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Legal: Foreign Exchange Control Reform
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Foreign Exchange Control Reform


By Manuel Torres (Managing Partner) and Lucy Luo (Associate) of Garrigues Shanghai


WBT201509_0042_Legal_-_002The Negative List is not the only reforming method carried out by Chinese government, in addition, the foreign exchange control led by State Administration of Foreign Exchange has been in progress in recent years.

FIEs in China have been subject to strict foreign exchange control for years, especially under capital account transactions. The reform on foreign exchange registration and capital registration was initially carried out in Shanghai FTZ in 2014 and is gradually applied to other pilot areas. On February 13th, 2015, Notice of the State Administration of Foreign Exchange on Further Simplifying and Improving the Policies of Foreign Exchange Administration Applicable to Direct Investment (“Circular 13”) was released, which intends to simplify the FDI foreign exchange registration procedure and offer more flexibility to the cross-border transactions. On April 8th, 2015, Notice of the State Administration of Foreign Exchange on Reforming the Administrative Approach Regarding the Settlement of the Foreign Exchange Capitals of Foreign-invested Enterprises (“Circular 19”) was released, which intends to relax the capital account settlement for all FIEs across the nation.

 

n SAFE Circular [2005] No. 13


Upon the effective date of Circular 13, June 1st, 2015, upon the effective date, foreign exchange registration at SAFE will be replaced with direct registration at qualified banks. Circular 13 also revokes the registration requirements regarding the confirmation of the monetary investment, non-monetary investment and consideration of equity transfer to the Chinese seller by a foreign investor and the revoked confirmation registration for foreign investor’s monetary investment will be replaced with registration at qualified banks. In addition, instead of foreign exchange annual inspection by SAFE, a foreign investor will be required to submit an annual report on SAFE’s information system by itself or its authorized accountant or bank.

 

n SAFE Circular [2015] No. 19


WBT201509_0039_Legal_highlight_01With the same effective date as Circular 13, Circular 19 comes into effective on June 1st, 2015. Under Circular 19, conversion-at-will of foreign exchange capital in capital accounts is allowed while the use of the converted funds is subject to certain conditions and bank’s review. After the foreign investor converts its foreign exchange registered capital, such converted RMB funds shall be reserved in a special RMB account (“Pending Payment Account”) to trace the usage of such funds. The converted RMB shall be used according to the PRC laws and regulations, in particular, Circular 19 set some prohibitions for the usage of the converted RMB funds, as these funds shall not be used for following purpose:

 

o Beyond business scope or prohibited by State laws and regulations

o Securities (except prescribed by laws and regulations)

o Making RMB entrusted loans (except permitted under business scope)

o Repaying inter-corporate loans (including third-party advances)

o Repaying RMB bank loans that have been sub-lent to third parties

o Purchase of real estate (except foreign-invested real estate enterprises)

 

As per our oral communication with Shanghai SAFE, under Circular 19 the FIE shall undertake in writing that all of the information provided by it for payment is true and authentic and the use of converted RMB funds shall be fully in compliance with the PRC laws and regulations within its business scope.

 

Other than the undertaking letter attached to Circular 19, Shanghai SAFE mentions that a standard undertaking letter is circulated to commercial banks, which requests the FIE to further undertake that the domestic reinvestment is not aiming to evade the foreign investment approval set by the Catalogue of Industries for Guiding Foreign Investment and equity investment is not the main business of the company.

 

It is further orally confirmed by Shanghai SAFE that FIEs with business scope covering “investment”, “investment consulting” or “investment management” are allowed to use the RMB capital in the Pending Payment Account for the contribution of registered capital to the companies invested by itself. To receive the contribution, the domestic company invested by the FIE shall register the domestic reinvestment with local SAFE (or the designated bank, as the case may be) and then open a Pending Payment Account.

 

Therefore, as qualification to use the converted RMB for domestic investment is subject to SAFE’s oral explanation and practice, the policy may be further adjusted. Take into account the commercial banks are authorized to enforce Circular 19, we also suggest consulting the details with the in-charge bank of FIEs.

 

WBT201509_0040_Legal_highlight_02The Draft Foreign Investment Law


The released draft Foreign Investment Law shows the PRC government’s strong effort to unify the legal system of foreign investment. Hereinafter, we would like to share some key features regarding this significant draft law.

 

The Ministry of Commerce (“MOFCOM”) released a draft of the Foreign Investment Law (“Draft”) for public comments on January 19th, 2015.

 

§ The Draft is aiming to replace the existing foreign investment legal framework by a uniformed foreign investment law.

§ This Draft is also designed for the purpose of keeping consistent with Company Law and other relevant laws and regulations.

§ The Draft also promotes the Negative List approach in order to simplify the approval procedure and offer national treatment to FIEs.

  • National Security review system will be improved to review all foreign investments that endangers or may potentially endanger national security.

The Draft expands the definition of foreign investor, under the Draft, a domestic company will be deemed as foreign investor if a foreign investor is:

 

o holding, directly or indirectly, more than 50% of shares, equity interest, share of property, voting power or other similar equity in the enterprise;

o being titled to, directly or indirectly, appoint more than half of the members of the decision-making body of an entity or holding sufficient voting power to have significant impact on the resolutions made by the decision-making body; and

o being able to have significant impact on the operation, finance, human resource or technologies by contractual control or trust arrangement.

 

The broader definition of foreign investor may question the feasibility of variable interest entity structure (“VIE”), which was first used by Sina.com and is now widely used by the foreign investors in those industries not allowing wholly owned by foreign funds, i.e. value-added telecommunication, education, etc..

 

WBT201509_0041_Legal_-_001It also provides a boarder definition of foreign investment, which not only covers green field investment and acquisition, but also iterates that he following activities directly or indirectly conducted by foreign investors shall be regulated as foreign investment:

 

o providing financing with a term of one year or more to their subsidiaries in China;

o obtaining a concession to exploit and develop natural resources in China or to build and operate an infrastructure project in China;

o obtaining real property rights in China; and

o controlling, or holding interests in, a domestic enterprise via contractual or trust arrangements or other means.

 

The Draft significantly expands the coverage to activities that were previously not subject to foreign investment review or reporting. Whether it could actually decrease the market entry barriers would be subject to the scope of the Negative List and the implementation of the Draft.

 

The foreign investment approval will adopt the Negative List model that has been applied in Shanghai FTZ, while the Information Reporting System, which requires the FIEs and their subsidiaries in China to upload Initial Information Report, Change Report and Annual report via the online reporting system provided by MOFOM, for those FIEs with total assets, sales income or revenues exceeding RMB 10 billion per annum in China, or having more than 10 subsidiaries in China, Quarterly Report is required for foreign investors.

 

The Draft expands the current scope of matters that are subject to national security review. Any foreign investment that endangers or may potentially endanger national security is subject to a unified national security review regime to be implemented by a joint committee, regardless whether any acquisition of controlling stake of domestic enterprises or any particular  is involved. Such a broad coverage raises much uncertainty to foreign investment, and hopefully the guidelines on national security review to be promulgated separately in the future will provide some detailed clarifications. The national security review decision shall be final and immune to administrative reconsideration and administrative litigation.

 

Under the Draft, the corporate governance of foreign invested entities should follow the same requirements as domestic enterprises under the PRC Company Law, the PRC Partnership Law and the PRC Individual Proprietorship Enterprises Law, etc.

 

For the VIE structure, which is commonly used by foreign investors to invest in Chinese enterprises which are restricted to foreign investment, the Draft provides following options:

 

o For those sectors permitted for foreign investment but not allowed wholly owned by foreign funds, the foreign investors could consider to use the joint venture structure to replace the VIE structure.

o For the prohibited sectors, VIE structure would not remain in the “grey area”, but would either be regularized or outlawed subject to the Negative List and the released provisions governing existing VIE structures.

 

The Draft allows the existing FIEs and VIEs to change the corporation governance structure to fully in compliance with the then stipulated Foreign Investment Law within a three-year transitional period.

WBT201509_0043_Legal_-_003

Outlook


China has progressively reforming relative laws and regulations for foreign investments in recent years. As a result of this, Chinese market is more opened to foreign investors than before.

 

Meanwhile, within the four FTZ, management measures will be/has been released by each FTZ to enforce the Negative List. The Draft Foreign Investment Law is subject to several rounds modifications, and before it comes into effective, current legal framework will continue to apply for certain period.

 

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