China Forex, a magazine under China's State Administration of Foreign Exchange (SAFE), on 21 March published an article on its WeChat platform, providing exclusive clarifications on some matters related to China's latest foreign exchange policy document --'The Notice of the State Administration of Foreign Exchange on Further Promoting the Reform of Foreign Exchange Administration and Improving the Examination of Authenticity and Compliance', known as the No. 3 Document (2017), which was released on 26 January.
The article, written in the form of a Q&A, discusses matters such sales of offshore debt by non-financial offshore debt providers to a Chinese domestic party, which is also a non-financial institution; offshore loans with onshore guarantees; "break fees"; and whether domestic banks are allowed to participate in offshore financing projects.
These are some key extracts:
Q: Does China allow offshore creditors (non-financial institutions) to transfer their creditor's right in respect of an onshore entity to another onshore entity (another non-financial institution)? If this is allowed, how should the relevant parties go about the foreign exchange payment? And in such case, will only the first onshore entity (the debtor) need to undertake foreign debt de-registration with SAFE?
A: An onshore company's purchase of creditor rights of another onshore company from an offshore company cannot be used as a legitimate basis for the first onshore company's outward remittances, unless law and regulations provide otherwise. Neither does it provide a legitimate basis for the onshore debtor (the second onshore company) to apply for de-registration of a foreign debt. If another onshore institution has provided a cross-border guarantee for the debt in accordance with relevant regulations and the guarantee is being fulfilled, the original creditor may undertake foreign debt de-registration and the guarantor will thus become the new creditor of the same debt.
Q: It's understood that when a Chinese enterprise enters into a contract to purchase a stake of an offshore entity, and the agreement entails a clause that if the Chinese acquirer chooses to terminate the contract on the basis of a failure to acquire the requisite outbound direct investment (ODI) registration certificate from the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), or SAFE, it must pay a "break fee" that amounts to a certain percentage of the transaction value.
Where a Chinese acquirer fails to obtain ODI registration from the Chinese government and thus invokes the "break fee" clause, how can the acquirer purchase foreign exchange and remit funds out of China to pay the fee? It's understood that if the Chinese purchaser fails to complete ODI registration, it is not allowed to remit funds on the basis of ODI. Is it possible to apply for a larger foreign exchange payment quota by virtue of early-stage transaction payments, taking into account the potential "break fee"?
A: As the above break fee amounts to a kind of liquidated damage, the payment of such fee should be conducted under the current account, not the capital account, and thus does not concern remittance of funds on the basis of offshore investment.
The “break fee" is a complicated issue and banks should handle such transactions prudently. SAFE advises relevant Chinese companies to learn from western companies to add a liability disclaimer clause to exempt them from liabilities arising from a failure to obtain requisite regulatory documents when the failure is not caused by them. Chinese companies should communicate with local foreign exchange authorities on the matter.
Q: According to No. 3 Document (2017), where a bank performs its guarantee obligation under offshore loans with onshore guarantees, relevant foreign exchange settlement and sale shall be managed as the bank's own foreign exchange settlement and sale. How to properly understand this provision?
Pursuant to the Notice of the State Administration of Foreign Exchange on Issuing the Provisions on the Foreign Exchange Administration of cross-border Guarantees, issued in 2014 and known as the No.29 Document (2014), where the guarantee fulfillment arises, the counter-guarantor may, with proof of guarantee fulfillment, directly purchase foreign exchange or make an outward remittance at the bank. In light of the new rule, how can a bank count relevant foreign exchange settlement and sale as its own foreign exchange settlement and sale?
Where the applicant of a letter of guarantee uses its own funds to purchase foreign exchange to make an outward remittance, should it be counted as the bank’s own foreign exchange settlement and sales, rather than its foreign exchange settlement and sales business for clients? Or simply, should the bank be considered as the party purchasing foreign exchange in such case?
A: The No. 3 Document (2017) provides that where a bank performs its guarantee obligation, it must use its own funds, not pledge funds of a counter-guarantor or a letter of guarantee applicant, whereas the No.29 Document (2014) permits the latter. Where, upon fulfillment, the bank uses funds of a counter-guarantor or a letter of guarantee applicant to settle or purchase foreign exchange, the relevant settlement or purchase should be counted as the bank’s own foreign exchange settlement and sales. However, whether such process needs regulatory approval from the relevant foreign exchange authority remains unclear.
Additionally, based on the No. 3 Document (2017), counter-guarantors are not allowed to use guarantee fulfillment as a basis for purchasing and remitting foreign exchange offshore and the guarantor should first use its own foreign exchange funds to fulfill the obligation.
Q: Are onshore banks allowed to purchase credit assets from an offshore bank, including RMB- and foreign currency-denominated assets? Are they allowed to join offshore financing projects through risk participation?
A: An onshore bank's purchase of offshore assets falls within the matter of credit right to offshore party. In 2015, SAFE carried out a trial program to conduct registration for Chinese-funded banks' offshore borrowing in Shanghai. In 2010, a trial programme was launched in Ningbo City, allowing registration of offshore borrowing by both Chinese-funded and foreign-funded banks. When it comes to onshore banks' risk participation in offshore borrowing projects, it's important to distinguish between capital participation and participation through the provision of guarantees only. For regulatory purposes, the former is categorised as offshore borrowing and the latter as a cross-border guarantee.