Highlights:

• SAFE recently released a Circular easing foreign exchange control in the following major aspects: foreign exchange account opening and fund remittance, reinvestment by FIEs in China, investment by foreign investors’ domestic vehicles, outbound foreign exchange payment and outbound investment by domestic entities, which cover a wide range of major FDI and M&A activities relating to China.
• Foreign investors and other parties involved in China-related FDI and M&A transactions will benefit from the simplified procedures, reduced uncertainty, and shortened timeframe to handle foreign exchange matters.
• While the quota-based control is still there, under the Circular, foreign exchange control will be primarily exercised through a sophisticated registration and reporting system, under which banks will play an important role in facilitating the transactions by verifying the underlying documents and reporting to SAFE through such system.

Main Article:

China’s foreign exchange regulator, the State Administration of Foreign Exchange (“SAFE”), recently released The Circular on Further Improvement and Amendment of Foreign Exchange Control Polices on Direct Investment (the “Circular”), effective from December 17, 2012.

The Circular represents a significant step forward of SAFE to ease foreign exchange control over foreign direct investment (“FDI”) and M&A in China, and is reportedly aimed at attracting more foreign investment.

By way of background, most FDI activities and cross border M&A transactions require approval from SAFE based on application documents proving that the underlying transaction is lawful and genuine, and it typically takes one to five weeks to obtain such approval.  In terms of M&A transactions, SAFE’s control has been extremely strict and its approval is currently required for (a) opening of foreign currency account with a Chinese bank, which has to be a special purpose account set up for each individual transaction and usually bears a ceiling set for the amount of funds that may be received by the account, (b) remittance of foreign currency into that account, and (c) conversion of funds into the local currency (i.e. Renminbi) for payment to the domestic seller.

The Circular contemplates the following major amendments:

(1)               Account Opening and Fund Remittance. SAFE approval is no longer required for opening the special purpose account required for an M&A transaction.  The domestic seller may directly open accounts with its bank.  SAFE approval is no longer required for remittance of funds into such account.

(2)               Reinvestment by FIE in China.  A foreign invested enterprise (“FIE”) in China may re-invest in other domestic entities (including its subsidiary) by utilizing the proceeds obtained from capital reserve, retained profit, conversion of debt, and other legal means, without SAFE approval.

(3)               Investment by Foreign Investor’s Domestic Vehicles.  For foreign invested holding companies (which is a special type of company established by many MNCs to umbrella their investment in China), foreign invested venture capital and foreign invested private equity firms in China, there will be generally no foreign exchange registration required for their subsidiaries in China, and SAFE approval is no longer required for infusion of capital into, and repatriation of investment from, such subsidiaries.

(4)               Outbound Foreign Exchange Payment.  The Circular abolishes SAFE’s approval required for repatriation of proceeds obtained by foreign investor from liquidation and capital decrease of FIEs.  Where a domestic buyer acquires equity interests/shares held by a foreign investor in an FIE, the buyer may directly purchase foreign currency from bank and remit the same to the foreign investor, without having to obtain SAFE approval.  In addition, domestic entities may lend funds to overseas borrowers (subject to certain limitations).

(5)               Outbound Investment.  Where a domestic company makes outbound investment, no SAFE approval will be required for remitting the pre-investment expenses up to 15% of the total investment amount (while the remittance of the remaining investment amount is still subject to SAFE approval).

Comments:

The Circular abolishes a number of items for which SAFE approval was required, and is a significant milestone in the context of the overall foreign exchange control reform implemented by the Chinese government.

Foreign investors and other parties involved in China-related M&A transactions will benefit from the simplified procedures, reduced uncertainty, and shortened timeframe to handle foreign exchange matters.

Under the Circular, the foreign exchange control on FDI and M&A will still be primarily exercised through a pre-determined quota (which is assigned to each individual FIE or transaction) and a sophisticated registration and reporting system of SAFE connected with the system of banks.  Banks will take an important role in facilitating the transactions by verifying the underlying documents and reporting to SAFE through such system.  We still expect to see how the banks will implement the Circular, and it is anticipated that there will be a transition period for the new system starts to work.