On 15 July 2014, the State Administration of Foreign Exchange (SAFE) issued the Circular of the SAFE on Relevant Issues Concerning the Pilot Reform in Certain Areas of the Administrative Method of the Conversion of Foreign Exchange Funds by Foreign-invested Enterprises(“Circular 36”), which came into effect on 4 August 2014. Circular 36 provides greater flexibility to foreign-invested enterprises (FIEs) in certain locations in China in converting foreign exchange in their capital account into RMB, and in particular it lifts the restriction on an FIE’s onshore equity investments with funds from their capital account.
As Renminbi is not a fully convertible currency, FIEs are subject to foreign exchange control when making transactions using either their current accounts or their capital accounts. While conversion for current account items (such as payments for imported goods and services, loan interest payments and profit distributions) is relatively straightforward, capital account transactions (such as payment of registered capital, cross-border fund borrowings and debt repayments) are subject to more restrictions.
As a general rule, FIEs can only convert the foreign exchange in their capital accounts into RMB and withdraw the converted funds on an as-needed basis. For each conversion and withdrawal, an FIE is required to provide various supporting documents evidencing the authenticity of the transaction to the bank for review and verification.
Furthermore, there are stringent rules on the purpose for which the converted RMB may be used. The converted RMB should only be used by FIEs in line with their approved business scope, for instance, for acquiring equipment and real property for self-use. Notably, FIEs are generally prohibited from using the RMB converted from their capital account balance to make equity investments in other companies in China due to restrictions set out in SAFE Circular 142 issued in 2008.
By a notice issued in February 2014, SAFE introduced certain liberalisation measures which relaxed the above restrictions on companies incorporated in the Shanghai Free Trade Zone (“Shanghai FTZ”). The issuance of Circular 36, which mirrors the measures implemented in the Shanghai FTZ since February, is seen as a step to further relax capital account settlement in more locations across the country. Circular 36 applies to 16 designated industrial parks, including Zhongguancun Science Park, Suzhou Industrial Park, Tianjin Binhai New Area, Shenzhen Qianhai, Hengqin New Area, Chongqing Liangjiang New Area, and Shenyang Economic Zone (“Pilot Areas”).
Conversion-at-will of foreign exchange in capital account
Under Circular 36, FIEs in Pilot Areas may choose to convert any amount of foreign exchange in their capital account into RMB at any time. The converted RMB will be kept in a designated account and if an FIE needs to make further payment from such account, it still needs to provide supporting documents and go through the review process with the banks.
If under special circumstances an FIE cannot provide supporting documents in time, Circular 36 grants the banks the power to provide a grace period to the FIE and make the payment before receiving the supporting documents. The FIE will then need to submit the documents within 20 working days after payment.
The above reform will facilitate the conversion process and allow FIEs to hedge risks of exchange rate fluctuation as they can convert the foreign exchange into RMB at any time.
Use of the converted RMB by FIEs
Pursuant to Circular 36, FIEs are still required to use the converted RMB within their approved business scope.
However, as a key highlight of Circular 36, FIEs in Pilot Areas are allowed to use their converted RMB to make equity investments in China (whether within or outside the Pilot Areas). Previously, due to the provisions of Circular 142, only special types of FIEs such as holding companies were permitted to convert funds in their capital accounts for use in equity investments, while other FIEs (like manufacturing companies) were practically restricted from making equity investments. The change brought about by Circular 36 potentially opens the door for foreign investors to set up investment platforms in the Pilot Areas to invest and hold equity interest in other companies in China.
In addition, FIEs in Pilot Areas with a primary business of equity investment (such as holding companies, venture capital and private equity firms) can now remit the converted RMB from their capital account to invest in their portfolio companies. Under the previous regime, they could only invest foreign exchange in their portfolio companies.
Under the prevailing regime across the country, stringent control is still imposed on foreign exchange conversion by FIEs. However, recent legislative reforms have witnessed a gradual liberalisation process being rolled out by the Chinese government. Starting with the Shanghai FTZ, SAFE has provided foreign investors with more options and flexibility in the conversion and use of foreign exchange. Both the reforms implemented in the Shanghai FTZ and the newly introduced Circular 36 are positive signs which reflect the Chinese government’s determination in reducing any unnecessary burden on FIEs, liberalising the conversion of foreign exchange funds and further pushing for RMB’s internationalisation.