On May 12, 2014, the State Administration of Foreign Exchange (SAFE) promulgated the Regulations on the Administration of Foreign Exchange for Cross-border Security (the New Regulations) and the Operation Guidance on the Administration of Foreign Exchange for Cross-border Security (the Operation Guidance), which came into effect as of June 1, 2014, and replaced 12 existing SAFE regulations on cross- border security. The New Regulations made significant changes and developments to the old regulatory regime on approval requirements and other aspects of the administration of cross-border security in China, as summarized below.
APPLICATION OF THE NEW REGULATIONS
The New Regulations regulate all types of cross-border security arrangements, which are classified as the following three scenarios:
- The security provided by a Chinese domestic entity to secure the debt between an obligor and a creditor, which are both registered outside China (Scenario 1).
- The security provided by an entity registered outside China to secure the debt between an obligor and a creditor, which are both registered in China (Scenario 2).
- Any type of cross-border security other than the above two scenarios, including where the creditor is registered in China and the obligor is registered outside China and vice versa (irrespective of where the security provider is registered), or where all parties are registered in China and the collateral is registered outside China and vice versa (Scenario 3).
PRE-APPROVAL REQUIREMENTS REPLACED BY SUBSEQUENT REGISTRATION
With respect to Scenarios 1 and 2, the pre-approval process on the effectiveness and enforcement of a security agreement required by the old regime are replaced with a subsequent registration process under the New Regulations. SAFE will take a subsequent compliance review, as the case may be, in the process of the registration of the security agreement under Scenario 1 if the security provider is a non-bank institution or in the process of the registration of the enforcement of the security agreement under Scenario 2. However, the validity of any cross- border security agreement is not subject to SAFE approval, registration, filing or any other SAFE administrative requirements.
For cross-border security under Scenario 3, unless otherwise required by law, no pre-approval, subsequent registration or filing is required for the effectiveness and the enforcement of any security agreement.
SAFE APPROVAL REQUIRED FOR SPECIAL MATTERS
According to the New Regulations, under any of the following four circumstances, prior approval by SAFE remains to be required:
- Under Scenario 1, funds borrowed offshore shall not be directly or indirectly repatriated and used onshore by means of loan, equity investment or securities investment without SAFE approval.
- Under Scenario 1, if the security provider is a non-bank institution, until the obligor repays its entire debt owed to the security provider as the result of the enforcement of the security, the security provider shall be suspended from entering into any new security agreement under Scenario 1 without SAFE approval.
- Under Scenario 2, a security arrangement must be pre-approved by SAFE if any of the following conditions is not satisfied:
- The obligor is a non-financial institution that is registered and operates in China.
- The creditor is a financial institution that is registered and operates in China.
- The secured debt is an RMB or foreign currency loan (excluding entrustment loan) or a committed facility provided by the creditor.
- The security is in a form recognized by Chinese and foreign laws and regulations.
If the security under Scenario 2 is enforced, until the obligor fulfills all of its debt owed to the security provider arising from the enforcement of the security, the obligor shall be suspended from entering into any new security agreement under Scenario 2 or from making any new draw-down pursuant to an existing security agreement under Scenario 2, without SAFE approval.
In addition to the changes in the SAFE approval requirements, the New Regulations have the following three notable developments:
- The old regime set up different administrative requirements for the security for financing purposes and the security for non-financing purposes. The New Regulations eliminate such distinction and provide unified rules for the security for both purposes.
- The New Regulations explicitly permit individuals to provide security under Scenario 1. In such case, the rules applicable to non- bank institutions shall apply by analogy.
- Under Scenario 1, except for the security provided for offshore bond issue, the requirements under the old regime on the affiliated relationship between security provider and the obligor are no longer required.
Scenario 1 generally applies to a Chinese entity securing the debt of its affiliate outside China owed to a creditor outside China. Scenario 2 generally applies to an entity outside China securing the debt of its affiliate inside China owed to a Chinese domestic creditor. Scenario 3 generally applies to a Chinese entity securing the debt of its affiliate outside China owed to a Chinese domestic creditor, and an entity outside China securing the debt of its affiliate in China owed to a creditor outside China. The removal of SAFE approval requirements for most of these cross- border security arrangements under the New Regulations can bring easier and quicker financing of investments both from and into China. The promulgation of the New Regulations is another step taken by the Chinese government to liberalize its foreign exchange control regime.