The Finer Points of Regulating Cross-Border Guarantees
The basic framework for China's foreign exchange regulations on cross-border guarantees was put in place in June 2014 with the implementation of the Provisions on the Foreign Exchange Administration of Cross-border Guarantees (No. 29 [2014] of the State Administration of Foreign Exchange,or document 29) and its operating guidelines. The regulations clearly specified the types of guarantees that were included under the State Administration of Foreign Exchange's registration requirements. At the same time,they eliminated limits on the size of guarantees,scrapped requirements related to the equity of companies' concerned and ended restrictions on relationships between the guarantor and the entity providing offshore loans. It also abolished the prior approval requirement on offshore guarantees for onshore loans,a move that has greatly facilitated the use of guarantees in cross-border trading,investments,financing,international project contracts and other cross-border business activities.
Document 29 stated that foreign exchange policies on cross-border guarantees were aimed at guarantee transactions that could affect the nation's balance of payments through capital flows or the transfer of assets. It established 14 categories for these guarantees according to the various combinations of the places of registration of the parties involved (guarantors,guaranteed parties and beneficiaries) and the place of registration of the actual obligation among other factors. It also expanded the scope of guarantee registrations to cover onshore guarantees for offshore loans and offshore guarantees for onshore loans which could increase our external credits or external debts.
Document 29 scrapped limits on the guaranteed amount and did away with financial guidelines on the guarantors for domestic guarantees of offshore borrowings but retained restrictions on transferring guaranteed funds directly or indirectly into China for domestic use without approval of foreign exchange authorities. In addition,it made a modest liberalization of individual onshore guarantees in offshore loan transactions.
The regulations stated that borrowers in onshore loan transactions with an offshore guarantee can be any legally established domestic or foreign-funded enterprise. There are some controls on the size of offshore guarantees for onshore loans - specifically that external debts should not exceed the total of the relevant enterprise's net assets of the previous year or its existing foreign debt quota. If guaranteed amount exceeds either of those limits,penalties can be applied on the excess amount. Financial institutions that provide exchange settlements or purchases related to guarantee performance bonds must receive authorization from foreign exchange authorities.
Cross-border guarantees in other forms do not need to be registered,but registration is required after a guarantee is executed.
As for foreign exchange management,guarantees were delinked from the effectiveness of their underlying contract. Instead,the regulations focused on the remittance of funds on the execution of a guarantee. This was primarily to reduce the administrative risks to the State Administration of Foreign Exchange stemming from possible inconsistencies in guarantee management policies of various government departments. The rules stated that even without registration,the cross-border guarantee contract signed by the parties would be considered effective. However,if the foreign exchange administration's requirements on cross-border guarantees were not met,companies in China might have difficulties in obtaining foreign exchange receipts and making payments. They could also be penalized by the foreign exchange management department,and this regulatory change was designed to encourage companies to comply with registration provisions.
Banks need to submit data related to onshore guarantees for offshore loans and offshore guarantees for onshore loans by using the capital account information system. A registration must be made for each transaction on onshore guarantees of offshore loans of enterprises or non-bank financial institutions..
The verification procedure on cross-border guarantee performance has also been scrapped. After conducting authenticity and compliance audits,banks can directly handle performance fund collection and payment on their own behalf or for clients.
The regulations established appropriate risk control measures,such as the addition of a clause on contract suspension due to breach of contract. A bank's guarantee execution ratio will also be included in the annual assessment of the bank's execution of foreign exchange regulations.
Document 29 abolished various restrictions on foreign guarantee transactions,and one of the more important changes allowed Chinese enterprises to accept without prior regulatory approval overseas guarantees linked to domestic financing. This greatly facilitated China's cross-border guarantee business,and enabled faster growth of this market. To take Shanghai as an example,the balance of its onshore guarantees for offshore loans as of March 2016 was up 103% from the level of May 2014. The outstanding amount of financing was up 114%,while the ratio of guarantees actually being executed was around 3%,which was only a slight rise over the 2014 level.
Risks in Offshore Guarantees For Offshore Loans
For offshore guarantees for offshore loans,once a guarantee is executed it will lead to an actual outflow of funds,and this will have an impact on the nation's balance of payments position and could affect the renminbi exchange rate. Without proper policy management,it could also create a channel for asset transfers and capital flight. Risks remain despite the fact that the State Administration of Foreign Exchange has taken a series of risk control measures,such as the temporary suspension of guarantee business for non-bank institutions once they actually need to execute a guarantee and the inclusion of a bank's guarantee performance ratio into its annual overall performance assessment.
Several steps need to be taken to address the risks in this business. The process of verifying the qualifications of the enterprises involved in these transactions needs to be strengthened,for example. Under existing regulations,when domestic institutions invest in or set up an enterprise outside