Key elements:

1. Currently there are two models for foreign-invested enterprises (FIEs) to borrow foreign loans. Each model provides different calculation formula for the amount of foreign loans can be borrowed by an FIE. An FIE can select one of the two models when it incurs first foreign debt and registers such first foreign debt with the State Administration for Foreign Exchange (SAFE) or its local counter parts.
2. Under current practice of the new Foreign Investment Law, the concept of total investment and the requirements on the minimum ratio of registered capital vis-à-vis total investment (Debt-Equity Gap) continue to exist. Subject to the practice adopted by the local SAFE where an FIE is registered, the FIE may choose to adopt the Debt-Equity Borrowing Gap Model or the Full Coverage Model (discussed in detail below) to determine the maximum amount it can borrow as foreign loans.
3. An FIE may also be required to make a filing with the National Development and Reform Commission (NDRC) for any foreign loans with a term of more than one year before it withdraws the funds loaned by the overseas lender, and we suggest an FIE consult with NDRC on a case-by-case basis.

In January 2017, the People’s Bank of China (PBOC) issued the Notice on Full Coverage Macro-prudent Management of Cross-border Financing (Circular 9), which adopts a new foreign loans model and management system that is applicable to financial institutions and non-financial enterprises incorporated in the PRC (including both domestic companies and FIEs, excluding government financing vehicles and real estate enterprises). Under the new model adopted by Circular 9 (referred to as the “Full Coverage Model” in this article), both domestic companies and FIEs are entitled to incur foreign debts and are subject to the same formula when calculating the quota and balance of foreign debts.

1. Traditional Model (Debt-Equity Borrowing Gap Model)—Still Valid

In accordance with the Interim Provisions on Foreign Loans Management (Article 18) issued by SAFE jointly with other Chinese governmental authorities in 2003, which is still effective, the sum of the accumulated amount of medium and long-term (longer than one year) foreign loans and the balance of short-term (one year or less) foreign loans borrowed by an FIE must be limited to the difference between the total investment and registered capital of such FIE (the Debt-Equity Borrowing Gap Model).

The registered capital of an FIE is the total amount of equity or capital contributions to be paid in full by the shareholders of the FIE, which is the amount of capital that all the shareholders subscribe and contribute to the FIE. Currently, there is no statutory requirement on the minimum amount of registered capital for an FIE. In practice, however, the company registration authorities in different cities may require that the investor(s) of an FIE determine and set a realistic amount of registered capital to be injected into the FIE that is sufficient to sustain operational cash flow until the business can support itself in China. The registered capital must be contributed by the investor(s) to the FIE during the term of the FIE.

The concept of “total investment” is an amount stipulated in the articles of association of an FIE. The investors are not required to actually make such contribution to the FIE. Nevertheless, the total investment refers to the amount of funds which an FIE needs to realize the company’s production or operations, namely, (i) the registered capital; plus (ii) the amount of loans (third-party loans or shareholder loans) required for the enterprise’s production or business scale.

PRC law imposes the following statutory minimum ratio of registered capital vis-à-vis total investment (R:T Ratio) in order to (i) ensure that FIEs are not under-capitalized and (ii) control the maximum amount of foreign debts that the FIEs can borrow. Although the R:T Ratio requirement was promulgated back in 1987 along with the promulgations and updates of the Three Laws, we note that the minimum ratio requirements have not been abolished along with the abolishment of the Three Laws.

After a foreign investor determines the registered capital of the FIE it subscribes to contribute, it is recommended that the foreign investor set a maximum amount of the total investment on the basis of the total amount of the registered capital and the R:T Ratio discussed above, so that the FIE may have more quota for foreign loans to be borrowed.

2. Mainstream Model (Full Coverage Model)

On January 11, 2017, the PBOC issued the Notice on Full Coverage Macro-prudent Management of Cross-border Financing (Circular 9) which adopts a new foreign loans management system that is applicable to financial institutions and other enterprises incorporated in the PRC (including FIEs, but excluding government financing vehicles and real estate enterprises). Under Circular 9, an FIE is permitted to incur foreign debts to the extent that its cross-border financings risk-weighted balance (as calculated based on a complicated formula involving the balance of short- and medium- and long-term foreign loans of the FIE and several risk indicators) does not exceed the applicable upper limit.

According to Circular 9, the applicable upper limit of risk-weighted cross-border financing balance of an FIE (the amount of foreign debts allowed to be borrowed) equals to:

(i) the amount of net assets in its latest audited financial report, multiplied by

(ii) leverage ratio (i.e. 2 for FIEs), and multiplied by

(iii) macro-prudent adjustment parameter (which was 1 under Circular 9 and has been adjusted to 1.25 in the latest circular issued by PBOC and SAFE on March 12, 2020).

An FIE that wants to borrow foreign loans from its foreign shareholder or any other overseas lenders must apply for foreign loans registration with the SAFE counterpart where it is registered.

Circular 9 became effective upon its issuance (i.e. January 11, 2017). FIEs (excluding foreign-invested real estate enterprises) were granted a one-year transitional period from the issuance date. During such transition period, FIEs and foreign financial institutions could select to use the Full Coverage Model or continue to use the Debt-Equity Borrowing Gap Model for borrowing foreign loans. Upon expiration of the transitional period (by January 10, 2018), the Full Coverage Model was automatically applied to foreign financial institutions, while the choice of management models for FIEs was to be decided by the PBOC and SAFE based on the overall implementation progress of Circular 9 after evaluation of the new Full Coverage Model.

In practice, although the one-year transition period expired in early 2018, PBOC and SAFE have not formally determined which of the two foreign loans management models applies to FIEs and therefore at this stage, the SAFE and its local counterparts allow an FIE to choose between the Debt-Equity Borrowing Gap Model and the Full Coverage Model the first time it applies for foreign loans registration with the relevant local counterpart of SAFE.

Please note that in certain provinces/municipalities (e.g. Beijing), once an FIE chooses one model, it will not be allowed to change to another model later. Therefore, an FIE needs to carefully plan and choose a model that is more suitable to its need for foreign loans. The two current models of foreign loans for FIEs reflect the Chinese government’s strict scrutiny and control over debts owed to overseas lenders by China-based FIEs.

3. NDRC Registration

In February 2020, the National Development and Reform Commission (NDRC) issued The Guidelines for Filing and Registration of Foreign Debt Issuance by Enterprises (NDRC Guidelines) on its official website. These detailed guidelines cover filing and registration of foreign debt borrowed by PRC incorporated enterprises in accordance with the Notice of the NDRC on Promoting the Reform of Managing Foreign Debt Issuance by Enterprises with a Filing and Registration System (2015 Circular 2044), issued and effective on September 14, 2015.

Although NDRC has published several Q&As since the 2015 Circular 2044 was published, the application of the vaguely drafted Circular 2044 remains somewhat ambiguous, including but not limited to the types of foreign debts and scope of enterprises subject to the filing and registration requirements under 2015 Circular 2044.

2015 Circular 2044 defines foreign debts as debt instruments with a term of more than one year that are borrowed from overseas lenders by a “domestic enterprise” and overseas enterprises or branches under its control, denominated in RMB or foreign currencies, including bonds issued overseas, medium- and long-term international commercial loans, etc. Neither the 2015 Circular 2044 nor the NDRC Guidelines explicitly specify whether the term “domestic enterprise” includes any FIEs incorporated within the territory of PRC. Based on our observation, there appear to be different opinions within NDRC regarding whether medium- and long-term foreign loans borrowed by an FIE are subject to NDRC registration. In practice, some FIEs have chosen to make a filing with the NDRC for its foreign loans since they believe an FIE is included in the term “domestic enterprise,” while some other FIEs have decided not to register with NDRC for the foreign loans since they believe an FIE is not a “domestic enterprise” so that the 2015 Circular 2044 is not applicable to FIEs.

Based on our no-names basis telephone inquiry with the NDRC, the official we consulted only asked us to follow the requirements under the NDRC Guidelines and did not confirm whether medium- and long-term foreign loans borrowed by an FIE are subject to NDRC registration. We suggest that an FIE consult with the local and national NDRC on a case-by-case basis when it wants to borrow a medium- or long-term foreign loan from a foreign lender.

4. Conclusions

Subject to the practice adopted by the local SAFE where an FIE is registered, the FIE may choose to adopt the Debt-Equity Borrowing Gap Model or the Full Coverage Model when it applies for foreign loans registration. Different models may result different amount of foreign loans that an FIE can borrow. Whether an FIE can change the model it registers with the SAFE to the other model depends on the practice adopted by the competent local counterpart of SAFE.

The Full Coverage Model under the PBOC’s Circular 9 provides more flexibility for FIEs in optimizing financial management. The amount of foreign loan that can be borrowed by an FIE under the Full Coverage Model may be significant if it has a large amount of net assets. However, it should be noted that under the Full Coverage Model, the net assets amount in the latest audited financial report will be used as the basis to calculate and determine the amount of foreign loans can be borrowed. Since in practice an FIE will not have an annual audited financial report until the second year of its incorporation, such an FIE will not be able to choose to use the Full Coverage Model before it has an audited financial report. On the other hand, under the Debt-Equity Borrowing Cap Model, once the accumulated amount of foreign loans with a term of more than one year reach the cap amount (balance between total investment and registered capital), the FIE is not allowed to borrow further foreign loans unless it increases the registered capital and the total investment.

An FIE may also be required to make a filing with the NDRC for any foreign loans with a term of more than one year before it withdraws the funds loaned by the overseas lender, and we suggest an FIE consult with NDRC on a case-by-case basis. The recent legislation and practice related to the new model of foreign loans management as well as the NDRC registration reflect the Chinese government’s strict scrutiny and control on the debts that can be owed to overseas lenders by China-based FIEs.