CHINA: An Introduction to Banking & Finance (PRC Firms)

An Introduction to Loan Transactions in China 

Introduction 

Overview of loan market 

The loan market in China has grown steadily in the past year in terms of volume. However, foreign currency loans reduced by USD 85.2 billion in 2023 pursuant to the statistics published by the People’s Bank of China (PBOC). Partly because of the reduction of foreign debt loans, which will be explained below.

Commercial banks are the main providers of corporate lending in China. Other institutions such as trust companies, securities firms, credit companies are also important players in the lending market. However, loans given by such non-bank institutions have been declined because of strict regulations on shadow banking.

Large banks are very active in key infrastructure projects and energy projects, both in China and in countries that joined the Belt and Road Initiative (BRI). Banks are becoming more and more sophisticated in structuring the project finance.

Recent reforms 

Deleveraging has been one of the key themes in Chinese financial markets for several years. The overall enterprise debt ratio has decreased but credit risks arose in certain sectors such as real estate, which used to be the key sector that obtains loans from financial institutions. Loans for commercial real estate development declined by around 10% in 2023.

Another key topic is institutional reform for financial regulators. 2023 witnessed the establishment of the National Financial Regulatory Administration (NFRA), which regulates all financial activities except the securities sector. NFRA will strengthen institutional supervision, conduct supervision, functional supervision, look-through supervision and on-going supervision. That means certain grey areas will be regulated under unified standards.

China’s financial market is opening up gradually and continuously. In 2023, Chinese government removed the last restrictions on foreign investors’ shareholding percentage in Chinese banks and insurers. As of today, there is no negative list for foreign direct investment in finance sectors.

Foreign Debt Registration 

Foreign debt is one of the most important and complicated issues for cross-border finance in China. Foreign debt is regulated by the National Development and Reform Commission (NDRC), PBOC and the State Administration of Foreign Exchange (SAFE). Foreign debt refers to any senior debt, perpetual debt, capital debt, notes, convertible bonds, exchangeable bonds, financial leasing and commercial loans borrowed by a Chinese enterprise or enterprise controlled by a Chinese national or entity.

As of 10 February 2023, NDRC will review all foreign debt exceeding one year. The Chinese borrower or ultimate shareholder shall, before first utilisation, submit loan documents to NDRC for registration. NDRC has the discretion to reject to register the foreign debt if it breaches any of the following requirements:

(i) a borrower shall use foreign debt funds on its main business, which is conducive to cooperating with the implementation of major national strategies and supporting the development of the real economy;

(ii) no violation of Chinese laws and regulations;

(iii) no threat or harm to national interests and economic security;

(iv) no violation of China’s macroeconomic objectives;

(v) no violation of China’s relevant development plans and industrial policies;

(vi) no use to make up losses and unproductive expenditures;

(vii) no on-lending except for financial institution borrowers. NDRC requires submission of foreign debt information within 10 working days after each foreign debt is withdrawn as well as some other post-drawdown reporting.

Security and Guarantees 

Forms of security 

The major types of security under Chinese law include mortgages, pledges, guarantees and liens. The security packages most used in finance transactions are share pledges, cash deposits, corporate or personal guarantees or a combination of the above. A mortgage of real estate (including land use rights), pledge over receivables or intellectual property rights may also be required by a lender. In the case of a listed company takeover, the listed company should not provide any form of financial assistance to the acquirer, or any security in favour of the acquirer or its affiliate(s).

Priority of Claims 

Secured claims should be repaid in priority from the proceeds of the secured assets. After full repayment of the secured claims, the remaining amount of the proceeds of the secured assets (if any) will be considered as the bankruptcy assets of an insolvent borrower. In China, subordinated bonds can only be issued by a financial institution in accordance with applicable laws and regulations. In addition, contractual subordination arrangements are not recognised by the Bankruptcy Law; therefore, it is uncommon to see this in practice.

Registration of security and guarantees

Registration is required to perfect most forms of security. For example, real estate mortgages shall be registered at the real estate registration centre, share pledges shall be registered at the authority in charge of company registration. A grant of cross-border security or guarantee is subject to regulation by SAFE. For example, the provision of a guarantee or security by an onshore non-bank entity in favour of an overseas entity securing the debt of an overseas borrower should be registered with the SAFE after the execution of security documents.

Tax and Other Regulatory Matters 

Lending license 

In China, an entity can only conduct lending business after obtaining the permit or approval from finance regulators. Major market players in the debt financing industry are commercial banks, policy-oriented banks, trust companies, finance companies, lending companies and micro-lending companies, which should conduct business according to the applicable laws and regulations.

Anti-money laundering and anti-corruption compliance

PBOC is the key regulator of anti-money laundering and counter-terrorist financing. In addition to the Anti-Money Laundering Law, there are several regulations issued by the PBOC that stipulate detailed requirements for financial institutions to comply with, including identifying a client’s identity, preserving information about their clients and transactions, and reporting large transactions or suspicious transactions.

Anti-corruption is largely stipulated in the Criminal Law, Anti-Unfair Competition Law and related regulations. There is no legislative guidance specifically applicable to financial institutions regarding the administration of anti-corruption matters.

Tax 

Interest on loans is taxable income, and unless otherwise stipulated by law, the taxable income is generally subject to 25% of the corporate income tax in China. Unless otherwise stipulated in the tax treaties or other tax preferential treatment, a Chinese resident borrower should withhold corporate income tax at the rate of 10% for the interest paid to the non-resident lender.

Financial institutions in China are subject to 6% VAT for income accrued from debt financing. A VAT exemption is granted if the loan is made to small or micro-enterprises or self-employed households.

Parties to a loan agreement executed within the territory of China shall pay stamp tax at a rate of 0.005% of the loan amount. If a loan agreement is executed outside China but will be used in China (eg, for governmental registration or court enforcement), stamp duty will also be applicable.

Jurisdiction 

Governing law 

In a domestic transaction, Chinese law should be the governing law of the finance agreement. In cross-border transactions, the parties may choose the governing law of the agreements. English law, Hong Kong law and New York law are most often chosen by the parties as the governing law of the cross-border credit facility agreement. Generally, the courts will uphold the choice of law provisions as long as such provisions do not violate the public policy of China or contradict the mandatory provisions of Chinese law.

Recognition of foreign judgment or arbitration award

China is a contracting state of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958. A foreign party may submit an arbitral award from a foreign arbitral tribunal to a Chinese court for recognition and enforcement. If the court determines recognition and enforcement do not violate the basic principles of Chinese law and are not contrary to the sovereignty, national security or public policy of China, it will recognise the arbitration award.

Enforcement of a foreign court judgement will be reviewed by the court case by case. A foreign court judgment may be rejected if:

(i) the foreign court has no jurisdiction;

(ii) the respondent has not been duly notified nor represented;

(iii) the judgment was obtained by fraud;

(iv) there is an effective PRC judgment for the same subject, or

(v) the judgment is contrary to the sovereignty, national security or public policy of China.