By Xiong Jin, Feng Caihong, Liu Qing and Wei Kao  King and Wood Mallesons’ Mergers & Acquisitions Group

On November 19, 2012, the State Administration of Foreign Exchange (“SAFE”) promulgated the Circular Regarding Further Improvement and Adjustment of Policies on Foreign Exchange Administration of Direct Investment (Hui Fa [2002] No. 59, the “Circular”) which aims to dramatically simplify foreign exchange administration procedures concerning inbound and outbound direct investment. The Circular is a response to a directive to reduce administrative approvals in the Decision of the State Council on the Sixth Abolishment and Adjustment of Administrative Examination and Approval Projects (Guo Fa [2012] No. 52) promulgated by the State Council on 23 September 2012, and it also reflects a trend of relaxing foreign exchange supervision given China’s accumulation of major foreign exchange reserves. The Circular will be become effective on December 17, 2012 and is expected to have a significant impact on foreign direct investment and outbound investment by domestic enterprises.

I. Overview of the Major Changes

Compared with the current foreign exchange regulatory regime over direct investment, the Circular has made major improvements in the regulatory and administrative process by downscaling required approvals for certain registration matters, with a view to monitor foreign exchange fund flow and foreign exchange quotas through registration systems. The major changes made in the Circular include:

A. Elimination of certain pre-approvals under direct investment

The Circular has substantially reduced the routine pre-approval steps required in the current procedures, including but not limited to: (i) approvals for account opening, cash remittance, foreign exchange conversion and purchase and payment of foreign exchange; (ii) approval for onshore transfer of foreign exchange in the direct investment; (iii) approval for re-investment by foreign investors with their legitimate income generated in China; and (iv) capital verification inquiries for capital reductions.

B. Simplifying current administrative procedures

The Circular also simplifies the types of foreign exchange accounts under direct investment and abolishes the special foreign exchange account for foreign investors (for purposes such as acquisition, guarantee, investment, expenses). After the adjustments, the foreign exchange accounts relating to direct investment are classified into seven categories: foreign exchange account for upfront expenses, foreign exchange capital account, account for onshore/offshore assets realization, special account for onshore/offshore deposits and special account for onshore re-investment.

Moreover, the Operation Manuals attached to the Circular also greatly simplify the application documents and shorten the processing timeline. For many matters, the processing timeline for approval is shortened from the current 20 working days to 3 or 5 working days.

C. Relaxing restrictions on fund utilization under direct investment

Compared with the current practice, the Circular permits multiple foreign exchange accounts and accounts opened in locations other than the registered offices. In addition, the sources for offshore lending are also expanded and the conditions for offshore lending are relaxed, permitting domestic entities to make offshore loans with domestic foreign exchange loans and foreign invested enterprises (FIEs) to make loans to its offshore parent company.

II. Impact on Onshore Direct Investment by Foreign Investors

The regulatory adjustments reflected in the Circular are expected to have a significant impact on the onshore direct investment by foreign investors, in particular the foreign direct investment, the re-investment of FIEs and the acquisition of equity interests in domestic enterprises by foreign investors, which will be further elaborated as follows:

A. Foreign direct investment

The Circular adopts many measures to simplify the foreign exchange regulatory procedure with respect to foreign direct investment and, if implemented properly, it is expected to greatly simplify the current foreign exchange administrative procedure of foreign direct investment. Due to the elimination of the approval for the foreign exchange account for upfront expenses, prior to the establishment of foreign invested enterprises, the foreign investors will only need to file certain information with SAFE, then the foreign investors are allowed to open the foreign exchange accounts in banks and remit foreign exchange funds within the quota prescribed and carry out the upfront activities related to such direct investment. During the different phases of establishment, operation and termination of FIEs, once the relevant approvals from the competent authorities are obtained and upon the registrations (i.e. set-up registration, change registration, de-registration) with SAFE, the foreign investors can directly open the foreign exchange account, transfer of funds and make purchase and payment of foreign exchange through banks. The bank will be responsible for filing documentation with SAFE once such activities are completed.

In addition, one of the most the important steps of foreign direct investment process – the capital verification inquiry – is also simplified compared to the current policy. The inquiry and verification can be processed online, and accounting firms can directly file applications through SAFE’s online system without submitting hard-copy materials, and use SAFE’s online reply as a basis for the capital verification. At the same time, the verification requirement for capital decrease by FIE’s foreign investors are also eliminated. Accounting firms can use the filing information in SAFE’s system as the basis for such inquiry and verification.

B. Onshore re-investment of FIEs

Major adjustments in foreign exchange administrative procedure are also being made with respect to the onshore re-investment of FIEs. Under the current regulatory regime, a prior approval from SAFE is required if a foreign investor has subscribed to the capital increase of an FIE with the capital reserve fund, surplus reserve fund, undistributed profit and registered foreign debts of such FIE that owned it or makes re-investment with the proceeds lawfully obtained such as profit from onshore investment, consideration for equity transfer or income generated as a result of capital increase or liquidation of the FIEs it invested. However, under the Circular, the administrative procedure is downscaled from approval to registration, whereby banks can make the fund transfer and accounting firms can conduct the inquiry and verification based on the registration information available in SAFE’s online system.

The Circular also simplifies the administrative procedure for onshore re-investment of foreign-invested holding companies (“FIHCs”). The current requirement for foreign exchange registration by the target company is removed as well as the approvals for the onshore transfer of investment fund by FIHCs and remittance of foreign exchange profit and dividends from FIEs to FIHCs. When the onshore re-investment of a FIHC is in the form of foreign exchange, the target company can open a special re-investment account with a bank upon registration with SAFE for the purpose of receiving such onshore re-investment foreign exchange and the funds from such account will be administrated and regulated as if it were the foreign exchange capital of an FIE.

C. Acquisition of Equity Interests in Domestic Enterprises

The foreign exchange administrative procedure for acquisition of equity interests in Chinese enterprises by foreign investors is also simplified under the Circular. Unlike the current practice, a domestic target company is no longer required to make onsite registration with SAFE for the purpose of the proposed equity transfer if the foreign investor pays the purchase price in foreign exchange from an offshore account. In such event, once the banks have completed filings with SAFE to confirm the purchase price is in place, SAFE’s online system will be automatically updated with the confirmation registration for the acquisition of equity interests by foreign investors. The above procedure will be slightly different if the purchase price is paid, in part or in whole, through non-monetary means, whereby the domestic target company shall submit the application to the local SAFE for the confirmation registration of the acquisition of equity interests by foreign investors.

III. Impact on Outbound Investment by Domestic Enterprises

To further support the “Go Global” strategy by Chinese enterprises, the Circular also brings significant changes in foreign exchange regulatory regimes governing the outbound investments of domestic enterprises. Major changes include:

A. Remittance of the upfront expenses for outbound investment

Under the Circular, the current requirement for the prior approval for the remittance of the upfront expenses for outbound investment by the domestic enterprises is downscaled to a registration with SAFE. Upon such registration, the banks will handle the foreign exchange purchase and outbound payment procedure for the domestic enterprises based on the registration information available in SAFE’s online system. However, in practice, many enterprises choose to use their offshore foreign exchange to satisfy such upfront expenses requirements for outbound investment due to the requirements to obtain such approval (for instance, normally such approval would require a project approval issued by competent authorities as opposed to a written application as set out in the application documents for the foreign exchange approval for upfront expenses). Hence, although such changes brought by the Circular may, to some extent, help to relieve the difficulties facing domestic enterprises in the upfront expenses of the outbound investment, the long-term impacts on actual implementation remain to be seen.

B. Offshore lending by the domestic enterprises

Similarly, the Circular replaces the prior approval for the remittance of the funds from the special account for offshore lending with the quota registration. If implemented, the banks will handle the foreign exchange purchase and remittance for the purpose of the offshore lending by domestic enterprises by using the registration information available on SAFE’s online system. In addition, the sources of the offshore lending are also expanded to include domestic foreign exchange loans (other than the self-owned foreign exchange fund, foreign exchange purchased using RMB and foreign currency pool verified by SAFE permitted under the current regime). Furthermore, the Circular would also permit an FIE to make offshore lending to its offshore parent company provided that the amount of the lending is not greater than the sum of the distributed but unremitted profits and the proportionate undistributed profits. It is expected that the above adjustments will alleviate some of the difficulty of financing outbound investment by domestic enterprises.

It is worth noting that the Circular has come with certain appendices, including the Operation Manuals for Foreign Exchange on Direct Investment (both a SAFE version and the bank version), which suggests SAFE has been preparing for such regulatory changes for quite some time and has taken into account some industry practices. If properly implemented, the new change introduced by the Circular can have significant and positive impact on direct investment in China by making the current regulatory regime much more efficient. The Circular aims to further improve the investment climate in China as well as to support the domestic enterprises to further adopt a “Go Global”strategy.

(This article was originally written in Chinese, the English version is a translation.)