The State Administration of Foreign Exchange (SAFE) issued the Notice of the State Administration of Foreign Exchange Regarding the Reform of the Administration of Foreign Exchange Registered Capital Settlement¹ for Foreign-Invested Enterprises [Huifa (2015) No. 19] (Circular 19) on 8 April 2015.

Circular 19 allows foreign-invested enterprises (FIEs) to convert their foreign exchange capital into Renminbi (RMB) at any time of their choosing, permits FIEs to use RMB converted from their foreign exchange capital for making equity investments within China, as well as streamlining the regulation of the use of, and payments made with, such RMB funds.

Currently, capital accounts (including without limitation, an FIE’s paid-up foreign currency capital) are not freely convertible into RMB, which limits the funding flexibility of FIEs. While there has been much debate about the introduction of full capital account convertibility, a clear timeline is still awaited.

In the interim, the changes gradually brought in by SAFE’s recent policies, including those under Circular 19, should help to better meet the operational and funding needs of FIEs. Circular 19 will take effect on 1 June 2015 and replace SAFE Circulars 142, 88 and 36 that are currently applicable. Set forth below is a summary of the salient points of Circular 19.

• Foreign exchange registered capital settlement at any time of FIE’s choosing. Under Circular 19, FIEs will be able to convert their foreign exchange capital to RMB whenever they see fit; 100% of such foreign exchange capital can be converted to RMB on this basis. By contrast, under the current policy FIEs are permitted to convert foreign exchange registered capital into RMB only when they have actual RMB payment needs. This change would enable FIEs to better hedge currency risk.
• Limitation on usage of RMB funds converted from foreign exchange capital. In addition to reiterating the policy that FIEs’ uses of converted RMB funds should only be for self-use, Circular 19 specifically prohibits an FIE from directly or indirectly using such RMB funds for:
  • Businesses outside its scope of business
  • Securities investments, unless otherwise permitted by other laws
  • Making entrustment loans, repaying loans owed to another non-bank company or repaying bank loans that have been on-lent to third parties
  • Paying for real estate other than real estate which it uses, unless the FIE itself engages in real estate development business.
• All types of FIEs² are allowed to use RMB converted from foreign exchange registered capital to make equity investments in China. Circular 19 no longer bans FIEs from using the RMB funds converted from their foreign exchange registered capital to make equity investments within China. This change is significant since, among other reasons, it will better facilitate a foreign investor’s ability to effectuate equity investments in China through its existing FIEs, rather than an offshore investment vehicle. Where the investment is in sectors where foreign investment is encouraged or permitted, using an FIE as an investing vehicle could be advantageous, because in the establishment phase of such investment it would be subject to a simpler and speedier regulatory process than if the investment were made through an offshore entity.
• Regulation of payments of converted RMB funds. Similar to the current policy, payments of RMB funds that are converted from an FIE’s foreign exchange registered capital out of the FIE’s account are generally subject to the handling bank’s review for confirmation of the payments’ authenticity and compliance. Specifically, banks are required to check the authenticity and compliance of the last payment when the bank is processing each payment out of an FIE’s RMB account. While Circular 19 eliminates the specific and onerous list of documents required for the review under the current policy, it remains to be seen what documentation different banks might require in practice.

Pending full convertibility of FIEs’ capital accounts, FIEs’ uses and payments of RMB funds converted from foreign exchange capital will still be under strict control. Circular 19 does, however, point in the direction of greater flexibility in using capital accounts and thus in structuring transactions. The details of implementation will ultimately determine the extent to which the full promise of Circular 19 is fulfilled. As in other aspects of Chinese business regulation, the effectuation of transactions no longer subject to government approval or government-mandated documentary requirements, will still need to comply with banks’ requirements. Circular 19 is a welcome step towards the further relaxation of capital controls. It gives FIEs and foreign investors additional flexibility in their PRC investments by allowing them to better manage currency risks and enhance their options for viable PRC investment structures.

1. “Foreign exchange capital settlement” (“Wai Hui Zi Ben Jin Jie Hui”) in the context of China’s foreign exchange control regime means the conversion of a foreign-invested company’s paid-in foreign currency registered capital into Renminbi (RMB). In this alert “settlement”, “settle” and “conversion”, “convert” are used interchangeably.
2. Prior to Circular 19, only FIEs whose businesses are making equity investments, such as foreign-invested holding companies, foreign-invested venture capital firms and foreign-invested PE firms, are permitted to make equity investments within China using their foreign exchange capital.

Client Alert 2015-096