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Policy to boost offshore fundraising
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China’s State Administration of Foreign Exchange (SAFE) is seeking comments on proposed changes to the country’s cross-border guarantee policies that, if implemented, would help companies incorporated in China raise funds in the offshore markets and support their overseas expansion.
One important change included in the February 13 proposal on SAFE’s website would allow onshore companies to register cross-border payment guarantees with SAFE rather than seeking the foreign exchange regulator’s approval. This proposal is another step in the Chinese government’s efforts to relax the country’s capital controls.
It is difficult for Chinese corporates to obtain cross-border guarantee approval from SAFE. Among the offshore bonds issued by Chinese corporates, only a small number used cross-border guarantees from onshore parents, including high profile state-owned enterprises (SOEs) State Grid Corporation of China, China Petrochemical Corporation and Baosteel Group Corporation. These SOEs obtained SAFE’s approval to support offshore bonds raised for strategic overseas acquisitions or offshore funding needs.
As a result, Chinese corporates do not have many options for supporting their offshore debt, which is sometimes issued by a thinly capitalized offshore subsidiary. Such offshore subsidiaries usually have much weaker credit quality than their onshore parents, meaning they need to pay a higher credit premium or may even be unable to obtain offshore funding to pursue overseas development opportunities.
An explicit guarantee from an onshore company with stronger credit gives investors more assurance that they would recover their principal if the offshore bond issuer defaults. And that in turn should enable the offshore subsidiary to obtain lower funding costs and capture acquisition opportunities in a more timely manner.
For some strategically important SOEs that have received cross-border guarantee approval in the past, the proposed policy change should enable them to make overseas acquisition decisions in a more flexible way. The existing approval process for cross-border guarantees, which are used to support offshore funding for acquisitions, is time consuming and cumbersome.
Another proposed change would replace preapproved annual quotas with quantitative limits for financial institutions. Though the proposed quantitative limits would not deviate materially from the maximum quota a bank could acquire based on current calculation standard, the current actual quota approved could be smaller than theoretical maximum due to regulators’ intention to incorporate policy directions. In this sense, we expect the change could give Chinese banks more flexibility to provide cross-border guarantees to meet their clients’ needs.
Striking a balance
With that being said, whether Chinese banks would fully explore this flexibility hinges on some other considerations. For instance, banks have to take capital charges and make loss provisions to off-balance sheet items, including financial guarantees. So ultimately they need to strike a balance between factors such as client relationship, premium income and regulatory requirements in the guarantee business.
We have seen an increasing number of China-incorporated companies, mostly large SOEs and property companies, using keepwell agreements and other credit support mechanisms such as equity interest purchase undertakings to enhance the credit quality of offshore bonds issued and/or guaranteed by their offshore subsidiaries.
One of the key considerations in assessing a keepwell agreeement structure is the strategic importance of the offshore subsidiary to its onshore parent. For Chinese corporates without meaningful offshore operations, simply setting up an offshore borrowing vehicle and using a keepwell agreement would make it difficult to establish the strategic linkage and get the rating of the offshore entity and/or offshore bond closer to the onshore parent’s rating.
In addition, owing to the legal uncertainty of keepwell agreements, the credit quality of bonds supported by these agreements is weaker than that of bonds with explicit guarantees from the bond issuer’s parent company. This weakness is reflected in the lower ratings of offshore bonds using the keepwell agreement structure compared to their onshore support provider. The difference in credit quality and ratings would likely result in higher funding costs for bonds using the keepwell agreement structure than those guaranteed or issued directly by the ultimate support provider.
It is noteworthy that, under SAFE’s proposed changes, the proceeds that Chinese corporates receive from the guaranteed bonds cannot be transferred to the onshore parent for equity or debt investments, unless approved by SAFE. Thus, the removal of the cross-border guarantee approval requirement would not immediately benefit corporates, such as property developers, that raise offshore debt primarily to support their onshore operations.
SAFE’s proposed policy changes follow a separate new policy it released on January 24, which loosens certain restrictions on intercompany loans between Chinese corporates’ onshore and offshore entities, and simplifies the documentation requirements and removes certain limitations on the amount of dividends that a foreign invested company can repatriate to its foreign shareholders. These changes also reflect the government’s efforts to further relax capital controls.
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