot financial institutions from non-residents, with PBOC having the jurisdiction of adjusting the cross-border financing leverage ratio and macro-prudential adjustment ratio etc., and SAFE having the jurisdiction of cross border financing administration and accounting monitoring etc.

The new cross border financing management regime will be applied to the pilot companies and the pilot financial institutions. Included in the first batch name list of the pilot financial institutions are 24 domestic banks and 3 foreign invested banks including HSBC, Standard Chartered Bank and Citi Bank. Companies eligible to join the pilot program shall be non-financial institution companies incorporated in the above mentioned four free trade zones excluding government financing vehicles and real estate companies. We note that non-bank financial institutions are therefore not included in the first batch of eligible borrowers.

2. Macro-prudential Policies

The key message in this PBOC Circular is that the pilot companies and the pilot financial institutions shall have the discretion to raise RMB or FX denominated financing from offshore, provided that they comply with the cross border financing restrictions based on borrowing entities’ capital or net assets which have been designed in accordance with the macro-prudential policies.

The cross border financing restrictions designed in accordance with the macro-prudential policies are mainly embodied in the followings:

  1. The aggregate drawdown amount that has not been repaid under the RMB and FX denominated cross border financing after calculated with the risk weight (i.e. Risk Weighted Outstanding Cross Border Financing) shall not exceed a ceiling amount (i.e. Cross Border Financing Risk Weighted Outstanding Upper Limit)
  2. Cross Border Financing Risk Weighted Outstanding Upper Limit = capital / net assets (tier 1 capital for pilot financial institutions and net assets for pilot companies) * Cross border financing leverage ratio (currently 1 for pilot companies and 0.8 for pilot financial institutions, subject to PBOC’s adjustment from time to time) * Macro Prudent Adjustment Parameter (currently set at 1, subject to PBOC’s adjustment from time to time)
  3. The Risk Weighted Outstanding Cross Border Financing =Σ aggregate outstanding amounts of RMB & FX cross border financing * Maturity Risk Conversion Multiplier * Type Risk Conversion Multiplier + Σ outstanding amounts of FX cross border financing * Exchange Risk Conversion Multiplier
  4. Scope of Risk Weighted Outstanding Cross Border Financing

When calculating the Risk Weighted Outstanding Cross Border Financing, certain categories of debts shall be excluded, including:

  • Passive RMB Debt: passive debt arising as a result of offshore entities investing to domestic bond market or placing RMB deposits with the pilot financial institutions;  
  • Trade Finance / RMB Trade Finance: pilot companies’ account receivables or advanced payment arising from genuine cross-border trade and RMB trade financing from offshore financial institutions; pilot financial institutions’ RMB trade financing of pilot financial institutions for the settlement of genuine cross-border trade;  
  • Account Payables between Group Member Companies: pilot companies’ debt owing to offshore entities under the duly approved cross-border cash pool for the concentration of groups’ cash flow generated from lawful business operation and non-financial investment of the group;  
  • Inter-bank Deposits etc.: pilot financial institutions’ debt owing to offshore entities arising from inter-bank deposits or payables to offshore affiliates;  
  • Self-used Panda Bonds: proceeds of RMB bonds issued by the offshore parents of the pilot companies in China which are lent back to the pilot companies;  
  • Transfer and Exemption: any amount of cross border financing converted to equity or exempted shall not be counted in.
  1. Calculation of Risk Weighted Outstanding Cross Border Financing
  • FX trade financing: the outstanding of FX trade financing shall be haircut to 20% when calculating the Risk Weighted Outstanding Cross Border Financing and the Maturity Conversion Multiplier shall be 1;
  • Off-balance sheet financing (contingent liabilities): contingent liabilities arising as a result of pilot financial institutions providing nei bao wai dai or derivative products based on genuine cross-border trade and asset-liability to hedge the currency or maturity risks of clients will be haircut to 20% when calculating the Risk Weighted Outstanding Cross Border Financing; contingent liabilities arising as a result of pilot financial institutions’ own currency or maturity hedging transactions and participating in international financial market transactions shall be haircut to 50% when calculating the Risk Weighted Outstanding Cross Border Financing;
  • Others: all other types of cross border financing shall be calculated as their actual outstanding amount.
  • Maturity Risk Conversion Multiplier: 1 for medium and long term cross border financing with a term of 1 year above and 1.5 for short term loan with a term equal to or below 1 year.
  • Type Risk Conversion Multiplier: 1 for balance sheet financing; 0.2 or 0.5 for non-balance sheet financing (contingent liabilities).
  • Exchange Risk Conversion Multiplier: 0.5.

3. Other points worth noting

  1. Points worth noting for pilot companies
  • Foreign invested companies could have the choice applying this new regime or sticking to the existing cross border financing regime applicable to it. 
  • SAFE will issue detailed implementation rules on how the pilot companies raise cross-border financing pursuant to this PBOC Circular.
  • No pre-approval is required; pilot companies shall make a filing with the SAFE’s capital information system within 3 business days before drawdown after the cross-border financing agreement is signed.
  • The FX-denominated cross border financing borrowed by pilot companies could be converted to RMB on its actual needs.
  1. Points worth noting for pilot financial institutions
  • The pilot financial institutions shall calculate the Cross Border Financing Risk Weighted Outstanding Upper Limit and Risk Weighted Outstanding Cross Border Financing and shall file the details of calculation with PBOC before embarking on the first cross border financial transaction.
  • The pilot financial institutions shall report the relevant data with PBOC and SAFE after the signing but before the performance of the cross border financing.
  • Foreign banks could have the choice applying this new regime or sticking to the existing cross border financing regime applicable to it.
  • The pilot financial institutions processing offshore financing in breach of PBOC Circular could be subject to regulatory punishments as severe as suspension of cross border financing settlement business.
  • Subject to approval by SAFE, the FX-denominated cross border financing borrowed by pilot financial institutions could be converted to RMB.

4. Comments & Implications

  • Allowing onshore entities to raise offshore financing based on certain risk conversion multiples according to the macro-prudential policies was initially introduced in the Shanghai Free Trade Zone for the management of the RMB cross border financing and the FTZ separate accounting system etc. This PBOC Circular is not simply having such principles and methods copied in other three free trade zones; rather, the significance of this PBOC Circular is that when implementing the macro-prudential principles in all the four free trade zones, PBOC will establish a comprehensive macro monitoring system and will take tools to smooth out boom-bust cycles to help control the systemic risks arising from cross border financing and build resilience in the financial system. We anticipate such macro-prudential principles will be promoted to nationwide when they are further tested in the four free trade zones.
  • Many market participants may have observed some recent PBOC and SAFE measures in controlling the capital outflow. The promulgation of the PBOC Circular seems signifying the tendency of the PRC regulators in slightly relaxing in-flow of capitals as versus more stringently in controlling out-flow of capital.
  • From the perspective of the pilot companies and the pilot financial institutions, the new cross border financing management regime means more autonomy on their part and less regulatory process in raising offshore debt financing. They could choose raising financing from onshore or offshore market with interest rate and exchange rate desirable to them. Of course, to what extent regulatory process applicable to cross border financing of the pilot companies differs from existing process will be subject to the implementation rules that are yet to be promulgated by SAFE.
  • The scope of jurisdiction of PBOC and SAFE with respect to RMB / FX cross border financing has always been a struggling point for the market participants. The PBOC circular has clearly addressed this by providing that the goal is to apply a unified cross border financing management system to both RMB and FX denominated cross border financing.
  • The PBOC Circular permits the pilot financial institutions to convert the FX cross border financing into RMB upon approval of SAFE. We expect the market participants will look at the deal structuring opportunities presented by this relaxation.

This article was first published on Chinalawinght.com