Friday Letter: Change in China

Recent legislative measures in China have further eased the way for foreign lenders to issue loans to offshore affiliates of Chinese companies. But there’s still plenty of room for further development of the PRC’s regulatory regime.

The State Administration of Foreign Exchange (SAFE) in China recently made efforts to improve the cross-border flow of capital in the country. Circulars 29 and 37 (‘Provisions on Foreign Exchange Administration of Cross-Border Guarantee and Security’ and ‘Issues Relating to the Administration of Foreign Exchange in Respect of Offshore Investments, Financings and Return Investments by Domestic Residents through Special Purpose Vehicles’) took effect in June and July respectively.  

Both measures are important, because they make it easier for foreign alternative lenders to provide financing to the offshore affiliates of PRC-domiciled companies.  

Under the prior regime, a PRC entity could not grant a guarantee or give onshore security to offshore loan providers without the consent of SAFE. This was rarely, if ever, forthcoming, according to law firm Jones Day.  

Yet the new regime means a PRC company can give a guarantee or security over its PRC-registered assets to secure offshore loans made to its overseas subsidiaries (or parent) without that approval. The guarantee or security agreement must then be registered with SAFE within 15 working days.  

Offshore loan proceeds cannot be repatriated onshore however, a prohibition designed to guard against speculative capital that could destabilise the Chinese market. Once the guarantee or security has been enforced, the Chinese obligor may not give additional guarantees or security until it has been fully indemnified by the offshore borrower, Jones Day explained. This guards against overexposure.  

The second circular, number 37, also allowed a PRC-registered parent company to lend to its offshore SPV, as long as there is a legitimate need. This will be welcomed as such shareholder loans are normally viewed as equity in a lending transaction. An equity cushion of this sort from a PRC-registered parent helps to reduce default risk, and makes the SPV a more attractive borrower to potential offshore lenders.  

Adamas Asset Management, an experienced private debt group active in China, published a white paper on the enforceability of loan security in China earlier this month. In it, the firm observed: “[The] new cross-border lending reform has been introduced by SAFE, and such easing of control can be expected to reduce transaction times and associated costs for offshore investors who also stand to benefit from increased flexibility and strengthened enforcement over security.”

These are positive measures, but there are still concerns about the country’s lending regulation. Although China has a thriving non-bank lending industry (popularly referred to as ‘shadow-banking’),  cracks are beginning to show. There were protests last month, for instance, after one of Sichuan’s largest credit guarantee companies failed to cover loans to SMEs it had insured. Regulators in China have tried in recent months to place greater constraints on the shadow-banking industry to allay fears of a build-up of debt, whilst at the same time attempting to facilitate greater investment from overseas lenders. Meanwhile, overall lending fell significantly in July to the lowest level since the financial crisis, according to the Chinese Central Bank.

So the picture in China remains a confused one. The conundrum – increase lending to your corporate sector to help boost growth / reduce risk in your financial system – is one however that most governments are grappling with, with varying degrees of success. The fact that China is taking steps to address both issues is undoubtedly a positive one, however.   


Join us at the PDI China Corporate Debt Forum on 6-7 November in Hong Kong, where—for the first time—we'll take an in-depth look at the factors affecting the burgeoning private debt asset class in China, with top-level discussion on high-yield investing, alternative lending, shadow banking risks, regulatory changes and more.