The State Administration of Foreign Exchange (the “SAFE”) of China recently announced new rules regarding cross-border security (the “New Rules”), which became effective on the 1st June 2014. The New Rules substantially relax the regulatory regime for the provision of cross-border security (including guarantees and proprietary security arrangements).
We highlight below the key changes introduced by the New Rules that are relevant to overseas creditors wanting to use assets located in China as credit support.
Relaxations under the New Regime - Before the New Rules came into force, Chinese entities would generally need to obtain prior approval from SAFE in order to provide guarantees or security over assets located in China for debts incurred by an offshore debtor outside China (“Nei Bao Wai Dai (内保外贷)” or “Outbound Security”). Such Chinese entities were also required to satisfy other preconditions such as annual quotas, financial ratios and shareholder relationship with the debtor. These have often put overseas creditors at a disadvantage compared with the creditors of onshore entities in terms of recourse to onshore assets.
The New Rules have removed the requirements for SAFE’s pre-approval, annual quotas and other preconditions on financial test and shareholding relationship. Under the New Rules, Chinese entities, including banks, non-bank financial institutions that are licensed to engage in the business of providing security and other corporates are now free to provide Outbound Security, as are Chinese individuals.
Repatriation Restrictions - Despite the above relaxations, restrictions remain in relation to the use of loan proceeds. Loans that have been acquired with the support of Outbound Security are not permitted to be repatriated, directly or indirectly, into China, whether by way of equity investment or lending. This restriction also covers equity investments in an offshore company that has 50% or more of its assets located inside China or the refinancing of debt that has been repatriated, directly or indirectly, into China, whether by way of equity investment or lending.
The New Rules will particularly benefit offshore lenders that provide offshore financing to support acquisitions of pure offshore assets or acquisitions of target groups with the majority of their assets located outside China. Under the New Rules, lenders would be allowed to obtain upstream security from onshore entities (that may or may not be affiliated with the offshore target).
Outbound Security for Bond Issuance - In addition to the restrictions on the use of loan proceeds described above, offshore bonds raised with the benefit of Outbound Security would also be subject to the following restrictions:
- the issuer must be directly or indirectly owned by an onshore entity;
- the bond proceeds must be used for an offshore project in which an onshore entity has an equity interest; and
- both the issuer and the offshore project have been duly approved and registered with the relevant Chinese authorities that regulate outbound investments.
Other Forms of Cross-Border Security - Other than (a) Outbound Security and (b) guarantees or security provided by an offshore entity for onshore credit raised by an onshore entity from an onshore bank or financial institution (which is commonly known as “Wai Bao Nei Dai (外保内贷)” or “Inbound Security”) both of which remain subject to post-signing registration with SAFE, the New Rules provide that all other forms of cross-border security structures can be effected without any prior approval from or post-signing registration with SAFE. Other conditions relating to annual quotas, financial test and shareholding relationship have also been removed. For example, an offshore lender lending to a foreign-invested enterprise inside China can now be protected by security granted by onshore entities (whether or not affiliated with the debtor) over their onshore assets.
Conclusion - The New Rules are a welcome development for market participants looking to tap Chinese assets when carrying out cross-border financing transactions. With the additional structuring options offered by the New Rules, we anticipate that there will be an increase in the use of Chinese assets being used as collateral for offshore funding.