On 30 July 2010, SAFE issued a Notice Concerning the Administration of Foreign Security Provided by Chinese Institutions (the 2010 SAFE Notice) which introduced significant changes to the existing regulatory regime governing foreign security granted by Chinese institutions.
Under the 2010 SAFE Notice, foreign security is defined to include foreign security of a financing nature 1 (financing foreign security) and foreign security of a non-financing nature 2 (non-financing foreign security), which are treated differently. Chinese institutions are classified as banks, non-bank financial institutions and ordinary enterprises3 , with each subject to different rules.
By contrast with the old regime, banks are now granted much more autonomy and flexibility to provide both financing foreign security and non-financing foreign security. Non-bank financial institutions and ordinary enterprises are still subject to a case-by-case approval from SAFE when providing foreign security, but can now enjoy a more relaxed administrative regime if they are qualified and approved by SAFE. According to an interview with SAFE officials, all the changes are intended to simplify regulatory procedures, improve administrative efficiency and to maintain regulation of the foreign security regime so as to provide strong support to Chinese enterprises in the implementation of their "going-global" strategy.
The main points of the new regulatory regime are:
Chinese banks now enjoy more autonomy and flexibility under the high-level quota control of SAFE
Provision of financing foreign security
- Chinese banks4 may provide financing foreign security within the annual foreign security balance quota (the Quota) approved by SAFE without being subject to case-by-case approval.
- Chinese banks may provide financing foreign security within the Quota for the obligations of any party - domestic or foreign, irrespective of the shareholding structure, net assets/total assets ratio or profitability status of the secured party (i.e. the party whose obligations are secured by the bank), provided they comply with the overall risk control requirements of the CBRC.
- Chinese banks need to apply for the Quota before 15 April each year and should only provide financing foreign security within the SAFE-approved Quota. Generally speaking, the annual Quota of a Chinese bank may not exceed (i) 50 per cent of the aggregate of its RMB and foreign currency actual capital or working capital, or (ii) the amount of its foreign currency net assets.
Provision of non-financing foreign security
Chinese banks are free to provide non-financing foreign security without being subject to any Quota or SAFE approval, provided that (i) they comply with the overall CBRC risk control requirements, and (ii) either the secured party or the beneficiary is a China-incorporated enterprise or a foreign entity set up or owned (directly or indirectly) by Chinese institutions. In short, the foreign security must have a "China link" over and above the Chinese security provider.
SAFE filing procedures and effectiveness of the foreign security
- Chinese banks must complete and submit the necessary forms as part of a monthly filing procedure with their local SAFE in respect of the foreign security they have provided (covering both financing foreign security and non-financing foreign security). Such filing will be regarded as due registration of the foreign security concerned and SAFE will not provide any additional foreign security registration certificates.
- Financing foreign security provided by the banks within their Quotas will come into effect without being subject to the SAFE filing procedure (as above). The 2010 SAFE Notice is silent on the effectiveness of financing foreign security which is provided outside the Quota and the effectiveness of non-financing foreign security provided by Chinese banks (we comment on this below).
Non-bank financial institutions and ordinary enterprises may enjoy a relaxed regulatory regime but are generally still subject to case-by-case SAFE approvals
Cases where the Quota applies
- Non-bank financial institutions and ordinary enterprises may
apply for the Quota (covering both financing and non-financing
foreign security) by following the same Quota application
procedures as banks and may be granted a Quota provided that:
- it frequently provides foreign security and has a standardised internal management system;
- in the case of a non-bank financial institution, SAFE may grant a Quota under the same conditions as banks (see section (c) under the heading 'Provision of financing foreign security' above); and
- in the case of an ordinary enterprise, its net assets/total assets ratio should not fall below 15 per cent and Quotas granted to it will not exceed 50 per cent of its net assets.
- Non-bank financial institutions and ordinary enterprises may provide foreign security within the Quota without prior SAFE approval. However, such foreign security should be registered with SAFE within 15 days of the execution of the relevant contract. SAFE will review the registration documents and, upon its satisfaction, issue a foreign security registration certificate.
Cases where the Quota does not apply
Non-bank financial institutions and ordinary enterprises that do not fall under the Quota administrative regime mentioned above are subject to case-by-case approval from SAFE for each foreign security it wishes to provide.
Foreign security provided by non-bank financial institutions and ordinary enterprises are subject to the following general requirements:
"China link" test:
The secured party must be (i) in the case of security provided by non-bank financial institutions, a Chinese enterprise or a foreign entity established or owned (directly or indirectly) by a Chinese institution; or (ii) in the case of security provided by an ordinary enterprise, its directly or indirectly-owned onshore or offshore subsidiary;
Net assets test:
The net asset value of the secured party must be a positive number; and
The secured party must have been profitable for at least one year out of the last three years (or five years for resource development companies) unless it has been established for less than three years (or five years for resource development companies).
SAFE may decline to grant approval or issue the foreign security registration certificate if the secured party fails any of these tests.
More straightforward voluntary enforcement of foreign security
If and when the foreign security becomes enforceable, Chinese banks may process the payment to the beneficiary directly without needing SAFE approval.
Voluntary enforcement of foreign security provided by non-bank financial institutions and ordinary enterprises still needs to be approved by SAFE on a case-by-case basis.
Other issues regarding foreign security
The Procedures for the Administration of Foreign Security Provided by Chinese Institutions, its implementation rules and other relevant SAFE regulations shall still apply in areas not addressed by the 2010 SAFE Notice.
Note that several SAFE regulations have also been repealed by the 2010 SAFE Notice and have ceased to be effective, e.g. SAFE Circular on the Changes to the Administration Measures of Overseas Financial Security as Provided by Chinese Banks for Overseas Investment Enterprises (promulgated on 16 August 2005).
Major issues needing clarification
Effectiveness of foreign security provided by Chinese banks
As mentioned above, the 2010 SAFE Notice does not give clear guidance on the effectiveness of financing foreign security provided outside the Quota of the bank concerned. Instead, it refers to the general SAFE regulations, none of which provides clear guidance either. It would be desirable for SAFE to stipulate expressly the legal consequences in such circumstances or make clear references to relevant existing regulations.
As SAFE will no longer issue foreign security registration certificates for foreign securities provided by Chinese banks under the 2010 SAFE Notice and the beneficiary is not in a position to know whether the bank has overrun its Quota limit or not, it would be unfair to the beneficiary if such foreign security is deemed as invalid or ineffective under PRC law.
The 2010 SAFE Notice is also silent on the effectiveness of non-financing foreign security provided by Chinese banks.
Given that the provision and voluntary enforcement of foreign security provided by Chinese banks is not subject to SAFE approval, one possible interpretation would be that all bank-issued foreign security would not depend upon SAFE registration to be effective, irrespective of whether it is a financing foreign security or if it falls within the Quota. However, it would be helpful for SAFE to clarify this.
Effectiveness of foreign security provided by non-bank financial institutions and ordinary enterprises
In 2001, SAFE promulgated the Circular of SAFE on Transmitting and Implementing the Interpretation of the Supreme People's Court on Some Issues Concerning the Application of the "Guarantee Law of the PRC" (2001 SAFE Circular) which provides that failure to obtain SAFE approval or conduct SAFE registration will render the foreign security invalid. In that case, only up to 50 per cent of the amount not recovered from the principal debtor may be allowed by SAFE to be remitted out to the foreign beneficiary in the case of a voluntary enforcement.
The 2001 SAFE Circular is still in effect and voluntary enforcement of foreign security provided by non-bank financial institutions or ordinary enterprises is still subject to the approval of SAFE. The result appears to be that foreign security provided by non-bank financial institutions and ordinary enterprises remains subject to the 2001 SAFE Circular, but foreign security provided by Chinese banks is not. Again, this is not entirely clear from the 2010 SAFE Notice and clarification of these issues from SAFE would be helpful.
Chinese banks may be utilised to circumvent limitations for non-bank financial institutions and ordinary enterprises
The 2010 SAFE Notice provides that counter-security provided by a Chinese institution in favour of another Chinese institution that is the security provider of a foreign security will not be subject to the foreign security-related regulations. In other words, such counter-security will not be treated as a foreign security.
While an onshore WFOE will not be able to provide foreign security for the obligations of its offshore parent company under the 2010 SAFE Notice, it seems that such WFOE would not be prevented from providing a counter-security to a Chinese bank which in turn provides financing foreign security to the offshore parent company.
As Chinese banks are granted flexibility to provide foreign security whilst others do not enjoy the same level of freedom, it is possible that Chinese banks will be used to structure transactions which would not have been feasible without their participation.
Overall, the 2010 SAFE Notice represents progress for China's foreign exchange reform on foreign security making cross-border trade and equity investments easier to undertake.
1. Defined to mean the foreign security provided in respect of an underlying contract which is of a debt-financing nature.
2. Defined to mean foreign security other than foreign security of a financing nature, including, for example, quality guarantees, project completion guarantees, tender guarantees, advance-payment guarantees, deferred payment guarantees and performance guarantees under a contract for sale and purchase of goods. Refund guarantees in respect of ship building contracts shall also fall within this category.
3. Ordinary enterprises include domestic enterprises and FIEs (including JVs and WFOEs). In the 2010 SAFE Notice, WFOEs are treated in the same way as domestic enterprises and JVs, unlike the previous regime.
4. For the purposes of this article, "Chinese banks" refers to domestic banks and foreign-invested banks (including foreign banks' onshore branches) whose business scope has been approved to include the provision of security.
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.