On 13 February 2014, State Administration of Foreign Exchange (SAFE) released a consultation paper on Foreign Exchange Rules On Administration Of Cross-border Security (the “Consultation Paper”). It is proposed in the Consultation Paper that restrictions on Cross-border Security will be dramatically relaxed so that FX/RMB will be fully convertible in respect of Cross-border Security. This is a significant reform in pace with Chinese Government’s streamlining administration and institute decentralization and opening up of capital account transactions.
Cross-border Security refers to (a) provision of security by a PRC entity in favor of an offshore entity in an offshore financing transaction (“Outbound Security”); or (b) provision of security by an offshore entity in favor of a PRC entity in PRC financing transactions (“Offshore Security”). The Consultation Paper penciled the following reforms:
Outbound Security will no longer be subject to any prior approval or verification; instead, it will be subject to registration after the Outbound Security is provided.
Non-financial entity will be free to provide any Outbound Security and will no longer be subject to any requirement on its relationship with the offshore obligor or its financial status.
Quota and other restrictions imposed on financial institutions for their provisions of Outbound Security will be removed, provided that the principal amount of the secured obligation should not exceed 50% of the net assets of the previous year of the security provider.
Individuals will be allowed to provide Outbound Security, which will be subject to the same procedures applicable for non-financial institutions.
No SAFE verification will be required for enforcement the Outbound Security.
The secured party must be a financial institution in China, the obligor (the borrower) must be a non-financial institution and the secured obligations shall be loans or credit facilities in either RMB or foreign currencies.
Registration will be carried out by the secured party. Enforcement will not be subject to any approval or verification, provided that SAFE approval will be required for currency conversion of the enforcement proceeds.
PRC borrower will be free to borrow loans in China with security to be provided by Offshore Security. When enforcing the Offshore Security, the PRC borrower shall register it as its foreign debt and the enforcement amount shall not exceed an amount that is twice of the PRC borrower’s net assets.
From the above, we see that all prior approval or verification and quota requirement currently applicable for cross-border security has been proposed to be eliminated. The remaining restrictions will be that
an Outbound Security provided by a PRC financial institution will be only enforceable within an amount of 50% of its net assets of the previous year;
offshore funding secured by an Outbound Security shall not be remitted into China for use without SAFE approval; and
an Offshore Security will not be enforceable to the extent that its amount exceeding twice of the PRC borrower’s net assets.
The reforms proposed in the Consultation Paper, once implemented, will encourage cross-border finance transactions; facilitate PRC entities to obtain offshore funding, as well as promote use of RMB in cross-border transactions.