On December 2, 2013, the People’s Bank of China (PBOC) issued its Opinion Concerning Financial Support for Building up Shanghai Free Trade Zone. The opinion aims to support the government’s goal to accelerate China’s economic development and further expand cross-border investment and trade by facilitating the conversion between RMB and other currencies and market-oriented interest rate reform in the Shanghai Free Trade Zone (FTZ). The opinion only contains guidelines; implementation will occur after implementing rules have been adopted. This alert focuses on several major measures in the opinion that are related to outbound investment by Chinese persons and inbound investment in China by foreign investors.
Free Transfer of Funds
The opinion introduced the RMB and Foreign Currency Free Trade Bank Account (Free Trade Account), a new type of bank account that can be opened by FTZ residents (entities as well as individuals) in the FTZ and non-FTZ residents with banks or their branches in the FTZ. Free Trade Accounts opened by FTZ residents (Resident Accounts) not only can be utilized in the financing activities discussed in the next section, but also for free transfer of funds with any offshore bank accounts, domestic bank accounts of non-PRC persons, Free Trade Accounts opened by non-FTZ residents, and other Resident Accounts.
A Resident Account will enable its resident holder to bypass time-consuming approval requirements when converting RMB into foreign currencies for purposes of outbound payment or receiving foreign currency from trade, licensing or other transnational business activities. This undoubtedly will speed up cross-border transactions and also make the process more predictable.
Although a non-FTZ resident can open a Free Trade Account, the person can only enjoy the financial services afforded to PRC persons prior to the person’s entry in the FTZ.
Relaxed Restrictions Over Outbound Investment, FDI and Financing
The opinion has simplified the foreign exchange related approval process for and relaxed restrictions on outbound investment by Chinese FTZ residents. Specifically:
- Chinese FTZ residents can make outbound investments without approval from the State Administration of Foreign Exchange (SAFE) and can convert RMB directly into foreign currencies for remittance out of China for investment purposes;
- FTZ resident individuals1 can invest offshore, including investing in foreign securities. Theoretically, offshore investment by Chinese individuals has long been permitted under PRC law. However, we have seen no successful incident of an individual actually obtaining approval for any such offshore investment. Whether the opinion simply reiterates a mere theoretical possibility or actually loosens up the practical restraints remains uncertain, especially when offshore investment requires approval from various other authorities;
- FTZ resident enterprises can provide loans to their offshore operating subsidiaries without SAFE approval (currently, foreign-invested enterprises may not lend to offshore affiliates and domestic enterprises may lend to offshore affiliates with approval by SAFE and other relevant authorities);
- Financial and other enterprises established in the FTZ may borrow RMB (enterprises outside the FTZ may only borrow foreign currencies offshore) from offshore entities after obtaining approval from government authorities; provided, however, that the borrowed RMB funds cannot be used to invest in securities and derivative products, or as entrusted loans;
- FTZ resident entities can apply for approval to remit guarantee payments out of China directly with banks without having to obtain approval from SAFE; and
- Financial lease companies engaging in offshore financing lease business need only register with (rather than seeking approval by) the relevant government authority, and may receive lease payments in foreign currencies directly.
The opinion allows foreign investors in an enterprise in the FTZ to make foreign exchange registrations with banks instead of SAFE and to freely convert foreign currencies in capital accounts to RMB based on the enterprise’s needs. This measure will not only shorten the approval process for foreign direct investment, but may also give foreign-invested enterprises (FIEs) in the FTZ more freedom in using their capital, especially considering that non-FTZ resident FIEs are still prohibited by SAFE Circular 142 from using their funds to acquire domestic companies.
Cross-Border RMB Transactions
Under the Opinion, RMB settlements by FTZ resident entities under both current and capital accounts can be handled directly by banks located in Shanghai, while the banks must still comply with the rules of “Knowing Your Customer,” “Knowing Your Business,” and “Due Diligence Investigation” for anti-money laundering and identity theft prevention purposes. Also in response to the fast expanding online shopping and electronic payment industry, the opinion permits financial institutions in Shanghai to provide RMB settlement services to online payment service providers located in the FTZ for cross-border e-commerce transactions.
Because the PBOC only has administrative authority over banking and (through SAFE, its subordinate body) foreign exchange control, this opinion does not apply to other governmental examination and approving procedures, including approval from Ministry of Commerce or its local branches on inbound or outbound investment, approval from National Development and Reform Commission on outbound investment, and registration with State Administration of Industry and Commerce or its local counterparts on inbound investment, to mention but a few. Furthermore, implementation of the concepts in the guidelines will be forthcoming only with the issuance of implementing rules by SAFE.
Considering that one of the major obstacles for outbound investment is the difficulty of exchanging RMB to foreign currencies under China’s foreign exchange control system, this Opinion, if fully implemented, will encourage more offshore investment by Chinese persons. On the other hand, many of the liberalizing measures in the opinion call into question whether the Chinese government will relinquish the foreign exchange control and supervisory system it put in place for decades. Whether the other agencies with supervisory authority over other aspects of inbound and outbound investment will respond with offsetting measures is a matter of speculation.