（抱歉，此文没有中文翻译）

The difficult global economic environment of the last twelve months has affected financial planning and budgets of most businesses around the globe. The global downturn has especially impacted on the international trading of multi-national businesses. China in particular has experienced a steep fall of export business which has forced many foreign investors to review the financing situation of their Chinese subsidiaries. The financing and foreign exchange regulations of the PRC, the People’s Republic of China, make it difficult to react quickly to financial needs of foreign-invested enterprises (FIE), since capital control mechanisms are in place for foreign exchange transactions across the Chinese borders under the supervision of SAFE, the State Administration of Foreign Exchange, China’s national regulator for foreign capital control. This makes it necessary to react to threatening financing problems of PRC subsidiaries at the earliest opportunity.

This article provides an overview of options to react to financing needs of FIE in China and any considered potential limitations to these. In practice, a mixture of these financing options is often applied.

Despite several regulatory efforts of the Chinese government in the aftermath of the entry of the PRC into the WTO, the World Trade Organisation, to create a level-playing-field for both domestic and foreign-invested enterprises in China, FIEs are still subject to financing regulations which are strictly applied by the examination and approval authorities, and which ensure that every foreign invested business is equipped with sufficient equity for its specific business scope. Minimum equity ratios are dependant on the project’s total investment volume, and range from 30 to 70% of the total amount of investment. For example, if the total amount of investment of a foreign investment project is US-Dollar 5 million, the total investment shall be financed by at least 50% equity to be injected by the investor(s) into the company as contributions to the registered capital within certain deadlines, and if the total investment is less than US-Dollar 3 million the minimum equity ratio is even 70%.
 
Therefore there is often very limited headroom for any loan financing because this would be limited to the gap between the required equity and the total amount of investment, and therefore investors often find themselves forced to increase the registered capital of their Chinese subsidiary in need for fresh money. Based on national foreign exchange legislation, some SAFE bureaus understand the amount of (foreign) debt to be considered in a cumulative manner when calculating the available lending headroom, i.e. a certain loan quota used by one medium or long-term loan would be used up for the entire life time of a FIE, and would not be available anymore even this loan is repaid already.

Injecting new registered capital into a FIE requires clearance from the Chinese examination and approval authorities, as well as the registration with the local AIC, the Administration of Industry and Commerce. The articles of association and in case of a Sino-foreign joint-venture company, the joint venture contract, need to be amended and the business licence re-issued. Under certain circumstances, and subject to local differences, the capital increase may need to be verified by the Development and Reform Commission which originally verified the investment project¹. This means that a capital increase for a FIE normally takes several weeks, and the timing when the required financing is in place cannot be controlled. Therefore, foreign investors would often need to consider alternative methods of providing fresh money to its Chinese subsidiary.

In order to avoid such lengthy procedures and considering that the injected capital is trapped in the Chinese subsidiary, foreign investors would usually consider a shareholder loan to be the most flexible and hassle-free option to provide fresh money to its overseas subsidiaries.  Newly injected equity contributions would remain in the subsidiary without the flexible means of repayment, and bank loans would usually be subject to the provision of security arrangements not always readily available to the subsidiary in a financially distressed situation. However, under PRC law any loan transactions are strictly regulated. Shareholder loans extended by foreign investors are foreign loans and as such are subject to restrictive PRC regulations, limiting the flexibility of shareholder loans within other jurisdictions.


1.  Foreign Loans

Foreign debts should only be incurred upon the verification of SAFE. Without such verification the borrower will not be able to convert such foreign loans into RMB for its use in China (the circulation of foreign exchange within the PRC is prohibited), nor will it be able to obtain the foreign currency needed to repay the loan. The approval to actually convert the foreign exchange derived from such a loan may not always be given as these approval requirements are used by SAFE as a foreign exchange control mechanism and it therefore depends on the foreign exchange policy in place at the time whether or not such approval is being granted. Therefore there is a risk that the conversion is not approved and the foreign currency obtained through such loan may only be used to purchase goods or services from outside of China. This should be carefully considered when deciding whether to obtain a foreign exchange or a domestic RMB loan.

Even if the approval will be granted, obtaining SAFE clearance is time consuming and cannot be controlled in terms of when the money is available to the borrower. In addition, SAFE reviews the commercial conditions of the loan upon the initial registration of the loan agreement and may require changes, e.g. to the agreed interest rate, if no sufficient explanation is  given by the parties in regard to conditions which deviate from what SAFE considers as market standards.

The same scrutiny is exercised by SAFE over the purpose of the loan as stated in the loan agreement as foreign exchange loans may not be used for some purposes, e.g. for the repayment of local RMB loans or for the financing of certain real estate projects, and new SAFE regulations aim at scrutinizing that foreign exchange loans are only used for the approved purposes². If the purpose however is for instance the financing of working capital requirements the registration and verification is usually smooth and the foreign exchange could then be converted into RMB and used for current account items.

Interest rate payments to overseas lenders are subject to a withholding tax in China of currently 20% which may be reduced to 10% under certain treaties for the avoidance of double-taxation. Both interest rate payments and repayments of the loan itself require the conversion of RMB into foreign exchange which makes the involvement of SAFE necessary for respective verification procedures.

FIE borrowers may also obtain foreign exchange loans from domestic financial institutions.

2.  Local Loans

Local RMB loans may in practice be obtained from local banks disregarding the debt financing headroom between the registered capital and the total amount of investment of the FIE borrower. Also local banks would usually require that security arrangements be in place for the lender to be secured.

Non-financial institutions are not permitted to extend any loans to each other, with or without interest, whether or not the borrower is an affiliate or third party of the lender³. In practice, such provision is often not strictly complied with and it is not uncommon to see inter-company loans among Chinese business firms. If any dispute arises over the loan transaction, the question is whether the borrower has to return the loan or whether the lender has any claim for repayment. Clearly, the lender would have to give up any interest profit as if there has never been such loan transaction. However, due to the lack of clear implementing provisions, it is not altogether clear what happens to any contractual arrangements regarding any preference of repayment from the borrowers over any other debts or stocks: The loan is illegal in the first place and may not enjoy preference anymore.

The formal way to obtain loans from non-financial institutions is the so-called trusted loan. Under such arrangements the non-financial institution lender would deposit the loan amount with a local bank which would extend the same amount as a loan to the borrower. Trusted loan agreements are usually structured in a way that lender and borrower determine the interest rate and the credit risk is vested with the borrower rather than with the bank. The bank charges a fee which is usually below 0.5%. 

¹   National Development and Reform Commission, Article 18 of the Verification of Foreign-invested Projects Tentative Procedures, promulgated and effective October 9, 2004.

² State Administration of Foreign Exchange, Several Issues for the Improvement of Administration of Payment and Settlement of FIE Foreign Exchange Capital Funds, promulgated August 29, 2008, as well as National Development Planning Commission, Ministry of Finance and State Administration of Foreign Exchange, Article 26 of the Foreign Debt Administration Measures promulgated January 8, 2003.

³ People’s Bank of China, General Provisions on Loans promulgated June 28, 1998 and effective August 21, 1998.