The State Administration of Foreign Exchange (SAFE) recently issued a circular that further regulates the process of foreign currency capital verification by foreign invested enterprises (FIEs) in China. This circular is one of a number of measures implemented by Chinese regulators in recent months to strengthen the management of the foreign currency conversion process and prevent “hot money” from flowing into China.  

On August 29, 2008, the General Affairs Department of SAFE issued the Circular on the Relevant Operating Issues Concerning the Improvement of the Administration of the Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, which went into effect on the same day. Circular 142 introduces more stringent requirements for the conversion and subsequent use of FIE foreign currency capital.

In July 2002, the SAFE reformed the management of foreign currency capital conversion by FIEs to allow qualified banks that met the SAFE requirements to handle conversions of foreign currency capital on FIEs’ capital accounts for FIEs without SAFE or its local offices’ prior specific approval of such conversions. However, loopholes in this regulation allowed FIEs to remit foreign currency into China under the guise of investment capital on FIEs’ capital accounts, convert it to RMB, and then use the RMB to make unapproved investments or speculations in China. In this way, irregular conversions of foreign currency capital were used as a channel for illegal hot money inflows. To block this channel, the SAFE set forth capital verification requirements in Circular 142 that increase scrutiny of the conversion process.  

Under Circular 142, before an FIE applies for any conversion of foreign currency capital into RMB, it must engage a qualified accounting firm to verify the amount in its capital account and issue a capital verification report, and it must present this report, along with supporting documents, to the bank. Before issuing a verification report, all accounting firms must confirm with the SAFE or its local offices. In addition, Circular 142 requires banks to verify the actual use of the RMB fund with the documentation before proceeding with the conversion. In any case, the amount of currency converted may not exceed the total verified capital of the FIE.  

Circular 142 limits FIE use of RMB converted from foreign capital in China to only those investments that fall within an FIE’s approved business scope. Circular 142 specifically prohibits FIEs from using RMB converted from foreign capital to purchase equity interests in Chinese domestic enterprises unless applicable rules otherwise allow for such an investment. In addition, unless an FIE is licensed as a real estate enterprise, Circular 142 explicitly prohibits the purchase of domestic real estate using RMB converted from foreign capital other than for the FIE’s own use. The FIEs must follow applicable laws and regulations in using RMB converted from foreign capital to invest in securities.

For approved foreign-invested investment companies to make equity investments in China, their domestic capital transfers must receive the SAFE’s prior verification and approval