Domestic Enterprises Overseas Debt Issuance

Abstract:On September 14, 2015, the National Development and Reform Commission (NDRC) published the “Notice of the National Development and Reform Commission on Promoting the Administrative Reform of the Recordation and Registration System for Enterprises Issuance of Foreign Debts”, which eased the restrictions on overseas debt issuance, encouraged domestic enterprises to issue overseas debt and cancelled the foreign debts issued by enterprises quota approval. Thereafter, there have been an increasing number of domestic enterprises that chose to finance through issuing overseas debt. According to the financial data provider Dealogic, in 2016 debt issuance in US dollars by Chinese enterprises stood at over $127.14 billion with 258 US dollar bonds, raised sharply by 18.3% from $107.5 billion in 2015, among which CITIC Asset Management Corporation Ltd. was the most prominent bond issuer with the issuance level of a single bond over $3.2 billion. In 2017 the overseas debt market remains buoyant. Golden Wheel Tiandi Holdings Company Limited, Huzhou Around Taihu Lake Corporation Ltd., China Zheshang Bank Co., Ltd., China SCE Property Holdings Limited, Ronshine China Holdings Limited, Yuzhou Properties Future Holdings, Zhanglong Group Co., Ltd. etc. have issued bonds in US dollar in recent months.

Compared to other financing means, such as, shareholders’ capital increase, bank loans, stock shares issuance or domestic debt issuance, overseas debt financing have various advantages. Besides, owing to current domestic macro-control policies, it became more difficult to obtain loans from domestic banks. Thus overseas debt issuance demonstrates its strength and significance for the issuing enterprises, including:

a. High financing efficiency, high execution efficiency and suitable for issuing enterprises to seize market opportunities to achieve low-cost financing;

b. Flexibility in financial utilization, as no restrictions are set for use of funds raised by bonds in accordance with overseas laws and regulations. Issuing enterprises could use the raised funds in constructing projects, repaying bank loans, supplementing operational funds as well as rotatable use of funds to pay off old debt with new debt. For enterprises that mainly engage in businesses domestically, repatriated funds from abroad could be utilized within the borders;

c. Diversity of financing currencies. While obtaining financing overseas, enterprises could choose the financing currencies or currency portfolio pursuant to actual needs to lower the cost for financing;

d. Relatively low cost of financing. Considering that foreign exchange interest rate is generally low in the international market, while RMB deposit interest rate remains at a relatively high level despite multiple times of interest cuts by the PBOC, domestic enterprises could achieve lower financing costs through issuing overseas debt.

e. Higher international profile. Overseas debt issuance could have impact on future external cooperation, international market expansion and overseas IPO of the enterprises.

At present, there are four major established approaches for issuance, respectively: domestic entities issue bonds in Hong Kong + bond rating by rating agencies; cross-border guarantee + bond rating by rating agencies; keepwell deed+ Equity Interest Purchase Undertaking + bond rating by rating agencies. In this article, we will discuss about feasible issuance structures and credit enhancement models for domestically registered enterprises (including those listed on H-shares), as well as major issuance approaches adopted in the market.

Approach 1. Domestic entities issue bonds in Hong Kong + bond rating by rating agencies

Domestic corporations act as the issuer to issue overseas debt directly. Under the new policies of NDRC, domestic enterprises could issue bonds overseas under recordation at NDRC and choose to repatriate the funds or use the funds abroad. At present, NDRC adopted segmented management for recordation jurisdiction: 4 cities specifically designated in the state plan - Shanghai, Tianjin, Shenzhen and Xiamen: recordation for local enterprises could be conducted by the municipal development and reform commissions; recordation for enterprises in other provinces and autonomous regions should temporarily be centrally conducted by the NDRC and scheduled to be forwarded from provincial development and reform commissions with the recordation documents to the NDRC. Issuers could submit the documents needed for recordation that are generally prepared by domestic lawyers to the development and reform commissions.

Advantages:

a. Best creditworthiness, no extra credit enhancement needed, optimal issue price;

b. Distinct structure, no need to set up overseas platform;

c. Interest could offset domestic income tax with tax shield effect.

Disadvantages:

a. Withholding tax of 17% concerning the interest may be involved each year (10% provision for income tax + about 7% value added tax);

b. Under current policies, the Administration for Foreign Exchange needs to be notified, if any portion of funds is kept to be used overseas, otherwise the recordation of overseas debt may be affected.

Approach 2: Cross-border guarantee + bond rating by rating agencies

The offshore SPV of the corporation acts as the issuer, while the domestic parent company provide cross-border guarantee. According to Section 2 of the Notice of the State Administration of Foreign Exchange on Further Promoting the Reform of Foreign Exchange and Improving the Examination of Authenticity and Compliance (No. 3 [2017] of the State Administration of Foreign Exchange), “funds under overseas loans with domestic guarantee to be repatriated and used domestically”. In practice, overseas debt could be recorded in accordance with relevant current regulations on overseas debt management. In the meantime, funds under overseas loans with domestic guarantee could be repatriated to make equity investment domestically in accordance with relevant regulations.

On May 19, 2014, the State Administration of Foreign Exchange introduced the Notice of the State Administration of Foreign Exchange on Issuing the Provisions on the Foreign Exchange Administration of Cross-border Guarantees to streamline the management procedure, improve the management mode, relax the restrictions on cross-border guarantees and foreign exchange administration and achieve the general convertibility of cross-border guarantees. The Notice has been effective from June 1, 2014. Compared to the major clauses in the previous Provisions, no restrictions are imposed for the guarantor or guarantee (for instance, when the guarantee liability under overseas loans with domestic guarantee fulfills the payment obligations under bond issuance of overseas debtors, overseas debtors should be indirectly or directly held by domestic institutions, while income arising from overseas bond issuance should be used in overseas investment projects that are associated with domestic institutions, and relevant overseas entities or projects have already obtained approval, registration, recordation or confirmation from domestic and overseas authorities of investment in accordance with relevant regulations) ; no approval of the Administration of Foreign Exchange is needed for it to become effective. Guarantor could sign the contract on its own (the approval, registration, recordation granted by the foreign exchange authority to a cross-border guarantee contract, or any other management matter or requirement specified by the Provisions does not constitute an essential element for the effectiveness of the contract; guarantor may handle the relevant procedures on its own without seeking approval from the Administration of Foreign Exchange (registration of external claim in accordance with the requirements of the Provisions after the fulfilment).

Advantages:

a. Plain structure, short period of preparations, widely accepted by overseas investor;

b. Strong credit enhancement, issuance yield equal to direct issuance;

c. Funds repatriation encouraged by domestic policies through bond and equity interest;

d. No withholding tax.

Disadvantages:

a. Overseas enterprises need to be set up as the issuance structure;

b. No tax shield effect;

c. 10% income tax may be generated in the interest of repayment through FDI repatriation;

d. Despite that no assessment process of cross-border guarantee is needed for cross-border guarantee, under the current policies, if any portion of funds is kept to be used abroad, the Administration of Foreign Exchange needs to be notified in advance, or otherwise the guarantee recordation may be affected.

Approach 3:keepwell deed+ Equity Interest Purchase Undertaking + bond rating by rating agencies

Overseas SPV of corporation acts as the issuer with overseas holding enterprises providing guarantee and domestic parent company issuing keepwell deed and equity interest purchase undertaking; If the issuer fails to pay the interest or reimburse the capital on time, domestic parent company will acquire the equity of domestic project company from the holding company and transfer the funds paid for the acquisition overseas to repay the interest or capital.

More specifically, keepwell deed requires the domestic parent company owns the controlling shares of overseas issuer. The domestic parent company guarantees that the net asset value of the issuer shall be no less than $1, the issuer has adequate liquidity to ensure maturity of bonds, no modification unfavorable to the bondholders would be made in the articles of associations of the issuer or guarantor, any or all actions would be taken or prompted to fulfill the obligations set in the articles of association of the issuer or guarantor, and the company agrees that the bondholder/entrustees shall perform the decision of keepwell deed on behalf of the guarantor and issuer under such circumstances of bond default and violation of keepwell deed by the listed companies. Keepwell deed does not possess the characteristics of a guarantee, but could assure that the issuer has adequate liquidity and sufficient net assets.

Equity Interest Undertaking entails that the parent company of the issuer undertakes to repurchase the equity interests of designated subsidiary company (WFOE) from the issuer with cash, which is sufficient to repay the capital and interest of unpaid bonds in full in the events of default of issuer. Besides, the structure does not involve cross-border guarantee, which effectively avoid the conundrum of guarantee approval and funds repatriation; meanwhile, as the asset disposal after the default is mainly associated with the domestic entities, relevant procedures should be relatively uncomplicated, thus the enforceability of credit enhancement should be multiplied.

Equity interest repurchase agreement needs to be approved by commercial department, registered with administration for industry and commerce for changes and registered with administration of foreign exchange for changes.

Advantages:

a. Has the functions of tax saving and tax avoidance;

b. Funds could be kept abroad, or repatriated in the form of equity or bond domestically;

c. Widely accepted by investors.

Disadvantages:

a. More complicated structure;

b. Strength on credit enhancement is not as much as in direct issuance and guarantee. Premium may arise in issuance yield compared to direct issuance and guarantee structures;

c. Communication with State-owned Assets Supervision and Administration Commission and Department of Commerce may need to be made concerning the establishment, if no existing overseas enterprises could be utilized.

As for the issuance of bonds in offshore markets by domestically registered enterprises, no regulations or restrictions have been set overseas concerning the qualification of issuer (company type, domicile etc.). Domestic enterprises merely need to comply with relevant policies and regulations and follow the market rules. The main restrictions that Chinese enterprises may be subject to are those imposed by Chinese government on overseas debt issuance, guarantee and funds repatriation to domestic enterprises.

To conclude, for domestic enterprises to issue bonds in offshore markets as issuer, circumstances alter cases as in the specific approach and structure in the issuance of bonds.

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