Given China’s closed capital account and the related restrictions governing the flow of foreign currency out of the country, many multinational companies have accumulated surplus foreign currency in China. Prior to the issuance of the new circular, SAFE limited the outward movement of funds to the following scenarios:
- Normal Trade or Non-Trade-Related Transactions
All such transactions must be accompanied by supporting documentation. - Advance Payments for Group Imports
China-based multinationals that import from their group subsidiaries are able to make advance payment for imports without requiring the beneficiary’s bank to issue an advance payment guarantee as long as the trade transactions between the two parties are legitimate. - Payment of Dividends
A corporation can freely pay dividends out of China with supporting documentation. Dividends can be remitted more than once a year if the company undertakes an interim audit of their financial statements. - Capital Reduction
Capital reduction under specific circumstances can be requested but this is rarely employed to take funds out of China. This method is usually associated with the restructuring or termination of a China-based operation.
New Regulation
Effective November 1, 2004, SAFE has issued a new regulation allowing subsidiaries of selected Chinese and Foreign multinationals to lend their surplus funds to their domestic or overseas subsidiaries. Following are the requirements and scenarios allowed.
Who Qualifies
- Subsidiaries of Chinese and Foreign Multinationals (MNC).
- MNC refers to group companies that own subsidiaries both in and outside of China, and have a China-based member company responsible for managing the group’s investments globally or for a region that includes China.
- Subsidiary company refers to a legal entity with a cross shareholding relationship with, or owned directly by, the parent company.
- Multinational financial institutions are excluded.
Domestic Borrowing and Lending of Foreign Currency between Domestic Subsidiaries
- Such transactions may be arranged through an entrust loan agreement with a China-based bank or a China-registered group financial company acting as agent.
- SAFE approval is NOT required.
- Entrust loans must be arranged through a specific loan account in the name of the borrower and managed by an entrusted bank.
Cross-border Borrowing and Lending of Foreign Currency between Group Companies
- Such transactions may be arranged through an entrust loan agreement with a China-based bank or a group financial company acting as agent, or may be alternatively structured as a direct lending.
- SAFE pre-approval is required in each and every case.
- All such cross-border lending arrangements must operate using a designated new China on-shore bank account in the name of the lender to manage the lending and repayment of funds.
Restrictions Applicable for both Domestic and Cross-border Foreign Currency Lending
- The lending rate used should be set on an armslength basis (using the commercial loan or international financial market lending rates as reference).
- The lending amount is limited to free capital, i.e. surplus balances from the lender’s capital account and/or current account.
- Foreign currency entrust loan borrowed locally cannot be converted into RMB or used as collateral for an RMB loan.
- The foreign currency lending cap of a subsidiary of a Chinese MNC is limited to 20 per cent its shareholder’s equity.
- The foreign currency lending cap of a subsidiary of a foreign MNC is limited to the sum of its unremitted distributed profits from the previous year and a foreign investor’s share of any undistributed profit from the current period.
Requirements for Domestic Foreign Currency Entrust Loans
- Borrowing and lending subsidiaries must have injected their registered capital in full as scheduled.
- In order to enter into a new domestic foreign currency entrust loan, any existing domestic entrust loan between the same parties much first be liquidated (principal and interest fully repaid).
Requirements for Cross-border Foreign Currency Lending between Group Companies
- The domestic subsidiary involved in the transaction has injected its registered capital in full as scheduled.
- In order to enter into a new cross-border foreign currency loan, any existing cross-border foreign currency loan between the same parties must first be liquidated (principal and interest fully repaid).
- Chinese MNC should have three or more overseas subsidiaries. Foreign MNC should have three or more domestic subsidiaries.
- In order to participate in a cross-border foreign currency loan, the foreign subsidiary of a Chinese MNC must have a total capital investment from its Chinese parent of not less than $5m.
- The overseas borrowing subsidiary of a Chinese MNC should receive at least Grade 2 certification by SAFE in its most recent “Overseas Investment Joint Inspection”.
- For a foreign MNC’s entity lending to an overseas entity the following requirements must be met:
- The percentage of previous year’s foreign currency accounts receivable over total foreign currency assets should be lower than the entity industry’s Foreign Invested Enterprises (FIEs) average (*).
- If the entity purchased more RMB than it sold in the prior year, or if it sold more RMB than it purchased, its net foreign exchange position must be lower than the entity industry’s FIEs average (*).
- Shareholder’s equity should be more than or equal to $30m.
- Net assets should be greater than 20 per cent of total assets.
(*) Note: the FIE industry data referenced is available from SAFE and the Ministry of Commerce - The tenor of MNC’s foreign currency overseas lending should not exceed two years.
Implications
Citigroup customers who are qualified under the new regulatory criteria will benefit from these changes as they allow them to improve efficiency in the use of their foreign currency excess liquidity. Besides facilitating domestic foreign currency pooling structures and reducing the group financing costs, the change gives companies with funding needs in overseas markets easier access to their China cash positions to propel their growth internationally.
This article is based on an unofficial translation of the SAFE Circular dated 27 October 2004. The original document can be obtained at https://www.safe.gov.cn.