On 19 May 2014, the State Administration of Foreign Exchange (the “SAFE”) promulgated the Provisions on the Administration of Foreign Exchange for Cross-Border Security (Hui Fa [2014] No.29, the “New Provisions”). The New Provisions will, after it comes into force on 1st June 2014, replace twelve existing regulations that provide for cross-border security (collectively, the “Existing Provisions”) such as the Implementation Measures on the Administration of External Security Provided by Onshore Entities and the SAFE Circular on Issues Concerning the Administration of External Security Provided by Onshore Entities (also known as Circular 39).

Main Changes

The biggest highlight of the New Provisions is the streamlining of administration. By eliminating registration procedure completely for certain types of cross-border security or narrowing the scope of registration for the rest, the New Provisions defined the scope of administration and regulatory responsibilities of SAFE. More specifically:

  • The New Provisions apply to and regulate all kinds of cross-border security structures and include the following three types: (i) Nei Bao Wai Dai (where the security provider is registered onshore, and the obligor and the creditor are both registered offshore, see Structure I); (ii) Wai Bao Nei Dai (where the security provider is registered offshore, and the obligor and the creditor are both registered onshore, see Structure II); and (iii) any other types of cross-border security (e.g. where the security provider and obligor are both registered onshore, and the creditor is registered offshore, see Structure III).

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  • The validity of any cross-border security agreement is no longer subject to SAFE approval, registration, filing, and any other SAFE administrative requirements.
  • Quota management and pre-approval are replaced with subsequent registration management in relation to Nei Bao Wai Dai and Wai Bao Nei Dai.
  • For any other types of cross-border security (for example, an onshore entity providing foreign security for its own foreign debt), no registration or filing is required.
  • The distinction on the administrative schemes regarding the security for finance purpose and security for non-finance purpose is eliminated.
  • Except for special cases such as offshore bond issue, the requirement for the affiliated relationship between security provider and the obligor, as well as the asset to debt ratio requirement imposed on the obligor are abolished.
  • Individuals are explicitly permitted to provide Nei Bao Wai Dai with reference to the corresponding rules applicable to non-bank institutions.
  • SAFE approval on the enforcement of security is abolished.

We have also noticed that the New Provisions have made further amendments compared to theProvisions on the Administration of Foreign Exchange for Cross-border Security (Draft for Comments)(the “Draft Provisions”) published by SAFE on 13 February 2014. For instance, the New Provisions no longer require financial institutions to comply with self-disciplinary ratio, nor require the form of cross-border security to comply with PRC laws.

Specific rules

The table below summarises the specific requirements imposed by the New Provisions:

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In summary, the only approvals remain to be sought after the New Provisions come into force include:

  • Under Nei Bao Wai Dai, funds borrowed offshore shall not be directly or indirectly repatriate and used onshore by means of loan, equity investment or securities investment without SAFE approval.
  • If the security provider is a non-bank institution, without SAFE approval, it shall be refrained from entering into new Nei Bao Wai Dai security agreement before offshore obligor fulfiling all of its obligation owed to the onshore security provider arising out of security enforcement under Nei Bao Wai Dai.
  • If the security is enforced under Wai Bao Nei Dai, prior to the onshore obligor fulfiling all of its obligation owed to the offshore security provider, without SAFE approval, the onshore obligor shall be refrained from entering into new Wai Bao Nei Dai security agreement. If the onshore obligor already executed Wai Bao Nei Dai security agreement but no draw-down has been made or has been made but not yet made in full, without local SAFE approval, the onshore obligor shall be refrained from making new draw-down.

Market implication

The promulgation of the New Provisions is a huge step forward by SAFE to regulate the cross-border security against the background of streamlining administration and capital account liberalisation. We expect the New Provisions will be warmly welcomed by market participants, as they offer increased flexibility, certainty and accessibility when using cross-border security. For example, in the past, keep-well deed or other quasi-security has been widely used in offshore bond issue or offshore debt financing deals. In the future however this may well be replaced by direct cross-border security provided by onshore parent.

Furthermore, with the promulgation of the New Provisions, banks may need to be more prudent in conducting financing business. For example, as other section of this news alert mentioned that under certain circumstances where no new security agreement under Nei Bao Wai Dai may be executed or new loan agreement secured by offshore security may be entered into without SAFE approval, banks are suggested to carefully examine whether the security provider or obligor is refrained from providing Nei Bao Wai and/or Wai Bao Nei Dai..

However, the New Provisions have also left a few points to be clarified. For example:

  • It is uncertain whether individuals are allowed to provide cross-border security other than Nei Bao Wai Dai and Wai Bao Nei Dai.
  • The New Provisions provide that when providing Nei Bao Wai Dai, onshore non-bank financial institutions are required to have the guarantee business qualification approved by relevant regulatory authorities. Nonetheless, the China Banking Regulatory Commission (“CBRC”) only grants guarantee business qualification to non-bank financial institutions under one narrow circumstance where financial leasing companies provide security for financing its holding subsidiaries or project companies. Any other guarantee business falls out of the above scope either by financial leasing companies or other non-bank financial institutions are not explicitly subject to CBRC approval. As a result, it is not clear how SAFE will determine whether a non-bank financial institution is qualified to provide Nei Bao Wai Dai in practice.
  • Although the New Provisions provide that the validity of a cross-border security agreement is no longer subject to SAFE approval, registration, filing and any other relevant administrative requirements, article 6 of the Judicial Interpretation of the Supreme People’s Court on Certain Issues Concerning the Application of the Security Law of the People’s Republic of Chinastipulates that a security agreement shall be rendered invalid if no approval nor registration for the provision of cross-border security is obtained from the relevant regulatory authority. Furthermore, article 19 of the Regulations of the People’s Republic of China on Foreign Exchange Control stipulates that where foreign security is to be provided, an application shall be made to SAFE and SAFE will, taking the assets, liabilities and other circumstances of the applicant in consideration, make a decision to either approve or disapprove the application. Where the laws require the applicant to have its business scope approved by the relevant authority, the applicant shall obtain such approval before making such application. After the foreign security agreement is executed, the applicant shall conduct relevant SAFE approval. It remains to be seen the extent to which such legislative inconsistency could impact judicial adjudication.