Foreign Exchange Control Liberalisation: A Step Forward in the Investment Arena

Driven by its ambition to play a more dominant role in the world economy, make the renminbi more convertible and remain attractive to foreign investment, China has been taking steady steps to streamline its foreign exchange control. Dr Michael Tan and Cara Meng from Taylor Wessing observe the latest development and its potential impact on the foreign business community.

FDIOn 21st November, 2012, the State Administration of Foreign Exchange (SAFE) published their Circular on Further Improving and Adjusting Direct Investment Foreign Exchange Administration (Circular 59), which has a substantial impact on direct investment by foreign companies in the People’s Republic of China. By explicitly abolishing eleven old rules while simultaneously making public detailed implementation guidance for both banks and SAFE’s local branches, SAFE takes positive steps in further liberalising capital account control over foreign direct investment (FDI). We have outlined some of the circular’s highlights below:

Easier company establishment

For the incorporation of a foreign-invested enterprise (FIE) in China, opening up a bank account to receive foreign currency for the purposes of handling pre-establishment expenditures and acquisition of assets (e.g. land use rights) was always a convoluted process. In the past SAFE gave such accounts a specific classification, such as expenditures and assets acquisition, and their opening was subject to approval by SAFE on a case-by-case basis. Under Circular 59, the opening of a pre-establishment expenditure account no longer requires approval from SAFE. In connection with such an account, settlement in renminbi (RMB), payment for incorporation expenditures, transfer into a capital account of the established FIE and the returning abroad as a result of establishment failure will now involve only bank procedures.

Similar liberalisation also applies to the opening of FIE capital accounts to receive capital contribution and reinvesting by using RMB profits from existing investment projects in China.

Facilitated M&A

Foreign companies have been legally allowed to enter China via mergers and acquisitions (M&A) since 2006, with strict foreign exchange control being exercised over all M&A activities. For example, previously payment by a foreign company to acquire equity from a Chinese party used to require the Chinese vendor to open a special account (i.e. an “assets disposal account”) upon SAFE approval, and the receiving of the equity purchase price required further SAFE approval. Under Circular 59 these SAFE approval requirements have been rescinded. The Chinese vendor can now directly open an account with its bank, and not necessarily in the city where the vendor is registered. After the foreign purchaser pays the full purchase price in cash the receiving bank will handle payment inflow filing, which will be automatically transmitted to SAFE to complete the related foreign exchange registration.

Change of stance towards holding companies

Due to the special nature of a foreign investment holding company (FIHC), i.e. it mainly functions as an on-shore investment arm of the foreign mother company, investment made by a FIHC has historically been treated as foreign investment under the related regulations. Circular 59 has now taken a quite different stance. First, it explicitly stipulates that a FIHC is no longer treated as foreign, but shall be treated as a ‘Chinese’ shareholder when making an investment in China. This means that a FIHC’s investee companies are no longer required to conduct foreign exchange registration which applies to FIEs. Secondly, to verify capital contributed by a FIHC, Certified Public Accountants (CPAs) are no longer required to get an official confirmation from SAFE. Finally, and most importantly, SAFE no longer requires approval for transfer of investment funds from a FIHC to its investee companies or for collection of dividends by a FIHC from its investee companies. Although certain foreign exchange related formalities still need to be submitted to banks for verification, the results of which will be filed with SAFE, a FIHC is now treated more like a Chinese company making an investment in China.

Improved exit scenario

Historically, withdrawing from an existing investment project in China has always proved more difficult than entry. Now, though, exit strategies have been eased with Circular 59 abolishing SAFE approval requirements in the following areas:

  • Repatriating proceeds from capital reduction, liquidation or early recovery of investment from China projects
  • Obtaining payment from Chinese purchasers who acquire an equity stake in a FIE
  • Repatriating proceeds from sales of real properties owned by representative offices or branches in China
  • Remitting out of China balance of a pre-establishment expenditure account when the planned establishment fails

In addition, some earlier restrictions on purchase and payment of foreign exchange in a different city are also lifted by Circular 59.

New possibility for financing optimisation

Besides generally shrinking SAFE’s administrative interference in investment-related foreign exchange matters, Circular 59 further creates room for foreign investment activities which were not possible in the past due to strict foreign exchange control. For example, it permits a FIE to lend to its mother company an amount equalling the profits owed to its mother company. This is another significant step in China’s capital account control liberalisation, since foreign exchange related regulations have previously been focussed on regulating lending at a national level by a FIE’s mother company to the FIE, but not the other way around.

As of 1st August, 2009, SAFE, via its Circular 24, permits domestic companies, including a FIE—within a quota amount as approved by SAFE—to grant direct lending to its foreign subsidiaries or companies in which it holds a stake. Such lending may be conducted directly and does not need to follow the entrusted loan model[1]. Circular 59 now further expands the scope of borrowers to include a FIE’s foreign mother companies. In addition, it also permits a domestic lender (which theoretically includes a FIE) to borrow foreign exchange loans in China for the purpose of further lending such loans to its foreign affiliates. Considering the withholding tax implication connected with FIE dividend repatriation and the different interest rates between China and foreign markets, Circular 59 presents the possibility of enabling foreign companies to benefit from the potentially better cash position of its Chinese subsidiaries.

Summary and outlook

Considering China’s ambition to make the RMB internationally convertible and the pressures it faces to consume the world’s largest foreign exchange reserve, opening up its capital account control further will be an inevitable step to take. According to a research report announced by China’s central bank earlier in 2012, a short term roadmap for capital account liberalisation is to release control over direct investment activities that have a true transactional background. This fits in with SAFE’s plan of deliberation for 2012 as reported by public media earlier that year, and is now reflected by the launch of Circular 59.

This circular represents a big step forward, even though a number of questions are still yet to be clarified. As has been witnessed under the various new regulations rolled out in recent years (e.g. equity investment and RMB direct investment), new opportunities are emerging in the Chinese FDI market, which still remains one of the most favoured FDI destinations. Foreign companies are recommended to keep a close eye on the deregulation progress in China’s capital account control which has a direct impact on all general FDI activities.

Taylor Wessing is an international law firm with 22 offices around the globe. Dr Michael Tan is Senior Counsel in Shanghai with profound experience in supporting multinational corporations in China, particularly in the corporate and commercial fields. He is also experienced in dealing with finance and foreign exchange control issues, and has an industrial focus on aerospace, aviation, TMT and other technology driven sectors. Contact Michael at Cara Meng, an Associate in Shanghai, specialises in general Chinese corporate and commercial law, and has substantial experience advising on foreign exchange related matters. She advises foreign companies on all aspects of Chinese laws in various industries with regard to their strategy and business in China. Contact Cara at


[1] Since all Chinese companies are only permitted to conduct business within the scope of its business activities, lending to other companies by a non-bank FIE will have to be conducted via a qualified bank by means of the so-called ‘entrusted loan’. This is the usual model in China for inter-company lending.