On 23 October 2019, China’s State Administration of Foreign Exchange (SAFE) issued a circular which liberalises foreign exchange control for foreign investment and cross-border trade. Known as Circular 28, the Circular on Further Promoting the Ease of Cross-Border Trade and Investment now gives foreign investors more choices when structuring their investments in China and simplifies certain foreign exchange requirements. In this bulletin we set out the key liberalisation measures introduced by Circular 28.

I. Non-investment foreign invested entities (FIEs) now permitted to convert foreign exchange capital into RMB for equity investments in China

II. Foreign exchange control on capital account items simplified

III. Foreign exchange control on current account items also simplified

IV. Our observations

I. Non-investment foreign invested entities (FIEs) now permitted to convert foreign exchange capital into RMB for equity investments in China

Prior to Circular 28, only FIEs whose registered business scope included equity investment business (for example, China investment holding companies (CHCs) and Qualified Foreign Limited Partnership (QFLP)) were allowed to convert foreign exchange capital into RMB for equity investment in China. Circular 28 now permits non-investment FIEs to do the same, provided that certain conditions are met. These include that the equity investment project is genuine, compliant, and is not restricted under the Negative List for foreign investment. The investee companies will need handle the re-investment registration requirements with SAFE (or an authorised bank) and open a special account. The investing FIEs can then transfer the converted RMB into the special account. Payments out of the special account will be subject to supervision, although this has been simplified as discussed in Section II.1 further below.

Circular 28 therefore gives foreign investors a choice of setting up a non-investment FIE as an investment platform in China, which can avoid the more stringent set up requirements for an investment FIE. However investment FIEs may still be a preferred structuring option as they continue to enjoy certain advantages (particularly in the case of CHCs) under the existing rules as set out below:

  • CHCs enjoy a higher quota for borrowing foreign debt. Under the current SAFE rules on foreign debt, a CHC can borrow up to four times its registered capital in foreign debt (for registerd capital of no less than USD 30 million) or six times its registered capital in foreign debt (for registered capital of no less than USD 100 million), while a regular FIE can only borrow foreign debt up to the difference between its total investment and its registered capital or twice its net assets. Further, Circular 28 does not remove the restriction on non-investment FIEs using foreign debt funding to make equity investments, whereas CHCs are permitted to do so under existing rules.

  • Converted foreign exchange capital from a CHC will sit in the common RMB capital account of the investee company, which is not subject to further supervision. However converted foreign exchange capital from a non-investment FIE is required to sit in a special account subject to special supervision.

  • CHCs can be recognised as a regional headquarters under local rules, entitling them to certain favourable governmental subsidies, tax and other policies.

Note that these advantages should be further reviewed if the old rules governing CHC are changed by any new rules following the effectiveness of the Foreign Investment Law in 2020.

II. Foreign exchange control on capital account items simplified

1. Payments out of special account permitted without bank verification in certain pilot areas

Since 2016, subject to certain requirements and restrictions on fund usage, FIEs have been able to convert foreign capital account items (including capital, foreign debt and the proceeds of an overseas listing) into RMB funds at will. Such converted funds are required to sit in an RMB special account and generally can only be used upon the bank’s verification that the funds will be used only for legitimate purposes. The bank generally requires the transaction documents or other materials to be submitted for the verification exercise which must be completed prior to the actual payment being made. The verification process may, therefore, result in delays to payments being made.

Circular 28 now exempts companies located in certain pilot areas (including Shanghai and the 18 free trade zones across China) from the requirements for prior bank verification. We understand from some banks that they have been providing this favourable treatment to companies with good records in areas including the Shanghai Free Trade Zone, Shenzhen, Suzhou and the Fujian Free Trade Zone.

It is important to note, however, that SAFE’s post-procedure supervision will still apply such that SAFE or banks may conduct inspections from time to time and require supporting documents for previous payments out of the special account.

2. Foreign debt registration regime simplified

Prior to Circular 28, onshore companies were required to register each foreign debt borrowing with their local SAFE which was burdensome and time consuming. Circular 28 now allows a company located in certain pilot areas (including Guangdong-Hong Kong-Macao Greater Bay Area and Hainan) to register with local SAFE a one-off foreign debt quota of up to twice the company’s net assets. The company is then permitted to borrow directly through the bank within the registered quota.

Foreign debt is also regulated by the National Development and Reform Committee (NDRC). According to its rules, any foreign debt with a tenor of more than one year incurred by a PRC entity (or any offshore branch or subsidiary controlled by it) requires filing with the NDRC. Previously, this requirement was not strictly followed in practice. However, over the past two years, the NDRC has issued announcements emphasising the need to comply.

Circular 28 also replaces the foreign debt de-registration procedure with local SAFE by a de-registration procedure with the local bank.

3. Other relaxations

Circular 28 lifts the restrictions on conversion of foreign exchange in onshore realisation account. An onshore realisation account is a domestic company’s specially opened bank account to receive payments from foreign investors. Prior to Circular 28, such foreign exchange conversion was regulated in the same way as the FIEs’ capital, with bank verification required prior to payments and restrictions on making equity investments.

Circular 28 now allows the money in a foreign exchange deposit account to be used for other onshore investments or payments after the underlying transaction has been completed, and permits conversion into RMB for paying consideration or monetary remedies in relation to the underlying transaction.

III. Foreign exchange control on current account items also simplified

Circular 28 covers new policies on both capital account items and current account items. Key policies include:

  • exempting micro and small cross-border e-commerce companies with foreign exchange payments/receipts of less than USD 200,000 per year from the requirement to register as a foreign exchange payor/payee; and

  • enlarge the pilot areas where the foreign exchange receipt and payment verification procedures for goods trading are simplified.

IV. Our observations

While the liberalisation measures under Circular 28 are very welcome, detailed implementing guidelines from SAFE on how the new policies are to be implemented at the local level have yet to be released.

Also, the Foreign Investment Law is about to take effect from 1 January 2020, which is likely to lead to significant changes to the existing filing and registration regime for FIEs. The documentation requirements for banks and local SAFE to transact foreign capital for FIEs is also likely to change.

We also understand that many local banks are still exploring ways to take the new rules forward and are uncertain about how this will affect their practices and their clients’ funding plans. These uncertainties may have an impact on deal making and project timetable in near term.