On 1 June 2014, new regulations1 and guidelines (collectively the Rules) were implemented by SAFE. The Rules relax Chinese foreign exchange controls limiting the provision of Chinese cross-border security or guarantees (cross-border security) and are relevant to anyone who either relies on or provides cross-border security. This includes (for example) banks providing financing for purchases of vessels or aircraft, and the buyers of newbuildings who wish to rely on refund guarantees provided at the behest of the yard constructing the vessel. It also includes PRC companies being named as the guarantors of charterers (e.g. under NYPE time charters).

A few issues remain to be clarified: existing Chinese legislation has not yet been amended to reflect the Rules, and it is unclear whether the Rules will apply retrospectively. Still, the Rules appear to mark a new dawn with regard to cross-border security.

SAFE troubles of the past

Cross-border security had to be pre-approved by SAFE for the cross-border security to be valid. If, on attempted enforcement, the cross-border security was deemed invalid, SAFE would not approve payment out of China. Under Chinese law, liability for the invalid cross-border security was apportioned according to the respective fault of the parties for failing to pre-approve the cross-border security.2 The result in most cases was that the recovery of the party seeking to rely on the cross-border security was dramatically reduced, even though the guarantor or security provider was solvent.

In Emeraldian Limited Partnership v Wellmix Shipping Limited, Guangzhou Iron & Steel Corporation Limited3 a guarantee was granted by an onshore guarantor on behalf of charterers, without SAFE pre-approval having been obtained. Chinese legal experts submitted that the guarantee was invalid, and applying Chinese legal principles of civil liability, the guarantor’s liability should be reduced to 50%. The case illustrates the great commercial uncertainty faced by parties as a result of the old SAFE rules. The problem was most acute where the security provider’s assets were all located in China (as enforcement against those assets was subject to Chinese law). Where the security provider also had assets abroad, the party seeking to enforce the cross-border security often fared better.

The Rules: a new dawn?

The Rules divide the provision of a cross-border security into three categories (illustrated in the below diagrams using simple loans as examples):

  1. Neibaowaidai (内保外贷): cross-border security provided by an onshore security provider to an offshore creditor, to secure the debts of an offshore debtor. Prior approval/ registration is not a pre-condition for neibaowaidai to be effective but, neibaowaidai must be subsequently registered with SAFE.

Click here to view the diagram.

  1. Waibaoneidai (外保内贷): cross-border security provided by an offshore security provider to an onshore financial institution (creditor), to secure the debts of an onshore non-financial institution (debtor). The onshore financial institution is required to report the transaction to SAFE. Prior approval/registration is not a pre-condition for waibaoneidai to be effective but subsequent registration with SAFE is required.

Click here to view the diagram.

  1. Others (其他形式): This refers to all other forms of cross-border security (which accord with the definition used under the Rules) that do not fall into categories (A) and (B) above. There are no registration or approval requirements from the perspective of foreign exchange controls for this category, unless SAFE otherwise specifies. An example of cross-border security falling in this category is security over onshore assets provided by an onshore company to secure debts owed to an offshore bank.

Click here to view the diagram.

Practical advice

Parties taking cross-border security should always identify which category applies so as to ensure that the relevant registrations with SAFE are made. Parties should also review other aspects of the security (in addition to SAFE issues) which may be subject to PRC/foreign law (e.g. capacity of the guarantor/security provider and the signatory(ies)) to ensure that the relevant security document is enforceable. A fuller article about the SAFE Rules can be found here: http://www.hfw.com/Changes-to-the-PRCs-SAFE-Rules.