Pilot project for cross-border transfer of claims on QEX

The term “cross-border transfer of claims” means that a creditor in China transfers claims that it lawfully holds (the subject claims) to an offshore investor, and the foreign investor replaces the existing domestic creditor to become the new creditor.

There are, in practice, two relatively successful means of effecting cross-border transfers of claims. The first involves a financial asset management company bundling non-performing assets and transferring them to foreign investors. This is the most direct and widely used method for foreign investors to participate in the disposal of Chinese non-performing assets. Both the National Development and Reform Commission (NDRC) and the State Administration of Foreign Exchange (SAFE) have issued regulations on the recordal and foreign exchange issues relating to this.

The second method involves a cross-border transfer on the Qianhai Financial Assets Exchange (QEX). In 2016, the first cross-border transfer of claims was completed on the QEX. A branch in China of a certain foreign-funded bank transferred the subject claims – a bundle of non-performing assets – to an offshore branch. The Shenzhen exchange control bureau referred the matter to the SAFE for approval, following which the transfer of the claims and the receipt and payment of foreign exchange were completed.

This article analyzes some of the issues involved in effecting cross-border claim transfer transactions on the QEX.

Foreign debt. When a domestic creditor sells the subject claims to a foreign investor, a foreign entity becomes the creditor and the domestic debt of the domestic debtor becomes a foreign debt, so the oversight and regulations of the state’s exchange control authority and the NDRC must be complied with. If the foreign debt approval and registration procedures cannot be completed, the debtor will not be able to make cross-border payments to the creditor or send the funds abroad when it attempts to effect repayment.

The QEX has applied to the SAFE for a foreign debt limit. Any foreign debts that arise from the cross-border transfer of claims on the QEX are incorporated into, and managed, as part of the QEX’s foreign debt limit, obviating the need for the transferor or the transferee to apply for approval or recordal on each occasion.

Amending the registration of security interests attaching to a claim. A subject claim generally has security attached. If the security is provided as a mortgage, registration of the change in the mortgagee will be involved. Given that the state land authorities and real estate authorities (i.e., the registrar) only accept mortgage registration where the mortgagee is a financial institution, a foreign creditor might not be able to carry out registration of the change in mortgage rights after acquiring the subject claims.

Article 81 of the Contract Law specifies that, “When a creditor transfers his rights, the transferee also obtains the incidental rights concomitant with the claim, unless such incidental rights are personal to the creditor himself”. Article 50 of the Security Law specifies that, “Mortgage rights may not be separated from the secured claim and transferred severally or used to secure another claim”. Article 192 of the Property Law specifies that, “Mortgage rights may not be separated from the secured claim and transferred severally or used to secure another claim. If a claim is transferred, the mortgage rights securing such claim must be transferred together, unless otherwise specified in law or provided by the parties”.

Accordingly, the author believes that failure to carry out registration of the transfer of mortgage rights after a cross-border transfer of a claim does not affect the foreign creditor’s securing of the mortgage rights. The QEX also does not offer a service for registering the change in mortgage rights for each transfer of a claim.

Registration of a claim transfer. To promote the compliance and transparency of credit asset exchange, each transfer of claims on the QEX is registered with the China Credit Assets Registration and Exchange (CCRE). The CCRE contains two systems, the “centralized registration system” and the “asset exchange platform”, which ensure the genuineness of subject claims, and that transfer is not duplicated, and protect the rights and interests of foreign investors.

Article 80 of the Contract Law specifies that, “When a creditor transfers his rights he shall notify the debtor. Without notification, such transfer does not enter into effect as for the debtor”. Article 8.2 of the CCRE’s Master Agreement for the Registration and Exchange of Credit Assets specifies that, “If, pursuant to the laws of China or the transaction documents, exchange of the subject assets requires notification of such relevant parties as the borrower, guarantor, custodian, etc., the exchanging entity shall notify the relevant parties in accordance with such laws or transaction documents”.

However, all actual credit transfer agreements will provide that no claim transfer notice need be given at the time of the transfer of the subject claims, and will only specify that notice is to be given when a “rights perfection event” occurs. Accordingly, cross-border transfers of claims on the QEX also abide by this practice.

Taxes. A foreign creditor, as a non-resident tax paying entity, is required to pay 10% enterprise income tax (or 7% if it is covered by a tax preference agreement) and 6% value added tax and surcharge on its loan interest income. However, unlike a domestic tax paying entity, the tax paid by a foreign creditor for the subject claims is counted for each individual claim, rather than on the bundle of assets. Accordingly, the gains and losses on each of the claims may not be set off against each other. The tax payable by a foreign creditor may be withheld by a loan service institution (usually the original creditor).

As the cross-border transfer of claims on the QEX is at the pilot stage, according to the Shenzhen exchange control bureau, the method of item-by-item submission for approval still applies, and the direction of transfer is limited to spreading the risks attaching to claims outside the financial system, and the transfer thereof from outside to inside is not supported, for the time being.

Transfers of non-performing claims to foreign parties by state-owned banks are still required to follow existing regulations for the time being to avoid erosion of state-owned assets. Currently, banks’ non-performing assets may only be sold at a discount to one of China’s four large asset management companies or a local asset management company.