State-owned enterprises engage in international trade that involves both domestic and foreign parties. Although they have customs declarations, shipping documents, and letters of credit, the risk of financing-related transactions cannot be entirely ruled out.

Summary of Key Points

Many state-owned enterprises (SOEs) believe that engaging in international trade with both ends outside China (involving customs declarations, shipping documents, letters of credit, and the physical movement of goods across borders) means they will not be classified as engaging in financing-related trade. However, this is a misconception. The essence of financing-related trade is "using trade as a cover for lending funds or providing credit." The presence of actual goods and documents only proves that the goods have been moved; they do not necessarily indicate that the SOE is not acting as a conduit for capital flows. Regulatory authorities and judicial systems use different criteria to identify financing-related trade, and the complexity of international trade makes it easier for such activities to hide their true nature. The key question is whether the SOE is genuinely involved in the trade (organizing the shipment, assuming risks, and earning profits from the transaction) or merely acting as a facilitator (providing funds on behalf of others and earning fixed-interest income).

Misconception: Does the Presence of Actual Goods and Documents Mean It's Safe? No!

Many SOEs think that if there are customs declarations, shipping documents from shipping companies, and bank letters of credit, and if the goods are actually imported from abroad, then it cannot be financing-related trade. However, these only prove that the goods have crossed borders; they do not demonstrate that the SOE is engaged in legitimate trade. For example, after importing a batch of soybeans from Brazil, the goods may go through several intermediaries in China and remain in storage without being sold. Even though there are contracts and invoices for each step, the customs declaration only shows that the soybeans have been imported but does not prove the commercial value of each transaction (for instance, whether all these intermediaries are necessary or if they are just used to transfer funds).

Financing-related trade can easily occur even when the goods and documents appear legitimate. The SOE may simply be providing funds or issuing letters of credit on behalf of others, without selecting suppliers or finding buyers itself. Although the title to the goods is in its name, control over them actually lies with someone else. The profit earned in this case is linked to the duration the funds are held (similar to interest), which is a characteristic of financing, not trade.

Different Approaches from Regulators and Courts

SOEs often wonder why courts may rule a contract valid while regulators classify it as financing-related trade, or why regulators may deem an activity illegal yet courts do not. The reason is that the two entities are addressing different issues:

• Regulators (such as the State-owned Assets Supervision and Administration Commission) focus on whether funds have been illegally lent: Regardless of the terms in the contract, if the SOE uses trade as a cover to lend money and causes losses to state assets, it may be identified as financing-related trade (an illegal operation).
• Courts focus on the actual legal relationship: If a contract appears to be a sale but is actually a loan, the court will rule it as such. However, just because a court validates a sales contract does not mean the regulator will overlook it; regulators will also inquire about the purpose of the transaction and whether there is any commercial value or if credit is being provided.

For example, if an SOE issues a letter of credit on behalf of a client, the court may consider the contract to be a genuine sale, but regulators will investigate whether the SOE is using its own credit to make payments for the client and earning profits from the period the funds are held.

Letters of Credit as Tools, Both for Trade and Financing

Letters of credit are designed to address trust issues in international trade: foreign sellers worry about not receiving payment for their goods, and domestic buyers worry about not getting the goods for their money. Banks act as guarantors (paying when the seller provides the documents, and the buyer receives the documents to pick up the goods). However, they can also be used for financing:

• Import letter of credit: Domestic clients without funds ask SOEs to issue a letter of credit; the bank pays the foreign supplier, and the client buys the goods from the SOE later. This seems like import trade, but in reality, the SOE is providing funds on behalf of the client, earning profits from the period the funds are held.
• Export financing: Domestic companies that need to export but cannot wait for payment ask the SOE to purchase the goods and then sell them to foreign buyers. The SOE pays the domestic company first and waits for the foreign payment before receiving its profit. In both cases, the documents and transactions appear legitimate, but the SOE acts as a conduit for funds, not a true trader, as it does not assume the risks associated with the goods (such as price fluctuations or sales failures) and only earns fixed-interest income.

The Hidden Risks of International Trade Financing

The long and complex chain of international trade makes it easier to disguise financing-related activities:

1. Multiple documents make formal reviews easier: With all the contracts, letters of credit, and customs declarations, reviewers may focus on surface compliance without questioning who is responsible for each step in the process or who bears the risks.

2. Difficult to identify overseas parties: Foreign suppliers might be colluding with domestic clients (but information about them is hard to obtain), leading SOEs to believe they are dealing with independent entities when in fact, they are just part of a scheme to siphon off funds.

3. Separation of title and control: The SOE may hold the shipping documents, but logistics and storage are managed by the client, meaning the SOE has little control over the goods.

4. Difficulties in resolution of issues: Cross-border litigation, enforcement of assets abroad, and selling goods overseas are more complicated than domestically. For example, if goods are detained at a foreign port, dealing with it through local courts is costly and time-consuming.

The Critical Question: What Is the SOE Really Doing?

Whether dealing with domestic or international trade, to determine whether an activity is financing-related, consider these three key questions:

1. Who controls the transaction? Does the SOE select suppliers, negotiate prices, and find buyers itself, or are these decisions made by others?

2. Who bears the risks? Does the SOE face risks related to price fluctuations, quality issues, or unsold goods, or does it only earn fixed income regardless of sales outcomes?

3. Where does the profit come from? Does the profit come from trade margins (e.g., buying low and selling high) or from the duration the funds are held (i.e., interest)?

If a SOE merely acts as a intermediary, does not control the transaction, does not bear risks, and earns profits from the use of funds, then it may be engaging in financing-related trade, regardless of the presence of actual goods and documents.

In conclusion, many SOEs involved in international trade with both ends outside China face difficulties if they cannot establish proper relationships with their suppliers and buyers, cannot withstand price risks, or are unwilling to provide upfront funding. These issues are often at the root of the associated risks.

(The entire analysis is written in plain language, avoiding technical jargon, making it easy for non-financial professionals to understand.)