China has said for many years that it will liberalise its foreign exchange regime at its own pace. A recently issued regulation, which simplifies foreign exchange procedures for direct investment in China and for Chinese outbound investment, is a step in that direction.

China's State Administration of Foreign Exchange (“SAFE”) has indicated that it will shortly cancel various foreign exchange approvals, opting instead for post-filing with simplified procedures and documentation. The new rules come with a change in the role of SAFE away from pre-approvals and toward post-filing monitoring and data analysis of cross-border capital flows for direct investment. As a result of these developments, foreign investors may expect to spend significantly less time dealing with foreign exchange matters.

The new rules are set out in the recently issued Notice on Further Improving and Adjusting Foreign Exchange Policies Related to Direct Investment (“Notice”). The Notice will become effective on 17 December 2012.

Background

Historically, SAFE has maintained stringent control over foreign exchange considered "capital" in nature. In the context of foreign direct investment, a foreign-invested enterprise (“FIE”) is currently required to be registered with and approved by SAFE before it can open dedicated foreign exchange accounts with designated foreign exchange banks (“Forex Bank”). Moreover, there are various SAFE pre-approval requirements and restrictions in relation to depositing, conversion, and remittance of foreign exchange into or out of these accounts. A foreign investor therefore needs to plan its investment projects carefully so as to ensure that the cash needs of its projects can be met on schedule; otherwise, the various pre-approval procedures required by SAFE can cause delays. In addition, a great amount of time and energy will have to be spent in preparing for such SAFE approvals. Under the Notice, the current procedures will be simplified from 17 December 2012.  

Cancelling various approval requirements

SAFE has cancelled 35 foreign exchange administrative approvals, and has combined a further 14 approvals.

These cancellations include:

  • approvals for the opening of foreign exchange accounts under direct investment (i.e., Preliminary-stage Expense Account, Foreign Exchange Capital Account, Domestic Assets Disposal Account, Domestic Re-Investment Dedicated Account and Deposit Dedicated Account) and the subsequent depositing, conversion, and remittance of foreign exchange using these accounts;
  • approvals for domestic transfer of foreign exchange in connection with direct investment activities;
  • approvals for payment by a foreign investor of the price paid for equity to be credited to the Asset Disposal Account (as defined below); and
  • approvals for re-investment by foreign investors of earnings legally obtained in China.

According to the Notice, as of 17 December 2012, an FIE need only complete a foreign exchange registration with SAFE's new electronic system (which links to a Forex Banks). Once registered, the Forex Bank with which the FIE opens an account will be directly responsible for processing the foreign exchange transactions for which SAFE has cancelled its pre-approval requirement. SAFE will no longer be directly involved, which is good news for foreign investors as, historically, the pre-approvals tended to be complicated and time-consuming.

In terms of re-investment, however, FIEs are still not allowed to convert their registered capital into RMB to make equity investments or security investments, or to buy real-estate not for self-use. For any FIE that intends to acquire equity or purchase real estate, the source of funding will remain problematic if the FIE is yet to generate sufficient RMB income.  

Simplifying administrative procedures

From 17 December 2012, administrative procedures will also be simplified in terms of foreign exchange capital conversion, capital verification inquiries, and types of special foreign exchange accounts required to be opened for specific purposes and re-investment by foreign-invested holding companies. In addition, the Notice clarifies and streamlines the documentation required for these procedures and sets out a statutory time-limit for SAFE and Forex Banks to complete the procedures. These improvements should help increase the efficiency and transparency of SAFE and Forex Banks, and should also reduce costs for applicants.

By way of example, a foreign investor that acquires a target company in China from a Chinese seller must register with SAFE its payment of consideration under the transaction and obtain a confirmation from SAFE that the payment has been duly made to the Chinese seller. Currently, certain steps, each of which involves SAFE, must be followed by the parties:

  • Step 1 – The target company applies for foreign exchange registration with SAFE.
  • Step 2 – The Chinese seller applies to SAFE for approval to open a special account at a Forex Bank to receive the consideration paid by the foreign buyer for the equity transfer (“Asset Disposal Account”).
  • Step 3 – The Chinese seller applies to SAFE for approval for the Forex Bank to credit the Asset Disposal Account with the foreign exchange remitted by the foreign buyer.
  • Step 4 – The foreign investor applies to SAFE for confirmation of the payment made to the Chinese buyer.

After the Notice takes effect, SAFE approvals for Step 2 and Step 3 will be removed entirely. The Chinese seller can open the Asset Disposal Account directly with the Forex Bank, which in turn will credit the account upon receipt of the consideration and upon filing with the SAFE electronic system. If payment is made in foreign currency, SAFE will automatically complete Step 4 via the electronic system, which will save the foreign investor significant time and energy. This is particularly important if the foreign investor is paying in several instalments and needs to apply for SAFE confirmation each time a specific instalment is paid.

Relaxing the use of foreign exchange

The Notice removes various restrictions on the number and locations of foreign exchange accounts that can be opened. It also permits the purchase and payment of foreign exchange in different locations. This should be of particular benefit to those FIEs which have established branches in different locations.

Under the Notice, an FIE will also be permitted to provide loans to its offshore parent, provided that the amount of the loan does not exceed the total of (i) dividends declared but not remitted to the foreign investor abroad, and (ii) the foreign investor's proportionate share in the FIE's undistributed profits.

In addition, an onshore company may lend money offshore using foreign exchange borrowed from Chinese banks in China. This development suggests that China intends to encourage more outbound investments by domestic companies.

Strengthening SAFE's monitoring role

While SAFE has significantly pulled back from its pre-approval role and has greatly simplified its administrative procedures for direct investment, it is enhancing its monitoring role over foreign exchange. The main way by which SAFE is enhancing foreign exchange monitoring is through data collection from Forex Banks via its new electronic system and by watching cross-border capital flow in an increasingly comprehensive, dynamic and sophisticated manner.

It is expected that, under the new system, foreign investors will be more closely supervised in terms of whether foreign exchange capital is appropriately used in all phases of investment, from incorporation and operation to re-investment, merger and acquisition. On the other hand, Forex Banks are being given an increasing role in ensuring day-to-day compliance of foreign exchange transactions. As such, foreign exchange banks are required to strictly follow the detailed operating rules provided in the Notice and to electronically report, in real-time, to SAFE information in relation to the inflow and outflow of foreign exchange.

Looking forward

The issuance of the Notice is expected to provide a more favourable investment environment for both foreign direct investment and Chinese outbound investment. Foreign exchange authorities at the municipal level have started training programmes for bank staff and foreign exchange bureaux; however, it remains to be seen how quickly and efficiently the new rules will be implemented in practice.

Whether implemented quickly or haphazardly, the Notice is a step toward China's often-repeated desire to liberalise its foreign exchange regime at its own pace.