Huang Caihua, Associate, Foreign Direct Investment

Recently, the Chinese government issued a couple of new laws and regulations to curb overseas “hot” money and strengthen the administration of foreign exchange. On August 5, 2008, the State Council amended and promulgated the Regulations on Foreign Exchange Administration of the People’s Republic of China which requires that foreign exchange and the fund for settlement in a capital account should be used as approved by relevant approval authorities. On August 29, 2008, the Circular of Relevant Implementation Questions Concerning the Improvement of Administration of Payment and Settlement of Foreign Exchange Capital of Foreign Invested Enterprises (the “Circular”) was then issued by the State Administration of Foreign Exchange (“SAFE”), according to which the RMB settled from the capital account of a foreign invested enterprise (“FIE”) should be used in accordance with the business scope approved by the governmental agencies and may not be used to make equity investments in China. This means foreign investors cannot directly make use of the foreign exchange in their capital account to invest in China, which is expected to have a major impact on domestic re-investment by FIEs.

In the past, a number of foreign investors used to invest in China by first establishing a FIE and then using the FIE as an investment arm to re-invest in China. Please note such an FIE referred to here is not the so-called “foreign funded investment company” (“Investment Company”) which is a special entity set up by foreign investors to mainly engage in direct investment in China. Rather it refers to such a FIE whose business scope may include production, retail, wholesale of products, consulting or technology services or other businesses rather than “investment” as permitted under PRC law.


Interestingly, the item of “investment” is normally not allowed to be included in the business scope of a FIE by approval authorities like the Ministry of Commerce (“MOFCOM”)  and corporate registration bodies like the State Administration for Industry and Commerce (“SAIC”) along with their local counterparts. However,  the Provisional Regulations on Investment within China by Foreign Invested Enterprises which was promulgated dated July 25, 2000 jointly by MOFCOM and SAIC does grant a FIE a qualification to re-invest in China. In practice, a FIE is permitted to conduct investment in China e.g. acquiring the equity interests of other FIE(s) or domestic company(s), but a FIE is required to use RMB to make such investment under the current PRC law. Thus a question arises: if a FIE has no or cannot obtain sufficient amount of RMB by whatever lawful means, could it be allowed to convert funds into RMB from its capital account for the purpose of investment?

Before the issuance of such a Circular, the above-mentioned question has for a very long time confused not only foreign investors, its lawyers, and other consultants, but also some local officials of SAFE partly due to the reason that SAFE did not clarify this question by issuing an official and universally-applicable rule. As a result the answer to this question has to depend, to large extent, on the local regulatory practice. Not surprisingly, in practice, some local offices of SAFE held a view that a FIE should not be allowed to exchange the foreign currency from its capital account into RMB for purposes of re-investing in China on the grounds that the foreign currency deposited in such account had been specially approved to satisfy the defined project as described in the business scope. In the meantime, some others officials held different views and allowed the FIE to settle the foreign exchange into RMB to satisfy the needs of re-investing in China. This is particularly the case where a local government is thirsty for foreign investment and it may be driven to take a more flexible policy.

Now, with the promulgation of the Circular, the door to direct re-investment by FIE(s) using the RMB settled from its foreign exchange capital account in China is closed. If a FIE happens to come upon a good investment opportunity, it will have to use its accumulated RMB profits or income or borrow RMB from domestic banks.

As is known in recent years, international “hot” money has unnerved the Chinese government which has thus taken a series of measures to cope with the issue. Without doubt the new rule is intended to strengthen the administration of foreign exchange flow and curb the inflow of hot money. However while it may contribute to the strengthening of its foreign exchange administration and the stability of its economic growth, it may also add the cost of making re-investment by foreign investors through their FIE(s) in some cases more difficult from a commercial perspective.