SAFE Circular 19 liberalizes domestic investments by foreign-invested enterprises

As of 1 June 2015, the Circular of the State Administration of Foreign Exchange on Reforming the Management Approach regarding the Settlement of Foreign Exchange Capital of Foreign-invested Enterprises (国家外汇管理局关于改革外商投资企业外汇资本金结汇管理方式的通知) (“Circular 19”) has come into effect.

According to Circular 19, foreign-invested enterprises (“FIE”) may, at their discretion, settle their foreign exchange (“forex”) capital into Renminbi (“RMB”) funds at banks based on the actual operation needs of the FIE rather than on the actual payment needs as before.

Article 4 of Circular 19 specifically outlines the permitted use of the RMB capital funds obtained from forex settlement. It provides that FIEs may use the funds for equity investments.

In simple words: Pursuant to Circular 19, it should be possible for a foreign investor to inject forex into a Chinese subsidiary, which subsidiary could then convert the funds into RMB and use them to acquire shares in another Chinese company.

Before Circular 19, only regulated foreign-invested investment companies, venture capital and private equity enterprises were generally permitted to use capital funds for equity investments. However, the regulatory thresholds for establishing such investment vehicles in China are rather high. Equity investments by “normal FIEs” (other than regulated investment vehicles) were only permitted if such normal FIEs used funds other than equity capital, such asRMB funds out of profits, equity transfer in China, etc.

Although the wording of Circular 19 provides for a relaxation in the use of capital funds for equity investment, the application of Circular 19 appears to vary in practice. Apparently, theSAFE and some of its local counterparts are of the opinion that the use of such RMB capital funds shall in general comply with the business scope of the FIE, and in case of equity investment the word “investment” shall be expressly reflected in the business scope of theFIE. On the other hand, administrative approval is required for changing the business scope of an FIE and an approval to include the “investment” activity in the business scope of an FIEmight in some cases only be granted by the competent commerce department if the FIE fulfils the aforementioned regulatory thresholds.

Nevertheless, based on our communications with banks which actually carry out the funds settlement and funds transfers, there are already a number of cases of successful implementation of Circular 19, in particular in certain free trade zones.