Key Points

  • Circular 37 replaces nearly ten-year old Circular 75
  • Definition of “Special Purpose Companies” amended
  • Definition of “Round-Trip Investment” amended
  • New Registration for Employee Option Shares of Unlisted Companies
  • Circular 37 allows two ways to make the contribution to the SPV

The State Administration of Foreign Exchange (“SAFE”) has further adjusted and streamlined its foreign exchange control on capital account by issuing the Notice of State Administration of Foreign Exchange on Further Improving and Adjusting Foreign Exchange Control Policies for Capital Account (the “Notice”) on January 10, 2014, which took effect on February 10, 2014.

Background

On July 4, 2014, the SAFE stipulated a Notice on the Administration of Foreign Exchange Involved in overseas Investment, Financing and Round-Trip Investment Conducted by Domestic Residents Through Special Purpose Companies (“Circular 37”). The Notice of the SAFE on the Administration of Foreign Exchange Involved in overseas Investment, Financing and Round-Trip Investment Conducted by Domestic Residents Through Special Purpose Companies issued by the SAFE on October 21, 2005 (“Circular 75”) was simultaneously terminated.

Highlights of the Legislation

1.       Definition of “Special Purpose Companies”

The term “Special Purpose Companies” (“SPV”) in Circular 37 refers to overseas enterprises directly established or indirectly controlled by domestic residents (including domestic institutions and domestic individual residents) for the purpose of investment and financing by utilizing the domestic or overseas assets or equity they legally hold. Compared with the definition used in the Circular 75, the new definition has two material changes: in Circular 75, an SPV is set up only for the purpose of financing, while in Circular 37 an SPV is also allowed to invest. The other difference is that, in Circular 75, domestic residents can establish an SPV by its domestic assets only, while Circular 37 also allows overseas assets legally held by such residents.

2.       Definition of “Round-Trip Investment”

Round-Trip Investment under Circular 75 was largely a description of the typical VIE structure. In Circular 37, such definition was changed  to a very general description of direct domestic investment activities conducted by domestic residents directly or indirectly through special- purpose companies, which not only refers to establishment of the wholly foreign owned enterprise, but also covers M&A transactions.

3.       New Registration for Employee Option Shares of Unlisted Companies

In 2012, SAFE issued Circular 7, pursuant to which, the stock option issued to a Chinese employee by a foreign company shall be subject to the registration with the SAFE before being exercised. However, that circular only stipulates the registration for a listed company, and SAFE does not accept any application for the stock options issued by a private company. Circular 37 has a clear requirement that the employee option shares issued by a unlisted SPV shall also be subject to the registration with SAFE. Pursuant to the Circular  37, before exercising the options granted by a SPV, the Chinese option holder shall file the registration with SAFE by submitting the requested documents, including the registration certificate of the SPV, the evidence of the employment relationship between the SPV and the option holder, and the evidence of the authenticity of the equity incentive plan.

4.       Contribution to SPV

Other than the set-up of the SPV by the overseas assets legally held by domestic residents, Circular 37 also allows the following two methods to make the contribution to the SPV:

  1. Domestic companies held or owned by domestic residents have the right to provide capital support to the SPV duly registered with the SAFE, based on real and reasonable needs and according to current regulations.
  2. Domestic residents may purchase foreign exchange and remit such foreign exchange to overseas countries for the establishment, equity repurchases or de-listing of the SPV, based on real and reasonable needs.

However, Circular 37 does not specify the procedure or requirement for such financial support to the SPV.

Conclusion

Circular 37 introduces interesting developments for the regulations and supervision of the establishment and operation of the SPV, and clarifies the requirements for certain grey areas. However, as many changes are new and fundamental, the local departments of the SAFE are still in the process of draft the implementation rules for the Circular 37. It is still hard to say when the Circular 37 can be fully applied.