Key Points

  • Legislation removes a number of rules previously introduced under Circular 142.
  • Most important are the changes to rules on conversion and use of foreign currency registered capital of FIEs.
  • Circular 36 adopts a concept of “conversion at will”.
  • Equity investment by converted registered capital is no longer prohibited.
  • Regulation provides separate rules applicable for general type of FIE and FIE whose principal activities are investment.

Background

On July 15, 2014, the State Administration of Foreign Exchange (“SAFE”) issued Notice on Issues Relating to Pilot Scheme of Reform of Administration of Foreign Currency Capital Settlement by Foreign Investment Enterprises in Certain Regions (“Circular 36”), which came into effect on August 4, 2014. The importance of Circular 36 is that it changes the rule on conversion and use of foreign currency registered capital of foreign invested enterprise (“FIE”), which were established under Huizongfa [2008] No. 142 (“Circular 142”).

Regulation Background

Under Circular 142, the Renminbi funds of an FIE created by converting registered capital shall be used within the scope of business approved by the respective authorities, and shall not be used for domestic equity investments. The conversion of registered capital shall be based on review of the usage of the fund, and conversion is only allowed based on actual payment basis. The company must submit documentary evidence for the purpose of the Renminbi funds for approval of the conversion.

Except for certain specified purpose (e.g. petty cash or salaries), the converted RMB funds should be paid to the approved recipient within a prescribed time.

Highlights of Circular 36

With the issuance of Circular 36, many rules under Circular 142 have been removed.

1.       Conversion at will of foreign currency registered capital

Circular 36 adopts a concept of “conversion at will” (also known as “discretion conversion” or “voluntary conversion”), as opposed to conversion on payment basis.

  • Conversion on payment basis is the principle set out in the old Circular 142, where conversion of foreign currency registered capital in a FIE’s capital funds account should be processed based on each single demand of Renminbi payment.
  • “Conversion at will” is roughly defined in Circular 36 as conversion of an FIE’s foreign currency registered capital in accordance with the enterprise’s actual business needs. No review of the purpose of the funds is required when doing the conversion.

Currently, the percentage of the registered capital that a FIE registered within the pilot scheme region (see the list of regions in Appendix) can be converted is 100%, according to Circular 36. SAFE may adjust such percentage where appropriate considering the national balance of international payments.

The Conversion at will scheme is not a mandatory measure to be implemented by FIE. FIE can choose whether to convert all or only part of the registered capital, where FIE may have more flexibility. However, once the registered capital has been converted into Renminbi, it is not allowed to convert it back to foreign currency into the capital account. Therefore, the timing and amount of the conversion should be well planned by FIE, considering the fluctuation of foreign exchange market.

2.       Administration of converted payment account

The FIE shall open a corresponding “Converted Currency Payment Account” to deposit the Renminbi converted from the registered capital under the conversion at will pilot program. Use of such Renminbi funds from registered capital by FIE shall be based on true transaction, and only for the purpose of its own capital demands. According to Circular 36, the following usages are strictly prohibited by SAFE:

  1. Renminbi funds shall not be used for expenditure outside the enterprise’s scope of business or expenditure prohibited by State laws and regulations;
  2. unless otherwise stipulated by laws and regulations, Renminbi funds shall not be used for securities investments;
  3. Renminbi funds shall not be used for Renminbi-denominated entrusted loans (except where permitted by the scope of business), repayment of loans between enterprises (including third party advances), and repayment of bank loans re-loaned to a third party;
  4. except for foreign-funded real estate enterprises, Renminbi funds shall not be used for payment of expenses relating to purchase of real estate not for its own use.

According to Circular 36, the usage of Renminbi funds in the Converted Currency Payment Account is still subject to scrutiny.

In this regards, it is believed that there is no fundamental change regarding the administration of the usage of registered capital, i.e., payment of the Renminbi funds converted from registered capital should still be based on real transaction. Thus it is more accurate to define the pilot scheme as “conversion at will”, rather than “use at will”.

3.  Equity Investment by converting registered capital

Though there is no fundamental change to the administration principle over the registered capital, there is indeed one noticeable change to the Circular 36. Equity investment by converted registered capital is no longer prohibited. Circular 36 provides separate rules applicable for general types of FIE and FIEs whose principal activities relate to investments.

  1. General Type of FIE

For equity investment made by the general type of FIE, the invested enterprise shall complete registration formalities for reinvestment in China with the foreign exchange bureau locally and open a Converted Currency Payment Account of its own. The investor will transfer the Renminbi converted in accordance with the actual investment scale to the Converted Currency Payment Account opened by the invested company. Use of the funds by the invested company in the Converted Currency Payment Account should still be subject to the same administrations by SAFE.

  1. Foreign Invested VC/PE Funds

According to the langue in the Circular 36, FIEs whose principal activity is investment can convert the registered capital in accordance with the actual investment scale. Those FIEs, as clearly listed by Circular 36, include: foreign invested holding companies (“CHC”), foreign invested venture capital enterprises (“FIVICE”), and foreign invested equity investment enterprises. The converted Renminbi of those FIEs can be transferred to the bank account of the invested company, as long as the investment is real and complies with the law.

Before the promulgation of Circular 36, the conversion of the registered capital could be subject to more restrictions and limits, especially for foreign invested VC/PE funds. As a nationwide policy, it was only feasible for foreign invested VC funds to invest into start-up new, high-technology companies with their converted registered capital. Conversion of registered capital to make equity investments in Renminbi by other foreign invested equity investment enterprises are only allowed and permitted in a local level under pilot programs and with several restrictions (known as local QFLP policies granted on a case by case basis), those restrictions may include strict qualification review of the foreign fund manager; the size the of the fund; a quota imposed on the registered capital that can be converted; the industries and sectors to be invested.

Under Circular 36, such restrictions seem to be removed from SAFE’s side. Procedurally, such change may help to facilitate a more efficient investment by foreign invested VC/PE funds.

Appendix: List of the Pilot Regions

  • Tianjin Binhai New District
  • Shenyang Economic Zone
  • Suzhou Industrial Park
  • Donghu National Innovation Demonstration Zone
  • Guangzhou Nansha New District and Hengqing New District
  • Chengdu Hi-tech Industrial Development Zone
  • Zhongguancun National Innovation Demonstration Zone
  • Chongqing Liangjiang New District
  • Heilongjiang Border Development and Open Foreign Exchange Administration Reform Pilot Scheme Area
  • Wenzhou Comprehensive Financial Reform Experimental Zone
  • Pingtan Comprehensive Experimental Zone
  • China-Malaysia Qinzhou Industrial Park
  • Guiyang Comprehensive Bonded Zone
  • Shenzhen Qianhai Shengang Modern Services Industry Cooperation Zone
  • Qingdao Wealth Management Comprehensive Financial Reform Experimental Zone