Cross-border securitization of trade finance credit assets

By Wu Jiejiang, Jingtian & Gongcheng

The State Administration of Foreign Exchange (SAFE) on 25 Oct 2019 issued the Circular on Further Facilitating Cross-border Trade and Investment (circular No. 28), which specifies that, “In the areas under the pilot programme, it is allowed to expand business scope and channels for cross-border transfer of domestic credit assets, and to expand the range of credit assets that can be transferred to foreign investors, including bank non-performing assets (NPAs) and trade finance”. This means that normal trade finance credit assets have been allowed for foreign transfer in addition to non-performing loans (NPLs).

In terms of classification of credit assets, according to the Guidelines on Risk-Based Loan Classification released by the People’s Bank of China (PBOC), loans are classified into five categories: pass (normal); special-mention; substandard; doubtful; and loss, of which the last three categories are recognized as NPLs.

Wu Jiejiang
Jingtian & Gongcheng

In addition, based on net value of assets, repayment ability of debtors, credit rating and guarantee of debtors, all kinds of assets other than loans, including direct credit substitutes in off-balance sheet items, are also classified into the above-mentioned five categories, and the last three categories are jointly recognized as NPAs.

Regarding cross-border transfer of NPAs, there are a series of clear and mature systems and regulations established, from the Interim Provisions on Attracting Foreign Capital into the Asset Restructuring and Disposal by Financial Asset Management Companies in 2001, to the Official Reply of The SAFE on Matters Concerning Continued Implementation of The Pilot Program of SAFE Shenzhen Branch For Foreign Transfer of NPAs in 2018. These cover: (1) the change from review of each transaction of NPAs in the pilot programme to filing in advance of such a transaction; (2) non-inclusion of the pilot programme-generated foreign reserve into risk-weighted balance of the transferors’ cross-border financing; and (3) foreign debt registration by the transferors on behalf of the underlying debtors.

Circular No. 28 extends the range of credit assets that can be cross-border transferred to normal trade finance. Whether new credit assets other than NPAs and trade finance will be included in the detailed implementation rules to be released for the Guangdong-Hong Kong-Macau Greater Bay Area and Hainan, as pilot areas, are subject to further observation.

The piloting of easing restrictions on foreign transfers has its basis. First, the trade finance credit assets held by commercial banks are in strict compliance with the regulatory requirements and their internal control procedures to ensure the authenticity of trade finance, thus ensuring the authenticity of the credit assets for cross-border transfers, and preventing adverse effects brought by false credit assets.

Second, for foreign investors, if there is an adequate number of transfers of trade finance credit assets, and if the overseas interest rate is low, they can to some extent hedge against the bad debt rate of trade finance credit assets to be transferred.

Previously, foreign investors have discussed and evaluated the securitization plan of overseas assets, which are formed by cross-border transfers of trade finance assets via internal linkages among domestic and overseas branches of commercial banks of China. However, it was not implemented due to the lack of clear and operable rules on transferring domestic trade finance assets.

Third, for transferors, by carrying out cross-border transfers of credit assets and liquidating existing credit assets, commercial banks can optimize their structures of assets and liabilities and reduce their operational risks. After the transfer, if the commercial banks continue to act as the managers of the transferred credit assets and provide account settlement and other related services, they can also gain income from the intermediary business.

Circular No. 28 is only a principled regulation for the external transfer of trade finance. In practice, there may be challenges arising. First, in terms of the transfer of credit assets categorized as “pass” and “special-mention”, the China Banking Regulatory Commission (CBRC) issued two guidance documents in 2009 and 2010, respectively, namely the Notice on the Issues concerning Regulating the Business of Credit Asset Transfer and the Business of Financial Management Based on Credit Assets; and the Notice on Further Regulating the Credit Asset Transfer Business of Banking Financial Institutions, stipulating that commercial banks should follow the principle of integrity in credit asset transfers, which means that the transferred credit assets shall include all outstanding principal and interest receivable.

Meanwhile, they should also follow the principle of clean transfer, namely assets and risks shall be truly and completely transferred. Transferors of credit assets should not transfer credit assets until obtaining consents from borrowers, unless otherwise agreed in the original loan contracts.

Transferees of credit assets should re-sign agreements with borrowers to confirm the modified debtor-creditor relationships. In case the credit assets to be transferred are guaranteed and have security interest, the consents of the guarantors should be obtained and the registration procedures of collateral change should be completed, or the collateral should be transferred, possessed and delivered so as to ensure effective transfer of the security interests.

The two guidance documents issued by the CBRC do not consider the cross-border transfer of trade finance credit assets by commercial banks, especially the difficulties of bulk transfers in practice.

Second, externally transferred trade finance credit assets will constitute external debt of debtors under the credit asset. Regardless of whether the debtors are willing to help complete the foreign debt registration or not, and even if they are willing to assist, when there are a large number of debtors of the proposed transfer of trade finance credit assets, how to deal with so many debtors is an issue that has to be considered, for it may affect the smooth and efficient execution of the cross-border transfer.

However, in this regard, the administration precedent of SAFE’s Shenzhen Branch in cross-border transfers of NPAs is available for reference. If the technical issues above are solved, the securitization of cross-border assets with domestic trade finance credit assets as the underlying assets should become a new business that may attract the attention of overseas funds.

Wu Jiejiang is a partner at Jingtian & Gongcheng


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