March 2014 Reform proposed by PRC SAFE Relaxation of PRC regulatory restrictions on cross-border security and guarantees 1 Introduction SAFE is considering making sweeping changes to the regulatory regime on cross-border security and guarantees by removing most of the restrictions that are currently in place in this area. On 13 February 2014, SAFE published the Regulation on Foreign Exchange Administration of Cross-border Guarantee and Security (Draft for Comments) (the Draft Regulation ) on its website, seeking comments from all sectors of the society. The consultation period closed on 10 March 2014. It is not clear whether changes will be made to the Draft Regulation and when it would be implemented although there are indications that this could be before the summer. Contents 1 Introduction... 1 2 Key Methodology in the Draft Regulation... 1 3 Outbound Security... 1 4 Inbound Security... 3 5 Application to Bonds and Derivative Transactions 4 6 Economic Drivers behind the Proposed Reform... 4 2 Key Methodology in the Draft Regulation A key approach in the Draft Regulation is to divide all cross-border guarantee/security transactions falling within SAFE s jurisdiction into two broad categories of transactions (i) onshore guarantee/security for an offshore loan ( Nei Bao Wai Dai or Outbound Security ) and (ii) offshore guarantee/security for an onshore loan ( Wai Bao Nei Dai or Inbound Security ). Each category is subject to a separate set of rules. 3 Outbound Security Unlike the narrow meaning that is usually ascribed to this term currently in the market (i.e. the SBLC structure), the term Nei Bao Wai Dai has a very broad scope under the Draft Regulation and comprises all transactions where an onshore PRC entity provides guarantees and/or security in support of a debt owed by an offshore debtor to an offshore creditor. The main rules on Outbound Security are summarised as follows: PRC companies can freely provide Outbound Security: Subject to the restrictions on the loan purpose referred to in paragraph 3(d) below and the registration requirement referred to in paragraph 3(c) below, Proposed changes to SAFE regulations 1
onshore companies which are not financial institutions can freely provide guarantees and/or security in support of a debt owed by an offshore debtor to an offshore creditor. This means that the Draft Regulation, if enacted in its current form, would remove all of following restrictions on Outbound Security which are currently in place: - requirement for prior case-by-case SAFE approval; - requirement that the onshore guarantor/security provider has to be a shareholder of the foreign debtor (currently only downstream guarantee/security and no upstream or crossstream guarantee/security is permitted); and - certain financial criteria which the onshore guarantor/security provider and the foreign debtor must satisfy. Under the Draft Regulation, there is no mandatory requirement for any shareholding or common ownership relationship between the onshore guarantor/security provider and the foreign debtor. This position, coupled with the fact that the corporate benefit concept is very loosely implemented under PRC company law, would mean a PRC company would be able to grant a guarantee of the debt of an entirely unrelated foreign debtor. (c) (d) PRC financial institutions can provide Outbound Security subject to a cap: If the guarantor/security provider is a PRC financial institution, then in addition to the restrictions on the loan purpose described in paragraph 3(d) below and the reporting requirement set out in paragraph 3(c) below, the onshore financial institution must ensure that the principal amount of all financial indebtedness guaranteed and/or secured by it under all its Outbound Security transactions does not at any time exceed 50% of the amount of its net assets as at the end of its previous financial year (as shown in its audited accounts). If the Draft Regulation comes into effect, the current system where each bank is allocated an annual quota on external security/guarantee would become redundant. SAFE registration/reporting requirements: After having entered into a contract providing external guarantees or security, an onshore company shall register the transaction with SAFE whilst an onshore financial institution should report the transaction to SAFE via a preestablished reporting system. Restrictions on use of proceeds: The use of Outbound Security loan proceeds would need to comply with the following requirements: - the loan proceeds can only be used within the debtor s ordinary scope of business and not for speculative purposes; and - without SAFE s approval, the loan proceeds must not be remitted into the PRC (whether directly or indirectly and Proposed changes to SAFE regulations 2
whether by way of debt, equity investment or any other means) (and the Draft Regulation does not say in what circumstances SAFE would grant a special approval). (e) Onshore individuals can freely provide Outbound Security: The rules applicable to external guarantee/security granted by PRC nationals will be the same as those applicable to PRC companies. Therefore, obtaining a personal guarantee and/or security from a PRC national would become straightforward after the reform. By contrast, at present only in very limited circumstances will SAFE recognise the effect of personal guarantees provided by PRC individuals (i.e. only when the PRC individual is acting as a co-guarantor with an onshore company which itself is permitted to be a guarantor). 4 Inbound Security As its name suggests, this type of transaction includes any situation where the creditor is a PRC financial institution, the debtor is an onshore company and the guarantor/security provider is an offshore entity. The key rules in the Draft Regulation in relation to Inbound Security are as follows: (c) Subrogation Debt subject to cap: Upon a guarantee and/or security provided under an Inbound Security transaction being performed or enforced, by way of subrogation there will arise a foreign debt (a Subrogation Foreign Debt ) owing by the onshore debtor to the foreign guarantor/security provider. The onshore debtor is required to ensure that the total outstanding principal amount of all its Subrogation Foreign Debt will not exceed the amount of the onshore debtor s net assets as shown in its audited financial statements for the previous financial year. SAFE registration required for Subrogation Foreign Debt: Once a Subrogation Foreign Debt has resulted from the performance of the guarantee/security, the onshore debtor must register it with SAFE, though any Subrogation Foreign Debt will be exempted from any general restrictions on the amount of foreign debt which the onshore debtor would be permitted to incur under the current foreign debt regulatory regime. Restriction on new Outbound Security where there is outstanding Subrogation Foreign Debt: Before any Subrogation Foreign Debt that has become due is fully discharged by the onshore debtor, the onshore debtor shall not enter into any new Inbound Security arrangement. So long as the rules set out above are complied with, the onshore debtor and the onshore creditor can freely enter into Inbound Security transactions. Compared to the present rules, the main liberalising effect under the Draft Regulation would come from the foreign debt exemption mentioned in paragraph 4 above. Currently the most significant hurdle in relation to this structure is the uncertainty as to whether the resulting Subrogation Foreign Proposed changes to SAFE regulations 3
Debt, once it arises, would be permitted by SAFE. If it falls outside of the permitted scope but has come into existence in any event, such noncompliance with SAFE rules may potentially impede the foreign guarantor/security provider s ability to convert foreign currency into RMB in order to perform its obligations under the guarantee/security. This is the reason why, to date, only FIEs with sufficient unutilised borrowing gap have generally been onshore debtors under Inbound Security transactions. In such case there is more certainty that any future Subrogation Foreign Debt can be duly registered with SAFE, in the hope that such foreign debt will be readily covered by the FIE s borrowing gap (and the lenders will usually require the FIE to undertake to maintain a sufficient borrowing gap throughout the term of the loan). Under the Draft Regulation, this problem will cease to exist, by virtue of the exemption expressly allowing any resulting Subrogation Foreign Debt. 5 Application to Bonds and Derivative Transactions The relaxations envisaged by the Draft Regulations extend to the provision of Outbound Security in respect of bonds and derivative transactions with the following additional restrictions: Restrictions on bond issuers: The bonds must be issued by a PRC controlled project offshore and the project must have been approved, registered, recorded or acknowledged by competent PRC authorities for overseas investments according to relevant regulations; Restrictions on derivative transactions: The derivative transaction must be for the purpose of stop loss or preservation of value, must come within the principal business scope of the debtor and be duly authorised by its shareholders. The Draft Regulations require the secured obligation benefiting from Inbound Security to arise under a loan or a credit facility and therefore do not expressly apply to bonds and derivatives transactions. 6 Economic Drivers behind the Proposed Reform As SAFE itself has stated in the explanatory note to the Draft Regulation, the guiding spirit of the reform is to relax control on capital out-flow but to maintain control on capital in-flow. This is due to the fact that China has accumulated a huge amount of foreign currency and is now more concerned with foreign hot money flowing into the country than with any potential depletion of its foreign currency reserve. It is also because of this position that the present restrictions under the SAFE foreign debt regime are unlikely to be materially relaxed in the near future. These relaxations will represent a significant easing of restrictions on outbound security and guarantees, which should have a major impact on certain types of financing transactions for PRC groups. Proposed changes to SAFE regulations 4
Contacts For further information please contact: Nathalie Hobbs (+852) 2842 4168 nathalie.hobbs@linklaters.com Andrew Malcolm (+852) 2842 4803 andrew.malcolm@linklaters.com Chin-Chong Liew (+852) 2842 4857 chin-chong.liew@linklaters.com Victor Wan (+852) 2901 5338 victor.wan@linklaters.com William Liu Author: Linklaters This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. The contents set out above do not constitute any opinion or determination on, or certification in respect of, the application of PRC law. Any comments concerning the PRC are based on our transactional experience and our understanding of the practice in the PRC. Like all international law firms with offices in the PRC, Linklaters LLP and its affiliated firms and entities (including Linklaters in Hong Kong) are not licensed to undertake PRC legal services. We have standing arrangements with a number of PRC lawyers. If you would like advice on the application of PRC law or other PRC legal services, please let us know and we would be pleased to make any necessary arrangements on your behalf. Linklaters. All Rights reserved 2014 Linklaters Hong Kong is a law firm affiliated with Linklaters LLP, a limited liability partnership registered in England and Wales with registered number OC326345. It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of the LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on www.linklaters.com. Please refer to www.linklaters.com/regulation for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com. (+852) 2901 5257 william.liu@linklaters.com Hwang Hwa Sim (+852) 2842 4103 hwang_hwa.sim@linklaters.com Frank Cui Managing Associate (+852) 2842 4859 frank.cui@linklaters.com A17859850 Proposed changes to SAFE regulations 5