In this China Law Special, Gerard van Swieten describes a number of specific features of cross border loans and securities between China and other countries.
“How to get financing?” and “How to ensure repayment?” are among world’s oldest commercial questions.
In answer, a range of financial products has become available to prospective borrowers and a similar range of securities to lenders. Global trade and investment have internationalized these products and securities, but specific conditions remain in a number of countries, including China.
This Special introduces some of these requirements and describes the practice. A “security” is limited in this Special to (third-party or parent) guarantee, mortgage, pledge and lien. These are the most common used forms of security which exist in China as well as most other countries.
Origin of specific conditions
China protects its economy from overheating, its currency from speculation and its population from excessive borrowing. This is evidenced by the regulation and supervision of banks, institutional investors, insurers and other financial institutions, borrowing restrictions and foreign exchange control. This policy has so far been effective. The Chinese economy has not been significantly affected in the Asian financial crisis (1997) and the 2008 banking crisis that has now progressed into a public debt crisis and recession in several countries.
Foreign exchange regulation
Conversion of the Chinese national currency, the renminbi, into foreign exchange (“forex”) and the other way around is regulated by the Chinese State Administration of Foreign Exchange (“SAFE”).
Lending to Chinese entities
Chinese law prohibits Chinese domestic entities from acquiring loans from other domestic individuals or entities with the exception of registered and authorized banks. Domestic entities are allowed to borrow forex loans from overseas lenders, provided such loans are approved and registered with SAFE.
Foreign Invested Enterprises (“FIEs”) are required to register forex loans with SAFE and ensure that the amount of foreign debt remains within the predefined percentage of the registered capital. There is no limit for FIEs to acquire loans from authorized lenders in China, including from licensed Chinese branches of foreign banks. In practice it can be difficult to have a foreign loan approved.
Registration of loans under external security
A foreign security for a forex loan does not have to be registered or approved and neither does a Chinese domestic security for a domestic (renminbi) loan. This is because the execution these securities (in case of nonpayment) does not have anforeign exchange implication.
In contrast, the execution of a foreign security for a domestic loan does require foreign currency to be converted into renminbi after which the loan can be repaid. A foreign security for a domestic loan therefore needs to be registered with SAFE.
Licensed credit institutions in China are required to complete and submit for registration details on their loans under external security to SAFE within 10 working days of the beginning of each month.
Funding a foreign invested subsidiary
Foreign headquartered multinationals with a subsidiary in China (usually taking the form of a FIE) often use their foreign credit arrangement to facilitate financing of the subsidiary. This is because the Chinese subsidiary is sometimes too small or newly established to acquire the necessary funding from a Chinese Bank on its own.
Chinese branches of foreign banks often extend renminbi loans to a FIE based on a foreign security provided by either from the parent company or a foreign bank. A foreign security to a Chinese bank is also possible, but can be hindered by the lack of familiarity with the issuing foreign company or the foreign legal system.
Execution of the foreign guarantee
When a domestic debtor fails to repay its domestic loan according to contract, the foreign security can be enforced. This leads to a conversion of forex in renminbi and repayment of the debt.
After payment by a foreign guarantor, the amount paid has to be registered by the domestic debtor as (additional) foreign debt. The total amount of the debtor’s foreign debt may not exceed the predefined percentage of the registered capital.
Chinese security with foreign beneficiary
To provide a valid security to a foreign beneficiary or for the benefit of a foreign debtor, a Chinese entity needs to ensure the security arrangement is:
i) pre-approved by SAFE;
ii) validly executed by the parties; and
iii) registered with SAFE.
There are mandatory qualifications to the Chinese security provider. These include solvency requirements for the security provider and the requirement that the security provider directly or indirectly holds shares in the debtor.
The security agreement needs to be drafted in accordance with the principal (loan) agreement which it secures to successfully pass the SAFE registration process. Foreign parties are advised to ensure that the principal contract and the security agreement are written in English and Chinese.
The security can be subjected to different legal systems as long as the mandatory requirements of Chinese law are complied with. The view that foreign judgments or arbitral awards are not enforceable in China is simply not true and, insofar as it refers to practice rather than law, outdated.
Foreign arbitral awards have been successfully enforced in China. It can be easier in circumstances to opt for Chinese law and arbitration with the China International Economic and Trade Arbitration Commission (“CIETAC”) as the applicable forum and law. However, this is not the apparent choice.
Recent problems in the cooperation between central CIETAC in Beijing and its subcommissions in Shanghai and Shenzhen could create problems for parties. In addition, arbitral proceedings in a third country under a different law can be more balanced, assert pressure on the Chinese party and still be enforceable. The best option depends on the parties and the circumstances.
Gerard van Swieten