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A ROADMAP TO CROSS-BORDER FINANCE II - AN UPDATE September 2014 by Richard Mazzochi, Minny Siu, David Lam and Stanley Zhou

2 King & Wood Mallesons / KWM Connect

1 http://www.kwm.com/kwm-connect.pdf

Thank you for your interest in our publication “A Roadmap to Cross-border Finance”1. There have been developments since the date of that publication which substantially change the PRC cross-border finance regime. In this issue, we update that publication to reflect the changes and subsequent practices that have been adopted by market participants.

THE KEY CHANGES: � facilitate cross-border credit support payable in foreign exchange (FX):

- parties are generally free to provide and take cross-border security without SAFE’s prior approval

- the security provider may perform its payment obligations without SAFE’s prior approval if the security is registered

- onshore individuals may give cross-border credit support;

� relax inbound finance for corporate entities incorporated in the China (Shanghai) Pilot Free Trade Zone (Shanghai FTZ); and

� expand the FX and Renminbi (RMB) centralised management pilot programmes across China.

Freeing capital controls and creating deep and liquid pools of RMB capital is creating a growing market in RMB-denominated financing. China’s regulators have recently announced changes which, broadly speaking, further ease the controls on financing between the People’s Republic of China (PRC) and offshore jurisdictions as well as the provision of security given in support of that financing. The changes are significant because they facilitate cross-border funding through the provision of loans offshore, and allow cash held in the PRC to be swept offshore. That funding will be used to fund cross-border trade, offshore investments and acquisitions and enable onshore treasury operations to be managed in global treasury pools. The changes further evidence the PRC’s determination to gradually ease capital account controls.

In this issue, we focus on:

� inbound finance, where a PRC-established corporate entity (whether a foreign invested enterprise (FIE) or other PRC corporate entity (PRC corporate)) (each, an onshore corporate) borrows offshore or issues bonds offshore;

� outbound finance, where an onshore corporate lends money to an offshore entity;

� cross-border security, where a security (such as a mortgage or pledge over assets) or guarantee (credit support) is given to support cross-border financing activities; and

� the rationalisation of cross-border treasury operations.

SAFE has recently relaxed its regulation of cross-border credit support payable in FX and replaced the previous quota and pre-approval requirements with post-transaction registration. These developments are particularly important as PRC corporates expand offshore. For example, by allowing PRC parent companies and PRC banks to provide credit support in support of funding borrowed for offshore acquisitions.

The new SAFE rules relax the provision of security onshore (by offshore entities in favour of onshore creditors) and offshore (by onshore entities in favour of offshore creditors). The new rules do not relax PRC’s control of foreign debt, that is when onshore corporates are permitted to raise financial indebtedness offshore.

King & Wood Mallesons / KWM Connect 3

KNOWING THE BASICS – KEY REGULATORS AND TERMSTable 1 highlights the key regulators that govern, and terms key to understanding, cross-border finance.

Table 1 – Key regulators and terms

Key regulators

Ministry of Commerce (MOFCOM) A ministry of the State Council which approves and regulates foreign direct investment, and formulates policies on foreign trade, export and import regulations, foreign direct investment and market competition

National Development and Reform Commission (NDRC)

A commission of the State Council which regulates macroeconomic management, with broad planning and administrative powers and is responsible for foreign investment projects

People’s Bank of China (PBOC) The central bank of the PRC which controls monetary policy and regulates financial institutions in Mainland China

State Administration of Foreign Exchange (SAFE)

A State bureau under the leadership of PBOC which regulates the flow of FX in China and all FX expenditure and outward remittance

Key terms

Borrowing Headroom The difference between an FIE’s total approved investment amount and registered capital, provided that if the registered capital is not fully paid up, pro rata to the ratio of the paid-in capital to the total registered capital

In respect of certain types of FIEs (eg foreign invested finance lease companies and foreign invested holding companies), Borrowing Headroom is a certain percentage of the FIE’s net assets or registered capital

Current account The account containing the value of goods and services transactions (eg trade in goods). This account carries free RMB convertibility under PRC law

Capital account The account containing the value of transactions that result in a change in the credit and debit levels in the PRC’s balance of payments (eg movement of capital, direct investment, securities investment, derivative products and loans). Convertibility on this account is restricted

FIE � Companies established in the PRC with more than 25% foreign ownership

� The types of FIEs include:

- wholly foreign-owned enterprises

- equity joint ventures

- cooperative joint ventures

- foreign invested companies/joint stock companies limited by shares

Quota SAFE grants several types of annual quotas. Examples include quotas for the benefit of:

� PRC corporates to borrow from offshore short-term loans denominated in FX

� onshore corporates to make loans offshore denominated in FX


Table 1 – Key regulators and terms

Key regulators

SAFE Rule 29 The SAFE Regulation on Foreign Exchange Administration of Cross-border Guarantee and Security and its operational guidelines issued on 19 May 2014

Security The types of security recognised by PRC law, and commonly provided, are:

� guarantees or standby letters of credit

� mortgages over real property, equipment and vehicles

� pledges of movable property or rights (such as equity interests, rights under deposit certificates or bills of exchange)

In this publication, “security” includes a guarantee and “security provider” includes a guarantor

Nei bao wai dai (Outbound Security) Onshore security for an offshore loan or offshore bond issue

security provider

offshore

onshore

creditor debtor

wai dai

nei bao

Wai bao nei dai (Inbound Security) Offshore security for an onshore loan:

Security Provider

security provider

offshore

onshore

creditor debtor

nei dai

wai bao

Key:

1. offshore debt2. cross-border security

Key:

1. onshore debt2. cross-border security


2 In addition to the Shanghai FTZ, the PRC has also established financial reform pilot programmes in those areas such as Qianhai and Kunshan. However, the financial reforms implemented in Qianhai and Kunshan are not as broad as in the Shanghai FTZ. For example, onshore corporates registered in Qianhai special economic development zone are only allowed to borrow RMB-denominated loans from commercial banks in Hong Kong; the two-way cross-border borrowing in Kunshan pilot area is only allowed for Taiwan-funded enterprise groups operating in Kunshan.

Falls within quota recognised by

SAFE

NDRC approval obtained

Falls within limit prescribed by

PBOC Shanghai

Loan can be made to Shanghai

FTZ Corporate

Loan can be made to FIE

offshore

onshore

Unrestricted UnrestrictedParent, affiliates or bank

Falls within Borrowing Headroom

Loan can be made to PRC corporate

Unrestricted

FX loan RMB loan FX loan only (unless specially approved)

RMB loan ≥12 month tenor

≤ 12 month tenor

> 12 month tenor

PRC requirement

INBOUND FINANCEABILITY TO INCUR FOREIGN DEBT

With tighter liquidity in the PRC and the need to diversify sources of capital, onshore corporates are increasingly seeking funding offshore. Onshore corporates may borrow loans offshore denominated in either FX or RMB. The rules vary according to whether:

� the onshore corporate is an FIE (foreign-owned) or is a PRC corporate; and

� the onshore corporate is incorporated in the Shanghai FTZ2 (Shanghai FTZ Corporates).

Financial indebtedness raised offshore by an onshore corporate is classified as “foreign debt” under PRC law. The term “foreign debt” includes an actual or contingent obligation to pay money denominated in FX or RMB by an onshore entity to an offshore entity.

The consequence for a PRC corporate of an obligation being a foreign debt is that the obligation must be (i) approved by NDRC if it is a loan with a tenor of more than 12 months or (ii) a loan that falls within a quota granted by SAFE if it is a loan with a tenor of 12 months or less and, in each case, be registered with SAFE. A foreign debt incurred by an FIE must fall within its Borrowing Headroom and be registered with SAFE.

A Shanghai FTZ Corporate (whether an FIE or a PRC corporate) may borrow RMB offshore subject to a limit prescribed by PBOC Shanghai and the loan must be for a tenor of 12 months or more.

SAFE Rule 29 does not change these requirements.

BORROWING FROM OFFSHORE

The requirements imposed on borrowing depend on the nature of the onshore corporate and, depending on the circumstances, the features of the loan. They are summarised in the following diagram:


3 The SAFE Administrative Measures for the Registration of Foreign Debt and the Operational Guidelines for the Registration of Foreign Debt. Issued 28 April 2013 (SAFE Measures).4 The PBOC Administrative Measures on RMB Settlement in Foreign Direct Investment and the implementing rules. Issued 13 October 2011 and 14 June 2012 (PBOC Measures).5 See footnote 2 above.6 SAFE Measures and PBOC Measures.7 The PBOC Measures require that cross-border RMB loans borrowed by an FIE from its offshore parent, any group affiliate or “offshore financial institution” are

aggregated for statistical purposes. Although not expressly provided under PRC law, the inclusion of “offshore financial institutions” in that calculation suggests that offshore financial institutions are able to provide RMB financing to onshore entities directly. We understand that, in practice, FIEs borrow RMB-denominated commercial loans from offshore banks.

8 Ie the outstanding amount of the borrowing must not exceed the amount calculated in accordance with the formula that is “the corporate’s paid-in capital x 100% x a macro prudential policy parameter”. An FIE that was already incorporated within the Shanghai FTZ before the launch of the Shanghai FTZ may choose whether to calculate its permissible borrowing using the Borrowing Headroom or the limit prescribed by PBOC Shanghai branch. It should file its decision with PBOC Shanghai branch. Such decision is irrevocable.

The key aspects of the rules 3, 4 are:

� freedom for FIEs to borrow offshore in either FX or RMB within their Borrowing Headroom without approval; and

� PRC corporates may borrow short-term foreign debt denominated in FX if it falls within their quota. Longer term-debt still requires NDRC approval. A PRC corporate may not borrow RMB offshore unless:

- specially approved; or

- it is a Shanghai FTZ Corporate5.

The significance of these recent developments is that onshore corporates now enjoy considerable freedom when borrowing from offshore. The rules also clarify the purpose for which proceeds of the loan may be used. Proceeds may not be used for a purpose that is contrary to PRC policy objectives (eg borrowing to invest in PRC securities or derivatives).

Loan details are still required to be registered with SAFE but now only details about the facility are required to be provided (rather than details of each drawdown as in the past).

A question remains as to whether the tenor of a loan must match the tenor of the commercial commitment funded by that loan – generally, short term borrowings may not be used to fund a long term commitment but a long term loan may be used to fund a short term commitment.

Other helpful aspects of the rules6 are that:

� refinancing existing FX loans is not counted in calculating a borrower’s use of its foreign debt quota; and

� offshore borrowing in FX or RMB by an offshore branch of a PRC bank is not counted in calculating that bank’s use of its foreign debt quota.

The key requirements imposed by SAFE and PBOC on FX and RMB-denominated inbound loans are set out in Table 2.

Table 2 – Inbound loans

Denominated in FX Denominated in RMB

Regulator SAFE PBOC

Criteria / Quota � PRC corporate borrowers:

- Loan term of more than 12 months (ie medium-long term foreign debt) – NDRC case-by-case approval is required

- Loan term of 12 months or less (ie short-term foreign debt) – must fall within a quota granted by SAFE

� FIE borrowers:

- No approval is required if the aggregate of medium-long term foreign debt plus the balance of short-term foreign debt is within the FIE’s Borrowing Headroom

- The foreign investor in the FIE must have paid its first instalment of capital

- The foreign investor’s capital payment must conform to the payment schedule provided in the FIE’s articles of association

� Onshore corporates incorporated outside the Shanghai FTZ:

- The borrower must be an FIE which is not a real estate development enterprise

- The borrowing must be within the FIE’s Borrowing Headroom

- An FIE may only borrow RMB loans from an offshore entity when its registered capital has been paid up in accordance with the payment schedule provided in the FIE’s articles of association

- The lender may be the offshore parent or a group affiliate of the FIE or an offshore financial institution7

� Onshore corporates incorporated inside the Shanghai FTZ:

- The borrower may be an FIE or a PRC corporate which is incorporated in the Shanghai FTZ

- The borrowing must be within the limit prescribed by PBOC Shanghai branch8

- The tenor of the borrowing must be 12 months or more


Table 2 – Inbound loans


Regulator SAFE PBOC

Registration Each borrowing must be registered with the local SAFE office


- Each borrowing must be registered by the FIE borrower9


- No specific rules

Use of proceeds � Short-term foreign debt can only be used for working capital purposes

� Loan proceeds can be used for trade and service settlement and other financial transactions (including refinancing existing FX loans and putting on deposit) but:

- no securities investment

- equity investment only within the borrower’s business scope

- generally, no on-lending

- generally, no mortgage or pledge may be given over the borrowed proceeds to secure any debt

� Conversion of FX proceeds into RMB:

- PRC corporate borrowers cannot convert FX proceeds into RMB without SAFE’s approval

- FIE borrowers:

- may convert FX proceeds into RMB; but

- RMB conversion proceeds cannot be used for repayment of RMB loans from onshore banks


- The proceeds can be used for any purpose within the FIE’s approved business scope

- The proceeds may be used to repay onshore or offshore loans

- Proceeds cannot be used for:

- investments in securities or derivative products

- on-lending in the form of an entrusted loan

- the purchase of wealth management products

- the purchase of real estate which is not for the borrower’s own use

- onshore re-investment unless the borrower is an investment FIE


- Proceeds can only be used for business operations and project investments in the Shanghai FTZ or offshore project investments

- Proceeds cannot be used for:

- investment in securities or derivative products

- on-lending in the form of an entrusted loan

- the purchase of wealth management products

9 The parties should check the local practice of the PRC city in which the borrower is incorporated. In some cities and provinces, foreign debt registration is made with SAFE’s local branch whilst in other cities and provinces, the registration is made with the Cross Border Department of PBOC’s local branch.


10 According to Reuters, China’s Ministry of Finance conducted a 14 billion dim sum bonds institutional sale on 21 May 2014 comprising 7 billion yuan of three-year bonds at 2.53 percent, 4 billion yuan of five-year bonds at 3.25 percent, 1 billion yuan of seven-year bonds at 3.8 percent, 1 billion yuan of 10-year bonds at 4 percent, 500 million yuan of 15-year bonds at 4.29 percent and 500 million yuan of 20-year bonds at 4.5 percent. Another 2 billion yuan was allocated to seven central banks and regional monetary authorities, comprising 1.4 billion yuan of three-year tenor, 400 million yuan of five-year tenor and 200 million yuan of seven-year tenor bonds.

Parent PRC bank

offshore

onshore

Subsidiary RMB bonds

100% Keep-well agreement / EIPU

Standby RMB facility

OTHER DEBT-RAISING OPTIONS – OFFSHORE BONDS

RMB bonds issued in Hong Kong are also known as “dim sum” bonds. Dim sum bond issuers have included the PRC government, PRC policy and commercial banks, foreign companies and PRC corporates.

The dim sum bond market is now characterised by:

� an ever increasing RMB deposit base held in Hong Kong, which fuels investor demand for better yields than is available on offshore RMB deposits;

� issuers that take advantage of lower interest rates prevailing in Hong Kong in comparison to those payable in the Mainland. Investors in the past have expected RMB appreciation against the US Dollar (USD);

� bonds with longer tenors10;

� increasingly, the listing of dim sum bond issues on either the Singapore or Hong Kong Stock Exchanges; and

� a range of types of credit enhancement. Dim sum bonds were initially issued by leading PRC financial institutions without the need for enhancement. More complicated structures have been developed in response to regulatory requirements and a broadening of the types of issuers coming to the offshore market. The structures aim to provide recourse to PRC operations where the issuer is either a special purpose vehicle or non-operating subsidiary. The more common structures are:

- guarantees, letters of support and keep-well agreements provided by parent companies or operating subsidiaries;

- on-demand guarantees or standby letters of credit from third party financial institutions;

- equity interest purchase undertakings (EIPU); and

- more recently, stand-by facilities given in support of EIPUs.

The following structure illustrates how credit enhancement can be used in practice.

An RMB-denominated bond is issued by an offshore subsidiary. The subsidiary’s payment obligations are supported by an EIPU entered into by the offshore subsidiary, the PRC parent and the trustee of the bond. The EIPU obliges the PRC parent to purchase equity in the offshore subsidiary. The obligations of the PRC parent under the EIPU are to be funded under a standby RMB facility granted by the PRC parent to the offshore subsidiary – that facility is possible because of recent developments which facilitate onshore corporates making loans to offshore related companies – see “Outbound Finance” below. The PRC parent’s obligation under the standby RMB facility might be supported by an onshore standby RMB facility granted by a PRC bank.


Structures have been developed in response to a few key PRC regulatory requirements:

� a PRC bank that issues dim sum bonds requires approval from PBOC and NDRC – the bank may remit the proceeds into the PRC11;

� onshore corporates (including PRC SOEs) that issue dim sum bonds require NDRC approval – the onshore corporate may remit the proceeds into the PRC with NDRC approval and must count the bond issue as “foreign debt”, meaning SAFE registration is required12;

� the issue of credit support from the PRC for a dim sum bond issued by an onshore corporate’s offshore subsidiary is similarly regulated – the key developments have been:

- PRC banks’ willingness to issue on-demand guarantees or standby letters of credit payable in FX in support of third party bond issuers. These structures mix the credit of the issuer and of the bank that issued the on-demand guarantee or standby letter of credit;

- PRC banks issuing guarantees or standby letters of credit in support of bonds issued offshore and under which amounts are only payable in RMB; and

- onshore corporates issuing security in support of bonds issued offshore and under which amounts are payable either in FX or RMB.

Press reports in February speculated that the use of standby letters of credit by PRC banks to credit enhance bonds issued offshore was banned by PBOC13. SAFE Rule 29 now makes clear that onshore corporates no longer need to rely on PRC banks to back offshore bond issues and may prefer to give security to add credit support to bonds issued offshore. See “Cross-border Credit Support” below.

The key structural issues are therefore:

� the identity of the issuer. The issue of dim sum bonds by PRC entities requires approval;

� security can be provided by onshore parent companies but the proceeds must be used to fund a particular project approved by the relevant authorities for outbound investment. Our view is that restriction on use of proceeds applies whether the security is payable in RMB or FX (see “Cross-border Credit Support” below); and

� the proceeds of dim sum bond issued by an offshore issuer with the benefit of credit support issued by a PRC bank or onshore corporate (such as its parent company), must not be remitted to the PRC. SAFE Rule 29 contains extensive provisions as to when proceeds will be deemed remitted to the PRC (for example, to fund the purchase of the equity in an offshore company with more than 50% of PRC-based assets). See “Cross-border Credit Support” below.

OUTBOUND FINANCEThe ability of onshore corporates to lend money offshore has historically been far more restricted than cross-border borrowing. There have been a limited number of ways to access liquidity held in the PRC (including by way of dividends and entrusted loans (lending through an intermediary)).

Broadly, recent developments14 facilitate onshore corporates making loans denominated in FX (with a quota registered with SAFE local branch) and RMB to offshore related companies (not limited to subsidiaries or parent companies).

11 The Interim Measures for the Administration of the Issue of RMB Bonds in the Hong Kong SAR by Domestic Financial Institutions issued by PBOC and NDRC. Issued 6 August 2007.

12 The NDRC Notice on Matters concerning the Issue of RMB Bonds in the Hong Kong SAR by Domestic Non-Financial Institutions. Issued 2 May 2012.13 “China ‘ban’ on letters of credit leaves banks in limbo”, South China Morning Post, 24 February 2014.14 The PBOC Notice on Simplifying the Procedures of Cross-border RMB Business and Improving Relevant Policies issued 5 July 2013 (PBOC 2013 Notice); the SAFE

Notice on Further Improving and Adjusting Foreign Exchange Policies related to Capital Account Items issued 10 January 2014.

Quota

Onshore corporate

offshore

onshore

Any related company

Any related company

FX loan

PRC requirement

RMB loan


In terms of RMB-denominated cross-border lending, except for the loan repayments, funds lent must not “flow-back” to the PRC (for example as a shareholder loan). No quota is required.

Issues that need further clarification by PBOC include:

� the lender’s eligibility requirements; and

� the criteria that an onshore bank should apply when considering an onshore corporate’s application to transfer RMB to fund a cross-border intercompany loan.

We understand the practice to be that:

� the lender must be an onshore corporate;

� restrictions apply to real-estate developers; and

� the lender must satisfy basic financial criteria, eg the lender’s net assets, net profit and net cash flow must be positive and a no-objection letter issued by the relevant PRC tax authority.

In terms of RMB-denominated cross-border lending, the source of the funds lent must bear a reasonable interest rate and be sourced from the lender’s own cash, not the proceeds of a loan.

Table 3 summarises the regulatory requirements for FX and RMB outbound loans:

Table 3 – Outbound loans


Regulator SAFE PBOC

Lender Onshore corporates � Onshore corporates (other than real estate enterprises)

� Funds lent must not “flow-back” to the PRC (for example, as shareholder loans)

Borrower Offshore related companies Offshore related companies

Quota � The total amount of the intercompany loans to offshore related companies must not exceed 30% of owners’ equity

No quota requirement

Registration / Approval

� The lender must register with SAFE local branch for a lending quota

No PBOC approval is required

Source of funds � Held or purchased FX funds

� FX cash pool approved by SAFE

� FX proceeds from onshore borrowings

There is no express provision in the PBOC 2013 Notice restricting the source of funds but we understand that, in practice, the onshore lender must use its own funds for intercompany loans


15 - The SAFE Notice on Regulation of Cross-border RMB Capital Account Business Operations. Issued 7 April 2011. - The PBOC Circular on Clarifying Relevant Issues concerning Cross-border RMB Business. Issued 3 June 2011 (PBOC 2011 Circular). - The PBOC 2013 Notice. - The SAFE Measures. - SAFE Rule 2916 From a PRC regulatory perspective, a security is considered to be “FX-denominated” when the payment flowing from its enforcement will be in FX.17 From a PRC regulatory perspective, a security is considered to be “RMB-denominated” when the payment flowing from its enforcement will be in RMB.

FX or RMB loan

FX or RMB loan

offshore

onshore

Creditor

Debtor

Debtor Creditor

Creditor Debtor

Creditor

Onshore entity

Offshore entity Collateral

Offshore entity Debtor

Onshore entity Collateral

FX security

FX security

FX security

FX security

FX or RMB loan

FX or RMB loan

Structure 1 Structure 2 Structure 3 Structure 4

CROSS-BORDER CREDIT SUPPORTThere have been a number of significant developments15 which enable:

� onshore banks and onshore corporates to give outbound credit support for loans borrowed, or bonds issued, offshore; and

� offshore entities to give inbound credit support for loans borrowed onshore.

SAFE Rule 29 governs the cross-border security denominated in FX16 and divides all FX-denominated security into three broad categories. Different rules apply to each category:

� nei bao wai dai – Outbound Security;

� wai bao nei dai – Inbound Security; and

� any other cross-border credit support (Other Support) – the advantage of a structure being Other Support is that the structure is not subject to SAFE approval or registration.

By way of illustration, Other Support might include any one of the following:

- the security provider is onshore and either the creditor or the debtor is onshore and the other is offshore (structure 1)

- the security provider is offshore and either the creditor or the debtor is onshore and the other is offshore (structure 2)

- all three parties are onshore but the collateral is offshore (structure 3)

- all three parties are offshore but the collateral is onshore (structure 4).

Practical issues that arise from the regulatory requirements are the need to:

� track the purpose for which financial accommodation is used when an Outbound Security is given;

� monitor whether other cross-border securities have been previously given, and fully performed when an Outbound Security or an Inbound Security is given. Table 4 sets out the due diligence that a creditor may conduct in receiving an Outbound Security or Inbound Security;

� monitor the prohibition on the remittance of proceeds from offshore to the PRC when an Outbound Security is given.

SAFE Rule 29 is silent as to whether SAFE regulates RMB-denominated17 cross-border credit support. We understand that SAFE imposes its rules on an Outbound Security whether the Outbound Security is payable in FX or RMB.


Table 4 – Due diligence by creditors

Outbound Security

� An offshore creditor may request the onshore corporate security provider to represent that no other Outbound Security has been given or that any previous Outbound Securities, if enforced, have been fully performed by offshore debtors.

Inbound Security

� An onshore financial institution may request the onshore borrower to:

- represent that there is no outstanding liability owed by the onshore borrower to any offshore security provider arising from the enforcement of any Inbound Security; and

- undertake that the onshore borrower shall ensure that the total amount of the principal owed by the onshore borrower under any Inbound Security shall not exceed the aggregate of (i) its net assets in the preceding financial year and (ii) its Borrowing Headroom (if any) (in the case of an FIE) or offshore borrowing quota (if any) (in the case of a PRC corporate).

OUTBOUND CREDIT SUPPORT

SAFE and PBOC have each issued their own rules to regulate the provision of outbound credit support for loans granted, or bonds issued, offshore. Table 5 summarises the different regulatory requirements depending on the denomination and type of security that is now able to be given in support of an offshore obligation:

Table 5 – Outbound credit support rules

Type of outbound credit support Denominated in FX Denominated in RMB

SAFE requirements PBOC requirements

Nei bao wai dai or Outbound Security

� Onshore banks, non-bank financial institutions, onshore corporates or PRC individuals may provide an Outbound Security

� No quota or case-by-case approval by SAFE

� Post-transaction filing with SAFE by onshore security provider is required within 15 business days upon execution except where onshore security providers are banks, post-transaction filing is done through the centralised capital account information system

� If the offshore debt is a bond issuance, an onshore entity must directly or indirectly hold shares in the offshore bond issuer – see “SAFE rules” below

� The proceeds must:

- be used for the debtor’s ordinary scope of business and not for speculative purposes; and

- not be repatriated to the PRC directly or indirectly by way of debt or equity or securities investment without SAFE approval

� The rules do not differentiate between Outbound Security and Other Support

� Onshore banks may provide outbound guarantees without being subject to any quota requirement

� Onshore corporates may provide outbound credit support pursuant to the PRC’s Property Law and the Security Law and no prior approval is required

� There are no specific rules for non-bank financial institutions providing RMB-denominated outbound credit support

� Subject to verifying the authenticity of the transaction, onshore banks may effect RMB settlement for the performance of RMB-denominated outbound credit support provided by onshore corporates

Other Support � Onshore banks, non-bank financial institutions and onshore corporates may provide Other Support

� Not clear whether PRC individuals may provide Other Support

� The underlying debt must comply with the relevant approval or registration requirements


It would therefore appear that no quota or approval is required for a security provided by an onshore entity in either of the following structures:

SAFE rules

Onshore financial institutions and onshore corporates are free to grant third-party outbound credit support payable in FX without being subject to any quota or approval requirements. The failure to comply with the registration, filing or other administrative measures by SAFE does not invalidate the outbound credit support. The debtors can be any onshore or offshore entity except that in an offshore bond issuance, an onshore entity must directly or indirectly hold shares in the offshore bond issuer.

As summarised in Table 5, SAFE Rule 29 allows FX-denominated credit support for the benefit of offshore debt in the following circumstances:

Onshore entity Onshore entity Borrower

offshore

onshore

BankBorrower Bank

FX or RMB security

nei bao wai dai or Outbound Security

Other Support

FX or RMB security

FX or RMB loan

FX or RMB loan

Post-registration only

Approval or registration of the offshore investment

No restriction

Onshore financial institutions, onshore corporates and

PRC individuals

Onshore financial institutions and

onshore corporates

offshore

onshore

Unrestricted for offshore

obligation other than a bond

issuance

Offshore bond issuers with direct

or indirect PRC shareholding

Unrestricted

Credit support payable in FX

SAFE requirement

nei bao wai dai or Outbound Security Other Support

Debtor


The proceeds raised from a transaction involving Outbound Security payable in FX must remain offshore and cannot be repatriated back to the PRC. The aim is to encourage onshore corporates to raise FX funds offshore.

In addition to general loan transactions, SAFE Rule 29 contemplates the provision of Outbound Security in respect of specific underlying transactions (eg offshore bond issuance and derivative transactions) and imposes additional requirements for those transactions:

Offshore bond issuance

SAFE Rule 29 allows credit enhancement for offshore bond issuance. However, if an Outbound Security is provided in support of an offshore bond issuance, the following conditions must be satisfied:

� ownership of the issuer – an onshore entity must directly or indirectly hold shares in the offshore bond issuer

� use of bond proceeds – must be used for offshore investment where an onshore entity has an equity interest

� registration of offshore investment – the relevant offshore entity or its offshore investment where the bond proceeds are used must have been approved, registered, filed or acknowledged by competent PRC regulatory authorities.

These restrictions do not apply to an offshore loan financing.

Derivative transactions

If an Outbound Security is provided to support an offshore derivative transaction, the derivative transaction must:

� be for the purpose of “stop loss or preservation of value” (ie for hedging purposes)

� fall within the principal scope of the offshore debtor

� be duly authorised by its shareholders.

These restrictions do not apply where Other Support is provided for offshore or cross-border derivative transactions.

The new rules enable an onshore entity’s ability to provide credit support (eg Credit Support Annex) for its own cross-border derivative transactions with offshore counterparties, or to receive credit support from its offshore counterparties. No prior approval or registration for such cross-border credit support is required provided that the onshore entity has the capacity under PRC law to enter into cross-border derivative transactions.

PBOC rules

PBOC issued its own rules in 2011 and 2013 on the regulation of outbound credit support payable in RMB. PBOC regulates credit support payable in RMB.

The PBOC rules allow RMB-denominated credit support for the benefit of offshore debtors in the following situations:

The PBOC rules turn on the identity of the entity providing the credit support.

Unrestricted Unrestricted

Onshore banks

Onshore corporates

offshore

onshore

Unrestricted Unrestricted

Guarantee only

Security created pursuant to the PRC’s Property Law and the

Security LawCredit support payable in RMB

PRC requirement

Debtor


� Onshore banks

The PBOC rules18 allow a PRC bank to provide an outbound guarantee payable in RMB. Importantly, the provision of the guarantee is not regulated under the foreign debt regime. PRC banks must, however, record the transaction information in PBOC’s cross-border settlement system.

� Onshore corporates

PBOC allows19 an onshore corporate to provide outbound credit support payable in RMB. If amounts are called under the credit support, the onshore corporate may request its onshore account bank to settle the amounts due after the onshore account bank has verified the authenticity of the transaction. The onshore corporate may also use its RMB funds retained offshore to pay amounts due.

The recent relaxation by SAFE of its regulation of outbound credit support payable in FX means that the discrepancies between the rules in respect of FX-denominated credit support and RMB-denominated credit support are now less significant.

SAFE Rule 29 is silent as to whether SAFE regulates RMB-denominated outbound credit support. We understand that SAFE imposes its rules on Outbound Security whether the Outbound Security is payable in FX or RMB.

18 The PBOC 2011 Circular.19 The PBOC 2013 Notice.


INBOUND CREDIT SUPPORT

SAFE Rule 29 allows onshore corporates to receive the benefit of credit support denominated in FX provided by offshore entities without being subject to any quota or approval requirements. PBOC has also issued separate rules regarding inbound credit support denominated in RMB20.

As summarised in Table 6 below, SAFE and PBOC allow onshore corporates to receive the benefit of credit support from offshore entities or individuals in the following circumstances:

PRC corporate

Financial institution FIE Onshore

corporate

offshore

onshore

Offshore entity or individual

Offshore entity or individual CreditorOffshore entity

wai bao nei dai or Inbound Security

Other Support

FX or RMB security

FX or RMB security

FX security only

FX or RMB loan

FX or RMB loan

FX or RMB loan

20 The PBOC Notice on Clarifying the Implementing Details regarding Renminbi Settlement Business for Foreign Direct Investment. Issued 14 June 2012.


Table 6 describes the situation where an offshore entity provides inbound credit support under which a demand is made by an onshore creditor. The offshore entity then has a right to recover amounts paid to the creditor from the onshore debtor (by way of subrogation). The subrogation claim is a foreign debt which is subject to PRC registration and other requirements – see Table 6.

Different regulatory requirements apply depending on whether the inbound credit support is an Inbound Security or Other Support and the denomination of the inbound credit support:

Table 6 – Inbound credit support rules

Type of inbound credit support Denominated in FX Denominated in RMB

SAFE requirements PBOC requirements

Wai bao nei dai or Inbound Security

� Onshore corporates which borrow from onshore financial institutions may receive the benefit of an Inbound Security payable in FX from an offshore entity or individual

� No quota or case-by-case approval by SAFE is required

� Post-transaction filing with SAFE by onshore financial institutions through the centralised capital account information system is required

� If the Inbound Security is enforced and the offshore security provider has performed its payment obligation, the onshore borrower must count the amount paid as short-term foreign debt arising as a result of the offshore security provider’s subrogation rights (Subrogation Foreign Debt) and register the Subrogation Foreign Debt with its local SAFE office

� The onshore debtor is required to ensure that the total outstanding principal amount of all Subrogation Foreign Debts does not exceed the aggregate of (i) its net assets for the previous financial year and (ii) the Borrowing Headroom (if any) (in the case of an FIE) or offshore borrowing quota (if any) (in the case of a PRC corporate). Failure to comply with this limit does not affect the validity of the Inbound Security. However, the onshore debtor will be subject to a penalty imposed by SAFE

� Only FIEs are allowed to receive Inbound Security payable in RMB from an offshore entity or individual

� If the credit support is enforced and the offshore security provider has performed its payment obligation, the onshore borrower must count the amount paid as short-term foreign debt in its Borrowing Headroom

Other Support � Onshore corporates which borrow a loan from an offshore bank may receive credit support payable in FX from an offshore entity without being subject to any SAFE regulation

� The underlying debt must comply with the requirements imposed by SAFE and PBOC on FX and RMB-denominated cross-border loans – see “Inbound Finance” above

� If the credit support is enforced and the offshore security provider has performed its payment obligations, the onshore debtor must register the change of offshore creditor with the registration authority for the underlying loan

� No specific rules regulating Other Support payable in RMB granted by an offshore entity

� However, there is little regulatory risk if an onshore corporate receives an RMB-denominated credit support provided by an offshore entity. If the underlying debt complies with the regulations on cross-border borrowing and the onshore debtor has registered the change of offshore creditor when the credit support is enforced, the payment from the onshore borrower to the offshore credit support provider will be deemed as the repayment of an inbound loan


OPPORTUNITIES FOR TREASURY OPERATIONSThere have also been recent changes to PRC law which facilitate cross-border payments made within treasury operations.

Examples of the combined effect of these developments are:

� Including RMB in the global cash pooling system

Many global entities operate a global multi-currency notional cash pooling system, under which cash balances in different currencies are held in global pools and utilised to meet the obligations denominated in that currency.

The ability to make cross-border RMB intercompany loans means that RMB cash balances held in the PRC may now be included in global cash pools.

� Funding mergers and acquisitions abroad

PRC companies with offshore treasury centres may channel onshore surplus RMB to the offshore treasury centre. RMB held offshore is able to be converted into foreign currency to fund acquisitions and other investments.

� Cheaper source of funding for RMB trade settlement

Entities which trade with suppliers or customers in the PRC may combine RMB cross-border loans with the proceeds of RMB cross-border trade settlement. Multinational corporations (MNCs) that hold surplus RMB in the PRC are now able to fund their offshore trading operations by lending RMB held onshore to the offshore operations.

CASH CENTRALISED MANAGEMENT PROGRAMMES

SAFE introduced a pilot scheme for two-way FX cross-border cash auto-sweeping in a letter to its branches in Beijing and Shanghai in September 2012. The implementation of two-way FX cross-border cash auto-sweeping was expanded to the whole country in June 201421. PBOC has also started its own two-way RMB cross-border cash auto-sweeping scheme in the Shanghai FTZ in February 201422. This two-way RMB cross-border cash pooling scheme was expanded to the whole country in June 201423. These schemes have opened new windows for corporate treasurers to more effectively manage intra-group funds.

SAFE FX centralised management programme

Under the SAFE scheme, an MNC may open an international FX master account (International Master Account) and a domestic FX master account (Domestic Master Account) with a PRC bank. The International Master Account is used to centralise the FX funds of all offshore companies in the group and cross-border loans from offshore entities. The Domestic Master Account is used to centralise the FX funds of all onshore group companies. FX funds in the cash pool must be generated from the group’s operating business activities and cannot be from external financing.

Funds can be freely transferred between the International Master Account and the Domestic Master Account, provided that:

� the net amount transferred from the International Master Account to the Domestic Master Account does not exceed the aggregate foreign debt quotas of all the onshore group companies; and

� the net amount transferred from the Domestic Master Account to the International Master Account does not exceed the aggregate cross-border lending quotas of all the onshore group companies.

An MNC must satisfy certain eligibility requirements24 in order to participate in this programme.

The programme allows an offshore group to:

� rationalise the payment in FX used for cross-border trade and services;

� combine holdings of FX onshore and offshore; and

� for accounting purposes, net FX trade payments owed between group members,

in each case, subject to group companies’ borrowing quotas (in the case of PRC corporates) or Borrowing Headroom (in the case of FIEs) and lending quotas (for all onshore corporates).

Consider the following example. A group with operations in the PRC wants to borrow FX from a related offshore entity. The aim is to centralise the FX borrowing capacity of the group. The group is now able to centralise the holding of FX in accounts held in the PRC by:

� aggregating the group’s borrowing capacity (in the form of quotas in case of PRC corporates or Borrowing Headroom in the case of FIEs); and

� for accounting purposes, netting FX trade payments owned between group members.

21 SAFE issued the Administrative Regulation (Trial) on Foreign Exchange Centralised Management of Multinational Corporations (FX Cash Auto-sweeping Regulation) on 25 April 2014. The FX Cash Auto-sweeping Regulation became effective on 1 June 2014.

22 The Opinion on Providing Financial Support for the Development of the China (Shanghai) Pilot Free Trade Zone issued by PBOC on 2 December 2013 and implemented by the PBOC Measures Supporting the Expansion of Cross-border Use of Renminbi in the China (Shanghai) Pilot Free Trade Zone issued on 20 February 2014.

23 Paragraph 5 of the PBOC Guidelines on Implementing the Several Opinions of the General Office of the State Council regarding Supporting the Stable Increase of Foreign Trade. Issued 11 June 2014.

24 Eg the MNC must have more than USD100 million in FX receipts and/or payments in the preceding year; it must have an established sufficient internal electronic systems to operate cash pooling.


Aggregate Borrowing

Headroom 1+2

Aggregate borrowing quota 1+2

Borrowing Headroom 2

Borrowing quota 2

Borrowing Headroom 1

Borrowing quota 1

FIE 1PRC corporate 1 FIE 2PRC

corporate 2

offshore

onshore

PRC multinational

groupOffshore entity

International Master Account

Domestic Master Account

Foreign multinational

group

FX loan

FX loan

PRC requirement


offshore

onshore

PRC multinational

groupOffshore members

Header Company

Onshore members

RMB Special Deposit Account

Foreign multinational

group

RMB RMB

RMB RMB

PBOC RMB centralised management programme

The two-way cross-border RMB cash pooling applies to an MNC which has one member registered and actually operating or investing in the PRC (Header Company). It is the mirror image of the SAFE FX centralised management programme with the following additional features:

� there is no eligibility requirement for the MNC provided that it has one member registered and operating or investing as an independent legal person in the PRC;

� the Header Company will open a RMB special purpose deposit account (RMB Special Deposit Account) with a bank in the PRC for the two-way RMB cross-border cash pooling purposes; and

� neither the inward nor the outward funds flow is subject to any foreign debt quota or outbound lending quota.

As in the case of the FX cash pooling, the funds in the cash pool should be generated from the group’s operating business or investment activities and cannot be from external financing.

The two-way cross-border RMB cash pool structure is illustrated in the following diagram:


Australia

Aaron Bourke Partner, Brisbane T +61 7 3244 8083 [email protected]

Kate Jackson-Maynes Partner, Melbourne T +61 3 9643 4326 [email protected]

Scott Farrell Partner, Sydney T +61 2 9296 2142 [email protected]

Martin James Partner, Sydney T +61 2 9296 2198 [email protected]

Katherine Forrest Partner, Sydney T +61 3 9643 4129 [email protected]

Anne-Marie Neagle Partner, Melbourne T +61 3 9643 4258 [email protected]

Greg Hammond Partner, Sydney T +61 2 9296 2487 [email protected]

David Olsson China Practice Consultant, Melbourne T +61 3 9643 4330 [email protected]

Phil Harvey Partner, Sydney T +61 2 9296 2484 [email protected]

Ian Paterson Partner, Melbourne T +61 3 9643 4237 [email protected]

China

Yun Chen Partner, Shanghai T +86 21 2412 6052 [email protected]

Xin Zhong Partner, Shanghai T +86 21 2412 6055 [email protected]

Shaun Lee Partner, Shanghai T +86 21 2412 6050 [email protected]

Stanley Zhou Partner, Shanghai T +86 21 2412 6056 [email protected]

Jack Wang Partner, Shanghai T +86 21 2412 6051 [email protected]

Europe

Alexandrine Armstrong-Cerfontaine Partner, Luxembourg T +352 (0)27 47 56 34 01 [email protected]

Walburga Kullmann Partner, Frankfurt T +49 (0)69 505032 171 [email protected]

Gregg Beechey Partner, London T +44 (0)20 7111 2663 [email protected]

Tamasin Little Partner, London T +44 (0)20 7111 2302 [email protected]

Ian Borman Partner, London T +44 (0)20 7111 2600 [email protected]

Joaquin Sales Partner, Madrid T +34 (0)91 426 00 46 [email protected]

David Calligan Partner, London T +44 (0)20 7111 2648 [email protected]

Henning Starke Partner, Frankfurt T +49 (0)69 505032 178 [email protected]

Massimo Chiaia Partner, Milan T +39 (0)2 36575724 [email protected]

Olivier Vermeulen Partner, Paris T +33 (0)144 346 390 [email protected]

Tim Dolan Partner, London T +44 (0)20 7111 2648 [email protected]

Hilger von Livonius Partner, Munich T +49 (0)89 89 081 238 [email protected]

Hong Kong

Hayden Flinn Partner, Hong Kong T +852 3443 1113 [email protected]

Paul McBride Partner, Hong Kong T +852 3443 1142 [email protected]

David Lam Partner, Hong Kong T +852 3443 8314 [email protected]

Minny Siu Partner, Hong Kong T +852 3443 1111 [email protected]

Richard Mazzochi Partner, Hong Kong T +852 3443 1046 [email protected]

About King & Wood MallesonsKing & Wood Mallesons is the first international legal network headquartered in the Asia-pacific. It combines the leading law firms in China and Australia with a leading European-based international law firm. As the only legal network licensed to practise Hong Kong, Chinese, Australian, UK and European law, we have unique coverage.

With over 2,700 lawyers in 30 locations across the world’s growth markets and financial capitals, we offer you the best of legal minds wherever you need them most.

This issue has been authored by King & Wood Mallesons Partners Richard Mazzochi, Minny Siu, David Lam and Stanley Zhou, and PSL, Vivienne Zang.

KWM Connect merely highlights issues and is not comprehensive, nor does it provide legal advice. Should you have any questions on issues summarised here or on other areas of law, please contact one of the contacts listed in this issue.

Key contactsRichard MazzochiPartner, Hong KongT +852 3443 1046 [email protected]

Minny SiuPartner, Hong KongT +852 3443 1111 [email protected]

David Lam Partner, ShanghaiT +852 3443 8314 [email protected]

Stanley Zhou Partner, ShanghaiT +86 21 2412 6056 [email protected]

Vivienne ZangProfessional Support Lawyer, Hong KongT +852 3443 1110 [email protected]

King & Wood Mallesons in Hong Kong is a member firm of the King & Wood Mallesons network. Legal services are provided independently by each of the separate member firms.

No member firm or any of its partners or members acts as agent for any other member firm or any of its partners or members. No individual partner in any member firm has authority to bind any other member firm.

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