New Policy on External Debt

The People's Bank of China recently rolled out its policy known as Document No. 18 -- or more formally called the Pilot Project for Expanding Full-coverage Macroprudential Regulation over Cross-border Financing (Yinfa No. 18 [2016]) This pilot program establishes a regulatory framework that allows market players to determine their  financing according to their capital or net assets. It covers 27 banks with operations across the country as well as a number of enterprises registered in free trade zones in the cities of Shanghai,Tianjin and Guangzhou and Fujian province.

Key Points of the New Policy

The new policy states that market players can borrow from foreign sources according to their capital or net assets. This regulates cross-border movements of foreign borrowings by controlling financial leverage ratios and imposing macroprudential limits. Document No. 18 has reduced the financial leverage ratio by half to prevent risks from large-scale offshore borrowings. Under the previous pilot policy,Chinese-invested enterprises -- which originally had no access to foreign exchange -- were allowed by the State Administration of Foreign Exchange to make foreign borrowings of up to twice the amount of their net assets. This was on a limited basis that applied only to designated pilot areas. The ceiling on offshore borrowings has now been lowered to 100% of their net assets. Additionally,borrowing terms and the currency of the borrowings are taken into consideration. Document No. 18 allows Chinese and foreign-invested enterprises and foreign-invested financial institutions to choose between the new macroprudential regulatory system and the original system under which market players can make cross-border financings equal to the difference between their investment and registered capital. It also states that the National Development and Reform Commission,which has a key role in economic planning,and other government departments can continue their role in setting medium and long-term macro debt targets. This will limit the impact of the new policy on financing volumes and demonstrates some flexibility in the new regulations.

Under the original Detailed Macroprudential Regulations on Separate Accounting of Overseas Financing and Cross-border Capital Flows in China (Shanghai) Pilot Free Trade Zone (Shanghai Headquarters Yinfa No. 8 [2015]) all branches of financial institutions were permitted to borrow from offshore at a designated ratio to their capital level. But Document 18 attempts to prevent duplicate borrowings from the branch level offices. It requires foreign borrowings of all branches to be counted in the total amount of borrowings of their head office.

In the past,the People's Bank of China and SAFE were responsible for regulating offshore borrowings in local currency and foreign currency,respectively. Document No. 18 reallocates the regulatory responsibilities,requiring the central bank to regulate foreign debt -- in local or foreign currency -- for all banks participating in the pilot projects while SAFE regulates enterprise borrowings. SAFE is also responsible for collecting and monitoring foreign debt information from all banks and enterprises in the pilot project to ensure the accuracy and comprehensiveness of all data. In addition,management of short-,medium- and long-term foreign debt is now conducted according to overall balances - a move that makes regulation much easier.

The regulatory system includes a risk coefficient factor that is set according to the type of overseas financing,as well as risks from foreign exchange conversions and taking into account the maturity period of the debt. In order to promote trade,20% of any trade-related credits - regardless of the term length -- would be counted against the total quota of foreign currency borrowings. Foreign currency loans that are secured by a standby letter of credit and external contingent liabilities from derivatives on behalf of clients will be given a risk-weighted cross-border factor calculated at 20% of the total. External contingent liabilities for hedging purposes will be assigned a 50% risk weighting on cross-border financing. Other types of cross-border financing will have their risk conversion factor se