The State Administration of Foreign Exchange ("SAFE")
of the People's Republic of China ("PRC") is the body
that supervises the country's foreign exchange transactions.
SAFE recently issued two circulars to encourage cross-border
transactions: Circular No. 29 [2014] Provisions on
Foreign Exchange Administration of Cross-Border Guarantee and
Security
(跨境担保外汇管理条例)
("Circular 29") and Circular No. 37 [2014] Issues
Relating to the Administration of Foreign Exchange in Respect of
Offshore Investments, Financings and Return Investments by Domestic
Residents through Special Purpose Vehicles
(国家外汇管理局关于境内居民通过特殊目的公司境外投融资及返程投资外汇管理有关问题的通知)
("Circular 37"). Circular 29 took effect on June 1, 2014,
and Circular 37 was issued on July 14, 2014. Both support
China's strategy for domestic companies to "go
global" by relaxing restrictions on foreign exchange
transactions.
Key Changes under Circular 29
Previously, overseas lenders found it difficult to get a
PRC entity to guarantee or provide onshore security for loans made
to that PRC entity's offshore affiliate. This was because under
the prior legal regime, a PRC entity could not grant a guarantee or
give onshore security for such offshore loans without SAFE
approval. In practice, SAFE approval was rarely, if ever,
given.
With effect from June 1, 2014, a PRC entity can give a guarantee or
security over its PRC assets to secure offshore loans to its
overseas subsidiary or parent without SAFE approval. Such guarantee
or security only needs to be registered with SAFE within 15 working
days of the execution of the relevant guarantee or security
agreement. This method of providing an onshore guarantee or
security for offshore loans, commonly known as "Nei Bao
Wai Dai (内保外贷)" (as
illustrated below), is expected to be widely welcomed by loan
market participants.
Under a "Nei Bao Wai Dai
(内保外贷)" structure, the offshore
lender may enforce the cross-border guarantee or security without
further approval from SAFE, provided that the relevant guarantee or
security agreement has been duly registered with SAFE.
Circular 29, however, prohibits offshore loan proceeds from being
repatriated onshore. This guards against speculative capital or
"hot money" inflows that could destabilize the market.
Further, once the cross-border guarantee or security has been
enforced, the PRC obligor may not give additional guarantees or
security until it has been fully indemnified by the offshore
borrower. This guards against overexposure of the onshore
obligor.
Certain Changes Under Circular 37
Circular 37 repealed Circular No. 75 [2005] Issues
Relating to the Administration of Foreign Exchange in Respect of
Financings and Return Investments by Domestic Residents through
Offshore Special Purpose Vehicles
(国家外汇管理局关于境内居民通过境外特殊目的公司融资及返程投资外汇管理有关问题的通知
) ("Circular 75"), which had been in effect since
2005.
Under Circular 75, a special purpose vehicle ("SPV") was
defined narrowly for the purpose of offshore equity financing.
Circular 37 has expanded the purpose of the SPV from "equity
financing" to "investment and financing." This
allows an SPV to be established for overseas acquisitions.
Circular 37 also allows a PRC parent to lend to its offshore SPV,
as long as there is a legitimate need. Again, this is likely to be
widely welcomed by loan market participants since such shareholder
loans are typically treated as "equity" in a lending
transaction. A larger "equity" cushion from a PRC parent
helps reduce default risk, and in turn makes the SPV a more
attractive borrower for potential lenders.
Conclusion
To encourage offshore acquisitions by PRC companies, SAFE, through
Circular 29 and Circular 37, has relaxed control over foreign
exchange restrictions. SAFE's sanctioning of "Nei Bao
Wai Dai (内保外贷)" provides
certainty for market participants looking to lend against onshore
guarantees or security. The expanded scope for SPVs under Circular
37 is expected to promote overseas acquisitions and related
financing activities. It should be noted, however, that the actual
implementation of Circular 37 is yet to be tested and may call for
additional clarification.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.