Two years ago PRC authorities officially launched a trial regime for cross-border RMB trade settlements . More recently, PRC authorities have expanded the permitted usage scope of RMB funds to outbound and inbound direct investments, although still on a trial basis. China’s Central Bank the People’s Bank of China (“PBOC”) has taken the lead during the first six months of 2011 in deregulating the PRC’s capital account transactions by issuing two sets of rules in January and June, which respectively facilitate RMB-denominated overseas direct investment (“ODI”) by domestic institutions and inbound RMB-denominated foreign direct investment (“FDI”). This alert summarizes those key developments and briefly updates channels for offshore RMB to access PRC capital markets.
RMB ODI by Domestic Institutional Investors
On January 6, 2011, PBOC issued the Administrative Measures for Trial Program of RMB Settlement of Overseas Direct Investment (the “ODI Measures”). The ODI Measures permit domestic institutional investors established in pilot regions to make RMB-denominated direct investments in certain offshore enterprises or projects by way of greenfield investment, merger and acquisition, equity participation, or other means of acquiring direct ownership or actual control.
According to the ODI Measures, before a domestic institution is permitted to remit RMB funds outside of the PRC, either as pre-investment expenses or as actual investments, the investor must first register the RMB funds with the local foreign exchange bureau (“local SAFE”). To register the remittance of any pre-investment expenses (generally no more than 15% of the proposed total ODI amount) or the actual investments, as the case may be, the investor is required to provide local SAFE with relevant ODI application documents (pending approval), or the ODI approval issued by the Ministry of Commerce (“MOFCOM”) or its local counterparts.
Dividends, increases and decreases of registered capital, consideration monies, and any distribution proceeds upon winding up or dissolution of the offshore investment vehicle can also be paid in RMB through the relevant processing bank, subject to providing relevant corporate and/or government approval documents.
A domestic investor must report to local SAFE within 30 days any major changes to the offshore entity including any change of partners, capital increase, reduction, transfer or swap, or any merger, division or liquidation.
Onshore banks may extend RMB loans to offshore entities established or acquired by domestic investors either directly or indirectly through an overseas branch or overseas agent bank. PBOC exercises oversight over such financing. Banks should file recordals of RMB loans with relevant PBOC branches within 15 days of RMB remittances.
RMB FDI by Foreign Investors
RMB inflow back to mainland China by way of FDI was first approved by PBOC on a case-by-case basis in the second half of 2010, without public issuance of formal regulations. On June 3, 2011, PBOC released the Circular on Clarifying Relevant Issues Regarding Cross-Border RMB Business (“Circular 145”) which, among other things, sets forth for the first time the approval procedures for settling inbound RMB-denominated FDI by foreign investors.
According to Circular 145, non-financial foreign investors approved by PBOC on a case-by-case basis will be able to wire RMB funds that they have obtained legally offshore to establish new onshore companies, make acquisitions (excluding round-trip investments ), increase capitals of existing subsidiaries or make shareholders loans. However, it is important to note that foreign investors are currently banned from investing in certain restricted sectors or “key regulated” projects.
To curb the inflow of hot money, however, domestic settlement banks are required to closely monitor and record the onshore usage of RMB funds in order to ensure that funds are utilized within the approved business scope.
Circular 145 makes it clear that FDI RMB settlement is still at a trial stage and approvals will be granted on a case-by-case basis. Generally, the approval process is initiated by submitting an application by a foreign investor or a domestic settlement bank to a PBOC branch and the final approval is granted by PBOC headquarters. Circular 145 does not provide any specific timeframe for the approval procedures. According to informal inquiries with a PBOC official, currently the bank headquarters regularly convenes a special review meeting to examine and approve FDI RMB settlement applications. One of the key conditions for PBOC to grant approval is that the investment project itself has been approved by the Ministry of Commerce (“MOFCOM”), or its authorized local counterparts.
Given the current circumstances discussed above, it is unlikely that there will be a big increase in RMB FDI in the near future, pending further coordination between PBOC and MOFCOM and their joint issuance of standardized approval procedures.
To benefit from RMB FDI in the long run, some non-financial multinational corporations are looking at issuing RMB-denominated bonds in Hong Kong, Singapore or other offshore RMB settlement centers for PRC FDI purposes.
Channels for Offshore RMB to Access PRC Capital Markets
BOCHK Tapping Onshore Bond Markets
As cross-border usage of RMB has expanded, Hong Kong has emerged as the largest hub for offshore RMB. As at the end of May 2011, RMB deposits in Hong Kong have grown nearly six-fold over a period of 12 months to RMB548 billion (approximately USD85 billion). However, while offshore RMB deposits have proved popular, offshore RMB asset creation has lagged, with only approximately RMB130 billion being invested in Hong Kong in the form of RMB-denominated bonds (the only form of RMB financial instrument currently available offshore). Given the burgeoning amount of RMB deposits in Hong Kong, pressure has been building to provide access for offshore RMB to onshore capital markets.
In early July 2011, Bank of China (Hong Kong) (“BOCHK”), the only clearing bank for offshore RMB in Hong Kong, is reported to have been approved to use RMB funds held on behalf of other banks in Hong Kong to invest in the PRC bond market, primarily in sovereign debt and short-term notes issued by the central bank. The approval received by BOCHK to invest offshore RMB in PRC capital markets appears to have been given in response to increasing concerns that the RMB asset pool available in Hong Kong is too small.
R-QFII Program in Pipeline
The proposed R-QFII program is another potential channel for offshore RMB to flow back to PRC capital markets. As widely reported in the media, the CSRC is considering the launch of such a pilot program, which would allow domestic securities investment funds to raise RMB in Hong Kong and remit those funds within approved quotas back to China for investment in onshore capital markets.
This term “R-QFII” where “R” stands for RMB has been used to describe this channel, which will mirror the existing Qualified Foreign Institutional Investor (“QFII”) program. Under the QFII regime foreign institutions are allowed to convert foreign currencies into RMB within approved quotas to invest in PRC domestic securities markets.
The first approvals under the R-QFII program are likely to be granted to Hong Kong subsidiaries of major mainland securities funds. To date, the CSRC has approved 13 domestic fund-management firms to set up subsidiaries in Hong Kong, of which nine have obtained Hong Kong asset-management licenses, while three are managing publicly raised capital.
No specific timetable for the R-QFII program is publicly available, although as recently as mid-May this year, the head of the CSRC’s Funds Regulation Department reportedly said that the program could be launched soon. It is reported that CSRC has had in-depth discussions with relevant Hong Kong regulatory authorities and with the Hong Kong Stock Exchange on sources of funding for R-QFIIs, product structure and investment execution.