China began its experiment to internationalize the national currency by permitting companies outside of China and certain Chinese financial institutions to issue debt denominated in renminbi ("RMB"). Since then, a small but growing number of companies have issued RMB bonds in Hong Kong. Like their culinary counterpart, these "dim sum bonds," named after a type of Cantonese cuisine, have often been served in bite-size morsels, with one of the first offerings as low as RMB200 million (US$30 million). However, the market for these bonds is rapidly growing and, in the first six months of 2011 alone, 22 issuers raised over RMB19 billion (US$2.9 billion) through dim sum bond sales. Although the majority of these issuers have been Hong Kong companies (including Chinese companies that have publically listed in Hong Kong), an increasing number of international players, such as McDonald’s, Caterpiller and Unilever, are developing an appetite for this new debt class.
The interest in dim sum bonds is driven by a number of factors. These include: the ability to issue debt at relatively low interest rates (in June 2011, Unilever sold RMB300 million of RMB bonds in Hong Kong with a yield of 1.15 percent); expectations that RMB will continue to appreciate over the near- and mid-term; and the limited investment options for RMB held offshore. On this last point, it is worth noting that some analysts expect total deposits of RMB in Hong Kong to reach RMB1 trillion (US$155 billion) by the end of 2011. The treasure trove of offshore RMB and the limited options to invest such funds have created a tension in the marketplace that China is now beginning to address.
On June 3, 2011, the People’s Bank of China ("PBOC") issued a circular (Circular on Issues Concerning Cross-Border RMB Transactions) (the "Circular"). The Circular officially formalized an existing pilot program (the "Pilot Program") that allows foreign companies to invest RMB held outside of China back into mainland China. If successful, the Pilot Program will open up foreign direct investment ("FDI") channels for investors, including dim sum bond issuers, to send offshore RMB back into the mainland.
Several key provisions of the Circular are summarized below.
Prior to the Circular, Chinese financial institutions were permitted to repatriate offshore RMB into the mainland for specified non-investment purposes. In February 2011, the Ministry of Commerce People’s Republic ("MOFCOM") issued a notice (the "MOFCOM Notice") that appeared to broaden the scope of eligible entities by requiring foreign investors to obtain MOFCOM approval with respect to any investment of RMB into China before proceeding to "other relevant procedures." Unfortunately, the "other relevant procedures" were never specified, which led many to wonder whether offshore RMB could, in fact, be invested onshore. The Circular clarifies this uncertainty by providing that all foreign companies (including Chinese companies that have listed in Hong Kong) may, subject to approval by PBOC and MOFCOM, invest back into China RMB that they have "lawfully obtained" from offshore markets. Thus, there is now an official regulatory basis for offshore RMB (including RMB that is raised in an offshore dim sum bond offering) to be brought into China for certain investment purposes (summarized below).
Investments under the Pilot Program are subject to various foreign investment restrictions. For example, foreign companies may not invest offshore RMB into sectors of the economy that are categorized as "restricted" or as "under macroeconomic control." According to a PBOC statement, such sectors would include the real estate and financial sectors.
The scope of permitted investments for offshore RMB includes both equity and debt investments. On the equity side, offshore RMB can be used in connection with mergers and acquisitions (excluding mergers and acquisitions that fall under the definition of "round-trip investments"1) to finance the establishment of new companies in China and to complete equity transfers and capital increases for existing companies. On the debt side, offshore RMB may only be used to provide shareholder loans to subsidiaries in mainland China.
Application and Approval Procedures under the Pilot Program
The application and approval procedures under the Pilot Program are as follows:
- Foreign investors who wish to invest offshore RMB into China must apply to MOFCOM to approve their investment into China.
- After obtaining approval from MOFCOM, the foreign investors must then select a PRC settlement bank. The PRC settlement bank will, on behalf of the foreign investors, submit the application forms required by the PBOC to the local branch of the PBOC (the "Local PBOC").
- The Local PBOC reviews and submits the application to the national PBOC, which then determines whether to grant approval.
- The national PBOC informs the Local PBOC as to whether it has approved or denied the application and, upon receipt of approval by the national PBOC, the Local PBOC issues a filing notice (the "Filing Notice") to the relevant PRC settlement bank.
- The PRC settlement bank establishes RMB settlement accounts and conducts cross-border RMB settlement activities for the foreign investors in accordance with the Filing Notice.
As evidence of China’s resolution to further internationalize RMB, Vice Premier Li Keqiang recently announced that China would take a series of measures to improve the mechanisms available to invest offshore RMB into mainland China, which would include implementing a quota for qualified foreign institutional investors to invest offshore RMB in mainland securities markets, continuing governmental support for RMB FDI and allowing shareholders of foreign-invested banks to increase their capital contributions with offshore RMB.
Following Vice Premier Li’s announcement, MOFCOM issued a draft circular (Circular on Issues Concerning Cross-Border RMB Direct Investment) ("Draft MOFCOM Circular") for public comment on August 22, 2011, in an effort to officially formalize the approval process for RMB FDI. Under the Draft MOFCOM Circular, foreign investors would be permitted to directly invest RMB that has been "lawfully obtained" in offshore markets back into mainland China, subject to approval by competent authorities. "Lawfully obtained" RMB generally refers to RMB that has been accumulated in connection with (i) cross-border trade settlements; (ii) the issuance of offshore RMB bonds or securities; and (iii) dividends and disposition proceeds of, and registered capital reductions or liquidation events with respect to, PRC foreign-invested enterprises.
Pursuant to the Draft MOFCOM Circular, MOFCOM will delegate partial approval authority with respect to approving RMB FDI investments to its local counterparts, while central MOFCOM will maintain ultimate approval authority under certain specified circumstances. Each application to MOFCOM or its local counterparts for a proposed RMB FDI would be reviewed in accordance with existing laws and regulations concerning foreign direct investment and, where required by MOFCOM or its local counterparts, applicants must submit additional documents, including (i) a written statement and related evidence describing the source of the RMB funds; (ii) the intended use of such funds; and (iii) an undertaking that the RMB funds will not, unless otherwise approved by MOFCOM, be used to directly or indirectly invest in securities or financial derivatives, to provide entrustment loans or to repay existing loan obligations.
While the Circular and the Draft MOFCOM Circular are a leap forward in terms of formalizing a cross-border RMB investment regime, many questions remain unanswered. For example, the Circular does not specify the underlying criteria that MOFCOM or its local counterparts will use to determine whether to approve an RMB FDI application. In addition, the Circular and the Draft MOFCOM Circular are silent regarding how a foreign-invested company in China that is capitalized by foreign-invested RMB may repatriate funds (e.g., profits distribution, capital reduction, shareholder loan repayment or distribution of liquidation proceeds) to its offshore parent, and whether such repatriation should (or would) be in RMB or a foreign currency.
If history offers any insight, further implementing guidelines will likely be issued at a later date. For now, those willing to test drive the Pilot Program must weigh the potential risks and rewards carefully.