Among a myriad of recent reforms to its foreign investment regime, China is relaxing it administration of foreign exchange in relation to foreign invested enterprises (“FIEs”). On 15 July 2014, the State Foreign Exchange Administration (“SAFE”) launched a pilot program in 16 locations (mostly in economic development zones) across 15 municipalities or provinces3, lifting its stringent restrictions on the conversion of foreign exchange in the form of registered capital contributed to FIEs.

For those who are unfamiliar with China’s foreign exchange regime, China has put in place a complex system of foreign exchange administration. Categorically speaking, current account items such as payment of foreign exchange in connection with the trade of goods and services, royalties, interests and dividends are subject to lenient review by banks. Such review is based on the principle of discovering the real underlying transactions taking place, and thus involves submission of relevant documentation and, if applicable, proof of tax payment. Capital account transactions, however, are scrutinized more closely in accordance with constantly evolving foreign exchange regulations that cover transactions like capital contribution, loans, and capital gains in foreign exchange. The aforesaid pilot program relates to capital account transactions, specifically the conversion of FIEs’ registered capital contributed by foreign shareholders into foreign exchange (e.g., USD or Euros).


Before the pilot program, conversion into Chinese currency (i.e., RMB) of registered capital injected into FIEs by shareholders was typically prohibited until FIE representatives could demonstrate the details of a real pending transaction. Such transactions often involved the FIE’s need to pay a third party such as a Chinese vendor engaging in a genuine transaction involving the FIEs’ business line. There were only limited exceptions for company reserve funds, employee compensation matters or minor amounts of USD 50,000 or less. Before converting foreign exchange capital, Chinese banks have been required to closely review relevant documents to check compliance as well as documentation consistency of the underlying transaction with previous transactions. When the RMB came under significant appreciation pressure a number of years back, the conversion process in practice usually turned out to be even more cumbersome and time-consuming.

Now, thanks to the pilot program, FIEs established within the pilot locations will be allowed to convert 100% of their foreign exchange registered capital at will (though the initial percentage may be adjusted by SAFE from time to time).Technically, the RMB proceeds derived from such at-will conversion must be channeled into an interim RMB account opened at the same bank managing the foreign exchange capital account. The interim account will receive continuing bank supervision to ensure application of funds to real transactions consistent with the FIEs’ business line.

To stem speculation of Chinese currency by “hot money” and plug holes for unauthorized foreign capital participation in certain sectors, SAFE prohibits funds in the interim account from:

  • being converted into foreign exchange and returned to the initial registered capital account unless approved by SAFE’s local counterparts;
  • being applied directly or indirectly to transactions outside of the FIEs’ registered business scope or to disbursements prohibited by Chinese laws and regulations;
  • making direct or indirect securities investment unless otherwise allowed by Chinese laws and regulations;
  • extending direct or indirect entrusted RMB loans (except permitted by the FIEs’ registered business scope), repaying inter-company loans (including third party advanced loans) or banks loans which have been transferred to third parties; or
  • purchasing non self-use real estate except for foreign-invested real estate companies.

Another more significant major change under the pilot program is the removal of the overall ban of foreign exchange conversion for purposes of equity investment, which was imposed in 2008 by Circular 142(The Circular of Operation Issues Related to the Perfection of Administration of PaymentRelated Settlement of FIEs’ Registered Capital from Foreign Exchange to RMB). In a nutshell, the pilot program allows foreign exchange capital to be converted into RMB to invest in non-public Chinese companies.

This is good news for international private equity and venture capitalmangers that have established funds in China. Besides for a few local pilot programs in Shanghai and other municipalities, such funds earlier were required to contribute to target companies in the original foreign exchange, which was subject to the aforementioned convert-to-pay scrutiny and a time-consuming conversion process. This gave rise to complaints and hesitations by investedand potential target companies, granting Chinese RMB funds an upper hand when competing for participation in or acquisition of Chinese target companies. The relaxation applies to all FIEs in the investment business, including foreign-funded investment companies, foreign-invested venture capital enterprises and foreign-invested equity investment enterprises. In the event of real and compliant investment projects, the capital committed to the Chinese targets can be converted into RMB and then wired into the target companies’ accounts. Foreign exchange other than those committed to actual investment must continue to abide by the aforesaid convert-to-pay rule.

The pilot program also lifts the ban of other FIEs not in the investment business from converting their foreign exchange capital to make equity investments. The target companies must first undertake re-investment (by the FIEs) registration with SAFE’s local counterparts and open an interim account as mentioned above to receive conversion proceeds from the FIEs based on actual investment terms. The same process applies if the target companies re-invest in China.

Incidentally, Chinese authorities have removed their mandatory requirement of capital contribution timelines for enterprises established in China, including FIEs. Other than a few specified types of companies such as financial institutions, companies are allowed to subscribe the registered capital but contribute on an as-needed basis. Coupled with the foreign exchange pilot programs, this creates a viable legal framework for foreign investors to incorporate special purpose vehicles (“SPVs”) in China to structure their Chinese business and investment.


Overall, the pilot program brings welcome development to the foreign investment legal regime. While it remains to be seen how the program fares in practice and whether and when the reforms will be extended to all of China, the latest legal developments show encouraging signs.

The pilot program will kick start on 4 August 2014.