On 28 October 2013, the State Administration of Foreign Exchange (the “SAFE”) promulgated the Circular on Foreign Exchange Control Issues Concerning Trial Implementation of the Business of Small Domestic Loans Secured by Security from Abroad in Certain Regions (Hui Fa (2013) No.40) (the “Circular No. 40”).

We highlight below the main content of this circular.

  1. Pursuant to Circular No. 40, subject to the following conditions, a company in China may directly sign agreements with a financial institution in China and an overseas security provider, under which such company will take out a loan from a financial institution and the loan is secured by the security provided by a foreign party (the “Structure”):
    1. The accumulative amount of the loans taken out by the company under the Structure in a calendar year shall not exceed RMB 50 million; and
    2. At any point of time, the amount of the remaining principals of the loans taken out by the company under the Structure shall not exceed its net asset value as of the end of the preceding year.
  2. In the past, the Structure has already been commonly used by foreign invested enterprises which took out the loans and their overseas parent company provided security for the loans. However, domestically-owned enterprises could only do so on a pilot basis and there was much red tape in order to get the approval from the competent SAFE. According to the Administrative Measures of Registration of Foreign Debts issued by the SAFE on April 28, 2013, a domestically-owned enterprise could apply to the competent SAFE for a so-called “quota of overseas security for domestic loans” (the “Quota”). After obtaining the Quota, a foreign party could provide a security in favor of a financial institution in China for the loan of such domestic company within the approved Quota.

However, based on Circular No. 40, it seems that it is now no longer necessary for a domestically-owned enterprise to apply for the Quota and instead it may directly sign the relevant loan agreement and security agreement as long as the conditions mentioned in item 1 above are fulfilled. Since Circular No. 40 does not explicitly confirm this understanding, it is advisable to still check with the competent SAFE about this issue on a case-by-case basis.

  1. Each financial institution in China shall report to the SAFE on a monthly basis the transactions it handled in accordance with Circular No. 40. In case of performance of the security obligations by the foreign security provider, the financial institution shall obtain the verification document from the competent SAFE. However, obtaining the verification is not a pre-condition for the financial institution to receive from abroad the funds from performance of the security obligation. After the verification has been issued, the relevant financial institution shall give a copy of the verification to the Chinese borrower.

The foreign security provider, after having performed the security obligation, shall have the right of recourse against the Chinese borrower. Under the current foreign exchange regime, the Chinese borrower shall register its short term debt towards the foreign security provider with the competent SAFE. However, under the Circular No. 40, the Chinese borrower does not have to register its debt towards the foreign security provider as its foreign debt with the SAFE and such debt will not take up its foreign debt quota. The Chinese borrower may make repayment to the foreign security provider on the basis of the copy of the SAFE verification document as mentioned in the preceding paragraph.

  1. Circular No. 40 only applies to companies and financial institutions in Guangdong, Zhejiang and Fujian Provinces. In addition, a company that is ranked as Grade B or C by the SAFE in accordance with foreign exchange regulations of international trading is not eligible to act as a borrower in accordance with Circular No. 40.

Circular No. 40 aims to broaden the financing channels for small and medium cap enterprises and ease the difficulties of financing those enterprises are currently facing. It remains to be seen whether in practice a domestically-owned enterprise really does not have to apply for a quota of overseas security for domestic loans for transactions in accordance with Circular No. 40.