Regional headquarters and inter-company loans

Inter-Company Loan Restriction

According to the General Provisions on Lending, inter-company loans are prohibited in China, even if the lender and the borrower are within the same group. From the group's perspective, this rule blocks sufficient utilisation of internal capital and increases the financing cost as the borrower has to pay a high interest rate to the banks while the abundant cash of its sister company may only be deposited in the banks to earn less interest. This is a big concern for many company groups.

How to Reduce the Financing Cost

The regional headquarters could assist its investee companies or managee companies (as the case may be¹) which are in need of loan in the following ways so as to reduce the financing cost:

(i) Arrange an entrusted loan to the investee or managee company

According to the Notice on Relevant Issues Regarding the Entrusted Loan Business by Commercial Banks, commercial banks are allowed to engage in the entrusted loan service.

The entrusted loan is a form of agency service provided by the commercial banks under which the capital is provided by the trustor and extended to the borrower in a specified amount and at a specified interest rate as instructed by the trustor through the trustee bank which would recover the principal with the interest on the behalf of the trustor. The trustee bank charges only a service commission.

Hence, the regional headquarters could arrange for such entrusted loan for its investee company or managee company which would enhance the utility of the capital within the group. It would, however, still incur costs such as commission charge and legal fees relating to the transaction documents.

(ii) Grant a direct loan to the investee company

To best optimise the utilisation of its internal capital, the regional headquarters could consider making a direct loan to its investee company. The Provisions newly included one clause to allow such acts; this echoes the relevant provision of the Measures for the Administration of Finance Companies of Enterprise Groups (Measures). The clause says that an investment holding company may, in accordance with the Measures, establish a finance company to provide centralised capital management services to its investee companies in China. Once a finance company is established, it could provide a more comprehensive capital management service, including but not limited to, collecting deposits from and granting loans to its group companies, undertaking inter-bank borrowing or lending, and so on.

It should be noted that only regional headquarters taking the form of investment holding companies are eligible to establish a finance company. The establishment shall be subject to the approval of the China Banking Regulatory Commission (CBRC) and must meet strict financial quantitative criteria as follows:

(a) the registered capital of the investment holding company shall be no less than Rmb800 million (US$117.2 million);

(b) the net assets of the investment holding company for one year immediately preceding the establishment application shall be no less than Rmb2 billion;

(c) the annual profit before tax of the investment holding company for two consecutive years immediately preceding the establishment application shall be no less than Rmb200 million; and

(d) the registered capital of the finance company shall be no less than Rmb100 million.

Conclusion

With the promulgation of the Provisions, more multinational corporations might consider establishing headquarters in Shanghai. However, to realise the inter-company loan among the group companies in China, they must structure their regional headquarters according to the prevailing rules and regulations. In the draft amendments to the General Provisions on Lending by the People's Bank of China and CBRC, the clause forbidding inter-company loans is deleted. It is expected that the Chinese authorities could further lift the ban on inter-company loans. This would attract more multinational corporations who are concerned with the efficient utilisation of their internal capital.

Endnotes

1. According to the Provisions, a regional headquarters usually could take the form of (a)an investment holding company which is incorporated in accordance with the Regulations on the Establishment of Investment Holding Companies by Foreign Investors (关于外商投资举办投资性公司的规定) and engages in direct investment activities; or (b) a management company which is incorporated for the purposes of integrating operation control, research & development, capital management, sales and distribution, logistics and support services, and other operational functions.

Correction

In Relevant Legal Issues in relation to Trust Arrangement in an Overseas Initial Public Offering, CLP October 2008, several editorial errors appeared. CLP apologises for any inconvenience caused.