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LEGAL ASSISTANCE: Recent Legal Developments in the Administration of Foreign Debt Raised by FIEs
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Foreign debts in China refers to the debts denominated in foreign currencies for which the onshore entities are liable to the non-residents, as per the definition thereof under the Tentative Measures on Foreign Debt Administration (‘Tentative Measures’) promulgated jointly by the State Development Planning Commission (currently named as the National Development and Reform Commission), the Ministry of Finance and the State Administration of Foreign Exchange (SAFE) on 8 January 2003 and effective as of 1 March 2003. According to the Tentative Measures, the ‘onshore entities’ means that the permanent organisations duly established within the territory of China, including without limitation, governmental organs, financial institutions, enterprises, institutions and social organisations; non-residents means that institutions and natural persons outside China and the non-permanent organizations duly established within the territory of China.
The debts raised by a foreign invested enterprise (FIE) from offshore enterprises (including the shareholder’s loans), offshore financial institutions or offshore individuals are categorised as the foreign debts, which shall be mainly subject to the administration of SAFE per relevant Chinese laws and regulations.
In recent years, the legal framework for foreign debt administration in relation to FIEs has undergone several updates, which has affected or will affect the financing strategies for FIEs. This article below will address some of such legal developments which may worth the attention of FIEs as well as their investors.
1. Quota for Raising Foreign Debts by an FIE
Among the various restrictions imposed by SAFE on the foreign debts raised by FIEs, it is one of the important ones that the total amount of the foreign debts raised by one FIE is limited, i.e. being subject to certain quota (Quota). The FIEs may pay close attention to the legal developments regarding the calculation method of the Quota for their financing arrangements.
1.1 Updates on Quota provided by SAFE on 9 November, 2011 
On 9 November, 2011, SAFE issued the Circular on Issues Concerning Further Clarifying and Regulating the Foreign Exchange Administration under Some Capital Accounts (Circular Huifa [2011] No.45), which has strengthened the administration on foreign debts raised by FIEs in certain aspects. 
The calculation of the Quota is one of the updates provided in this circular.
• Prior to Circular Huifa [2011] No.45
Prior to the effectiveness of this circular, the Quota shall be limited to the gap between the said FIE’s total investment and registered capital. 
According to relevant laws and regulations on FIEs, the concept of Total Investment means all the funds necessary to operate a FIE based on its business scale, which consists of the funds for ‘basic construction’ and the funds for working capital, while the Registered Capital means the share capital of a FIE, which is contributed by its shareholder(s) and is the extent to which the shareholder(s) is/are liable to the FIE. 
Such gaps between the Total Investment and the Registered Capital limit of the amount of foreign debts a FIE can duly raise. 
• After Circular Huifa [2011] No.45 
For strengthening the foreign debt administration for FIEs, Circular Huifa [2011] No.45 stipulated that, in order for a FIE to borrow foreign debts, its foreign shareholder(s) shall make the capital contribution to the FIE as scheduled, and the limit for its foreign debt shall be calculated by multiplying the upper limit for borrowing foreign debt (i.e. the gap between Total Investment and Registered Capital) by the percentage of paid-in capital from its foreign shareholder(s).
Therefore, if the foreign shareholder of a FIE does not contribute into the Registered Capital according to the payment schedule as stated in the FIE’s articles of association, which is approved by the competent authorities, such FIE is not allowed to raise foreign debts.
Provided that such capital contribution is on schedule, the Quota under the regime established by this circular is not the maximum gap between the Total Investment and Registered Capital, instead, it shall be further subject to the percentage of the Registered Capital already paid up by the foreign shareholder. For example, if a wholly foreign owned enterprise (WFOE) has the Total Investment being EURO 30 million and Registered Capital being EURO 10 million, and its foreign shareholder has contributed EURO 3 million as per the payment schedule, the Quota of the WFOE for borrowing foreign debt upon that time is EURO 6 million, i.e. (EURO 30 million – EURO 10 million) × EURO 3 million / EURO 10 million = EURO 6 million.
1.2 Updates on Quota provided by MOFCOM on 22 October, 2012
Ministry of Commerce (MOFCOM) has recently issued the Interim Regulations on Equity Contribution of FIEs (Interim Regulations) which took effective on 22 October, 2012. According to the Interim Regulations, a new FIE could be incorporated with maximum 70% of its Registered Capital being contributed by its investor(s) in the form of equities held by such investor(s) in other onshore companies. However, the Quota of such FIEs shall be calculated based on its Total Investment corresponding to its Registered Capital, which excludes the part contributed in the form of equities.  
Therefore, the Quota has been further limited for such FIEs with equity contributions. However, as the Interim Regulations were issued by MOFCOM, the implementation in terms of the Quota is further subject to the coordination by SAFE.
2. Short Term Foreign Debt vs. Medium and Long-term Foreign Debt
Apart from the above stricter calculation method for the Quota, Circular Huifa [2011] No.45 also stipulated the circumstances whereby a short term foreign debt of a FIE will be deemed as a medium and long-term foreign debt.
- Short term foreign debt
The short-term foreign debt refers to the foreign debtor whose term is one year or less. 
For analysing the available Quota, such foreign debt already repaid by the FIE will be disregarded from the Quota, i.e. it will be released from the Quota, and only the balance thereof will comprise the Quota.
- Medium and long-term foreign debt
The medium and long-term foreign debt refers to the foreign debt which has a term of more than one year. 
In order to assess the available Quota, the total amount borrowed for such foreign debts shall be taken into account and the Quota occupied by such foreign debt could not be released even after its repayment.
Circular Huifa [2011] 45 required that if a foreign debt raised by a FIE is overdue and the FIE fails to apply before the competent counterpart of SAFE for foreign debt modification registration formalities, SAFE shall suspend the acceptance of this FIE’s application for raising any new foreign debt.  
In addition, where any short term foreign debt of a FIE is overdue or renewed and the actual term of such foreign debt exceeds one year, this foreign debt will be deemed as the medium and long-term foreign debt. In another words, after the repayment of such foreign debt, the Quota occupied by such debt could not be released. 
Therefore, for a FIE borrowing short term foreign debts, in order to remain within its Quota, such debt shall be duly repaid before the maturity date; otherwise a relevant portion of the Quota occupied by such debt could not be released even after repayment, and thus such a portion of the Quota could not be utilised for borrowing foreign debt again.
3. Simplified Formalities by SAFE for Debt-for-Equity Swap
The foreign shareholder of a FIE may convert the principal of a loan granted by the FIE together with the accrued interests (i.e. a shareholder’s loan, one type of foreign debts raised by a FIE), which has been duly registered by the competent counterpart of SAFE in advance, into the equities of such FIE and thus increases the Registered Capital of the FIE (collectively, ‘Debt-for-Equity Swap’).
According to the Circular on Relevant Issues Concerning the Improvement of Foreign Exchange Administration of Direct Investments by Foreign Investors (Circular Huifa [2003] No.30)1 promulgated by the SAFE and effective as of 3 March, 2003, such Debt-for-Equity Swap shall be approved by the competent counterpart of SAFE in advance. Without such approval, a certified public accounting firm shall not issue a capital verification report for such swaps.
However, SAFE has recently abolished such approval formalities under its Circular on Further Improving and Adjusting the Foreign Exchange Administration Policies for Direct Investments (Circular Huifa [2012] No.59) promulgated on 19 November 2012 and effective as of 17 December 2012. According to this circular, a certified public accounting firm could perform the capital verification for such a swap based on a relevant foreign exchange registration information of the FIE without an approval of SAFE in this regard.
Although SAFE has simplified the formalities for the Debt-for-Equity Swap, please note that the implementation of such swaps shall still be subject to the approval and registration by other governmental authorities such as the competent counterparts of MOFCOM and State Administration for Industry and Commerce (SAIC), etc.
4. Raising Foreign Debts in CNY by FIEs
According to the Tentative Measures in 2003, the foreign debts are denominated in foreign currencies. However, with the gradual internationalisation of the Chinese Yuan (CNY) in recent years, SAFE and the People’s Bank of China (PBOC) have gradually allowed FIEs to borrow foreign debts denominated in CNY from abroad.
In November 2010, the Fujian Branch of SAFE issued its circular allowing companies duly registered in the Fujian Province to borrow foreign debts in CNY, subject to relevant requirements; and later in January 2011, the Shanghai Branch of SAFE also issued its circular adopting similar practices for companies in Shanghai. With these trial implementations in certain provinces and municipalities, on 7 April 2011, SAFE adopted such practices on a nationwide scale by promulgating its Circular on Relevant Issues on Regulating the Operational Procedures of Cross-border CNY Capital Account Item Business (Circular Huizongfa [2011] No.38). According to this circular, the onshore entities (including financial institutions) borrowing foreign debts in CNY shall be handled as per the current administration regime for foreign debt in principal, and it is not necessary to apply before the competent counterpart of SAFE to open special foreign exchange accounts to deposit such CNY funds from abroad.
Apart from the above Circular Huizongfa [2011] No.38 issued by SAFE, PBOC also indicated in its Measures on Administration of CNY Settlement in Foreign Direct Investment effective as of 13 October 2011 that the debts denominated in both CNY and foreign currencies borrowed by FIEs from their offshore shareholders or affiliated companies, as well as from the offshore financial institutions, shall be calculated together for the total scale of their foreign debts. The FIEs shall duly open CNY deposit accounts to deposit the funds denominated in CNY as borrowed from abroad.
Raising foreign debts by FIEs is one of their important financing options, and the awareness of the latest administration policies in this regard may help FIEs and their investors to optimise their financing portfolios in advance. It is recommended that FIEs and investors to pay close attention to the further development of the Chinese legal framework for foreign debt administration.
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