The State Administration of Foreign Exchange (SAFE), China’s foreign exchange regulator, recently issued the Notice on Further Promoting the Convenience of Cross-border Trade and Investment (in Chinese: 国家外汇管理局关于进一步促进跨境贸易投资便利化的通知) (the Notice) which took effect from October 25, 2019. The Notice has introduced a variety of measures to further relax regulatory controls over foreign exchange income and payment in respect of current account transactions (e.g. import/export of goods and services) and capital account cross-border transactions (e.g. equity investment and debt financing).
We highlight below some key changes under the capital account regime which may be of particular interest to foreign investors.
- Ordinary foreign-invested enterprises (FIEs) may now make equity investments in China with their capital fund
Previously, in practice, only “investment-type” FIEs (such as foreign-invested holding companies and foreign-invested venture capital/private equity investment enterprises) were allowed to use their capital funds in making further onshore equity investments. Now, with the implementation of the Notice, ordinary FIEs which do not have “investment” in their business scope may also make onshore equity investments with their capital funds (whether denominated in a foreign currency or denominated in Renminbi) provided that (i) the restrictions of the applicable Negative List (see below for more information) are complied with and (ii) the investment is genuine and legitimate.
As background, China has established a legal regime under which foreign investments may enjoy national treatment unless otherwise falling within the scope of the “Negative Lists”, which set out the industries in which foreign investments are prohibited, restricted or subject to special administrative measures. The latest version of the national Negative List was issued by the National Development and Regulatory Commission and the Ministry of Commerce and came into effect on July 30, 2019. Foreign investments into the pilot free trade zones in China are subject to a separate Negative List.
Practically, allowing ordinary FIEs (rather than just the investment-type FIEs which are subject to more stringent market entry restrictions and requirements) to use capital funds for further equity investments in China is a significant relaxation of China’s foreign exchange control over capital account transactions. The change will also provide an easier path for foreign investors to make further investments in China through their existing “ordinary” subsidiaries in the country.
- The use of Renminbi funds converted from foreign currency income derived by Chinese sellers from cross-border M&As now enjoys simplified procedures at banks
Under the previous rules, foreign currency proceeds received by Chinese sellers from disposal of equity interests in domestic companies to foreign buyers may be converted into Renminbi for use in China; however, prior to processing payments by using such Renminbi funds for the Chinese sellers, the relevant commercial banks must review and be satisfied with the supporting documents evidencing the use of such funds.
Under the Notice, commercial banks may process payments of the Renminbi funds according to the payment instructions of the Chinese sellers directly, rather than having to make such payment exercise conditional upon the banks’ satisfactory review of the supporting documents as mentioned above. This change will expedite the Chinese sellers’ access to the proceeds generated from cross-border M&As, which used to be a concern of many Chinese sellers when selling domestic targets to foreign buyers (and hence, Chinese buyers were often preferred) under the previous regime. Beyond just a procedural relaxation, it is also understood that under the Notice, the Renminbi funds so derived will no longer be subject to the previously applicable stringent requirements in the usage of such funds but will instead be treated in the same way as other Renminbi income of the Chinese sellers.
- Foreign currency deposits paid by foreign investors may now be converted into Renminbi and used for justifiable purposes in China
Under the previous rules, foreign currency deposits paid by foreign investors for potential transactions in China could not be converted into Renminbi. Such foreign currency deposits may only be used either as the relevant foreign investor’s capital contribution (in a greenfield investment project) or as payment of the transaction price of the underlying transaction (or be refunded to the foreign investor if the transaction does not proceed).
Such deposits may now be converted into Renminbi and used for the above purposes, as well as for the purpose of settling liquidated damages/compensation if the foreign investor is in default of its contractual obligations.
- Foreign debt de-registration procedures simplified
Under the previous rules, Chinese borrowers outside the banking sector were required to conduct foreign debt de-registration procedures with the competent local counterparts of SAFE within one month after the final repayment of the principal and interest.
According to the Notice, such a borrower may now conduct the foreign debt de-registration procedures with a qualified local bank (rather than having to make the application to a local SAFE). The one-month time limit restriction mentioned above has also been lifted by the Notice.
- Foreign debt quota control relaxed in designated pilot areas
The borrowing by Chinese borrowers from foreign lenders has been subject to tight control by SAFE. Historically, a FIE may borrow from such sources up to the difference between its total investment and its registered capital (or, on a pro-rated basis if the registered capital has not been contributed in full). A new regime was introduced in 2016 whereby a Chinese non-financial enterprise (being a FIE or a purely domestic company) may borrow foreign debt within a quota which, under the current rules, is essentially equivalent to two times of its net assets value. Each such foreign debt shall be registered with the competent local counterpart of SAFE.
Under the Notice, non-financial enterprises located within the designated pilot areas may conduct a foreign debt registration with the local counterpart of SAFE for a total amount equivalent to its eligible quota as explained above, and subsequently may borrow foreign debts through its account bank directly. There is no need to conduct a case-by-case registration of each such foreign debt with local SAFE as long as the total quota has not been exceeded. According to a spokesman of SAFE, the designated pilot areas will include the Guangdong-Hong Kong-Macao Greater Bay Area and Hainan Province.
China’s foreign exchange control regime concerns all cross-border transactions to a greater or less extent and often plays an important role in driving transaction structures and financing arrangements for transactions. China has made progress in relaxing the control and restrictions in this space over the past few years and further reforming initiatives are being considered. Shortly after the Notice was issued, the State Council issued Opinions on further Improvement the Utilisation of Foreign Investment (in Chinese: 国务院关于进一步做好利用外资工作的意见) on November 7, 2019 which, amongst other things, states that China will lower the cost of cross-border use of funds and will issue new rules to support FIEs in expanding the cross-border use of Renminbi, enlarge the scope of pilot programs to improve payment convenience under capital accounts, and to encourage FIEs to use their capital funds for further equity investments in China.
There will be more changes to come in the future – investors should continue to watch this space.