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Regulatory Issues on Onshore Guarantee for Offshore Loans

作者：k8凯发天生赢家·一触即发金融部

I.Onshore Guarantee for Offshore Loan and Its Regulatory Background

Onshore guarantee for offshore loan (Nei Bao Wai Dai, or 内保外贷 in Chinese, hereafter “NBWD”) is one of the most common form of cross-border guarantee. According to Circular on Foreign Exchange Management of Cross-border Guarantees issued by the State Administration of Foreign Exchange (SAFE) in 2014 and its operating guidelines (Hui Fa [2014] No.29, hereinafter referred to as “Circular No.29”), cross-border guarantee is defined as a legally binding guarantee made by the guarantor to the creditor in writing, which promises to fulfill the relevant payment obligations in accordance with the guarantee contract, and may lead to the international balance of payment transactions such as cross-border payment of funds, cross-border transfer of asset ownership, etc. Cross-border guarantees is divided into 3 main categories: onshore guarantee for offshore loan, offshore guarantee for onshore loan (Wai Bao Nei Dai, or 外保内贷 in Chinese) and other forms of cross-border guarantees in terms of the registered places of the parties to the guarantee. Onshore guarantee for offshore loan means the cross-border guarantee where the guarantor is registered in China while the registered places of the debtor and creditor are outside China.

The supervision of NBWD has experienced a strict to relaxed process. Circular No.29 revised the NBWD regulation from prior approval to post-registration. Non-banking institutions and enterprise guarantors shall go through the registration at local branches of SAFE within 15 days after signing the guarantee contract, while the bank guarantors only need to submit the NBWD data to SAFE via online system. On 26 January 2017, Circular on Further Promoting the Reform of Foreign Exchange Management and Improving Examination of Authenticity and Compliance (Hui Fa [2017] No.3, hereinafter referred to as “Circular No.3”) further stipulates that the proceeds under NBWD loan may be transferred to China for use in the prescribed manner. On 24 November 2017, SAFE further issued the Circular on Improving the Foreign Exchange Management of Bank-guaranteed Foreign Loans (Hui Zong Fa [2017] No.108, hereinafter referred to as “Circular No.108”), aiming at improving the foreign exchange management of bank-guaranteed foreign loans. Circular No.108 especially put forward more detailed requirements on the authenticity and legality of the debtor’s subject qualification, use of proceeds and transaction background.

II.Key Regulatory Requirements of NBWD

According to Circular No.29, when applying for NBWD registration, the guarantor shall examine and verify the debtor’s subject qualification, use of proceeds, expected source of repayment, the possibility of the guarantee performance and relevant transaction background. The guarantor shall also conduct due diligence on whether the above items comply with domestic and foreign laws and regulations, and appropriately supervise the debtor to use the proceeds in the prescribed way. Circular No. 108 further explains in detail the examination, verification and investigation obligations of banks when handling the domestic insurance and foreign loan business.

1. Debtor’s Identity

Pursuant to Circular No.29, SAFE shall examine the application submitted by non-banking institutional guarantors in accordance with the principle of authenticity and compliance. Circular No.108 explicitly indicates that banks shall strictly examine the authenticity and compliance of the debtor’s identity when handling the NBWD loans. Relevant examination materials shall be kept for future reviewing. In practice, SAFE usually asks for copies of the incorporation certificate of the debtor when a non-banking institutions guarantor submit the NBWD for SAFE registration.

2. Use of Proceeds

According to Article 11 of Circular No.29, the proceeds under NBWD loan shall only be used within the normal business scope of the debtor. It is prohibited to make up a transaction background for arbitrage or engage in other forms of speculative transactions. After the promulgation of Circular No.3, the debtor can directly or indirectly transfer the loan proceeds to China by capital or equity investment in China; however, investment in securities market is not allowed.

In addition, Article 12 of Circular No.29 also requires the guarantor to supervise the debtor's use of proceeds according to the stipulated purpose in an appropriate way, which requires the guarantor to continuously monitor and track the use of loan proceeds.

3. Estimated Sources of Repayment and the Possibility of Guarantee Performance

It is the key obligation of the guarantors to examine and verify the estimated source of repayment and the possibility of guarantee performance according to Circular No.29, which is also the major concern of SAFE. Moreover, Circular No.108 emphasizes that, when handling NBWD, banks shall strengthen the examination and verification of the first repayment source and the possibility of guarantee performance according to laws and regulations. Banks shall not sign cross-border guarantee contracts when they know or should have known that the performance obligation is certain to occur. On the basis of the following circumstances and considering reasonable commercial principles, a bank can decide whether the guarantee contract has obvious guarantee performance intention at its sole discretion from the following perspectives:

(1)Whether the borrower has sufficient solvency or a predictable source of repayment when signing the guarantee agreement. Banks shall not handle the NBWD business if the debtor’s expected source of repayment is unknown or has obvious defects. Besides, banks should carefully handle this business if the debtor’s business condition is poor or its debt ratio is too high even though it has a clear source of repayment. 

(2)Whether there is an obvious inconsistency between the financing conditions under the main loan agreement and the stipulated use of proceeds by the borrower.

(3)Whether the parties to the guarantee have the intention to repay the debt in advance through the performance of the guarantee. 

(4)Whether the parties to the guarantee have maliciously guaranteed performance or defaulted on their debts as guarantors, counter-guarantors or debtors.

In practice, SAFE generally asks for audited financial reports of the guarantor and the borrower when reviewing the application for NBWD registration in respect of non-banking institutions, and analyzes the commercial rationality in combination with the use of proceeds, the guaranteed amount and period to estimate whether there is the intention of guarantee performance. In addition, SAFE may also ask the guarantor to explain the source of fund when enforcing the guarantee.

4. Transaction Background

The requirements of due diligence verification and the investigation regarding the transaction background can be divided into two aspects: authenticity and legal compliance. Authenticity requires banks to verify finance documents, such as the loan agreement. In term of legal compliance, Circular No.29 requires non-banking institutions to provide supplementary supporting materials for the underlying transactions, including the approval of the National Development and Reform Commission (NDRC) and the Ministry of Commerce on overseas investment, when applying for NBWD registration. In other words, SAFE needs to properly verify the legal compliance of the transaction background when accepting the registration application from non-banking institutions. Meanwhile, according to Circular No.108, if the proceeds are used to obtain the equity or the creditor’s rights of overseas institutions, banks shall also ensure compliance with the relevant provisions of domestic and overseas investment.

III.Breaching Situations and Legal Risks 

Among the violation cases published by SAFE from time to time, there are many cases of being punished for violating the regulatory requirements of NBWD. For example, a bank was warned and fined CNY 42,661,600 for violating such regulation in September 2022.

The penalties imposed by SAFE include warnings, fines and confiscation of illegal income in accordance with Articles 43[1] and 47[2] of the Administrative Regulations on Foreign Exchange. Fines could reach 30% of the transaction value.

Among the NBWD violation cases published by SAFE in recent years, many relates to bank’s failure to examine and verify strictly when handling onshore guarantee for offshore loan business, including: 

(1)a bank failed to conduct due diligence to review and investigate the source of repayment of the borrower.

(2)a bank failed to fulfill its obligation to examine the authenticity of the transaction background, for example, “the beneficiary of the bill of lading is inconsistent with the buyer and seller of the trade in the documents submitted by the enterprise”, “the content of the loan use message cannot be identified, the letter of intention for extension does not reflect the use of proceeds, and the performance amount is greater than the loan amount”.

(3)a bank failed to conduct due diligence and investigation on the debtor's subject qualification and the source of guarantee funds.

(4)a bank failed to examine and verify the use of proceeds according to applicable provisions, failing to continuously monitor and track the proceeds, and handling foreign exchange purchase and payment business in violation of regulations.

(5)a bank failed to conduct due diligence and investigation on the possibility of guarantee performance as regulated.

IV.Our Suggestions

1. For Banks

There are two key points for SAFE to supervise banks’ NBWD business: (1) whether the bank as the guarantor, has fulfilled its due diligence and investigation obligations as stipulated in Article 12 of Circular No.29; (2) whether the bank has fulfilled its obligation to review the transaction background, and the legality and compliance of the guarantee contract, when handling the foreign exchange purchase, payment or settlement business related to NBWD.

When a bank guarantor handles NBWD, it shall ask the debtor to provide relevant information, and pay attention to the authenticity and compliance of the debtor’s identification documents, the use of proceeds under the guaranteed loans, the expected source of repayment, the possibility of guarantee performance and the transaction background. It may include: whether the debtor’s identity is true and compliant; whether the proceeds are used within the debtor’s normal business scope, and whether there is any illegal use of proceeds, and it is necessary to continuously monitor and track the use of proceeds; whether the source of repayment is unclear or defective, and whether the debtor has poor management or low debt ratio; whether the guarantor has obvious intention to guarantee performance (reviewed in combination with Circular No.108); whether the transaction background is legal, compliant and authentic (relevant approval documents and finance documents shall be reviewed).

When banks handle the foreign exchange purchase, payment and settlement business related to NBWD, the legality and compliance of the transaction background and the guarantee contract shall be examined and verified.

2. For Non-banking Institutions

When applying the SAFE registration for NBWD, a non-banking institution shall also provide information with reference to the above-mentioned aspects for SAFE’s review. According to the requirements of Circular No.29 and our practical experience, the information that a non-banking institution must provide to SAFE generally includes but is not limited to, the following:

(1)A written report regarding the registration of NBWD (including the basic information of the parties, the balance of all cross-border guarantees that have been registered but not yet settled, the key points of the guarantee transaction, the estimated source of repayment, and other matters that need to be explained, such as a co-guarantor.);

(2)Guarantee agreement and the main debt agreement under the guarantee (if the contract contains too many contents, the applicant only needs to provide a summary of the contract and affix the seal; the Chinese translation shall be provided if the contract is in a foreign language);

(3)Relevant supporting documents that SAFE deems necessary to supplement according to applicable provisions (e.g. the approval documents of the NDRC and the Ministry of Commerce on the underlying overseas investment projects; and the alteration documents that need to be provided when applying for a change of registration);

(4)A copy of the legal certificate of the debtor’s incorporation documents;

(5)Proof of the guarantor’s commercial rationality (e.g. the financial report);

(6)Proof of the debtor’s repayment capacity (existing cash balance, or predictable income sources such as investment project analysis, profit analysis, etc.).

[1] “Anyone who violates the management of foreign debts by borrowing money from overseas, issuing bonds abroad or providing external guarantees without authorization shall be given a warning by the foreign exchange administration authority and fined up to 30% of the illegal amount.”

[2]“Where a financial institution falls within any of the following circumstances, the foreign exchange administration authority shall order it to make corrections within a specified period of time, confiscate its illegal income and impose a fine of between CNY 200,000 and CNY 1,000,000; where the circumstances are serious or no remedial action has been taken within the period of time specified, the foreign exchange administration authority shall order it to stop operating relevant businesses: (1) where, in handling the receipt and payment of funds on current account, it fails to reasonably examine the authenticity of finance documents and their consistency with foreign exchange receipts and payments; (2) where, in handling the receipt and payment of funds on capital account, it violates the applicable provisions; (3) where, in handling foreign exchange settlement and sales business, it violates the applicable provisions; (4) violating the comprehensive position management of foreign exchange business; (5) violating the administration of foreign exchange market transactions. ”

*本文由金融部合伙人任谷龙撰写

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