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China – Hot Topics In Banking Rules: New SAFE Rules Provide More Structuring Options for Cross-Border Financing.

20 June, 2014

 

Legal News & Analysis – Asia Pacific – China – Regulatory & Compliance 

 

On May 19, 2014, the State Administration of Foreign Exchange (“SAFE”) released the Foreign Exchange Administrative Provisions on Cross-Border Security (“New Rules”). The New Rules came into effect on June 1, 2014 and fundamentally change the cross-border security regime and provide more structuring options to financiers in cross-border financing.


Key Changes 


As defined under the New Rules, “cross-border security” means the security which may result in cross-border payment or cross-border title transfer of collateral, including (i) a security provided by an onshore security provider for a debt owed by an offshore debtor to an offshore creditor (“Outward Security for Offshore Lending”); (ii) a security provided by an offshore security provider for a debt owed by an onshore debtor to an onshore creditor (“Inward Security for Onshore Lending”); and (iii) other types of cross-border security.
The New Rules substantially streamline the SAFE administration on cross-border security: 


1. Qualification Requirement 


In relation to the Outward Security for Offshore Lending, SAFE has removed the requirement of pre-approval, quota limitation, financial test (e.g. the profitability of the debtor), shareholding relations between security providers and secured parties and other qualification requirements (to be further discussed below). 


In relation to the Inward Security for Onshore Lending, before the enactment of the New Rules, only foreign invested enterprises and domestic enterprises which have obtained a special quota from SAFE may borrow onshore loans secured by offshore security providers from onshore financial institutions. Now, all types of non-financial institutions registered in PRC may borrow this type of loan. That said, only financial institutions registered in PRC (which is generally regarded as entities holding license from a financial regulator, like CBRC, CSRC or CIRC) are qualified lenders of this type of loans. In another words, domestic inter-company debts (including entrustment loan) or individual debts are still not permitted to take offshore security. 


Individuals are expressly permitted to provide Outward Security for Offshore Lending whether or not a corporate security provider is involved in the transaction. 


2. Registration Requirement 


No SAFE registration/approval is required for the creation of cross-border security (subject to otherapplicable SAFE rules), except that for the Outward Security for Offshore Lending and Inward Security for Onshore Lending, a post-signing registration is still needed. For Outward Security for Offshore Lending, such registration shall be made with SAFE within 15 working days after the execution of the relevant security agreements. For Inward Security for Onshore Lending, the onshore financial institution shall report the relevant transaction data to SAFE.


Note, however, that registration of cross-border security with SAFE is no longer a “perfection” requirement. The New Rules have helpfully specified that the validity of any cross-border security agreement will not be impacted by any failure to carry out any SAFE approval, registration or filing. 


The New Rules also remove the requirements for SAFE approval or registration in relation to the other types of cross-border security (for instance, the security provided by onshore entities to secure its own foreign debts or other onshore entities’ foreign debts), provided that other applicable SAFE rules are complied with. 


3. Enforcement 


Prior SAFE verification is not required in general for the enforcement of any cross-border security. Commercial banks may process the currency conversion and remittance as required for enforcement of cross border security. 


For Outward Security for Offshore Lending, if the security provider is a non-bank institution, it shall not provide new Outward Security for Offshore Lending before the offshore debtor fulfills all its obligations to the security provider arising out of the enforcement under the existing Outward Security for Offshore Lending; for Inward Security for Onshore Lending, the onshore debtor shall not accept new Inward Security for Onshore Lending before it fulfills all its obligations to the offshore security provider arising out of the enforcement under the existing Inward Security for Onshore Lending. 


4. Use Of Proceeds – “No Flow-back” Restriction 


According to the New Rules, “no flow-back” restriction still applies under the Outward Security for Offshore Lending, namely, loan proceeds advanced by offshore lenders to offshore debtors and secured by domestic entities can not be repatriated to onshore by way of equity infusion or extension of loans unless approved by SAFE. In addition to direct equity investment and lending to PRC entities, such restriction also applies to the following indirect ways: (i) refinancing existing loans proceeds of which was repatriated to PRC by equity investment or lending; and (ii) acquisition of an offshore company where more than 50% of its assets are located in the PRC. 


Although the New Rules have helpfully clarified that violation of relevant foreign exchange administration requirements (like the above “no-flow back” restriction) contained in the New Rules will not result in the invalidity of the security agreement, SAFE may impose on the relevant PRC entity a penalty in the amount of 30% to 100% of the amount flowed back to PRC. 


5. Cross-Border Security Over Property 


According to the New Rules, SAFE will not review the validity of a cross-border security over property, and the remittance or collection of proceeds arising out of the disposal of the secured property may be directly processed by banks without SAFE approval or verification.


More Structuring Options 


1. Upstreaming Security For Inbound Secured Financing Becoming Permissible 


Before the New Rules come into effect, when an offshore lender advances loans to an offshore borrower with main assets and operation in PRC, such offshore lender is structurally subordinated to the onshore lenders of the relevant PRC subsidiaries and has no access to the onshore asset collaterals held by the PRC onshoreoperating entities. The reason for this subordination is that onshore companies may only be able to provide security for debts owed by their offshore investees (subject to case by case SAFE approval or annual quota management), but are not allowed to guarantee their offshore parents’ debt borrowings.


With the implementation of the New Rules, the requirement that the offshore debtor must be the onshore security provider’s investee has been removed and onshore companies may provide security for their offshore parents’ debt borrowings without being subject to pre-approval, quota management and other qualification requirements. This movement means that (i) the offshore lender may now benefit from onshore asset pool/collateral package; (ii) onshore trapped cash may be transferred offshore by way of an upstreaming guarantee by onshore subsidiaries; (iii) in onshore/offshore two-tier financing, now onshore lenders and offshore lenders may share the same collateral package. 


Given the above said “no flow-back” restriction (which has implication of 30% to 100% penalty to the relevant PRC companies), the application of this new structuring alternative will be limited to the situations where use of proceeds will not be deemed as a “flow-back”. 


2. Outbound Acquisition Financing Could Be Implemented In A More Efficient Way


Before the New Rules come into effect, the onshore parent providing guarantee for its offshore subsidiary’s acquisition financing is subject to case by case SAFE approval or outward security quota approval on an annual basis which, in some cases, may be difficult to obtain or time consuming. With the implementation of the New Rules, the onshore parent or other affiliates may be able to directly provide security for its offshore subsidiary’s financing activities without being subject to SAFE approval, quota control or other qualification requirements. 


3. Onshore Financing May Receive More Credit Enhancement From Offshore Sponsors – A New Conduit For Importing Offshore Capital? 


As discussed above, a much wider range of onshore borrowers (not limited to FIEs) now can use Inward Security for Onshore Lending structure to obtain onshore loan facilities. More importantly, certain quantitative restrictions for Inward Security for Onshore Lending (to be discussed below) have also been lifted. For those offshore sponsors who either have difficulty to bring offshore capital onshore, or do not own a credit-worthiness onshore platform to obtain onshore financing, this new movement provides with more financing flexibilities. 


Before the enactment of the New Rules, when the borrower is a foreign-invested company, if the secured amount exceeds its then-available foreign debt quota (being total investment amount minus registered capital) at the time of security enforcement, the borrower may not register the foreign debt owed by it to the offshore security provider and then the lending banks may not convert the security enforcement proceeds into RMB and pay off the onshore loan; if the borrower is a domestic-funded company, it shall apply for a quota from SAFE before using the Inward Security for Onshore Lending, while the approval of such quota is conditional upon a series of financial conditions and industry requirement and thus relatively difficult to obtain. 


After the New Rules come into effect, the above quantitative restrictions hae been removed, and replaced with a new requirement that the outstanding principal debt owed by the onshore borrower to the offshore security provider shall not exceed the borrower’s audited net assets for the last fiscal year (the excessive part will then occupy its foreign debt quota). 


Pending Issues 


The New Rules left some pending issues to be further clarified:

 

1. The New Rules allow a PRC individual to provide Outward Security for Offshore Lending, but are silent on whether a PRC individual can provide other types of cross-border security, especially the security for a debt owed by an onshore debtor to an offshore creditor. 


2. It is uncertain whether the New Rules also apply to cross-border security denominated in RMB, so it is still pending that in the scenario of Outward Security for Offshore Lending, whether the offshore RMB loan proceeds are subject to the same “no flow-back” restriction.


3. It remains uncertain how the “no flow-back” restriction will be interpreted and applied in practice where the use of offshore loan proceeds does not directly fall into the restricted scope as specified under the New Rules, e.g. the offshore loan are to refinance an existing acquisition loan for acquiring a target company where more than 50% of its assets are located in the PRC. 


4. Though SAFE registration is no longer required for the perfection of cross-border security pursuant to the New Rules, the Judicial Interpretation of the Supreme People’s Court on Certain Issues Concerning the Security Law still stipulates that an outbound security agreement will be held invalid if it fails to obtain approval from or complete registration with relevant authorities. Since the above judicial interpretation will not be superseded by the New Rules, it is uncertain how such legislative inconsistency will affect judicial practice.

 

Jun He 4

 

For further information, please contact:

 

Jianeng Liu, Partner, Jun He

[email protected]

 

Homegrown Regulatory & Compliance Law Firms in China

 

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