Foreign Exchange Reforms Expanded in Qianhai Free Trade Zone

By Wang Shouqun, Li Chengjiao and Shi Nian

T he State Administration of Foreign Exchange’s Shenzhen branch has unveiled a policy document aimed at deepening the reform of foreign exchange management in the Qianhai Free Trade Zone. The policy has a number of innovative features regarding the use of capital account foreign exchange for investment purposes as well as facilitating foreign exchange income payments and cross-border financing.

The document, issued in July, is formally known as the Detailed Rules for the Implementation of Promoting the Pilot Program for Foreign Exchange Reform in China (Guangdong) Pilot Free Trade Zone Qianhai & Shekou Area of Shenzhen (SAFE Shenzhen Branch Document No. 19 [2019]). It is a more detailed version of a reform document issued in 2018 and will be referred to in this article as Document 19 for the sake of convenience.

As stipulated in Document 19, “non-investment foreign-funded enterprises within this zone may use capital account foreign exchange income or renminbi funds acquired through foreign exchange settlement to purchase stakes in domestic companies. The renminbi funds used for this purpose must conform with the actual investment scale and be in accordance with relevant law”. This article examines the use of overseas capital for investment in domestic companies.

According to the Notice of the State Administration of Foreign Exchange on Reforming the Settlement Management Mode of Foreign Exchange Capital for Foreign-Funded Enterprises(SAFE Document No. 19 [2015]), foreign capital and renminbi funds obtained from foreign exchange settlement by foreign-funded enterprises shall not be directly or indirectly used for expenditures outside the scope of business operations or in areas prohibited by national laws and regulations.Investment-oriented foreign-funded enterprises may transfer the renminbi funds from direct settlement of foreign exchange capital or “accounts for settled foreign exchange to be paid” to the invested enterprise. The sums transferred must conform with actual investment amounts.

Non-investment foreign-funded enterprises that want to use foreign exchange funds to buy stakes in domestic companies need to transfer the renminbi funds obtained from foreign exchange settlement to the “settlement foreign exchange to be paid account” of the target enterprise. In such cases, the invested enterprise should first register for domestic reinvestment and open the “settlement to be paid account” with the SAFE branch (bank)where the company was registered.

According to the Notice of the State Administration of Foreign Exchange on Reforming and Regulating the Policies for the Administration of Foreign Exchange Settlement under the Capital Account (SAFE Document No. 16 [2016]), foreign exchange receipts under the capital account and the renminbi funds derived from related settlement may be used for expenditures under the current account within the scope of an enterprise’s business operations. The funds may also be used for expenditures under the capital account as permitted by laws and regulations, but may not be used directly or indirectly for expenditures outside the scope of business operations or in areas prohibited by national laws and regulations.

Based on the above-mentioned policy requirements, overseas funds can be used to purchase stakes in domestic companies in the following manner. Investors can set up a new investment company to invest in domestic companies, or realize their investment objectives through mergers and acquisitions according to relevant laws and regulations. They could also establish a platform enterprise with domestic equity investment as part of its business scope.This could include domestic foreign-invested venture capital investment enterprises, domestic investment companies founded by foreign investors, or foreign-invested equity investment enterprises established in mainland China based on regional and nationwide regulations. Document 19 has opened a new path for overseas funds to invest in domestic companies through equity stakes and made it more convenient for offshore funds to be used to support domestic enterprises.

However, there are issues that should be addressed to ensure successful implementation of any such transaction.

First, at the macro level, this innovative measure allows non-investment foreign-funded enterprises to invest their renminbi funds derived from capital settlement to purchase a stake in a domestic corporation. The issues that still need to be clarified include whether there are relevant restrictions on the business scope of foreigninvested equity investment enterprises, whether there is a cap or proportional limit for investments and whether there are any different requirements between “foreign-invested equity investment enterprises” and “non-investment foreign-funded enterprises” as far as investing in domestic companies is concerned. As for enterprises whose main business is equity investment, no matter whether it is domestically funded or foreignfunded, current laws and regulations have already provided detailed rules and requirements designed to ensure the stability of financial markets and the underlying economy.

The second area where clarity is needed is how this differs from the merger and acquisition activities of domestic enterprises by foreign investors. According to the Provisions of the Ministry of Commerce on M&A of a Domestic Enterprise by Foreign Investors, approval procedures established by the Ministry of Commerce or a provincial commerce department must be complied with. These apply to mergers and acquisitions of a domestic enterprise by foreign investors, including foreign investors purchasing an equity interest from shareholders of a domestic enterprise with no foreign investment or subscribing to a capital increase by a domestic company with the result that the domestic company becomes a foreign-invested enterprise(equity merger acquisition), or the foreign investor establishes a foreign investment enterprise and then, through that enterprise, purchases the assets of a domestic enterprise by agreement and operates such assets.

Document 19 has provided new methods for foreign investors to acquire domestic enterprises.Foreign investors can set up a general foreigninvested enterprise first and realize an acquisition of a domestic company by means of a merger afterwards. In such cases, whether enterprises should follow the same procedure specified in the Provisions of the Ministry of Commerce on M&A of a Domestic Enterprise by Foreign Investors still needs to be further determined by regulatory authorities.

Third, there are regulatory requirements on the subsequent use of capital that can be used for domestic equity investment. Previously, the rules barred the use of capital settlement funds for making securities investments, entrusted loans or the repayment of inter-enterprise loans. There is now a need for more clarity in how to prevent the use of capital settlement income as a disguised channel for stock market purchases.

Expanding the Scope of Payment Facilitation

According to Document 19 “enterprises in the policy trial zone may make use of the provisions for facilitating payments using foreign exchange income under the capital account.” The provisions state that non-financial enterprises registered in the trial area (except real estate companies and government financing platforms) and classified as a “Category A” company under the list of foreign exchange receipts and payments of trade in goods do not need to provide proof of authenticity on each instance of a request to make a payment.They also must have no record of foreign exchange administrative penalties in the past year or since their establishment if they have been founded less than one year ago.

The payment facilitation trial program was launched in early 2018. One of its purposes was to change the regulatory management practice of requiring the submission of authenticity materials in advance on a case by case basis for payments.This changed the capital account foreign exchange income payment of enterprises from “approval first” to a “payment first” formula. It simplified the formalities in foreign exchange income payments under the capital account and shortened the entire procedure as well. Building on these prior reforms,Document 19 further relaxes the scope and requirements of the pilot project.

Facilitating Cross-border Financing Operations

Document 19 stipulates that “enterprises in the policy trial area that have already chosen the formula based on the difference between actual investment and registered investment for regulation of their foreign borrowings may change to the macro-prudential management method.Once a change is made, however, there should be no further changes.

Document 19 also states that “consistency requirements on the contract currency used in cross-border financing, the designated withdrawal currency and repayment currency are relaxed.”It states that the currency used in a bank account withdrawal and repayment in the trial zone can be different from that of the currency referred to in contracts. However, the currency chosen for making bank account withdrawals and for repayments should be consistent.

Currently, foreign borrowings by onshore companies are generally managed under two guiding principles – one is based on the difference between registered capital of a company and the company’s actual investment. The other is regulatory management under macro-prudential guidelines. According to the Notice of the People's Bank of China on Matters Concerning the Macro-Prudential Management of Cross-Border Financing(PBOC Document No. 9 [2017]) , within one year from the issuance date of Document 9 (January 12, 2017), foreign-funded enterprises and foreignfunded financial institutions could choose to be regulated under either of these methods as well as the two listed in Document 9. After a period of one year, the central bank and SAFE was supposed to make a determination of which method applied based on overall implementation requirements.Provisions in Document 19, however, make it clear that foreign-funded enterprises may continue to choose from either of the two types.

Document 9 requires that for cross-border financing purposes there should be consistency among currencies as stated in contracts and for any related funds withdrawn from a bank account and used in repayments. Document 19 relaxes this requirement, however. Enterprises only need to ensure that account withdrawal and repayments are made in the same currency and these can differ from any currency stated in a business contract.This change expands enterprises' financing options.

Registering the Discharging of Debt

As specified in Document 19: “In the pilot region,the registration of foreign debt cancellation may be handled at any bank within the jurisdiction of the Shenzhen foreign exchange office. The time limit for enterprises to complete this procedure shall also be eliminated.” Previously, enterprises in the free trade zone, in accordance with the Measures for Foreign Debt Registration and Administration,needed to complete the registration formalities at the foreign exchange bureau within one month from the last payment on outstanding debt. The new policy greatly simplifies procedures.

Document 19 provides new support for companies operating in the Qianhai Free Trade Zone. As a core driver of growth in Guangdong-Hong Kong-Macao Greater Bay Area, Qianhai has natural advantages in the introduction of foreign capital and thus has great significance in the further deepening of reform as well as promoting development in the region.