Impact of China's foreign exchange control on foreign investment in China

Being a vast market, China has been attracting an increasing amount of foreign investment since the implementation of its open-door policies in the late 1970s. However, foreign investments are, to date, still subject to various restrictions, including those arising from China’s foreign exchange control regime.    

In this article, we set out several foreign exchange issues that commonly affect foreign investment into China.

The State Administration of Foreign Exchange (including its authorised local counterparts, collectively, SAFE) is the regulator in charge of foreign exchange control matters in China.

Background

Incorporated foreign-invested enterprises (FIEs) include equity joint ventures (EJVs), cooperative joint ventures (CJVs) and wholly foreign-owned enterprises (WFOEs). FIEs are subject to a general equity/debt ratio requirement which means that a certain percentage of the total investment of an FIE must be funded by capital (which is referred to as “registered capital”) contributed by the investors. The amount of total investment and registered capital is required to be set out in the constitutional documents of the FIE and is subject to approval by the governmental authorities.

Capital contribution

Opening of a foreign exchange capital account by an FIE is subject to SAFE approval.

• Each capital payment by the investors of an FIE is subject to verification conducted by a duly qualified accounting firm registered in China before the capital may be used by the FIE.
• Registered capital may be contributed in the form of currency (foreign currency or lawfully obtained RMB), industrial assets, land use rights, intellectual property or other assets that may be agreed by the parties and approved by the approval authorities.
• Registered capital may be paid in one lump sum or in instalments and should be paid in full within 2 years (or within 5 years for foreign-invested holding companies) of the issuance of the FIE’s business licence.

Use of foreign exchange capital

• An FIE may convert foreign exchange capital into RMB for use in its business operations which fall within its business scope. The bank responsible for handling the conversion of the foreign exchange capital will review the relevant transaction documents and process the payment in respect of such conversion for the FIE directly without the need first to obtain an approval from SAFE.
• The RMB amount converted from the foreign exchange capital of an FIE cannot generally be used for any further onshore equity investment. This general restriction constitutes a significant obstacle for any foreign-invested onshore investment vehicles (RMB funds in particular) to use foreign exchange capital received from foreign investors for making further investments in China (for more information regarding foreign-invested RMB funds, please refer to our article Recent regulatory developments in China: FIPs and FIVCIEs
• Foreign exchange capital received by foreign-invested holding companies or venture capital investment companies may be used for onshore investment in China subject to SAFE approvals and verifications.
• Foreign exchange capital of an FIE may be used under a “cash pooling” arrangement through qualified PRC banks so that companies within the same group may benefit from the foreign exchange “cash pool” contributed by the parent and associated companies incorporated in China in accordance with the applicable SAFE rules promulgated in October 2009.

Foreign debt financing of FIEs

• An FIE is only allowed to obtain foreign debt financing (i.e. loans provided by an offshore lender) for an amount up to the difference between its total investment amount and its registered capital (such difference is normally referred to as the “borrowing gap”).
• Foreign debt of the FIE is required to be registered with the local SAFE within 15 days after the signing of the relevant loan agreement.
• FIEs may provide security in favour of an offshore entity to secure its own foreign debt without the need first to obtain an approval from SAFE. In the case where an FIE is to provide foreign security in favour of an offshore entity for the foreign debts of a third party, (subject to certain qualification requirements) the prior approval of SAFE would be required if the FIE is a joint venture enterprise; but if the FIE is a WFOE, only SAFE registration would be required.
• FIEs are not allowed to provide foreign security for the foreign debts of a foreign entity which is not the relevant FIE’s subsidiary. In other words, the provision of only downstream foreign security is feasible.

Remittance of dividends or sale proceeds to foreign shareholders

• Distribution of profits of an FIE to foreign shareholders is conditional upon the satisfaction of various conditions (for example, that: all taxes have been fully paid; all losses of the previous financial years have been made up; allocations have been made to statutory funds; and the registered capital of the FIE has been paid in accordance with the approved schedule).
• A qualified PRC bank will review the application documents and, upon its satisfaction with the application documents, it will process the payment in respect of the remittance of dividends to foreign shareholders for the FIE (the prior approval of SAFE is not required).
• EJVs are required to distribute profits to the shareholders in proportion to the shareholders’ respective equity interests in the EJV. CJVs and WFOEs enjoy more flexible arrangements in terms of the distribution of profits to shareholders.
• An FIE may use its own foreign exchange income or purchase foreign exchange from a bank in order to remit dividends in a foreign currency to foreign shareholders.
• The collection of proceeds by a foreign shareholder arising from the sale of its equity interest in an FIE to an onshore entity is subject to SAFE approval, but such SAFE approval will not be required if the foreign shareholder sells its equity interest to another foreign entity.