On 19 May 2014, the State Administration of Foreign Exchange (“SAFE”) released Regulations on Foreign Exchange Administration on Cross Border Guarantee and Securities (the “Regulations”), which came into effect on 1 June 2014. The Regulations are applicable to cross-border security and guarantee arrangements and regulate the flow of funds with respect to such arrangements. The Regulations replace much of the pre-existing regulatory framework applicable to cross-border security and substantially relax prior restrictions on the provision of cross-border guarantees and security. The Regulations eliminate or reduce the approval and the registration requirements for most types of cross-border security. These new Regulations will facilitate the provision of security in cross-border financing transactions.
Framework of Regulations
The Regulations classify cross border guarantees and security into three separate categories and provide for differentiated regulatory treatment based on that categorization. The category classifications are as follows:-
- Guarantees provided by an onshore guarantor for a debt owed by an offshore debtor to an offshore creditor (“Nei Bao Wai Dai”);
- Guarantees provided by an offshore guarantor for a debt owed by an onshore debtor to an onshore creditor (“Wai Bao Nei Dai”); and
- Any cross-border guarantee arrangement other than those set out in Categories A and B above.
Nei Bao Wai Dai
The Regulations permit both banks and non-bank entities to provide Nei Bao Wai Dai guarantees (Category A). Pursuant to the Regulations, bank provision of such a guarantee is no longer subject to an annual quota. Subject to having a business licence that permits it to engage in the business of providing guarantees and security, an onshore bank would be free to grant such guarantee or security and would only have a post issuance reporting obligation.
For onshore non-bank entities, the pre-approval of SAFE is no longer required for such a guarantee. It is only necessary to register the guarantee with the local branch of SAFE 15 days after the guarantee is issued. An onshore entity may also provide such guarantee without SAFE approval. However, such non-bank entity must have the required industry qualification to grant a cross-border guarantee.
With approvals eliminated, the guarantor is responsible for ensuring the credit transaction complies with the applicable regulations, including those with respect to investment overseas. Affiliated shareholder requirements that were previously required for an onshore non-bank entity to provide a foreign guarantee have largely been eliminated with certain narrow exceptions.
Use of Proceeds
The use of the proceeds arising from transactions involving this type of security is restricted. The proceeds from such transactions can only be used in the ordinary course of business of the borrower abroad and absent SAFE approval cannot be repatriated onshore by way of debt, equity or investment. The funds raised aboard are required to comply with PRC requirements on outbound investment. The use of such funds in derivative transactions is highly restricted. Individuals are expressly permitted to be guarantors.
In the event of a debtor default, SAFE approval is not required for a guarantor to perform its obligations under such guarantee. The guarantee obligation can be performed through a qualified bank with the presentation of SAFE registration documents. The guarantor will have a subrogation right with respect to the debt paid and that amount paid must be registered within 15 days with SAFE.
After such payment, there are restrictions on the guarantor’s ability to issue further guarantees. The onshore guarantor cannot enter into any new Category A guarantees without SAFE approval until the offshore debtor has discharged all outstanding obligations owed to the onshore guarantor with respect to the subrogated foreign debt.
The guarantee registration must be deregistered upon the payment of the debt.
Wai Bao Nei Dai
SAFE approval requirements have been eased. SAFE approval is not required for Wai Bao Nei Dai guarantees (Category B) above provided the creditor is an onshore financial institution and the debtor is a non-financial institute registered and operated onshore. The foreign guarantee must secure an onshore credit facility (not an entrusted loan) and must be in compliance with both foreign and domestic applicable legal requirements. SAFE approval still required for Category B arrangements that do not comply with the foregoing.
For an FIE, a loan secured in such manner does not count toward the gap between its total investment amount and registered capital.
Use of Proceeds
The Regulation does not contain any explicit restrictions on the use of proceeds in connection with such Category B arrangements.
The onshore creditors may receive payment from the offshore guarantor without SAFE approval. After a guarantee is performed, the debtor’s aggregate debts should not exceed its audited net assets for the preceding financial year.
Debt registration is required for the subrogated debt owed to the guarantor. Registration of the debt as short term foreign is required within 15 days and the debtor cannot enter into further Category B arrangements without SAFE approval until the debt is settled.
For a security arrangements falling under Category C, SAFE approval or registration is not required, unless explicitly required by other SAFE regulations. Existing regulations with respect to the providing of pledge and mortgages will continue to apply. The proceeds derived from the enforcement of a proper security against property may be remitted abroad by a domestic bank without SAFE approval, subject to any other regulation. The underlying debt is subject to SAFE foreign debt registration if the security is enforced.
The relaxation of registration and approval requirements should greatly facilitate access to financing for PRC entities. The shift from approval to registration requirements should improve the ability of onshore entities to raise its funds offshore and encourage borrowers to seel financing there. For a more fuller analysis of these changes, please see “SAFE Issues New Regulation of Ease Requirement on Cross-Border Guarantees and Security” published in May 2014.