FIE Financing and the New Foreign Debt Measures

A key FIE financing constraint, reaffirmed by the Foreign Debt Procedures, is the “difference between total investment and registered capital”. This article will refer to that “difference” as an FIE's “borrowing limit”. Both the amount of total investment³ and the borrowing limit are subject to a mandatory maximum ratio⁴ to an FIE's registered capital.⁵

Examples of this maximum ratio are set out in the following table (all figures in US dollars).⁶

FIE Borrowing Limits Concerns

The above borrowing limits tend to force foreign investors to contribute high levels of registered capital to fund an FIE's start-up. This is often undesirable for two reasons. One reason can emerge if an FIE's start-up is slow or unsuccessful: the entire originally approved amount of registered capital is required to be contributed within a limited time period,⁷ which requirement both restricts foreign investors' ability to delay capital contributions until needed by the FIE, and prohibits foreign investors from canceling any approved capital contributions, e.g., due to any unexpected disappointment or other change of mind. The only way to avoid this requirement is to apply originally for approval only of registered capital amounts needed for the FIE's early stages, and then to re-apply for additional approval of an expansion. A second reason for the undesirability of high levels of registered capital can emerge when an FIE begins to generate strong cash flow: registered capital cannot normally be withdrawn before the FIE's termination,⁸ with the result that, after the FIE's revenues meet or exceed operating expenses, and the FIE's capital assets have been depreciated (unless new capital assets are acquired), the FIE can easily be stuck holding excess cash that cannot be distributed back to investors.

Fewer Exemptions from Borrowing Limits

In the past, foreign investors seeking to minimize the amount of FIE registered capital, and the impact of borrowing limits, sometimes benefited from an unwritten policy of SAFE that exempted, from the above borrowing limits, any “short-term” (one year or shorter)⁹ foreign borrowings for the purpose of funding an FIE's liquid capital for operational expenses. Similarly, some PRC domestic lenders took the view that short-term domestic borrowings for the same purpose were also exempt. Under these exemptions, a foreign investor could often support its FIE subsidiary by making or arranging short-term foreign and/or domestic borrowings, subject to lenders' requirements relating to creditworthiness, security, etc.

But the Foreign Debt Procedures will end the exemption for short-term foreign borrowings, by requiring that the “balance” of existing short-term foreign debts be aggregated with existing medium-term and long-term foreign debts for the purpose of applying the borrowing limit to new foreign debt.¹⁰ “Balance” is not defined but appears clearly to mean the net amount of an FIE's outstanding short-term foreign debts.

By ending the exemption for short-term foreign borrowings, the Foreign Debt Procedures are consistent with recent trends affecting domestic borrowings. Major PRC lenders no longer exempt short-term domestic borrowings from an FIE's borrowing limit.

Compartmentalized Administration

The clarity of borrowing limits continues to be weakened by the fact that SAFE supervises only foreign debts while ignoring domestic debts. The wording of the Foreign Debt Procedures reflects this narrow focus by referring only to existing foreign debts as criteria for determining whether new foreign debts are registrable and effective.¹¹ This wording appears to open the possibility that an FIE, after obtaining domestic borrowings equal to its entire borrowing limit, could then re-use the same borrowing limit to register foreign debts with SAFE. This possibility would be blocked if SAFE takes existing domestic borrowings into consideration despite the above wording, whether on the basis of the eventual implementing regulations or merely as an informal interpretation. Different SAFE branches and officials have in the past taken different views on this type of interpretative question.

MOFTEC takes the view that domestic and foreign borrowings aggregated together must not exceed an FIE's borrowing limits but, while MOFTEC approves an FIE's registered capital and total investment, which dictate the FIE's borrowing limits, MOFTEC normally has no direct role in administering an FIE's repayment of debts.

Trade Credit

Another source of financing flexibility has been for FIEs to purchase raw materials or components under seller credit terms of less than 90 days. This form of credit has long been exempted in practice from the definition of short-term debt for the purposes of the borrowing limit and of SAFE's registration of foreign debts. This source of flexibility appears likely to remain available. The Foreign Debt Procedures include “trade financing” within the definition of “foreign debt”¹² but, when this definition is considered in tandem with pre-existing regulations, it appears clear that seller credit with a term of less than 90 days will remain outside the definition of foreign debt for purposes of determining registrability and effectiveness under the Foreign Debt Procedures.

If seller credit originally provided with a contracted term of less than 90 days is not paid within the contracted term, there is no requirement to register the continuing payment obligation with SAFE as a foreign debt. In contrast, seller credit originally provided with a contracted term of 90 days or more would constitute foreign debt that must be registered with SAFE.

High Level Government Sentiment

The issuers of the Foreign Debt Procedures include the State Development Planning Commission along with the Ministry of Finance and SAFE. Many previous notices relating to foreign debt registration were issued only by SAFE. The participation of the Commission, which is responsible for approving especially large foreign investment projects that exceed the authority of MOFTEC, appears to indicate increased support at high levels of government towards tightening supervision of foreign debts, particularly those of domestically owned PRC borrowers.

Waiting for Implementing Rules

The Foreign Debt Procedures are likely to be implemented and interpreted slowly, as confirmed by informal comments of SAFE officials who advise that implementation is likely to await the issuance of implementing rules, for which no target date has been announced.

But the trend appears to be clear towards the basic goals of tightened supervision of foreign debts, along with continued leeway for transactions involving customary trade credit, and relatively narrow opportunities for foreign investors to retain flexibility in financing their FIEs.

Endnotes

1 SAFE officials advise informally that the Foreign Debt Procedures, despite their stated March 1 2003 effective date, will not be implemented until implementing rules are issued.

2 See Article 22 of the Foreign Debt Procedures.

3 “Total Investment” is defined as “all funds for construction [investment in capital assets such as purchase of land, buildings and equipment] and production working capital [liquid capital for operational expenses such as personnel, raw materials, components, inventory and lease of land, buildings and equipment]” of an FIE.

4 See Foreign Investment Enterprise Debt Equity Ratio Regulations, issued by State Administration of Industry and Commerce, effective from March 1 1987.

5 The phrase “registered capital” is used to describe both a company's capital contributed by investors, and the denomination of investors' ownership interest in the company.

6 Article 3 of the Debt Equity Ratio Regulations provides as follows:

(1) If the total investment of an Equity Joint Venture is less than US$3 million (inclusive of US$3 million), its registered capital shall be at least seven-tenths (7/10ths) of the total investment.

(2) If the total investment of an Equity Joint Venture is over US$3 million up to US$l0 million (inclusive of US$l0 million), its registered capital shall be at least one-half (1/2) of the total investment; within this range, if the total investment is less than US$4.2 million, the registered capital shall not be less than US$2.1 million.

(3) If the total investment of an Equity Joint Venture is over US$l0 million up to US$30 million (inclusive of US$30 million), its registered capital shall be at least two-fifths (2/5ths) of the total investment; within this range, if the total investment is less than US$12.5 million, the registered capital shall not be less than US$5 million.

(4) If the total investment of an Equity Joint Venture is more than US$30 million, its registered capital shall be at least one-third (1/3) of the total investment; within this range, if the total investment is less than US$36 million, the registered capital shall be not less than US$12 million.

7 15% within 90 days and the balance within a limited period set according to the amount.

8 “Reduction” (withdrawal) of registered capital, which was absolutely prohibited for many years, is now permitted in theory but requires special approval based on strict criteria.

9 “Short-term” borrowings are borrowings with a term of one year or less, “medium-term” borrowings are borrowings with a term of more than one year and less than five years (including five years), and “long-term” borrowings are borrowings with a term of more than five years. See Article 2, Lending General Provisions, issued by the People's Bank of China, effective August 1 1996.

10 See Article 18 of the Foreign Debt Procedures.

11 Idem.

12 See Article 8 Paragraph III of the Foreign Debt Procedures, listing “trade financing” within the definition of “foreign debt”.

By Xiaowei (Sherry) Yin, Neal Stender & Julia Jiang Nan Kong, Coudert Brothers
Hong Kong, Beijing & Shanghai