Cross-Border Guarantee

In the context of PRC cross-border financing, cross-border guarantee and security (“CBG”) means the act of guarantee or provision of security (collectively as “Guarantee”) which (1) involves a written binding commitment by the guarantor or security provider (collectively as “Guarantor”) to pay the creditor and (2) might cause cross-border payments and receipts, transfer of property ownership, or other transactions affecting the balance of payments of the PRC.

This article will outline and elaborate the PRC regulatory framework on CBG under the Regulations on Foreign Exchange Administration of Cross-Border Guarantees and Security (《跨境擔保外匯管理規定》) (the “Regulations”) and the Operational Guidelines on Foreign Exchange Administration of Cross-Border Guarantees and Security (《跨境擔保外匯管理操作指引》) (the “Guidelines”) promulgated by the State Administration of Foreign Exchange (the “SAFE”) in its No. 29 Document (《匯發 [2014] 29號》) dated 19 May 2014 which has taken effect since 1 June 2014 (the “No. 29 Document”).

Among other things, the No. 29 Document regulates the following CBGs:

1.         the Guarantor is registered in the PRC and both the debtor and the creditor are registered outside of the PRC (內保外貸) (“PRC-guaranteed Foreign Loans”);

2.         the Guarantor is registered outside the PRC and both the debtor and the creditor are registered in the PRC (外保內貸) (“Foreign-guaranteed PRC Loans”).

PRC-guaranteed Foreign Loans
The No. 29 Document requires that the financial institution and non-financial institution corporate Guarantors shall have consent and clearance from their industry regulatory authorities to be eligible to engage in the business of issuing Guarantee. This requirement is considered reasonable as SAFE is only responsible for administration of the foreign exchange control policy of the PRC. Other regulatory bodies responsible for economic and sectoral development policies of the State may control the issuance of Guarantee by enterprises in the relevant sectors for the purposes of both macro-economic and sectoral development control.

Prior to the promulgation of the No. 29 Document, there are no rules and regulations in the PRC governing the provision of Guarantee by an individual which is a PRC national. The No. 29 Document formally puts Guarantee issued by an individual under the regulation by SAFE. Under the No. 29 Document, an individual Guarantor providing Guarantee is subject to same control as non-financial institution corporate Guarantors by SAFE.

Also, Guarantors shall conduct due diligence on the underlying transaction to ensure that it is compliant with the PRC laws and the No. 29 Document. Such due diligence requirements include:

1.         the proceeds obtained from PRC-guaranteed Foreign Loans shall only be used for meeting payment in connection with the ordinary course of business of the debtor;

2.         the proceeds shall not be remitted to the PRC directly or indirectly via debt financing, equity investment, securities investment or any other means. Specifically, the proceeds must not be used for, among other things:

a.         arbitrage by fictitious trade transactions or any other speculative transactions;

b.         directly or indirectly investing in a PRC entity by way of debt or equity investment;

c.         directly or indirectly acquiring shares of an entity registered outside of the PRC (“Offshore Entity”), of which over 50% of the assets are located in the PRC;

d.         repaying existing debt of the debtor or another Offshore Entity, where the funds previously raised from such existing debt were directly or indirectly remitted to the PRC by way of debt or equity investment; or

e.         making advance payment to a PRC entity for supply of goods or services with deferred delivery term of longer than 1 year where the payment exceeds USD1 million and 30% of the total consideration of the relevant supply of goods or service agreement.

For bonds issued by Offshore Entity under a PRC-guaranteed Foreign Loan transaction, the No. 29 Document imposes the following additional requirements:

a.         the debtor must be owned, directly or indirectly by the Guarantor;

b.         the proceeds from bond issuance must be used in offshore investment project in which the Guarantor has an equity interest; and

c.         the debtor or the investment project must have been approved, registered, filed or acknowledged by the relevant PRC regulatory authorities responsible for offshore investment.

The No. 29 Document requires that if a PRC-guaranteed Foreign Loan is used for acquisition of offshore equity and debts, such acquisition shall comply with the rules and regulations on investments of the relevant regulatory authorities.

The No. 29 Document permits derivatives transactions funded by a PRC-guaranteed Foreign Loan for the first time. Such derivatives transactions should fulfil the following 3 criteria:

1.         the transactions should be used for hedging against losses and protection of capital;

2.         the transactions taken should be compatible with its main stream of business;

3.         the transactions shall be authorized by the shareholders.

From the above requirements, it is clear that the PRC Government’s economic policy of using PRC-guaranteed Foreign Loans is for (i) fostering the country’s foreign direct investment in projects approved by the regulatory authorities, (ii) facilitating genuine international trade, and (iii) making use of derivative transactions in the international capital market and commodity market for hedging risks.

The PRC Government never allows the channelling of funds raised from PRC-guaranteed Foreign Loans into the Mainland and SAFE clearly elaborates on the scenarios of use of funds raised from PRC-guaranteed Foreign Loans that are regarded as channelling of funds into the Mainland in the No. 29 Document. Such prohibition on inflow of fund raised through PRC-guaranteed Foreign Loans into the domestic money market is for avoidance of volatility of local money supply caused by inflow of foreign fund into the domestic money market.

Upon fulfilment of the pre-requisites under the No. 29 Document, the Guarantor may execute a PRC-guaranteed Foreign Loan agreement without prior approval from SAFE. Thereafter, the Guarantor shall register the Guarantee with SAFE. For bank Guarantors, they shall upload the data of the Guarantees via an online system to SAFE. Non-bank Guarantors will apply for registration of the Guarantee with SAFE within 15 working days from the date of execution of the Guarantee. SAFE will base on commercial justification and applicable rules and regulations in considering the application and may make requisitions. If the non-bank Guarantors are unable to give satisfactory reply to the requisitions, SAFE may decline registration of the Guarantee with supporting reasons.

Therefore, registration of Guarantee executed by non-bank Guarantors by SAFE is not automatic. The lenders of PRC-guaranteed Foreign Loan transactions shall require registration of Guarantee executed by non-bank Guarantors by SAFE as a condition precedent of making advances so as to ensure that such Guarantee is enforceable under the PRC foreign exchange regulatory regime.

Foreign-guaranteed PRC Loans
The No. 29 Document formally puts domestic borrowings secured by foreign Guarantee or security, i.e. Foreign-guaranteed PRC Loans, under the foreign exchange control regulatory regime of SAFE. A Foreign-guaranteed PRC Loan is allowed provided that (i) the debtor is a non-financial institution enterprise registered in the PRC; (ii) the creditor is a financial institution registered in the PRC; (iii) the object of the Guarantee is the loan provided by financial institution (excluding entrustment loan), denominated in RMB or foreign currency, or a binding facility; and (iv) the form of the Guarantee shall be compliant with all applicable PRC and foreign laws. It follows that only PRC bank (or financial institution) loan to PRC non-financial institution enterprises can make use of foreign guarantee. The lending institutions shall consolidate the data of such Guarantee to the capital account items recording system of SAFE.

In the event of enforcement of Guarantee, the creditor may directly collect payment from the Guarantor. Then, the domestic debtor shall register such offshore debt with the relevant local branch of SAFE within 15 working days after performance of the Guarantee. Such registration requirement reflects that the foreign Guarantor has subrogated the rights of the domestic lending institution after the performance of the Guarantee and become the foreign creditor of the domestic debtor.

Before the debtor fulfils its payment obligations to the foreign Guarantor after the latter’s performance of the Guarantee, the total outstanding principal amount owed by the debtor under a Foreign-guaranteed PRC Loan shall not exceed the debtor’s audited net worth as at the close of the latest financial year. Any excess will be deducted from the foreign borrowing limit of the debtor. If borrowings under a Foreign-guaranteed PRC Loan of the debtor exceed the aggregate of its net worth and foreign borrowing limit, the excess amount will be treated as unauthorized foreign borrowings. The No. 29 Document is not specific about the consequence of unauthorized foreign borrowing by the debtor. It is therefore important for the foreign Guarantor in a Foreign-guaranteed PRC Loan to seek prior PRC legal advice on such consequence and on ascertaining the outstanding foreign indebtedness under the Foreign-guaranteed PRC Loan of the domestic debtor.

Conclusion
The No. 29 Document is a major overhaul of the foreign exchange control system of the PRC. Among the others, the No. 29 Document is the policy initiatives of the PRC Government in directing funds raised by borrowings of foreign debtors secured by outbound Guarantee to be used in government approved foreign investments and to bulwark such funds from entering into the domestic money market and causing volatility in domestic money supply; and formally putting Guarantee and security provided by PRC individual Guarantors, outbound Guarantee for financing derivative transactions in the international capital market and commodity market, and taking foreign Guarantee and security for domestic borrowing under the foreign exchange control regime of SAFE.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.