The recently published Circular on Foreign Exchange Control Issues Relating to Offshore Lending by Enterprises in China (the “Circular”),will create more flexibility for Chinese entities to fund their overseas operations from August 1, 2009. In a media session convened by the State Administration of Foreign Exchange (“SAFE”), officials explained the main purpose of the Circular is to address issues Chinese companies are facing due to the worldwide financial crisis in funding their offshore operations and expansion.

Prior to the issuance of the Circular, a non-financial company incorporated in China must qualify as a “multinational company” (as defined under the Circular on Issues Relating to the Administration of Internal Operation of Multinational Companies’ Foreign Exchange Funds issued in 2004, the “2004 Circular”) before such company is permitted to extend loans to their offshore member companies by using its then-available foreign exchange funds. To qualify as a “multinational company”, such company must have a certain number of subsidiaries or affiliates within its “group”. In addition, the total amount of outbound lending by a Chinese company is limited to 20% of such company’s equity base. Furthermore, under the 2004 Circular, both the lending Chinese company and the overseas affiliated borrower must meet certain other financial criteria.

The Circular now makes it possible for smaller Chinese companies to extend financing to their offshore affiliates that are either wholly owned or invested by them. These overseas entities can either be operational entities or pure investment vehicles. Other major changes include: (1) increasing the cap from 20% to 30% and allowing Chinese companies to lend up to 30% of its total equity (but subject to the total investment amount the Chinese company has been approved to make in the overseas entity); (2) permitting Chinese companies to use its RMB funds to purchase foreign exchange to fund the overseas financing in addition to using its own foreign exchange reserves; and (3) promising to adopt simpler procedures to further facilitate the loan remittance process. Most of the processing will be handled by the bank without the necessity to go to local branches of SAFE. Chinese companies can directly enter into loan agreements with the overseas affiliates but they can also engage banks and other financial institutions to act as intermediaries to provide entrustment loans.

SAFE will still be controlling and overseeing the actual amount of funds being lent to overseas entities. However, the Circular will definitely ease the cash flow needs of the overseas companies established by non-multinational Chinese companies. This ability to finance its overseas affiliates will also increase the appetite for outbound investments by Chinese entities.