For a foreign-invested enterprise (“FIE”), under PRC law it is required to register with the company registry (being the local branches of the State Administration for Market Regulation, “SAMR”) an amount of the registered capital of the FIE that its shareholders subscribe for (the “Registered Capital”). If some shareholders of the FIE are foreign investors, then the amount of the Registered Capital that the foreign investors subscribe for is the amount of capital that such investors can inject from offshore into the PRC (the “Foreign Capital”).

(i) Foreign Exchange Registration

The FIE will be required to complete the foreign exchange registrations necessary for the remittance of the Foreign Capital into the PRC, including the registration of the basic information of the FIE with the local branches of the State Administration of Foreign Exchange (“SAFE”). The FIE does not need to actually go to the offices of SAFE to apply for such registrations. Instead, they can be handled by a bank designated by the FIE and located at the place of the FIE’s domicile registration.

(ii) Opening of Foreign Capital Account

Once the basic information of the FIE has been registered with SAFE through its bank, the FIE may open bank account(s) onshore (the “Foreign Capital Account”) to receive the Foreign Capital remitted by the foreign investors from offshore. Currently there is neither restriction on where the Foreign Capital Account should be opened, nor restriction on the number of accounts that the FIE may open.

(iii) Conversion of Foreign Capital into RMB

The funds deposited into the Foreign Capital Account of the FIE may be converted into RMB through the method of voluntary settlement of foreign exchange (the “Voluntary Conversion”) or the method of settlement of foreign exchange by payment (the “Payment Conversion”).

Voluntary Conversion means, the FIE may, at its sole discretion, decide when to convert the funds into RMB and the specific proportion/amount of the funds that it wishes to convert into RMB. Once the Foreign Capital is converted into RMB, the FIE should open a “capital account – account for foreign exchange settlement pending payment” (the “Pending Payment Account”) to receive and hold the RMB proceeds. When the FIE actually needs to pay certain amounts due and payable to a transaction counterparty, they can pay the relevant amount from such Pending Payment Account.

Payment Conversion means that, when the FIE actually needs to pay certain amounts due and payable to a transaction counterparty, the FIE will convert the Foreign Capital into RMB just before the payment, and, upon the completion of the conversion, immediately pay the RMB proceeds to the relevant counterparty.

(iv) Use of Foreign Capital Proceeds

The Foreign Capital of an FIE can be used for the purposes of (i) the current account items within its business scope and (ii) the capital account items permitted under PRC law. The current account items include the transaction of goods, services, etc. The capital account items currently permitted by SAFE generally include (i) repaying the RMB loan that has been advanced to the FIE and utilised in compliance with PRC law, (ii) advancing loans to the affiliated companies of the FIE and (iii) making equity investments, provided that the relevant equity investments are not in breach of the existing special management measures on market access for foreign investors (negative list) and the relevant investment projects are genuine and do not violate PRC law.

As a general rule, the Foreign Capital cannot be used toward (i) directly or indirectly investing in securities, (ii) advancing loans to non-affiliated companies (unless otherwise specifically permitted in its business scope), (iii) being mortgaged or pledged for the purposes of obtaining RBM loans (iv) constructing or purchasing non-self-use real estate properties (unless in the case of real estate enterprises).

(v) Repatriation of Foreign Capital

If an FIE would like to repatriate its profits out of the PRC, it may process the repatriation through its account bank by providing the following information to its account bank: (i) the board resolution approving the profit distribution, (ii) the audited financial reports and (iii) the tax payment receipt.

If an FIE would like to repatriate proceeds out of the PRC after capital decrease, liquidation, early recovery of investment, transfer to onshore entities and individuals of equity interests in an FIE, etc., it should (i) complete the foreign exchange change or deregistration procedures through banks located at the place of the FIE’s domicile registration, (ii) carry out the necessary company registration changes, (iii) pay the taxes due and payable, and then (iv) remit the proceeds out of the PRC through its foreign exchange bank.

For an FIE, its “Foreign Debt” refers to that FIE’s RMB and foreign currency debt raised from a non-PRC resident pursuant to the terms of a financing agreement, and the behavior of borrowing Foreign Debt (i.e., borrowing RMB or foreign currency funds from a non-PRC resident) is also referred to as “Cross-border Financing”.

The Foreign Debt that an FIE may borrow will be subject to the upper limits set by PBOC or SAFE (the “Foreign Debt Quota”). Currently SAFE and PBOC have two management models to manage the Foreign Debt Quota, including (i) the “Foreign Debt Borrowing Gap Model” and (ii) the “Macro-prudential Model”. An FIE may choose either of these two management models, and needs to file with SAFE its choice. It should be noted that, once the FIE has decided to choose the Macro-prudential Model, in principle it may not change its management model any more.

Since 2018 Beijing, Shanghai, Guangzhou, Shenzhen, Tianjin and other places introduced the Foreign Debt Facilitation Quota Trial Program to allow micro, small and medium-sized high-tech enterprises that meet certain conditions to borrow foreign debts within the quota of US$5 million to US$10 million. If an enterprise has been approved to participate in the pilot program, they are not able to concurrently borrow foreign debts through Macro-prudential Model or Foreign Debt Borrowing Gap Model.

(i) Foreign Debt Borrowing Gap Model

Before the introduction of the Foreign Investment Law of the PRC in 2019, FIEs in China has a unique concept of “Total Investment”. When the establishment of an FIE is approved by, or filed with, the Ministry of Commerce or its local branches (“MOF”), the amounts of “Total Investment” and “Registered Capital” will need to be respectively specified by that FIE for itself. Then the difference between its Total Investment and its Registered Capital is the “Foreign Debt Borrowing Gap”.

Subject the SAFE registration referred to below, the FIE may borrow Foreign Debts without any approval, provided that: (i) the foreign shareholder of the FIE has made its capital contributions in accordance with the timetable set out under the FIE’s articles of association; and (ii) after such borrowing, the aggregate of that FIE’s accumulated principal amount of medium and long-term foreign debts and the balance of that FIE’s short-term foreign debts falls within the Foreign Debt Borrowing Gap. 

For a general FIE, the Foreign Debt Borrowing Gap means an amount equal to the difference between its total investment and its registered capital[1]. If the FIE is registered as a foreign-invested investment holding company, the foreign debt quota may be up to four times its paid-up capital if the registered capital is between US$30 million (inclusive) and US$100 million (exclusive), or six times its paid-up capital if the registered capital is US$100 million or more. For foreign-invested lease companies, their total risk assets[2] (total risk assets = total assets – cash – bank deposit – government bonds – entrusted lease capital) should not exceed ten times the amount of their total net assets. All the capital constituted by foreign invested lease companies’ borrowing foreign debts should be treated as the risk assets.

(ii) Macro-prudential Model

In 2016, PBOC and SAFE introduced the Macro-prudential Model to manage Foreign Debts. Other than real estate FIEs, an FIE may borrow Foreign Debts by using a risk-weighted approach within the specified upper limit.

Under the Macro-prudential Model, for an FIE, its aggregate risk-weighted outstanding cross-border financings (the “Outstanding Financing”) should not exceed the upper limit of risk-weighted outstanding cross-border financings (the “Upper Limit”). The amounts of Outstanding Financing and Upper Limit should be respectively calculated as follows.

(1) Outstanding Financing

The amount of Outstanding Financing should be calculated in accordance with the following formula:

Outstanding Financing = Σ outstanding amount of cross-border financing in RMB and foreign currencies * the risk conversion factor of maturity * the risk conversion factor of loan category + Σ outstanding amount of cross-border financing in foreign currencies * the risk conversion factor of exchange rate.

In this formula:

(a) risk conversion factor of maturity: the risk conversion factor of maturity for mid-to-long-term cross-border financing with a repayment period of longer than one year shall be one, while that for short-term cross-border financing with a repayment period of not longer than one year shall be 1.5. If the loan tenor is more than one year but the loan agreement has a prepayment clause, then, unless it is specified that the prepayment can only happen after one year of the date of the loan, the relevant loan shall be viewed as a short-term cross-border financing.

(b) risk conversion factor of loan category: risk conversion factor of loan category for financing included in balance sheets shall be set as one, while that for off-balance sheet financing (contingent liabilities) shall temporarily be set as one.

(c)  risk conversion factor of exchange rate: the risk conversion factor of exchange rate shall be 0.5.

(2) Upper Limit

The Upper Limit generally applicable to an FIE is 2.5 times its net assets. The amount of its net assets should be determined on the basis of its most recent audited financial reports.

After the introduction of the Macro-prudential Model, PBOC and SAFE set a one-year transition period from January 2017 to January 2018 (the “Transition Period”) for FIEs to transit from the “Foreign Debt Borrowing Gap Model” to the “Macro-prudential Model”. The plan was that:

(a) within the Transition Period, an FIE may choose either (i) the “Foreign Debt Borrowing Gap Model” or (ii) the “Macro-prudential Model”; and

(b) after the expiry of the Transition Period, PBOC and SAFE will access and decide the model(s) to be further used.

As of the date hereof, the “Foreign Debt Borrowing Gap Model” and the “Macroprudential Model” still work in parallel. Some FIEs already chose to transit to the Macro-prudential Model, whilst others are still borrowing Foreign Debts under the Foreign Debt Borrowing Gap Model.

(iii) Trial of Foreign Debt Facilitation Quota

In 2018, in order to support high-tech enterprises, SAFE introduced a pilot program that allows high-tech enterprises to borrow foreign debts within a certain quota without any linkage to their net assets. In May 2022, SAFE issued the Circular on Supporting High-tech Enterprises and Specialized and Sophisticated Enterprises to Carry Out the Pilot Program for Cross-border Financing Facilitation (Hui Fa [2022] No. 16), expanding the pilot areas from specific regions in 9 provinces/municipalities (Shanghai, Jiangsu, Hubei, Guangdong, Beijing, Chongqing, Hainan, Shenzhen and Ningbo, the “Existing Pilot Areas”) to all regions in 17 provinces/municipalities (adding Tianjin, Shandong, Sichuan, Shaanxi, Zhejiang, Anhui, Hunan, the “Newly Added Pilot Areas”). The foregoing pilot program is open to high-tech enterprises and specialized and sophisticated enterprises recognized by the relevant authorities. The quota for enterprises in the Existing Pilot Areas is up to US$10 million, and the quote for enterprises in the Newly Added Pilot Areas is up to US$5 million.

(iv) Foreign Debt Registration and Filing

The FIEs should, within 15 working days of the execution of a financing agreement and no later than 3 working days before the drawdown, register the financing agreement with SAFE for foreign debt registration in respect of the relevant financing. If there are any material revisions to the financing agreement, including the creditor, tenor of the loan, financing amount, interest rate, etc., the FIE should register such revisions with SAFE.

SAFE is introducing a pilot program to cancel the requirement that each financing agreement should do a separate registration with SAFE. An FIE in a pilot area may make a general registration with SAFE of all of its future foreign debts up to the Upper Limit and, after such registration, the FIE may enter into financing agreements to borrow Foreign Debts within the registered amount, without having to entering into the financing agreement at first and register with SAFE each financing agreement that it has entered into.

Moreover, SAFE has cancelled the management requirement that a non-bank debtor should actually go to SAFE’s office for SAFE to handle the deregistration of a Foreign Debt. The non-bank debtor may directly handle the deregistration at a bank located at the place of the FIE’s domicile registration.

(v) Opening of Foreign Debt Accounts

Before the issuance by SAFE of the Notice of the State Administration of Foreign Exchange on Further Promoting the Facilitation of Cross-border Trade and Investment in October 2019 (the “SAFE Notice”), there is a requirement that an FIE can only open up to three Foreign Debt Accounts for each Foreign Debt. After the issuance of the SAFE Notice, the restriction on the number of Foreign Debts Accounts is lifted. An FIE may open one or more than one Foreign Debt Account based on its actual needs.

As a general rule the Foreign Debt Accounts should be opened at banks located at the place of the FIE’s domicile registration. If the FIE wishes to open accounts at other locations, it needs to obtain verification from SAFE.

(vi) Conversion and Use of Foreign Debt Proceeds 

The conversion of Foreign Debt proceeds into RMB and the use of such proceeds generally should follow the same rules and restrictions applying to Foreign Capital as described above.  In addition, the following rules apply to the conversion and use of Foreign Debts:

(1) it should follow the terms of the financing agreement;

(2) the use of proceeds should match the tenor of the loan. For example, short-term debts normally cannot be used for the purposes of long-term project construction; and

(3) there is still restriction that the proceeds cannot be used to do equity investments in the PRC.

(vii) Repayment of Foreign Debts

The repayment of Foreign Debts can be directly handled by settlement banks without having to obtain any approval or complete any registration at first. The currency of drawdown can be different from the currency specified in the foreign debt contract, but the currency of repayment shall be the same as that of drawdown.

The settlement bank will do a compliance check, including whether or not the amount of principal and interest match the same registered with SAFE, whether or not there is indeed prepayment clauses set out in the financing agreement (if the FIE wishes to prepay the loan), whether or not the identity of the offshore payee match the creditor registered with SAFE, whether or not the repayment currency match the currency of the loan set out under the financing agreement and the drawdown currency, etc.

Cross-border guarantee and security refer to the guarantee and security provided by the guarantor/security provider to a creditor that may lead to cross-border receipt and payment of funds or cross-border transfer of asset ownership and other transactions of international receipt and payment.

SAFE divides all cross-border guarantee and security into three categories on the basis of the places of registrations of the parties:

(1) Nei Bao Wai Dai (内保外贷) or outbound security;

(2) Wai Bao Nei Dai (外保内贷) or inbound security; and

(3) other types of security with a cross-border element.

We will analysis in more details the regulatory requirements on each of those three categories of guarantee and security. As a general rule, the overall compliance requirement on each of them is that the guarantor/security provider and debtor should not enter into a cross-border guarantee/security contract if it knows or should have known that the enforcement of guarantee/security obligations is sure to be triggered. 

(i) Nei Bao Wai Dai (内保外贷)

Nei Bao Wai Dai (内保外贷) or outbound security means a guarantee/security provided by an onshore security provider for a debt owed by an offshore debtor to an offshore creditor.

If an FIE provides outbound security, it should register the guarantee/security agreement with SAFE within 15 working days of the execution of the guarantee/security agreement, and it is recommended to complete such registration before the drawdown of the loan under the underlying financing agreement. Furthermore, if there are any material revisions to the guarantee/security agreement, such revisions also need to be registered with SAFE. 

Funds guaranteed/secured by an outbound security may only be used for the relevant expenditures within the normal business scope of the debtor concerned. Such funds may not be used to support the debtor to (i) engage in transactions beyond the normal scope of business, (ii) finance offshore projects which investments are restricted under PRC law, (iii) invest in securities back into the PRC, (iv) fabricate trade background for arbitrage, and (v) other forms of speculative transactions. It should be noted that, if the underlying debt guaranteed/secured by an outbound security is a debtor’s payment obligation under a bond, the offshore debtor should be an entity directly or indirectly held by an onshore entity. There is no such direct or indirect shareholding requirement if the underlying obligation is not payment obligation under a bond. 

If the FIE needs to perform its payment obligations under the guarantee/security, it may purchase foreign exchanges and make payments offshore through its settlement bank. As a general principle the currency to be paid offshore should be the same currency as set out under the guarantee/security agreement. After the FIE has performed its payment obligations, the funds paid by the FIE offshore may be treated as a loan advanced by the FIE to the offshore debtor and therefore subject to the restriction that a PRC company can only advance loans to offshore in an amount up to 30% of that PRC company’s net assets as shown in its most recent audited financial report.

(ii) Wai Bao Nei Dai (外保内贷)

Wai Bao Nei Dai (外保内贷) or an inbound security means a guarantee/security provided by an offshore security provider for a debt owed by an onshore debtor to an onshore creditor.

If an onshore FIE wishes to borrow a loan or obtain a facility from an onshore financial institution, an offshore entity or person may provide guarantee/security to secure the repayment of the loan/facility, provided that the following conditions are all met:

(1) the FIE as the debtor is a non-financial enterprise registered within the PRC;

(2) the creditor is a licensed financial institution registered within the PRC;

(3) the underlying debt is a loan or a binding facility advanced/provided by that financial institution itself to the FIE;

(4) the form of the guarantee/security in not in violation of the applicable laws and regulations.

If all of the four conditions set out above are satisfied, then an inbound security may be provided for the underlying debt without any approval. Only the financial institution that advance the loan or provides the facility needs to report the information of the inbound security to SAFE. If some of the four conditions set out above cannot be satisfied, then a SAFE approval is required for the relevant inbound guarantee/security.

It should be noted that, even if the conditions set out above have been satisfied and there is no restriction from SAFE for the provision of such inbound guarantee/security, SAFE requires that, if the offshore guarantee/security provider’s payment obligation under the guarantee/security is actually triggered and the offshore guarantor/security provider would like to request the onshore debtor to repay to the offshore guarantee/security provider the amounts that it has paid to the creditor on behalf of the debtor, the amounts payable by the onshore debtor to the offshore guarantor/security provider will be treated as Foreign Debts and subject to the upper limit of the onshore debtor’s quota of Foreign Debts.  

(iii) Other types of cross-border guarantee and security

For the other types of cross-border guarantee and security, as a general rule no approval, registration or filing is required for such types of cross-border guarantee and security themselves, provided that the relevant SAFE approvals, registrations or filings for the underlying debt of the guarantee and security (such as the SAFE registration for the Foreign Debt and the SAFE registration to be completed by an FIE for the purposes of advancing loans to offshore) have been completed.

On 5 January 2023, the National Development and Reform Commission (the “NDRC”) released the Administrative Measures for Review and Registration of Medium- and Long-Term Foreign Debts of Enterprises (the “New Measures”) which took effect on and from 10 February 2023. The New Measures replaced the Circular of the National Development and Reform Commission on Promoting the Reform of the Administrative Reform of the Filing and Registration System for the Incurrence of Foreign Debts by Enterprises (the “Existing Circular”) which had been in force since 14 September 2015. The New Measures established a “review and approval” regime for Foreign Debts, which replaced the filing requirement under the Existing Circular.

The filing/review and approval procedure set out under the Existing Circular/the New Measures will be triggered if (i) the debtor is onshore entity, or an offshore entity controlled by a PRC person, and (ii) the foreign debt has a maturity of over one year. The New Measures further expanded the scope of application to foreign debt borrowings by non-PRC controlled debtors whose main business activities are in the PRC (“Indirect Foreign Debts”). Enterprises shall obtain the Foreign Debt Registration Certificate (the “Registration Certificate”) before the borrowing of the foreign debts.

For an FIE, whether it is subject to the review and registration procedures under the New Measures generally depends on its the equity structure. In line with the Circular of the General Office of the State Council on Retaining Certain Non-administrative Licensing Examination and Approval Items issued by the General Office of the State Council in 2004, for an FIE, NDRC generally requires information such as equity structures to decide whether the FIE (not a red-chip enterprise) is allowed to borrow foreign debts under Foreign Debt Borrowing Gap Model without having to go through the NDRC review and registration procedures.

[1] If the FIE’s foreign shareholder has not paid up the entire registered capital, the foreign debt quota shall be calculated in proportion of the foreign shareholder’s actually paid-up capital to the registered capital for which such foreign shareholder has subscribed.

[2] We understand that, as a matter of practice, the local SAFE office will ask the foreign-invested lease company to submit a specific auditing report on its risk assets on an annual basis and then determine the amount of foreign debts that such lease company is able to borrow in the next year. It is difficult – if not impossible – to use the real time figures to calculate the risk assets which are a moving target.