On June 16, 2011, the State Administration of Foreign Exchange of the People’s Republic of China (“SAFE”) issued the Circular on Improving the Administration of Banks' Own Foreign Exchange Settlement and Sales (“2011 Circular”). The circular has (1) optimized provisions regarding banks’ foreign exchange settlement and sales on behalf of an obligor issued in the 2004 Circular on Principle and Procedure for Approving Foreign Exchange Settlement and Sales of Banks’ Own Capital and Finance Projects (“2004 Circular”) and (2) provided specific standards for banks' foreign exchange settlement and sales activities involving banks’ capital.

Requirements for Banks in Foreign Exchange Settlement and Sales on Behalf of Customers

Under the 2004 Circular, a bank may purchase foreign currency on behalf of its obligor with RMB income received from the obligor as long as it falls under one of four stipulated circumstances which are: (1) RMB received pursuant to court judgments or arbitration awards; (2) RMB received upon the realization of mortgage or other pledged interests; (3) receipt of RMB-based security guarantees; or (4) RMB acquired through other legitimate processes.

The 2011 Circular sets out specific requirements to allow a bank to perform foreign exchange settlement and sales on behalf of its obligor. They are: (1) the obligor cannot perform the foreign exchange settlement and sales itself due to bankruptcy, dissolution of the business, suspension of the business, mismanagement, a legal dispute with the bank or other similar reasons; and (2) payment to the bank by the obligor or guarantor is from legitimate source, i.e., the four circumstances set out in the 2004 Circular. Therefore, the 2011 Circular further restricts the banks’ performance of foreign exchange settlement and sales to cases where banks’ obligors are unable to perform such activities themselves.

The 2011 Circular requires applications for such foreign exchange settlement and sales to be sent to the SAFE branch closest to the bank, which may lead to stricter scrutiny of such applications, while the 2004 Circular requires the application be sent to the SAFE location (a branch or sub-branch of SAFE) closest to the bank’s obligor.

Standards for Foreign Exchange Involving Banks’ Capital

The 2004 Circular does not have explicit guidelines for standards of foreign exchange involving banks’ capital. The 2011 Circular stipulates banks must ensure that “(the owner’s equity in foreign exchange + operating funds in foreign exchange)/assets in foreign exchange” approximately equals “(the owner’s equity in RMB + operating funds in RMB) /assets in RMB.”

In calculating the above formula, a bank shall: (1) only use the balance sheets of its domestic branches; (2) not double-count operating funds and owner’s equity; (3) deduct certain equities in foreign exchange acquired by policy reasons; (4) use the average of the end-dates of the last 4 calculating quarters for amounts due from the interbank market and amounts owed to the interbank market when calculating its assets in RMB.

The 2011 Circular notes that Chinese banks beginning to engage in foreign exchange, and foreign banks beginning to engage in RMB exchange, may apply for currency conversion but it is limited to no more than 10 percent of their capital funds.

The 2011 Circular also allows foreign banks that establish branches or subsidiaries in China to open foreign exchange accounts with domestic commercial banks. However, the total amount of inward remittance of foreign exchange to the account shall not exceed 5 percent of the registered capital of the branch or subsidiary during the establishment period. Additionally, foreign banks are allowed to conduct the pre-settlement of foreign currency exchange on a monthly basis or an actual expenditure basis for RMB, but the amount of the pre-settlement cannot exceed 105 percent of the previous month’s actual RMB expenditures.

For the full text of the 2011 Circular, please refer to the following Chinese language links: http://www.safe.gov.cn/model_safe/laws/law_detail.jsp?ID=80500000000000000,96