Relaxing foreign exchange controls

As stated both in the Old rules and the New circular, Safe primarily regulates the provision of Foreign security by the security provider in favour of a third party. It is not subject to Safe's regulatory requirements when the provider of Foreign security creates the mortgage or pledge to secure its own debts. However, the requirements for registration with Safe and approval from Safe for performance of obligations under the Foreign security still apply.

Under the New circular, Safe adopts different regulatory regimes for different types of providers of Foreign security which are categorised as banks (including PRC-owned banks and foreign-invested banks in the PRC), non-banking financial institutions and enterprises in China. Enterprises are specifically referred to as non-financial institutions and include both pure domestic enterprises and foreign-invested enterprises (FIEs, including wholly foreign-owned enterprises (WFOEs)). The respective regulatory regimes for these types of providers of Foreign security are discussed below.

Banks

Administration Regime

Under the New circular, except for Non-financing security (as defined below) provided by banks, the provision of Foreign security is either subject to quota administration or Safe approval on a case-by-case basis. Under the quota administration system, the provider of Foreign security only needs to apply to Safe for an annual quota and Foreign security provided within the approved quota is not required to be approved by Safe on a case-by-case basis.

For Foreign security provided by banks, different regimes have been adopted for the provision of security that covers debts under financing arrangements (such as loans, bond issuances, finance leases, etc. known as “Financing security”) and other forms of debts (Non-financing security).

Previously, according to a circular issued by Safe in August 2005, only where debtors were overseas enterprises invested by domestic entities (PRC-invested overseas enterprises), was Financing security provided by banks subject to quota administration.

The New circular has broadened the application of quota administration to all Financing security provided by banks, thus having greatly simplified and expedited the provision of Financing security for domestic entities, which was previously subject to case-by-case approval.

Under the New circular, the provision of Non-financing security by banks is not subject to any administration of Safe, and may be provided at the banks' own discretion under relevant risk management principles.

Quota / Outstanding secured amount

Whether or not subject to quota administration, there is a general limitation (except in the case of Non-financing security provided by banks) on the amount of outstanding liability that a security provider may assume under all Foreign security provided by it. For the avoidance of confusion, such limitation is referred to as “quota” under the quota administration system and otherwise as the “outstanding secured amount”.

The New circular provides that the quota of Financing security provided by a bank should neither exceed 50% of its combined renminbi (Rmb) and foreign exchange paid-up capital or working capital, nor exceed the total value of the bank's net foreign exchange assets. Compared with the previous quota which was restricted to foreign exchange capital of a bank, the combined Rmb and foreign exchange capital test seems to better match the increasingly relaxed foreign exchange policies in China.

No cap on the outstanding secured amount of Non-Financing security is set under the New circular and the previous foreign exchange asset/liability ratio restriction under the Old rules has now been specifically lifted.

Scope of and financial requirements on debtors

According to the Old rules, the debtor must be either a domestic enterprise or a PRC-invested overseas enterprise.

The New circular has for the first time included foreign enterprises (as opposed to PRC-invested overseas enterprises under the Old rules) into the scope of the debtor. For Non-financing security provided by banks, either the debtor or the beneficiary may be a foreign enterprise as long as the other is a domestic enterprise or a PRC-invested overseas enterprise. For Financing security provided by banks, the debtor and the beneficiary could both be foreign enterprises. Such changes will significantly enhance the competitiveness of PRC domestic banks in the overseas markets.

Moreover, the New circular has released the profit and net asset requirements that were imposed on debtors under the Old rules.

Scope of secured debts

Previously, Foreign security provided by domestic entities (other than FIEs) may only cover the part of obligations which are proportionate to the investment of domestic parties in FIEs. As a result, domestic entities (other than FIEs) were not allowed to provide Foreign security for WFOEs, which had its position confirmed in a Safe reply issued in 2000.

The New circular provides that Foreign security provided for domestic or overseas joint ventures is not restricted by the investment proportion of domestic or overseas shareholders of such joint ventures. This is no doubt good news for domestic and overseas joint ventures as well as WFOEs that wish to seek more security support from Chinese financial institutions and, in the case of joint ventures, from their PRC parents.

Performance

The New circular further simplifies the procedure for the performance of obligations under the Foreign security by a bank. A bank is now able to make payment to the beneficiary without prior approval from Safe.

Filing

The previous registration requirement for banks has now been replaced with a monthly record filing procedure under the New circular.

While Safe has the authority to refuse registration of a Foreign security, which may affect the legal effect of the same, record filing is not a condition to the effectiveness of a Foreign security. It has long been argued that registration requirement under quota administration grants Safe the de facto power of posterior review and approval. Therefore, the newly adopted record filing procedure will greatly facilitate the provision of Foreign security by banks.

Non-banking financial institutions

Administration regime

Similar to the situation under the Old rules, Foreign security provided by non-banking financial institutions generally requires prior Safe approval on a case-by-case basis. However, the New circular has expanded the application of quota administration to those non-banking financial institutions that provide a relatively large number of Foreign security and maintain a high level of internal control. Subject to the approval of Safe, such non-banking financial institutions are free to provide Foreign security within the approved annual quota. Both Financing security and Non-financing security provided by non-banking financial institutions are covered by such quota.

Nevertheless, for those non-banking financial institutions enjoying quota administration, provisions of certain types of Foreign security (such as the Foreign security provided for outbound acquisition financing) are still subject to case-by-case approval from Safe.

Quota / Outstanding secured amount

The quota of Foreign security (Financing and Non-financing security) provided by a non-banking financial institution under quota administration is subject to the same cap applicable to banks, namely, 50% of the combined Rmb and foreign exchange paid-up capital or working capital or the total value of net foreign exchange assets of that non-banking financial institution.

The New circular has not specified the cap on the outstanding secured amount of Foreign security provided by non-banking financial institutions which are subject to the case-by-case approval regime. In our view, the cap on the quota mentioned in the preceding paragraph shall equally apply here.

Same as in the case of banks, the previous asset/liability ratio restriction which is linked to the self-owned foreign exchange capital of financial institutions has now been replaced with a more reasonable combined Rmb and foreign exchange quota.

Scope of and Financial Requirements on Debtors

Same as under the Old rules, non-banking financial institutions are still only allowed to provide Foreign security for domestic enterprises or PRC-invested overseas enterprises. However, the New circular has made it clear that PRC-invested overseas enterprises include overseas enterprises indirectly held by domestic entities.

The New circular has also loosened the relatively strict profit and net asset requirements imposed on the debtors under the Old rules. The debtor now only needs to have positive net assets and have made a profit in any one of the last three years, or the last five years for certain long-term projects such as resource exploration. Enterprises that have been established for less than three years, or five years in case of enterprises engaged in resource exploration, are exempted from the profit requirement.

Scope of secured debts

As discussed in the case of banks, Foreign security provided by non-banking financial institutions for domestic or overseas joint ventures is no longer restricted by the investment proportion of domestic or overseas shareholders in such joint ventures.

Performance

The case-by-case approval from Safe is still required for performance of obligations by non-banking financial institutions.

Registration

Under the New circular, non-banking financial institutions are required to register with Safe within 15 days after a Foreign security is provided, representing a slightly heavier burden as compared with the monthly registration requirement under the Old rules.

Enterprises

Administration regime

Under the Old rules, case-by-case approval from Safe was always required for Foreign security provided by enterprises, except for WFOEs. WFOEs may provide Foreign security at their own discretion without being required to seek prior approval from Safe.

Now, similar to non-banking financial institutions, eligible enterprises may also be exempted from the case-by-case approval requirement and instead be subject to quota administration.

On the other hand, the New circular eliminates the autonomy enjoyed by WFOEs and has made it clear that WFOEs not subject to quota administration are required to seek case-by-case prior Safe approval just like other domestic enterprises.

Quota / Outstanding secured amount

Previously the maximum outstanding secured amount of Foreign security provided by an enterprise should not exceed 50% of its net assets or its foreign exchange revenue of the preceding year.

While the 50% net assets restriction remains the same under the New circular, the quota or maximum outstanding secured amount of Foreign security provided by an enterprise is no longer linked to its foreign exchange revenue.

Scope of and financial requirements on debtors

Previously, further to the general rule that the debtor may only be a domestic enterprise or a PRC-invested overseas enterprise, pure domestic enterprises were only permitted to provide Foreign security for enterprises directly owned or invested by them. FIEs were subject to the general rule but not the additional restrictions as imposed on pure domestic enterprises.

Under the New circular, an enterprise (including a pure domestic enterprise and an FIE) may provide Foreign security for domestic or overseas enterprises established or held, directly or indirectly, by such enterprise.

Benefiting from the New circular, pure domestic enterprises are now able to financially support their indirectly invested enterprises through the provision of Foreign security. On the other hand, however, the direct or indirect ownership requirement is new to FIEs and as a result, FIEs may no longer provide Foreign security for enterprises in which they do not hold any shares, in particular, their sister companies.

For Foreign security provided by enterprises, the New circular has loosened the profit and net asset requirements on the debtors in the same way as in the case of non-banking financial institutions.

Scope of secured debts

As discussed in the case of banks, Foreign security provided by enterprises for domestic or overseas joint ventures is no longer restricted by the investment proportion of domestic or overseas shareholders in such joint ventures.

Financial requirements on security providers

Previously, the net asset to total asset ratio was required for pure domestic enterprises as security providers: 15% for trading enterprises and 30% for non-trading enterprises.

The New circular unifies net asset to total asset ratio applicable to trading and non-trading enterprise, and for the first time, impose such restrictions on FIEs. Now, both pure domestic enterprises and FIEs which intend to provide Foreign security have to meet a net asset to total asset ratio of at least 15%.

Registration

The registration requirement on enterprises remains the same, namely enterprises must register with Safe within 15 days after a Foreign security is provided.

Performance

Case-by-case approval from Safe is still required for performance of obligations by enterprises.

The relaxation of the regulation on the provision of Foreign security is to further implement the “outward bound” strategy of domestic entities and facilitate domestic entities to better utilise the resources in overseas markets. It will be much easier for PRC-invested overseas enterprises to procure a loan facility in overseas jurisdictions with credit support from their domestic parent companies or domestic financial institutions. In the meantime, domestic banks are able to provide security to pure foreign entities, which may significantly enhance the competitiveness of PRC domestic banks in overseas markets.

However, the promulgation of the New circular is not positive for everyone. FIEs, especially WFOEs, no longer enjoy any favourable treatment in respect of the provision of Foreign security.

Philips Ding and Candy Chen, Run Ming Law Office