China’s foreign exchange control has created complexities for international operations in China. The China (Shanghai) Pilot Free Trade Zone (SHFTZ) project was granted the role to further open up the financial system to the outside world, which will inevitably touch upon capital control issues. Dr Michael Tan and Sophie Wei from Taylor Wessing share their observations on the latest development in this on-going project.
Controls of foreign exchange under current accounts were removed in China in 1996, but control of capital account transactions are still in place today. Governmental procedures and formalities for control have been streamlined and simplified by the continuous efforts of the State Administration for Foreign Exchange (SAFE) in recent years, however, there has not yet been a substantial breakthrough regarding capital account control. Against this background the business community has high expectations that reform measures will be rolled out under the SHFTZ project, which is widely reported to be a national experimental project aimed at testing some “strategic moves of China” in the areas of economic and financial reforms.
Abolishing capital account control is a topic closely connected with the overall reform of China’s financial system. This is why the General Plan for the China (Shanghai) Free Trade Zone (General Plan)—announced by the State Council on 27th September, 2013, and functioning as the blueprint for the SHFTZ—addresses foreign exchange control reform in the context of innovation and opening-up of the financial system. These include:
- testing reforms in the area of foreign exchange control with an international outlook, so as to facilitate trading and investment;
- experimenting with free convertibility under capital accounts, interest rate liberalisation and cross-border use of the renminbi (RMB), subject to risk controls;
- deepening reform of foreign debt control to facilitate cross-border financing; and
- bringing forward and promoting the pilot scheme of centralised funds management by multinationals’ regional headquarters.
A rough picture of further liberalisation emerges from these points, but due to the complexities of the topic more detailed rules came very slowly. While various ministries rushed out their rules supporting the SHFTZ’s development at the end of September 2013, the People’s Bank of China (PBoC) only managed to promulgate its Opinions on Financial Support to Construction of the SHFTZ (PBoC Opinions) on 2nd December, 2013. These opinions provide further detail along the lines drawn up by the General Plan, but still take the form of a general statement without practicable guidance.
The more detailed rules only came three months later. On 20th February, 2014, the PBoC Shanghai Branch issued a notice to various banks in Shanghai (Circular 22) kicking off measures promoting cross-border use of the RMB. Even more recently, on 27th February, 2014, SAFE’s Shanghai Branch promulgated detailed rules on new foreign exchange control measures (Circular 26) which signifies the commencement of a new capital control regime in the SHFTZ.
One of the few technical concepts, which first appears in the PBoC Opinions, is the so-called Free Trade Account for Residents (FTA). Such accounts are available to companies registered within the SHFTZ or individuals working in the SHFTZ. Put simply, a FTA may be understood as an offshore account which is physically onshore. It may be used for cross-border financing and security provision. Capital flow between a FTA and an onshore account will still be treated as a cross border transaction and subject to controls, which are expected to be further reduced.
Circular 26 does not explicitly address the topic of FTAs, but in general reduces control in many areas:
- Foreign exchange transactions under current accounts will be further simplified. Instead of focusing on lengthy and cumbersome paper work, banks have more freedom to handle such transactions by following the principles of ‘know your client’, ‘know your business’ and carrying out diligent reviews.
- Banks will take over SAFE’s role of handling foreign exchange registration relating to foreign direct investment (FDI) activities, which makes such procedures easier for companies. Capital contributed to a foreign-invested enterprise (FIE) can now be freely converted into RMB and be spent for business operations. In the past, such conversion could only be conducted when there was an actual need for spending, which was inflexible and sometimes even resulted in exchange loss.
- With regard to foreign debt control, provision of security or making payments of security fees to foreign companies will no longer require approval. The ceiling amount of foreign exchange lending by companies within the SHFTZ to its foreign affiliates is increased from 30 to 50 per cent. Outward debt approval for offshore leasing is lifted and leasing companies will be permitted to collect foreign exchange rentals in China.
- The present pilot scheme for multinationals’ regional headquarters to conduct centralised foreign exchange funds management, foreign currency cash pooling and functions of international trading settlement centres will be further improved. In general this scheme streamlines intra-group payable and receivable settlement, and permits multinational companies (MNCs) to freely balance their cash positions between their onshore and offshore operations up to the balance ceiling designated by SAFE. It is presently only available to a few big MNCs, but will now become more accessible to other companies within the SHFTZ. The related procedures and account control will also be further simplified.
- Control over foreign exchange settlements will be improved to allow banks to offer over-the-counter trading of bulk stock derivatives to companies within the SHFTZ.
In general these measures allow for increased flexibility and convenience for companies within the SHFTZ to conduct their operations and manage their investment. Some of the measures are an extension of SAFE’s existing efforts in generally reducing and streamlining its control over foreign exchange transactions (e.g. those concerning current account transactions, FDI activities and foreign security). At the same time Circular 26 reiterates risks control and the possibility of “tentative control measures” in case of a serious imbalance of international payments.
In the broader context of foreign exchange controls, the role of the RMB should not be ignored. In recent years China has been exercising substantial efforts promoting the internationalisation of the RMB. This national strategy is also reflected in the SHFTZ Project. With the issuance of Circular 22, piloting measures further promoting RMB internationalisation are entering the implementation stage.
For example, the PBoC Opinions explicitly states that cross-border RMB settlement for current account transactions and investments will be further facilitated. Companies in the SHFTZ will be permitted to borrow RMB funds from offshore markets to finance their operations within the SHFTZ or abroad, and may also conduct RMB cash pooling for its onshore and offshore affiliates, as well as centralised payments and collection under current accounts. With the rapid development of offshore RMB markets and the increasing popularity of use of the RMB for operations concerning China, all these RMB-related measures rolled out for the SHFTZ project help to further reduce capital control from another angle.
There is no doubt about the positive direction in which the SHFTZ project is generally heading. Progress in the area of cross-border capital control might appear lagging behind progress achieved in the other areas, such as the negative list system and the simplified company establishment procedures, but the reasons behind this are understandable. The fact that risk control is repetitively mentioned under various rules demonstrates the cautious approach of the regulators.
From a foreign exchange control perspective, measures seen so far are mainly an extension of existing deregulation efforts of SAFE outside the SHFTZ. Although they provide more convenience and flexibility for companies within the SHFTZ, substantial breakthroughs regarding capital control are not yet seen. It would be unrealistic to predict that control over capital accounts will be completely abolished during the three-year piloting period as granted by the national legislative body. It is more likely to see a system with limited extent of freedom for funds to flow across the firewall, such as an overall quota-control system or a system in which free convertibility is linked to the credit of a company.
The SHFTZ project keeps moving. Although Circular 22 and Circular 26 have covered most of the items addressed under the PBOC Opinions, there are still some others not yet covered by detailed rules (e.g. access to domestic capital and futures market, issuance of RMB bonds by foreign mother companies of a FIE, interest rate liberalisation). From a long-term point of view, the complete lifting of capital control is a task Beijing has to face and accomplish. The progress of this topic will impact its leverage in the anticipated talks regarding the Trans-Pacific Partnership (TPP) led by the United States, which was the fundamental driving factor for the launch of the SHFTZ project.
Taylor Wessing is a full service law firm with approximately 900 lawyers in Europe, the Middle East and Asia, with offices in Shanghai and Beijing. For more information please visit www.taylorwessing.com. Dr Michael Tan is Senior Counsel (Chinese Partner) in Shanghai with an industrial focus on aerospace, aviation, TMT and other technology-driven sectors.