Firms capitalise on the back door
It takes place behind the scenes, but inter-company loans have become a favoured way to move funds in and out of the mainland, with Beijing's nod
Regulators have opened a back door to firms to move capital in and out of the mainland in the form of an inter-company loan.
The loan lets firms bring in money raised offshore for use onshore, and it lets multinational firms release profits "trapped" on the mainland for use offshore.
The inter-company loans happen behind the scenes, undisclosed to investors. But it is increasingly the engine that moves capital in and out of the mainland. It is a large part of the reason so many mainland firms are issuing dim sum bonds in Hong Kong, for example, and it is part of Beijing's programme to implement a controlled exit from its controlled-currency regime.
"Beijing is going for a multi-pronged approach where it opens different channels allowing money to come in and out China in a way that can be monitored, to see what happens. As these channels become big enough, they will lift these restrictions once and for all," said Kelvin Lau, a senior economist at Standard Chartered, of the inter-company loans.
Issuers started using inter-company loans in 2010 when the People's Bank of China and the State Administration of Foreign Exchange opened the dim sum bond market to foreign issuers.
Mainland companies began to issue dim sum bonds through their offshore subsidiaries. They brought the capital back onshore by lending the proceeds to the onshore operating firm, where the money was needed in the first place.
Likewise, foreign firms have been issuing paper through the cross-border parent, and then lending proceeds to the onshore subsidiary.
French bank Societe Generale followed this template. In April last year, it sold into Hong Kong and Singapore a 500 million yuan (HK$636 million) dim sum bond. It then immediately lent the proceeds to its wholly owned mainland subsidiary SG Equipment Finance, which provides capital to mainland companies for equipment leasing.
The loan agreement precisely matched the bond terms. For all intents and purposes, SG Equipment Finance had sold the dim sum bond to Hong Kong and Singapore investors.
"Everything was back to back. The subsidiary got the funding on the same day SG issued the bond, and the money was on-lent … at terms that mirrored the terms of the dim sum bond," said Yves Jacob, the Asia-Pacific head of debt capital markets at Societe Generale.
There are a number of formalities. Issuers still need to send loans documents to SAFE for vetting. But Jacob said light rules governed such documents. Issuers typically submit a six to seven-page loan agreement that sets out the basic terms of the loan, such as the interest rates and repayment schedule, and SAFE usually approves the document quickly with few comments.
Repayment also has to go through an onshore bank, to ensure it is genuine funding that is repaid according to the terms that SAFE approved.
Foreign firms transferring cash to mainland subsidiaries through inter-company loans are also subject to an annual debt quota. The loans count towards this quota, which acts as a cap to how much money can be transferred in a given year using such loans. Other than that, it is all go.
Mainland authorities have been steadily easing the rules on inter-company loans since these were introduced. For example, the funds that were brought onshore through such schemes were originally only supposed to be used for new investment, said Tee Choon Hong, the global head of CNH capital market products at Standard Chartered.
Last year, regulators allowed firms to use the same proceeds to repay domestic yuan loans. This let mainland firms refinance expensive onshore debts with cheaper offshore loans or bonds.
In August, officials launched a pilot scheme in which Taiwan subsidiaries based in Kunshan, Jiangsu province, can send capital back and forth to the Taiwanese parent company through loans, without quota. The scheme is designed to encourage the use of yuan in Taiwan.
HSBC in September announced a 1.49 billion yuan two-way lending programme for Kunshan President Enterprises Food, a subsidiary of Taiwan's Uni-President.
In July, the PBOC introduced another measure that lets foreign firms use inter-company loans to release profits sitting in their mainland subsidiaries. Prior to this easing there was no easy way to send such trapped profits offshore. It works just like the onshore inter-company loan, but in reverse. The onshore subsidiary lends money to its offshore parent, once again going through a mainland bank that ensures both parties abide by the terms.
The inter-company loan is not a loan in any conventional sense. Firms use the instrument primarily to circumvent currency controls. But Beijing is encouraging the use of the instrument because it suits its agenda: to ease currency controls in a series of well-controlled and well-monitored steps.
Because the inter-company loans go through mainland banks and are screened by SAFE, Beijing always knows what is going on, and can turn off the taps at any time.
"When it comes to the capital account, China has shown a lot of willingness to build a lot of bridges, but they keep a tight control of the traffic that goes over the bridges," Lau said.