On October 14, 2011, MOFCOM released its Circular on Issues Relating to RMB Cross Border Direct Investment dated October 12, 2011 (the "Circular"). The Circular provides for a framework to regulate direct investments into mainland China of Renminbi legally obtained outside mainland China (the "Offshore RMB").   

Ideas behind the Circular 

The Circular is part of China's efforts to expand cross border use of RMB[1].  Direct investments made by foreign investors with Offshore RMB (the "RMB FDI") is one way to return Offshore RMB onshore, to facilitate investment by foreign investors, and to make RMB more acceptable to global investors, all of which ultimately serve the purpose of internationalizing RMB step by step and reducing risks associated with accumulating excessive foreign exchange reserve.

Key terms of the Circular   

  1. Scope of Offshore RMB

Under the Circular, Offshore RMB includes (i) RMB legally acquired by foreign investors through settlement of international trade, (ii) RMB received by foreign investors as a result of profit distribution, equity transfer, reduction of registered capital, liquidation or early return of investment in mainland China but has been remitted outside, and (iii) RMB legally acquired or raised by foreign investors outside mainland China by means of, including without limitation, issuance of bond or securities denominated in RMB.

  1. Regulatory authorities

Local counterparts of MOFCOM are responsible for approving RMB FDI in accordance with existing PRC rules and regulations relating to foreign direct investment.   However, any of the following RMB FDI activities shall be first examined and verified by central MOFCOM: (i) investment equal to or more than RMB300,000,000; (ii) investment in sectors that are subject to macro-economic control of the State such as finance security, finance lease, micro finance and auction; (iii) investment in foreign invested investment companies[2], foreign invested venture capital enterprises or equity investment firms[3]; and (iv) investment in such sectors as cement, steel and iron, electrolytic aluminum and ship building.  The application in respect of RMB FDI in the above areas must be submitted to MOFCOM for examination and verification by its local counterparts, and MOFCOM shall complete such examination and verification within five working days.

  1. Industries in which Offshore RMB can be invested

Under the Circular, Offshore RMB may be used to invest in any industry as long as foreign direct investment rules are complied with, with an exception that it may not be used to invest, directly or indirectly, in securities or financial derivatives in mainland China, and may not be used for entrustment loans.  

The Circular indicates that Offshore RMB may be used in such transactions as private placements and share transfer in respect of a PRC public company.  In this case, these transactions would be subject to the existing Administrative Measures Regarding Strategic Investment by Foreign Investors in Public Company (《外国投资者对上市公司战略投资管理办法》).

Implication of the Circular on Foreign Invested VC/PEs in China

Pursuant to the Circular, Offshore RMB can be used to invest in a foreign invested VC/PE firm in China.  However, such investment is subject to examination and verification by MOFCOM (as described above), in addition to the usual approval procedures for all foreign investments, thereby adding time pressures and uncertainty.

The State Administration of Foreign Exchange ("SAFE") will likely continue to play an important role in the process.  First, for any foreign investor having Offshore RMB, although RMB FDI enables it to bring in Offshore RMB directly, avoiding the procedure of converting foreign currency to RMB, the foreign investor must open a RMB settlement account onshore (the "Bank Account") to remit the Offshore RMB into mainland China, and all direct investments of Offshore RMB must flow from such Bank Account.  It is unclear whether or not transfer of any amount from the Bank Account to a company receiving the investment is subject to SAFE examination and verification.  Secondly, for the purpose of capital verification enquiry by an accountant, SAFE may be required to verify authenticity of capital contribution through Offshore RMB.  In any event, the company receiving the Offshore RMB will be treated as a foreign invested enterprise and therefore still subject to general SAFE regulation in respect of foreign direct investment.  Thirdly, with respect to any re-investment made by an Offshore RMB invested company (e.g. foreign invested investment company), SAFE will examine and verify such re-investment, although such approval is for the purpose of verifying capital contribution and not of currency conversion.  

That said, we expect that the examination and verification process of SAFE or its local counterparties as described above will generally be procedural.  As a matter of practice, SAFE normally issues internal guidance on how it would examine and verify certain matters, and such guidance generally sets forth legal basis, documents to be submitted, key points to be examined and verified, and so forth.  However, the guidance on matters regarding RMB FDI is not yet available, and we shall report again as they are released.