The money mill that undergirds many of China‘s aggressive — if not reckless — assets buying in Hong Kong and overseas may be coming to a temporary halt, if the cat has the upper hand this time.

In an effort to protect the yuan, the People’s Bank of China issued a directive late last month to rein in cross border borrowing that has been fuelling the mill.

On the radar are not only 24 mainland banks but also three overseas lenders – HSBC, Citibank and Standard Chartered Bank.

Before discussing the cat’s move, let’s recap what the mice have been doing to stockpile their cheese in the past year or two.

Step one: Sign a contract to buy a piece of land, a hotel chain or a prestigious apartment block overseas that costs, say HK$10 billion. As always, it doesn’t have to be genuine.

Step two: Pledge a mainland Chinese asset with a mainland bank for a standby letter of credit (SBLC), which is a promise by the bank to pay. Use the SBLC to get a loan in Hong Kong to pay for the asset.

Step three: Pledge the overseas asset with the banks in Hong Kong to get a HK$5 billion loan

Step four: Pledge the HK$5 billion cash with another bank for a SBLC.

Step five: Use the second SBLC as security at a mainland financial institution to purchase top notch bonds. Pledge the debentures for another SBLC at HK$3.5 billion, given a routine discount of 30 per cent for financial products.

Step six: Use the third SBLC as collateral and get a HK$3.5 billion loan in Hong Kong. Repeat step four and five and so on so forth.

The result is a swift creation of capital, which can be as high as HK$28 billion, and the moving of more than HK$15 billion out from the country in our hypothetical example.

This is a simplified version. The real thing normally involves the play among different currencies to magnify the gains.

For example, pledge a renminbi deposit for a U.S. dollar SBLC, which can be used as collateral for a Euro loan, in the name of paying off an Australian dollar-denominated acquisition.

The money “created” would be poured on to more buildings and even companies. As long as the new asset keeps the ball rolling, price doesn’t really matter.

The Chinese central bank is trying to put a leash on the game by capping the total size of cross-border borrowings for individual companies, financial institutions and banks.

Only genuine trade financing, approved intragroup transfers and a few other categories will be exempted. So, to complete the six-step programme, you will need to create two “genuine” trade deals plus all the documents.

You and your bankers are required to report each borrowing in details to the regulators three days before the draw down.

While these will make the snowballing more troublesome and therefore costly, the authorities are also trying to cut the rewards.

You are no longer allowed to exchange your yuan into foreign currency to pay off the cross-border lending. Pay with whatever foreign exchange you have in Hong Kong or overseas, said the directive.

No more playing with currency. If you sign a U.S. dollar loan, then you must draw down and repay in dollars.

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The regulators threatens to punish any irregularity with hefty financial penalties, as well as suspensions of cross-border borrowing businesses.

The heat has been felt, making the eve of the Year of the Rooster a special one. It used to be a time of tight liquidity and loans draw down.

Instead, mainland companies were busy repaying loans in Hong Kong in order to have the SBLC up north cancelled. Obviously, no one wants to be singled out by the regulators – at least not for the moment.

The mice will need some time to map out a route around the traps. After all, government financing platforms and property companies are not covered by the new central bank directive.

It’s also encouraging companies to borrow with their balance sheets instead of pledging mainland assets or renminbi. The ceiling has been doubled.

The challenge for financiers is to keep the money mill rolling as quickly as ever, even with these clauses and speed bumps in place.

Bankers are working hard on that. Given their track record, it shouldn’t take long.

Commentary by Shirley Yam from the South China Morning Post.

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