The General Affairs Department of the State Administration of Foreign Exchange stipulated further requirements for matters relating to overseas loans under domestic guarantees provided by banks by promulgating the Circular on Perfecting Foreign Exchange Administration of Overseas Loans under Domestic Guarantees Provided by Banks (the “Circular”) on November 24, 2017. The Circular primarily seeks to guide the healthy and orderly development of overseas loans under domestic guarantees, as well as to better support true and compliant foreign trade investment activities. Therefore, the regulatory requirements under the Circular of the State Administration of Foreign Exchange Concerning the Provisions on Cross-border Guarantees (Hui Fa  No. 29; “Directive No. 29”) was reiterated in this formal Circular to again stress the compliance requirements for authenticity. This is expected to have a major impact on the trading structure of overseas loans under domestic guarantees, which are still extensively used in the current cross-border financing market.
The Circular is highlighted below:
1. Proposal of bases to be considered in the “authenticity and compliance examination”
First, the Circular stresses in Items 1 and 2 of its main text that the authenticity and compliance examination for overseas loans under domestic guarantees should be enhanced. Specifically, funds from overseas loans under domestic guarantees shall be used by the debtor for its normal operations and not transferred for domestic use directly or indirectly through securities investment without the approval of the State Administration of Foreign Exchange, and that it shall not fabricate the backgrounds of the transactions to engage in arbitrage or for other forms of speculative transactions.
In addition, the Circular points out that if the oversea loan under domestic guarantee is being guaranteed through the repayment obligation under bonds issued by the overseas debtor, the shares of the overseas debtor shall be directly or indirectly held by a domestic institution.
Furthermore, if the overseas loan under domestic guarantee is being guaranteed through the payment obligation under the derivative transactions of an overseas institution, the overseas debtor’s derivative transactions shall be done with a goal to stop losses and preserve value, remain compliant with the scope of its main business and be properly authorized.
To verify the authenticity of overseas loans under domestic guarantees, the Circular stresses again that a bank is required to retain relevant examination materials for reference and shall strictly manage how the funds from the overseas loans under domestic guarantees are being used.
Therefore, the Circular also stipulates that if the funds obtained from overseas loans under domestic guarantees are being directly or indirectly used to obtain equity of or creditor claims to another overseas institution, such investment shall meet the state’s relevant policy directions concerning overseas investment as well as the relevant requirements of domestic agencies for overseas investment. If the debtor is an overseas institution that is directly or indirectly controlled by domestic residents, the bank shall focus its examination on whether the relevant administrative provisions concerning overseas investment are met.
2. Proposal of bases to be considered in determining “if there is an obvious attempt to guarantee contractual performance
Although Directive No. 29 has stipulated that no cross-border guarantee agreement can be executed when it is clearly known or reasonably should have known that a performance guarantee obligation will be incurred, the Circular re-iterated this again and points out that a bank may determine if “there is an obvious attempt to guarantee contractual performance” based on the following scenarios: (1) whether the debtor is sufficiently solvent or has expected funding sources for repayment at the time the guarantee agreement is executed; (2) whether there is any obvious inconsistency between the financing terms under the master debt agreement and the purposes of the loans stated by the debtor; (3) whether the parties to the guarantee intend to repay the debt as guaranteed through a performance guarantee; and (4) whether the parties to the guarantee have ever maliciously guaranteed performance or defaulted on the debt as a guarantor, counter guarantor or debtor.
3. Registration upon occurrence of the performance guarantee in fact and the handling of other issues
If the default of a guaranteed master debt occurs, the Circular requires the bank to first perform by using its own funds and shall not directly purchase foreign exchange to perform the guarantee through using its counter guarantee funds. In case of a mismatch between the bank’s local and foreign currency funds after performance, the relevant formalities for foreign exchange settlement cannot be processed until this matter is recorded with the local branch office of the State Administration of Foreign Exchange.
On the other hand, the Circular also points out that should an overseas loan under domestic guarantees trigger a performance guarantee, the domestic guarantor or counter guarantor who ultimately becomes an external creditor shall register the external claim pursuant to the relevant regulations. If the bank ultimately becomes an external creditor, it shall submit the information to the State Administration of Foreign Exchange on its own. If an enterprise ultimately becomes an external creditor, it should be prompted by the bank to separately report to and register with the State Administration of Foreign Exchange.
In conclusion, the Circular reiterates the requirements for overseas loans under domestic guarantees under Directive No. 29, in particular compliance with the current relevant legal requirements for investment if overseas investment is involved. It can be inferred that the main objective is to suppress the evasion of overseas investment supervision under the pretext of overseas loans under domestic guarantees. Therefore, if an enterprise needs to make an overseas investment, it is advisable for it to consider viable investment options according to the principle of authenticity and compliance.