Circular on Several Issues Concerning the Administration of Foreign Exchange in Outbound Lending by Domestic Enterprises

In an effort to help non-financial Chinese enterprises invest abroad, the State Administration of Foreign Exchange (SAFE) has issued the Circular on Several Issues Concerning the Administration of Foreign Exchange in Outbound Lending by Domestic Enterprises (the Outbound Lending Circular), which enables Chinese companies to make loans to overseas enterprises in which they have a financial stake. Effective as of August 1, 2009, it is designed both to satisfy the needs of offshore companies for working capital and to make better use of China's huge foreign exchange reserves.

China has by far the largest foreign exchange reserves of any nation in the world—as of mid-2009, more than US$2.1 trillion, according to People's Bank of China figures. On the other hand, while China has enacted rules and policies encouraging Chinese companies to make outbound investments (see, for example, China Law Update's April 2009 summary of the Measures for the Administration of Outbound Investments), those companies have often found it difficult to find the liquid capital to make such overseas investments.

Before implementation of the Outbound Lending Circular, overseas lending by Chinese companies was mainly regulated by the Circular on Several Issues Concerning the Management of Internal Operation of Forex Funds in Multinational Companies (the Forex Funds Circular), which was issued in October 2004. As the title of that circular suggests, it confined outbound lending to multinational corporations, which in turn had to meet high thresholds in order to make such loans. The new circular, in contrast, removes many restrictions and greatly expands the number and type of China-based enterprises that are permitted to loan money abroad. The new rules also offer more flexibility and simplify the approval process for outbound lending, allowing companies to seek approval from provincial SAFE branches rather than the central agency. A key change in the Outbound Lending Circular is that it allows companies either to use their own foreign currency deposits or to convert RMB funds to foreign currency for foreign loans.

Definitions and Forms of Outbound Lending

As defined under the Outbound Lending Circular, outbound lending is a method of financing in which a domestic Chinese enterprise other than a financial institution provides a loan to a wholly owned foreign subsidiary, overseas branch, or foreign enterprise in which it holds a financial interest. Any type of domestic enterprise (except a financial institution) is allowed to engage in outbound lending, which dramatically expands the scope of companies eligible to make such loans. Loans must still, however, be within limits approved by SAFE or, in most cases, provincial SAFE branches.

Outbound lending may be either in the form of a direct loan from the China-based parent company (Lender) to the overseas business (Borrower) or via an entrustment loan in which the Lender deposits funds in a bank or financial institution that is allowed to engage in foreign exchange business, with the bank or institution then making the loan to the Borrower.

Thresholds for Outbound Lending

Unlike the Forex Funds Circular, which set very high thresholds for eligibility to make outbound loans (for example, the lending company had to own at least three overseas enterprises, and the total outbound investment had to be at least US$5 million), the Outbound Lending Circular focuses mainly on companies' compliance with foreign exchange rules.

Companies that want to engage in outbound lending must satisfy the following requirements:

• Both the Lender and the Borrower shall be duly incorporated, with fully paid-in registered capital.
• Both the Lender and Borrower shall have a record of continuously good business operation, sound financial and internal control systems, and a record of compliance with foreign exchange rules over the preceding three years.
• All previous outbound investments by the Lender must be in compliance with government approval requirements.
• The Borrower must have received a Level I or Level II grade in the latest annual inspection for overseas investments that is conducted jointly by SAFE and the Ministry of Commerce (unless it has been less than a year since the Borrower was established).
• For Lenders that have already engaged in outbound lending, previous loans shall be operating normally, with no breach having occurred since the loans were made.

Sources of Funds for Outbound Lending

The Outbound Lending Circular expands the potential sources of funds that can be used for outbound lending. Lenders may loan not only their own foreign currency funds (previously the only permissible source under the Forex Funds Circular), but also funds converted from Renminbi to foreign currency, as well as money in the corporate group's foreign currency pool, with SAFE's approval.

Restrictions on Outbound Lending

Despite the liberalization of rules in the Outbound Lending Circular, overseas lending by companies based in China is nevertheless still subject to quotas and other controls. Any domestic Lender that wants to make an overseas loan must first apply to SAFE for a quota (limit) on the amount of money it can lend overseas. This quota will be valid for a term of two years and may be extended upon application within one month before its expiration. The Lender is allowed to remit funds abroad either in one lump sum or in installments, so long as the total amount loaned remains within the quota. Revolving loans are also permissible under the Outbound Lending Circular. The total amount loaned shall be limited to the lower of: (i) 30 percent of the Lender's ownership equity interest in the Borrower or (ii) the Lender's duly registered outbound investment quota.

Procedures for Application

A Lender that wants to engage in outbound lending must follow certain procedures:

• Seek SAFE Approval. A Lender shall first apply to its provincial-level SAFE branch for approval to engage in outbound lending and verification of its outbound funds quota. The SAFE branch shall make its decision within 20 working days after accepting all application documents.
• Open a Special Bank Account. After obtaining its verified quota from SAFE, the Lender must apply directly to a foreign exchange bank to establish a special account for outbound investment. All funds for outbound lending must be remitted into and out of China through the special account.
• Remitting Funds Overseas. Where a Lender wishes to make an overseas loan with its own foreign currency funds, or with foreign exchange purchased using its own Renminbi funds, the Lender may directly seek remittance of those funds at the authorized foreign exchange bank where it has its special outbound lending account. Foreign currency funds from other resources, such as securities, are still subject to verification by the Lender's provincial SAFE branch. Under the Forex Funds Circular, such verification was required with each remittance.