By King & Wood Mallesons Banking Group

On 13 February 2014, the State Administration of Foreign Exchange ( “SAFE”) published the Provisions on the Administration of Foreign Exchange for Cross-border Security (Draft for Comments) (“New Provisions”) on its website, soliciting public opinions. The New Provisions, if implemented, will further loosen the country’s foreign exchange capital control.

Compared to the existing regulations (“Existing Rules”) such as the Implementation Measures on the Administration of External Security Provided by Onshore Entities and the Circular of SAFE on Issues Concerning the Administration of External Security Provided by Onshore Entities (“Circular 39”), the main changes are:

  • The types of cross-border security subject to SAFE supervision are greatly reduced   The New Provisions mainly provide detailed administration on the following two structures: (i) Nei Bao Wai Dai (an onshore security provider providing security in favor of an offshore beneficiary to secure obligations owed by an offshore obligor to the offshore beneficiary) (see Structure I in the below diagram); and (ii) Wai Bao Nei Dai (an offshore security provider providing security in favor of an onshore beneficiary to secure the obligations owed by an onshore obligor to the onshore beneficiary) (see Structure II in the below diagram). Any other form of cross-border security (such as Structure III in the below diagram) is no longer required to be registered or filed with SAFE.

  • All prior SAFE approvals are abolished   The New Provisions, if implemented, will abolish all prior SAFE approval in respect of cross-border security transactions. Previously banks need to apply to SAFE for an annual external security quota on a yearly basis. Now, they are only required to monitor and control their own Nei Bao Wai Dai volume to ensure the aggregate payment obligation thereunder at any given working day is below 50% of their audited net asset as at the end of the previous year. Notwithstanding the above, the parties to the Nei Bao Wai Dai and Wai Bao Nei Dai will still need to register the cross-border security with SAFE in accordance with the New Provisions.
  • SAFE filing/registration is no longer a pre-condition for the validity of cross-border security   Previously all external security needs to be approved by and/or registered with SAFE, failing which the external security will be rendered void. With the promulgation of Circular 39, banks with an annual external security quota granted by SAFE may issue external financing security within the quota without SAFE approval and the validity of such external security is no longer conditional upon the SAFE filing. The New Provisions further expressly provide that SAFE filing/registration of cross-border security documents is no longer a pre-condition for the of such document validity, which if implemented, would constitute a great breakthrough. Nevertheless, as SAFE has no power to make amendments to the Judicial Interpretation of the Supreme People’s Court on Certain Issues Concerning the Application of the “Security Law of the People’s Republic of China” (the “Judicial Interpretation on Security Law”), the applicability of the provision on the invalidity of external security contracts without the approval from or registration with the relevant regulatory authority contained in the Judicial Interpretation on Security Law remains to be clarified by the Supreme People’s Court.
  • Most restrictive conditions attached to cross-border security are removed   According to the Existing Rules, a non-financial institution can only provide external financing security for the obligations of the entities established by it or the entities with their share directly or indirectly held by it. At the meantime, the obligor must meet certain requirements with respect to the net asset and profitability. The New Provisions will remove such restrictions, except in certain exceptional circumstances such as an offshore bond issue.
  • Onshore individuals are explicitly permitted to provide   Nei Bao Wai Dai Although there is no specific prohibition on the provision of external security by individuals under the Existing Rules, in practice, there lacks detailed guideline on this, apart from a special exception which allows onshore individuals to provide external security along with onshore entities for offshore obligations in an outbound investment. Regarding the above, the New Provisions expressly provide that onshore individuals may conduct Nei Bao Wai Dai with reference to the corresponding rules applicable to non-financial institutions.
  •  All SAFE verifications of performance of external security are abolished   According to the New Provisions, SAFE verification of performance of external security is no longer required. Under the Nei Bao Wai Dai, after enforcing the security, financial institutions may make fund transfer on their own and non-financial institutions may also directly request a bank to assist with the fund transfer upon the presentation of SAFE filing of external security, in each case, without SAFE verification.

Given the New Provisions is merely a draft for comments, there are still a number of points that are subject to clarifications or considerations. For example, it is not clear whether the New Provisions are applicable to RMB-denominated cross-border security. Another example is the New Provisions’ lack of detailed guidance on certain operational procedures. We expect that SAFE will make necessary modifications and clarifications based on the comments received, revise and improve the current draft, and promulgate a final official version.

With regards to the impact of the New Provisions on the market practices, we will provide further information in the coming client alert.