On July 14, 2014, the State Administration of Foreign Exchange (the “SAFE,” Chinese regulator on foreign exchange matters) promulgated the Circular on the Relevant Matters Concerning Foreign Exchange Administration on Outbound Investment/Financing and Round-Tripping Investment through Special Purpose Companies by Domestic Residents (the “Circular No. 37”).
This new Circular supersedes all prior SAFE regulations on round-tripping investments, including the well-known Circular on Issues Relating to Foreign Exchange Administration of Financing and Round-Tripping Investment by Domestic Residents Utilizing Offshore Special Purpose Companies of 2005 (the “Circular No. 75”).
In a typical “round-tripping investment” structure, a Chinese entrepreneur will first incorporate/acquire a foreign special purpose vehicle (“SPV,” often a Cayman or elsewhere shelf company). The SPV will then act as the issuer to be listed offshore after it establishes holding structure of the relevant underlying assets/business within China by an inbound acquisition. Foreign public investors can then acquire the indirect ownership title to the Chinese underlying assets/business by subscribing to the SPV’s shares. Given the burdensome statutory requirements on direct overseas listing/financing of Chinese enterprises, Chinese entrepreneurs used this structure very often for indirectly attracting foreign capital.
Under the Circular No. 75, Chinese entrepreneurs were required to register extensive details in respect of their offshore structures with the competent SAFE branches. Failing to complete such registration, a Chinese entrepreneur may encounter huge obstacles when remitting the funds raised overseas into China.
Many local SAFE branches further held different views and discrepant standards in implementing the Circular No. 75 during the past years. This has made the Circular No. 75 one of the major hurdles in Chinese entrepreneurs’ offshore private placement and IPO attempts.
Major Changes under the Circular No. 37
Wider Scope of Entities and Activities to be Covered
The Circular No. 75 only regulated those SPVs holding assets or equity within China for offshore financing/listing purposes. Now the Circular No. 37 has broadened the scope of “SPVs” to cover offshore enterprises either directly or indirectly held by Chinese entrepreneurs, and such SPVs can hold assets or equity either inside or outside of China.
Also, the definition of “round-tripping investment” is expanded to cover not only direct acquisition of Chinese underlying business by a SPV (strictly regulated by the Circular No. 75), but also all of green-field investment, contractual control and other means for a SPV to gain a stake in China.
Clarified and Simplified Registration Formalities
The Circular No. 37 and its implementing guidelines provide for clearer and simplified procedural rules on SAFE’s review and registration. These new rules have also relaxed the required disclosure requirement by local entrepreneurs. In the past, a thorough disclosure of details of every layer of a Chinese entrepreneur’s offshore shelf companies was required. Now, a domestic entrepreneur only needs to register certain details of the first level of the offshore SPV structure.
Other Noteworthy Developments under the Circular No. 37
The Circular No. 37 further introduced, for the first time, the foreign exchange registration regime of stock option plans issued by private offshore SPVs to the Chinese employees of the entrepreneurs. This provides more flexibility for Chinese entrepreneurs to structure their offshore investment and financing transactions.
The effect of the Circular No. 37 is yet to be tested, since local officials are still discussing operative details for these new rules’ implementation. However, it appears that Chinese entrepreneurs could now structure their overseas investment and financing with SPVs through a more straightforward SAFE formality. For foreign counterparties or financiers, the Circular No. 37 also offers more predictability and transparency on the status of Chinese parties’ clearance of governmental procedures.