Cross-border Lending - What Offshore Lenders Need To Know

The onshore entity must register its foreign debt with SAFE or SAFE’s local counterpart as a condition precedent to drawdown. In our experience, registration of foreign debt with SAFE should not constitute a material obstacle if the amount of debt does not exceed the relevant foreign debt quota. Any cross-border security provided in respect of foreign debt does not require registration with SAFE.

If the foreign debt has a maturity of longer than one year, the onshore entity must also make relevant filings with the NDRC.

Neibaowaidai – increased scrutiny and corporate resolution requirements

Neibaowaidai (内保外贷) refers to any guarantee or security provided by an onshore obligor to guarantee or secure the debt owed by an offshore debtor to an offshore creditor.

The rules which require neibaowaidai to be registered with SAFE have been relaxed since their introduction in 2014. This includes the removal of most restrictions on the repatriation into PRC of proceeds of offshore debt under a neibaowaidai structure.

Applications for neibaowaidai registrations have faced closer scrutiny in recent years as a result of China’s crackdown on illegal remittance of funds offshore. A neibaowaidai registration may be unsuccessful if SAFE is not satisfied as to:

• the “authenticity and compliance” of the offshore debtor
• the intended source of repayment of the offshore debt, or
• the ability of the offshore debtor to repay the offshore debt.

An unsuccessful registration would pose a major obstacle in remitting funds offshore if the guarantee or security is enforced.

The recently implemented PRC Civil Code and its accompanying SPC Interpretation also clarified the circumstances where corporate resolutions are required to be passed by a company providing a guarantee or security. More importantly, if the guarantor or security provider is a listed company or a publicly disclosed subsidiary of a listed company, it is essential that it makes a public announcement on the passing of corporate resolutions to grant any guarantee or security. For further details and relevant exceptions, please refer to our May 2021 alert.  

Real estate finance restrictions – can offshore lenders benefit from a mortgage over onshore property?

While the foreign debt regime in PRC provides a relatively clear channel for direct lending by offshore lenders to onshore corporates, no domestic real estate enterprise or foreign invested real estate enterprise (FIRE) has been allowed to incur any foreign debt since 1 June 2007 (except where limited grandfathering rights apply).

As a result, offshore lenders intending to lend to a FIRE typically adopt an “onshore/offshore” financing structure.

How foreign invested real estate enterprises are typically structured

The offshore lenders under this typical structure do not directly benefit from any mortgage over onshore real property. Where offshore lenders require a mortgage over onshore real property and obtain priority over and direct recourse against that onshore real property, the following factors should be considered:

• the granting of an onshore real property mortgage in favour of offshore lenders in respect of their loan to the offshore holding company constitutes neibaowaidai, and requires registration with SAFE
• a mortgage over PRC real estate requires registration with the local real estate registration authorities, which might not, as a matter of practice, allow foreign non-financial institutions to be registered as mortgagees, and
• local real estate registration authorities may require notarisation and legalisation of relevant incorporation documents of the offshore lender or the offshore security agent, which adds to the time and cost for completing the relevant registrations.

More details regarding cross-border real estate mortgage can also be found in our May 2022 alert.

Control over cashflow – creation of security over bank accounts in multiple jurisdictions

In cross-border financings involving revenue-generating assets or businesses in the PRC, it is important to consider how to exercise control over cashflows arising from the PRC for the purpose of servicing interest payments and the repayment of offshore loans to offshore lenders.

One important tool is to require the deposit of all or part of specified receipts or recoveries (eg operating income, sale proceeds or incurrence of debt) into designated bank account(s) of the borrower or other obligors. 

If the borrower and other obligors open bank accounts in the PRC as well as offshore jurisdictions (such as Hong Kong), offshore banks should consider which bank account(s) they would like the cashflow to be deposited into, and whether security could be created over such bank account(s).

It is relatively easy to create effective security over bank accounts in common law jurisdictions such as Hong Kong. As for bank accounts in the PRC, Article 70 of the SPC Interpretation implemented recently also introduced much needed clarification on how security over cash deposits may be created and confirmed that fluctuations in deposit account balance does not invalidate security created over the deposit account. More details regarding Article 70 can also be found in our May 2021 alert.

Whether effective security is created over cash deposits under PRC law therefore depends on designation (in Chinese: “专门化”) and control, rather than whether there is a fixed balance. While this is a welcome change that provides more flexibility to borrowers and lenders in structuring a security package for loan facilities, offshore lenders should beware of the differences between taking security over cash deposits under PRC law and taking security over cash deposits under Hong Kong or English law - the common law offers various forms of security such as fixed or floating charges depending primarily on the degree of control by the secured creditor over the cash deposits.

Choice of governing law – factors to consider

When it comes to choosing the governing law of a finance document in a cross-border loan transaction involving the PRC, offshore lenders should consider the following:

• PRC courts will generally only recognise and enforce the choice of foreign governing law in a contract if the contract has a “foreign element”, eg if one of the parties to the contract is a foreign party or if the subject matter is located outside of the PRC
• so long as there is a “foreign element” in a contract, the parties are free to choose any law to govern the contract, regardless of whether the chosen law has a connection to their transaction. This makes it possible for parties to a direct lending transaction involving a Hong Kong bank and a PRC borrower, to choose English law (which has no connection to the loan transaction) as the governing law, and
• there are, however, circumstances where PRC law is applied mandatorily, despite the existence of a “foreign element”. Such circumstances include but are not limited to:
  • Sino-foreign joint venture contracts
  • certain contracts relating to real estate, securities or a pledge of rights where such assets are located in the PRC, or
  • when the use of foreign law is against public interest.

Therefore, in the case of a real estate mortgage to be granted by an onshore borrower in favour of an offshore bank, the mortgage agreement is governed by PRC law despite the existence of a “foreign element” (the offshore bank).

Offshore lending by domestic banks – PBOC No. 27

The People’s Bank of China and SAFE jointly issued the Notice on Offshore Lending Business of Banking Financial Institutions (PBOC Notice 27), which became effective on 1 March 2022. PBOC Notice 27 regulates offshore lending of RMB or foreign-currency loans by domestic banks to offshore enterprises. From an offshore syndication perspective, it enlarges the pool of participating banks which can join an offshore syndication. Market participants should pay close attention to the criteria on which offshore lending may be made under PBOC Notice 27, including relevant lending limit, restrictions on loan purpose, eligible borrowing entities, data reporting requirements, and the management of trade facilities, “OSA” (offshore accounts) and “FTA” (free trade accounts), etc.

A 10-minute video on PBOC No.27 KWM jointly made with the Asia Pacific Loan Market Association can be accessed here.

For capitalized terms which are not defined in this alert, please refer to 'Sidebar - The Words We Use' in our foreword here.

Read this alert in Chinese here. 

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Disclaimer: This alert is provided for general information purposes only and does not constitute legal advice.