Knowledge

Routes for International Capital Investing in China Debt Market

2020-04-01


微信图片_20200402153351_副本.png


中文摘要:

自新型冠状病毒肺炎全球性爆发后,许多国家担心世界经济可能陷入衰退,纷纷宣布降息,推行低利率甚至负利率,以应对可能出现的流动性风险、信用风险和系统性风险。中国人民银行通过实施准确的公开市场操作以及定向降准等各种货币政策组合举措应对疫情冲击,一方面保持了银行体系流动性的合理充裕、切实降低了实体经济的融资成本,另一方面亦维持了基准存贷款利率基本稳定、金融体系运行平稳。目前,中国与世界主要国家之间存在一定利差,将不断吸引国际资本进入中国的债券及其他债权类投资市场。


在这种背景下,本文将根据中国现行有效的法律、法规和规章,为国际机构投资者介绍中国债权类投资市场的共8条可行路径,包括投资债券市场以及为中国企业提供贷款等其他债权融资的形式。


After the global outbreak of Covid-19, worrying that the world economy, in high probability, will be tipped into recession, many countries declared to cut interest rate to zero or even to negative to cope with the liquidity risk, credit risk and even the systematic risk. Similarly, the People's Bank of China cut loan prime rate (LPR) by 10 bps, and then in March lowered the amount of cash holdings that banks are required to keep in reserve, which is a measure intended to free up loans to businesses and guide the real interest rate of loans to continue to decline. However, comparatively speaking, the latest LPR of China is much higher than major countries with the number of 4.05% for one-year period and 4.75% for more than five-year period as announced on March 20.


The interest rate spread between China and other major countries may attract some international capital into China notwithstanding the currency exchange rate. Under this basic scenario, available routes for international capital investing in the Chinese debt market will be discussed in this article. To enter into the Chinese debt market, there are two basic categories, namely the bond market and the direct loan market, for both of which there are 8 routes in total. For the purpose of this article, only the routes for international institutional investors (hereinafter the “Investors”), will be discussed here according to the effective PRC laws, regulations and rules up to the date of this article.


1.The Bond Market


The main routes for the Investors to China's bond market include:

(1)Route 1: Direct Investment in Bond Market


According to the Announcement No. 3 [2016] of the People's Bank of China ("PBC" hereafter) -Announcement on Matters concerning the Issue of Further Improving the Investment in the Interbank Bond Market by Foreign Institutional Investors, international commercial banks, insurance companies, securities companies, fund management companies and other asset management institutions, investment vehicles or products issued by the aforesaid financial institutions, pension funds, charitable funds, and all other financial institutions or medium and long-term institutional investors, registered and established outside China, are allowed and encouraged to invest in the interbank bond market as long as satisfying some specific conditions.


The investors, who want to invest in the China's interbank bond market, shall file an application to Shanghai head office of the PBC by filling in the "Registration Form for Overseas Institutional Investors in China's inter-bank bond market" by themselves or by a settlement or registration agent in China. Upon obtaining the filling notice issued by the Shanghai head office of the PBC, the investor shall, within the term of validity, apply for registration in the capital account information system of the Sate Administration of for Foreign Exchange ("SAFE" hereinafter). Then, the Investors are allowed to make exchange between foreign currency and RMB to make investment and repatriate the profits and principals without the exchange limit.


In addition, only by this route, the Investors may utilize domestic RMB-foreign exchange derivatives to manage their foreign exchange risk exposure arising from their investment in the interbank bond market under the hedging principle subject to some restrictions on the trading channel. An inevitable risk for overseas capital into a country's market is the foreign exchange risk, so that an access permission to the domestic foreign exchange derivatives market is considered as a key measure for regulators to promote overseas investors to enter China's bond market, which will definitely reduce the foreign exchange hedging cost of overseas capital and attract more international investors to enter the Chinese bond market.


(2)Route 2: QFII Investment in Bond Market


QFII are allowed to invest in the interbank bond market. QFII refers to qualified foreign institutional investors that invest in the PRC domestic securities market with the approval of the China Securities Regulatory Commission (hereinafter "CSRC"). As the SAFE announced to remove the quota management of investment and exchange scale for QFII in September 2019, the Investors, registered as QFII, are free to convert their own currency into RMB to invest in China's bond market and also recover investment and convert RMB back to their currency with no scale and exchange limitation.


(3)Route 3: RQFII Investment in Bond Market


If the Investors are already registered as RQFII in China, they are also allowed to invest in the interbank bond market. RQFII refers to RMB qualified foreign institutional investors who uses their own overseas RMB funds to make securities investment in China with the approval of the CSRC. Similar to QFII, investors, registered as RQFII, are allowed to independently carry out securities and bond investment after making registration in SAFE.


In addition, the Investors are allowed to choose to switch between different aforesaid routes to invest in the bond market. Specifically speaking, one investor may, as required for its investment management, conducts the two-way non-trade transfer of bonds on the interbank market held by it under bond accounts of QFII or RQFII (Route 2 and 3) and bond accounts under the account of direct investments in the interbank bond market (Route 1). After the bonds are transferred from a QFII or RQFII account to a direct investment account, the Investors are also allowed to use RMB-foreign exchange derivatives to hedge their foreign exchange exposure against such bond investment.


(4)Route 4: Bond Connect (债券通) Investment in Bond Market


As an important part of Bond Connect, "Northbound trading" (北向通) is another route through which international institutional Investors may invest in the China's bond market via Hong Kong market, which means the institutional arrangements in relation to trading, custody, settlement and other aspects for interconnection between Hong Kong and mainland infrastructure institutions that enable investors from Hong Kong and other countries and regions to invest in the mainland inter-bank bond market.


Under this route, the Investors can open account in Hong Kong without any registration procedure in China mainland by using their own currency or overseas RMB to invest in China's bond market through Bond Connect. If using foreign currency, the exchange of currency can be handled through the banks in Hong Kong, which offer RMB clearing and the overseas RMB approved by Hong Kong to enter the domestic inter-bank foreign exchange market for transactions.


Overall, the convenience for the Investors to participate in China's financial market has been greatly improved in recent years, and China's bond market will be more widely accepted by international investors. According to the latest statistics monthly report issued by China Central Depository & Clearing Co., Ltd., by the end of June 2019, the total face value of the bonds deposited by global investors had reached RMB1.645 trillion. In addition, according to the announcement of China Foreign Exchange Trade System and National Interbank Funding Center, as of the end of June 2019, (i) the overseas business volume of the inter-bank bond market reached RMB386.1 billion, and the daily average trading volume exceeded RMB20.3 billion; (ii) the net buying volume of Chinese bonds by global investors reached RMB89.7 billion; (iii) the number of overseas institutional investors was 923, and the number of overseas institutional investors through Bond Connect was 1038.


Although the scale of international capital entering into China's bond market is getting larger and larger, it is worth noting that the risk appetite of the Investors in China's bond market is comparatively low. More than half of the investment are made in treasury bonds, policy bank bonds, and etc., while the Investors’ participation in corporate bond and issuance market is low.


2.The Direct Loan Market


Except for investing in the standardized products of the bond market, the Investors may invest in China's debt market by using direct loan, i.e. lending to Chinese enterprises directly. In this category, there are three main routes based on different status of the Investors, and one potential route for future consideration.


(1)Route 5: Foreign Debts or Cross-border Financing


If the Investors do not want to establish legal entity in China, they may lend their own currency or USD directly to Chinese entities, for which this lending is called foreign debts in China. The structure of this route is as followed:


In this structure, the Investor does not need to fulfill any substantial or procedural requirements with payment and recovery in its own currency, while it is the borrower's responsibility to make registration or application for foreign debt and bear the exchange rate risk. However, several restrictions or requirements of the borrowers should be noted by the Investors to avoid legal restriction of any interest payment or repayment.


A.Size of the Borrowing


In January 2017, the Notice of the PBC on Matters concerning the Macro-Prudential Management of Full-Covered Cross-Border Financing stipulated that under macro-prudential principles, Chinese non-financial enterprises (not including government financing platforms and real estate enterprises in this Notice) and financial institutions are allowed to implement cross-border financing in RMB or foreign currencies from non-residents based on the capital or net assets constraint mechanism. The outstanding cross-border financing balance of an enterprise or a financial institution shall be calculated by using a risk-weighted approach and shall not exceed the specified upper limit, namely: risk-weighted outstanding cross-border financing balance ≤ the upper limit of risk-weighted outstanding cross-border financing. The formula of the upper limit is as followed:


The upper limit=net asset of enterprise or capital of financial institutions*cross-border financing leverage ratio*macro prudential adjustment parameter


The PBC shall, according to macroeconomic momentum, the international balance of payments and the requirements for macro-financial control, adjust the cross-border financing leverage ratio, risk conversion factor, and macro-prudential regulation parameter in the formula calculating the above upper limit. In this Notice, the cross-border financing leverage ratio was set to be 2 for enterprises, 1 for non-bank financial institutions and 0.8 for banks, and the macro prudential adjustment parameter was set to be 1. In other words, non-financial enterprise is allowed to borrow foreign debt in the size of 200% of its net assets, while financial institution is allowed to borrow foreign debt in the size of 80% or 100% of its capital.


On March12, in order to cope with coronavirus epidemic prevention and control work, facilitate domestic institutions, especially small-and-medium-sized enterprises and private enterprises, to raise funds from both domestic and international resources and markets, the SAFE raised the macro prudential adjustment parameters of the full scale foreign debt from 1 to 1.25, which means that domestic enterprises and financial institutions can borrow more foreign debt. That is, non-financial enterprise is allowed to borrow foreign debt in the size of 250% of its net assets, while financial institution is allowed to borrow foreign debt in the size of 100% or 125% of its capital.


Notwithstanding the foregoing borrowing size restrictions, the SAFE lately allowed medium-,small-and micro-sized high-tech enterprises that meet certain conditions in some high-tech zones, free trade zones of Beijing, Shanghai and Hubei as well as in Guangdong and Shenzhen (Guangdong-HK-Macao Greater Bay Area) to borrow foreign debt independently within a certain amount.


Regardless of the size of the borrowing, Chinese borrower shall, after signing the cross-border financing contract with the Investors but not later than 3 working days before the withdrawal of money, submit the signing and filing of cross-border financing with the capital project information system of the SAFE. After such filling, the borrower can settle the foreign exchange of the principals and interest payments.


B.Borrowing longer than one year


If the foreign debts, including bonds issuance, medium and long-term international commercial loans and others, borrowed by Chinese enterprises from the Investors last longer than one year, such enterprises shall apply to the National Development and Reform Commission (the "NDRC" hereinafter) in advance for registration, and within ten working days after the completion of each borrowing, report information to the NDRC. Although there are no substantial obstacles in obtaining this registration from NDRC, around additional 12 working days are required for the borrower to apply such registration from NDRC before signing the loan contract.


C.Borrowing from Real Estate Enterprises and Local State-owned Enterprises


Due to the macro-control implemented by the Chinese government, it shall be particularly noted for the Investors who want to lend money to real estate enterprises and local state-owned enterprises (especially local governmental financing platforms). At this stage, these two types of enterprises are restricted to borrow foreign debt.


(2)Route 6: Lending to Overseas Subsidiaries of PRC Enterprises


If the PRC borrowers have overseas subsidiaries or affiliated companies, the Investors may lend money directly to the borrowers’ overseas subsidiaries or affiliated companies in any kind of currency. Like route 5, the borrowers are responsible of making registration or application for exchange and remitting the capital cross-border by themselves. The structure of this route is as followed:


Normally, the Investors may require guarantee or any other collateral from the borrower. Such guarantee or collateral is also required to be registered in the SAFE by the borrower.


(3)Route 7: Setting up PRC Domestic Entities


For the Investors, who wish to deeply explore the Chinese market, setting up PRC domestic entities are suggested, especially after the new PRC Foreign Investment Law, governing the establishment of legal entities by the Investors, i.e. foreign investment enterprises (“FIE” hereinafter), comes into force on January 1, 2020, which gives more protections and less restrictions to the Investors and their FIE. The structure of this route is as followed:


During the registration of FIE, depending on different needs of business model, business scope and capital scale of the Investors, different types of the FIE shall be applied, including (but not limited to):


a.Financial company: bank, trust company, small loan company, financial leasing company, fund management company, financial asset management for distressed debt (which is stipulated in the Economic and Trade Agreement signed by China the US on January 15, 2020), financing company


b.Other types of company: consulting, property management or any other non-investing company (also allowed to make investment)


c.Limited liability partnership or investment fund


d.Qualified Foreign Limited Partner if the Investors wish to invest in both forms of debt and equity (QFLP refers to foreign institutional investors, who are allowed to convert the foreign capital into RMB to invest in the domestic PE and VC markets)


(4)Route 8: Purchasing PRC Domestic Loan


According to the Notice of the PBC on Simplifying the Process of Cross-border RMB Services and Improving Relevant Policies (No. 68 [2013]) and the Notice by the SAFE of Further Facilitating Cross-border Trade and Investment (No. 28 [2019]), the PRC domestic banks in some districts are allowed to sell their loans, trade receivables, financing and other assets directly to the Investors to offload risks. In practices, some banks began to try cross-border sales of their domestic assets, such as financial lease, trade financing, distressed debts, domestic letters of credit, bank's acceptance bills and etc. However, due to the lack of specific laws and regulations in this area and the guiding policies out of line with the practices of international banks, this route 8 is merely a potential method in the future and needed to be further improved by relevant laws, regulations and supporting policies.


For more discussion and details of different routes regarding requirements, conditions, procedures, legal compliance, risk prevention & management and all other governing law issues, please consult us by email.


Authors:

微信图片_20200402153358_副本.png            


LI Guangxin                    

                       

Partner/Associate                        



         

LI Guangxin, Beijing DeHeng Law Offices. Mr. Li Guangxin has over-20-year professional experience to provide legal service in the field of capital and debt market and M&A at home and abroad, and has participated in projects with extensive influence in the capital market such as the Agricultural Bank of China A+H IPO, Sinotruk red chips IPO on the Hong Kong Stock Exchange, ICBC's issuance and global offering of US$5 billion Commercial Paper/Certificate of Deposit. Mr. Li Guangxin can combine legal skills with a wealth of enterprise knowledge, profoundly understand the necessary conditions and possible difficulties to make a deal, and then design practical methods to balance the interests and aspirations of all parties, and promote a smooth conclusion of transactions within the legal framework. .        

Email:ligx@dehenglaw.com         


微信图片_20200402153402_副本.png                       


LI Jiahui                        

                       

Associate                        



         

LI Jiahui, Associate of Beijing DeHeng Law Offices. Bachelor of Law from Sun Yat-sen University, Master of Law from the University of Manchester, UK, postgraduate diploma of Common Law from the University of Law, UK. Ms. Li has 11-year professional experience to provide legal service in the field of cross-border investment and financing.                

Email:lijh@dehenglaw.com         


微信图片_20200402153407_副本.png                       


QI Hui                        

                       

Associate                        



         

QI Hui, Associate of Beijing DeHeng Law Offices. Master's degree in international commercial law, graduated from Sutherland Law School of University College Dublin, studied as an exchange student at University College London, UK, with 5-years legal practice experience in the field of corporate finance and M&A.                

Email:qihui@dehenglaw.com         


Disclaimer:

This article was written by the lawyer of DeHeng Law Offices. It represents only the opinions of the authors and should not in any way be considered as formal legal opinions or advice given by  DeHeng Law Offices or its lawyers. If any part of these articles is reproduced or quoted, please indicate the source.

Relevant Lawyer

  • Guangxin LI

    Partner

    Tel:+86 10 5268 2888

    E-mail:ligx@dehenglaw.com

Search

QR Code

Scan QR Code
Share With My Friends