Foreign Exchange Reforms Expanded in Qianhai Free Trade Zone
The 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 foreign-invested 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 foreign-funded，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