On 28 February, the State Administration of Foreign Exchange (SAFE) issued the Notice on Further Simplifying and Improving Administrative Policies on the Direct Investment of Foreign Exchange (Forex Notice) and its complementary Guidelines for the Operation of Foreign Exchange Transactions Relating to Direct Investment, which took effect on 1 June.

The Forex Notice brings about changes in forex compliance relating to foreign direct investment and outward direct investment with the purpose of simplifying forex procedures for direct investments in China by foreign investors (FDI). These include new establishment of foreign-invested enterprises and acquisitions of Chinese enterprises by foreign investors as well as outward direct investment (ODI).

FDI compliance

Previously FDI forex operations were governed by the Notice on the Issuance of the Regulations on the Administration for Foreign Exchange in Respect of Direct Investment in China by Foreign Investors and Supporting Documents (Direct Investment Notice) and the Notice on Issues Related to the Administration of Foreign Exchange of Offshore Financing and Round-trip Investment via Special Purpose Vehicles (SPVs) by Persons Resident in China (SPV Notice). Under the Direct Investment Notice and SPV Notice, FDI forex registration had to be carried out with the competent forex administrative bureau, the entire registration procedure being 15 working days.

The Forex Notice brings changes to FDI forex compliance, among other things, by delegating downward the authority for carrying out FDI forex registration from the forex administrative bureau to the bank. It also abolishes the registration of confirmation for non-monetary capital contributions of newly established foreign-invested enterprises and the registration of confirmation for capital contributions of a foreign investor that acquires equity from a Chinese counterparty. Further, the Forex Notice does not set forth any time requirements, but allows the bank to decide at its own discretion; this thus gives enterprises greater control as there usually exists a commercial relationship between the enterprise and the bank.

Matters worth noting

During an acquisition by a foreign investor of a Chinese enterprise, the target enterprise will register its basic particulars as a foreign-invested enterprise before being able to make a payment. The business licence of the target enterprise which indicates the change in shareholder must then be submitted when carrying out that forex registration. This implies that the shareholder of the target enterprise is changed to the foreign investor before the Chinese counterparty receives acquisition payments and may expose the Chinese counterparty to uncertain risks.

Previously the confirmation and registration of capital contributions by a foreign investor acquiring equity from a Chinese counterparty set out under the Direct Investment Notice was the final administrative protection of the Chinese counterparties’ rights and interests. Pursuant to the Direct Investment Notice, if the foreign party did not pay the acquisition consideration, it could not remit income (by means of or through liquidation, capital reduction, equity transfer, early recovery of investment, profits, etc.) derived from the target enterprise outward or use the same for reinvestment in China, even where it has become the shareholder.

While the Forex Notice simplifies the forex administrative procedure, it also takes away the last administrative protection for the Chinese counterparty by abolishing the registration requirement. The Chinese counterparty thus must draft the equity transfer agreement carefully – especially the terms and conditions with respect to the payment schedule of the foreign investor and the liability for breach of these terms – when involved in an acquisition by a foreign investor. Certain protective measures, e.g. opening a joint escrow account for the acquisition payments, must also be taken to ensure that the acquisition payments are safely credited to its account.

ODI compliance

ODI forex operations previously were governed by the Notice on Further Adjusting and Improving Administrative Policies on the Direct Investment of Foreign Exchange and the SPV Notice. Under these, forex registration (including initial registration, amendment, cancellation, and late registration) in connection with outward investments by Chinese enterprises and the SPVs set up by individuals resident in China had to be carried out with the competent forex administration bureau.

Now that the Forex Notice has taken effect, changes have been made to the forex compliance requirements relating to ODI. The registration of ODI forex and startup costs (with the aggregate outward remittances not to exceed US$3 million or 15% of the total investment of the Chinese enterprise in principle) is delegated to the bank.

Filing for the record outbound reinvestment of forex by the Chinese-invested offshore enterprise is also abolished. The initial forex registration in connection with the SPVs of individuals resident in China, and amendment and cancellation thereof are also delegated to banks. Notwithstanding the downward delegation of authority, the quantity of application materials required to be submitted to the bank for registration are substantively the same as those previously required by the exchange control bureau.

It should be noted that the exchange control bureaus retain authority over the registration of ODI startup costs with the aggregate outward remittances exceeding US$3 million or 15% of the total investment of the Chinese enterprises. Cases where the amounts exceeding such limits will be reviewed by the competent forex administrative bureau in accordance with its collective review system for individual cases. Furthermore, late forex registration in connection with the SPVs of individuals resident in China has not been delegated downward from the forex administrative bureaus; the bureaus will continue to handle these cases where a violation of exchange control laws and regulations is suspected.

Conclusion

The Forex Notice changes the compliance requirements specified in existing regulations governing FDI and ODI. This reflects the government’s intention to gradually relax foreign exchange restrictions governing capital accounts.

However, with respect to ODI, the authors note that the Forex Notice only delegates the authority for forex registration in connection with outbound direct investment and repatriation of offshore profits downward to banks, without substantively simplifying the steps or application materials involved. In this respect, it is hoped that SAFE will adopt more substantive measures so as to provide further flexibility to the forex administrative system for capital accounts relating to cross-border investment.

Chen Miaojie is a partner and Qiu Mengyun is an associate of AllBright Law Offices in Shanghai