what we think

Certain activities will continue to require approval, but application materials and approval processes will be simplified.

Foreign exchange restrictions continue to be a challenge for international businesses that invest in a subsidiary in China. Approvals are necessary for just about every kind of transaction, from confirming the investment amount (registered capital) to contributions, to converting the foreign exchange to local currency for use in China and repatriating dividends. Foreign exchange restrictions add a level of complexity to foreign direct investment (FDI), and occasionally create serious challenges to a chosen business model or implementation strategy.

To encourage and facilitate FDI, the department in charge of foreign exchange - the State Administration for Foreign Exchange (SAFE) - as introduced new rules in the form of the "Circular on Issues Concerning Further Improvements and Adjustments of Administration Policies of Directly Invested Foreign Exchange", which will take effect on 17 December 2012. After summarizing the general contents of the Circular, we highlight two changes that will have a direct impact on foreign investors.

• Various activities that currently require administrative reviews and approval, will only require registration - thus cutting the time and administrative burden, and limiting the discretion of the local SAFE officers in rejecting an application. Examples are the opening of a foreign currency bank account; foreign exchange purchases, sales and settlement; and foreign exchange transfers between onshore bank accounts (e.g. to contribute dividends, proceeds or liquidated assets to a new investment).
• Certain activities will continue to require approval, but application materials and approval processes will be simplified. For example, the verification of a capital contribution can be verified through a computer system - CPA's no longer need to obtain a physical approval document from the SAFE.
• Restrictions will be relaxed or lifted entirely. For example, foreign-invested companies will be permitted to lend foreign currency to foreign companies, though restrictions remain on the amounts.

We highlight two specific changes that will impact foreign investors as well as some foreign individuals with assets in China.

Pre-investment Bank Accounts to pay Initial Expenses

A foreign investor can only pay in his registered capital after the company is established. This creates a gap - how can a foreign investor pay for initially pre-investment expenses such rents and rental deposits, and government administration fees, and even agency or legal fees? Chinese legal procedures have traditionally allowed investors to open a temporary bank account, but the SAFE approval procedures were so strict and impractical that very few foreign investors followed this approach.

The preferred solution is usually for the foreign investor to pay expenses directly, but then they cannot be included in the accounts of the invested entity. The Circular tries to solve this problem, by simplifying the procedures for a foreign investor to open a bank account pre-investment, and keeping the required information and documents to a minimum. After the WFOE or JV has been formally established, the amounts already contributed through this temporary bank account can then be included in the capital contribution. To avoid abuse of this channel to get funds into the China, some restrictions will continue to exist on the amount that can be pre-invested. Some limitations on how these funds can be used, should also be expected.

Conversion of Local Currency Proceeds for International Remittance

Foreign-invested companies, representative offices and foreign individuals that earn local currency from the sale of Chinese real estate or equity, or from liquidating a company, will be able to use the proceeds to purchase foreign currency
from the bank directly and can then remit this foreign currency abroad.

The erstwhile approval by the SAFE for such a conversion will be cancelled. Moreover, funds no longer need to leave the country from the location where the proceeds were earned. For example if one sells a house in Beijing, the proceeds can be converted and remitted abroad from a Shanghai bank account.

Conclusion: what potential impact?

The Circular does not liberalize all transactions on the capital account, but does go some way in easing restrictions on the handling of foreign exchange for investment purposes. Foreign companies that plan to invest in China, as well as foreign-invested companies (and even foreign individuals) that frequently encounter foreign exchange issues, should take note.