Control over capital accounts | Doing Business with China

China maintains a policy of actively encouraging FDI while guiding the direction of capital flows. According to the strategic long- term goal of foreign exchange administration in China, the basic principle of administering capital accounts is to perfect the administration system and to advance the convertibility of capital accounts in a progressive and planned manner.

Foreign exchange on capital account is controlled nowadays in the following ways:

All foreign exchange gains on capital account should be repatriated from abroad except those cases specified by the State Council.
All domestic entities should put their foreign exchange income on capital account into special accounts opened in the designated banks and approval from SAFE is required when foreign exchange needs to be converted into RMB. ^[5]
All purchases of foreign exchange and payments on capital account to abroad must be checked by SAFE and the banks cannot process a payment without an approval document from SAFE.

At present, there are three major types of transaction on capital accounts in China: external debt, foreign direct investment and the Chinese investment abroad.

Administration of external debt and external guarantee

The general aim of external debt control is to limit the size of the external debt to a moderate level, to set up a rational debt structure and safe debt servicing sources.

China's control over external debt and external guarantees takes three major forms: management through planning, examination of financial qualifications and the registration system.

External debt includes:

international financial institution loans;
foreign government loans;
foreign bank and financial institution loans;
buyer's credits;
foreign enterprise loans;
foreign currency bonds ;
international financial leases;
deferred payments;
debts repaid directly in foreign exchange in compensation trade; and
external debt in other forms.

Funds borrowed in foreign exchange by debtors from banks with foreign capital and Chinese and foreign joint banks registered in China are also regarded as external debt. Funds borrowed in foreign exchange from abroad by banks with foreign capital or by Chinese and foreign joint banks, which are registered in China, are not regarded as external debt.

Foreign borrowings by Chinese financial institutions and Chinese enterprises with a term longer than one year, excluding government loans, must be incorporated into the state external debt plan made by the State Development and Planning Committee (SDPC). SAFE gives case-by-case approval to the international commercial loans borrowed by all Chinese financial institutions except the state-owned commercial banks, which exercise management of the long and mid-term external debt. The People's Bank of China (PBC) controls the nationwide scale of short-term external commercial debt balances . Within the scale, SAFE allocates debt quotas to provincial financial institutions and/or enterprises. All financial institutions can borrow external loans with one-year maturity within the given quotas and quotas may be used repeatedly within their limits. Foreign- funded enterprises can borrow external loans without any advance approval.

China follows a policy of managing external debt by registration. The registration of external debt may be on a case-by-case or periodic basis. All domestic entities (including foreign-funded enterprises) are required, while borrowing , to register at and obtain a case-by-case registration certificate for their external debt from the local branch of SAFE by submitting a copy of the loan agreement within 15 days of signing the formal agreement.

For international financial institution loans, foreign government loans, external borrowing by the Bank of China or other authorized banks and financial institutions, the debtors concerned are required to register at and obtain periodic registration certificates for their external debt from a domiciled branch of SAFE. All repayments of principal and interest should be approved by SAFE (except for banks).

External debt inflows and outflows are managed by special accounts. External debt special accounts (including External Debt Special Accounts and Debt Service Special Accounts) shall be opened in the designated foreign exchange banks. Domestic foreign-funded banks can only open external debt special accounts for their own lending . External debt special accounts shall be opened upon the approval of SAFE and its branches.

Issuing bonds abroad (including convertible bonds, negotiable certificates of deposit and commercial paper) is under strict control. The qualifications to issue bonds abroad of all domestic entities, except the Ministry of Finance (MOF), are appraised biannually jointly by the SDPC, PBC and other relevant organizations and approved by the State Council. Before a qualified entity issues bonds, it should undergo an appraisal made by SDPC together with SAFE and receive approval of the State Council. The selection of target market, the timing for bond issues and other relevant conditions must be examined by SAFE. Local governments are forbidden to issue bonds abroad. The issuance of commercial bonds by domestic entities must be approved by SAFE and the amount of the issues should be deducted from their short-term external loans quotas. Convertible bonds issued in overseas markets by listed foreign- funded enterprises are exempt from qualification examination but must follow the same approval formalities as applied to domestic entities on issuing bonds abroad within their annual quotas.

An external guarantee is regarded and controlled as external debt in China. 'External guarantee' refers to guarantees in the forms of guarantee letters, stand-by letters of credit, promissory note, cheques and drafts, mortgages over properties, hypothecation of current assets, or by property rights as stipulated, provided by institutions within Chinese territory to institutions outside China. Guarantees provided to foreign-funded financial institutions inside China are also regarded as external guarantees.

Only financial institutions with authorized licences for external guarantees (excluding foreign-funded financial institutions) and non-financial institutions having the ability to repay the external debts they guarantee are permitted to provide external guarantees. Governmental institutions should not guarantee external debts except for the State-Council-approved utilization of foreign government loans or loans from international financial institutions. It is forbidden to guarantee overseas enterprises against loss.

SAFE examines and approves each external guarantee provided by a domestic entity case by case and all cases of external guarantee must be filed with SAFE. While examining and approving an external guarantee, SAFE will examine the amount and risk, the ratio between assets and debts, losses and benefits of the guarantees before appraising and deciding the guarantee ceiling.

External guarantees for up to and including one year can be examined and approved by the SAFE at province , autonomous region, municipality, listed city or special economic zone levels.

Those external guarantees for more than one year should be submitted to local branches of SAFE for initial examination and then to SAFE headquarter for examination and approval. Verification by SAFE is required when the warrantor will fulfil the guarantee liability.

Management of foreign direct investment (FDI)

Flexible management is adopted in foreign exchange payments and earnings under capital account of foreign- funded enterprises in China to encourage FDI.

The capital subscriptions of foreign investor(s) in an enterprise can be reserved in the form of foreign exchange under its foreign exchange account and can be converted into RMB upon approval by SAFE.

To open a capital account, temporary account or investment special account the FFE should apply to SAFE presenting the following documents:

Application form stamped with the seal of the enterprise which illustrates the basic situation of the enterprise, the reason for opening the account, and the potential bank where the account is to be opened;
Registration certificate of foreign exchange (to be returned after inspection);
Phased investment plan and investment contract to be provided by a foreign investor as a non-legal entity when applying to open an investment special account;
Certificate of credibility issued by the account opening bank of the foreign legal person or natural person;
Legally notarized proxy agreement when a domestic legal person or natural person applies to open an account on behalf of a foreign person;
Other documents required by SAFE when necessary (such as investment contract, or company constitution etc).

Foreign-funded enterprises can borrow foreign exchange loans and repay directly to overseas banks without approval in advance, while the transaction must be registered with the foreign exchange administration afterwards. The balance of mid-to-long term loans of the enterprise can not exceed the difference between total investment and the registered capital of the enterprise concerned. ^[6]

When a foreign investor in a foreign-funded enterprise terminates an investment legally, the foreign exchange received can be remitted abroad from its foreign exchange account or be paid at the bank upon approval.

Foreign exchange registration and the annual inspection system are applied to foreign-funded enterprises as means of supervision and management.

Within 30 days of receiving a business licence for legal person status in China, a FFE should carry out foreign exchange registration with the local branch of SAFE. SAFE will issue a Foreign Exchange Registration Certificate of Foreign-funded Enterprise after reviewing the documents including: approval for establishment issued by the relevant government agencies, business licence as legal person of the PRC issued by the State Administration of Commerce and Industry, approved and valid enterprise contract and constitution, and other documents required by SAFE. The enterprise can open foreign exchange accounts at designated banks with the certificate; SAFE will inspect the registration certificate annually.

A foreign-funded enterprise is permitted to reinvest its profits in RMB and the reinvestment is treated the same as an investment in foreign exchange.

In order to reinvest its distributed foreign exchange or RMB profit domestically in a new FFE, the foreign party of an existing FFE shall apply for verification of authenticity with the local branch of SAFE by presenting the following documents:

Capital assessment report issued by CPA;
Annual financial audit report;
The board of directors' profit distribution resolution;
The re-investor's confirmation of its reinvestment of profits;
Foreign exchange registration certificate of the existing FFE;
Other documents required by SAFE.

At present, the opening of China's financial market is at a very early stage. Only a few kinds of listed stocks in foreign exchange are available to foreign investors such as B shares listed on the domestic stock exchanges, H shares on the Hong Kong Stock Exchange and N shares on the New York Stock Exchange. Possible investors in B shares include: natural persons, legal entities and other organizations in foreign countries , Hong Kong, Macao or Taiwan, and Chinese citizen residing abroad.

Management of investment abroad

Capital in China is far from sufficient and therefore, capital outflow is under strict administration. The term 'investment abroad' refers to a China-registered enterprise which sets up any kind of enterprise, purchases stocks, or participates in an overseas enterprise for the purpose of production and operation.

Currently, the SDPC and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and their delegated agencies examine and approve all overseas investment projects. SAFE is responsible for examining the project in terms of foreign exchange flow. Before domestic entities submit their applications to SDPC and MOFTEC, SAFE must carry out its examination.

SAFE will review the following documents:

certificate of approval by the competent state department,
official assessment of the investment risks and availability of foreign exchange sources;
investment contract or any other documents testifying to the amount of foreign exchange funds to be remitted abroad. The purpose of the examination is to appraise the qualification of the domestic entity as an investor abroad, the foreign exchange risk for the investment and the capital resource to invest abroad.

SAFE offices at the provincial level are responsible for the review, and emphasis will be placed on three aspects: qualification of the domestic investors, assessment of investment risk and sources of foreign exchange.

Profits gained by Chinese investors should be wholly repatriated home.

When an enterprise abroad legally terminates its operation or disincorporates, the domestic investor must submit to SAFE for recording the relevant documents after liquidation including its balance sheet, asset inventory, and property valuation, etc. The property in foreign exchange belonging to the Chinese investors must be remitted back within 30 days after liquidation and can not defalcate or remain abroad without the approval of SAFE.

Except for authorized financial institutions and industry-trade integrated enterprises, no resident individuals are permitted to purchase securities abroad. Such purchases by authorized financial institutions are subject to SAFE's prior examination and approval. Foreign currency securities (except blue chips and government bonds) purchased by banks should not exceed 10 per cent of the total of their foreign exchange assets. The corresponding ratio for non-bank financial institutions is 25 per cent. Banks and non-bank financial institutions should present detailed reports to SAFE on a quarterly basis when trading securities in foreign currencies other than listed stocks on overseas stock exchanges.

^[5] All the foreign founded enterprises can convert their registered capital in the authorized banks without approval from SAFE since 1 July 2002.

^[6] Foreign holding companies are allowed to expand the difference up to 1:7.