Part one of the story examines big picture issues affecting outside investment in China. At issue: Foreign investors always want to know how they can get their money out of China. But with FX policies constantly changing, how should they navigate the complex regulations in place?
FX controls play a critical but often overlooked role in the operations of companies in mainland China whether they are domestic capital or foreign invested.
How such FX policies operate and translate into facts on the ground is often a serious concern for foreign investors unfamiliar with the legal framework. The question always being asked in this area by foreign investors is: once I have invested in China, can I get my money out?
Even for many Chinese investors and professionals, understanding and keeping pace with China’s fast-evolving FX law is challenging.
The cornerstone of Chinese FX policy is the distinction between current account transactions and capital account transactions.
The Chinese government has liberalized the conversion of RMB on current account transactions since its acceptance of Article VIII of the Articles of Agreement of the International Monetary Fund Agreement in December 1996.
However, free conversion of RMB on capital account transactions remains a long-term goal. The Chinese government has striven to promote use of RMB in both cross-border trade and cross-border direct investment, with a view to ultimately achieving the conversion of RMB on the capital account, making RMB an internationally-accepted trading and reserve currency on a par with USD.
The Chinese government’s efforts toward relaxation and RMB internationalization have manifested themselves in the acts highlighted in the graphic below.
| China's government expands the role of the RMB |
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| Source: China Law and Practice |
Current or capital account transactions
At present, RMB is not freely convertible into foreign currencies on the capital account, and foreign currency inflows to and outflows from mainland China are regulated.
China’s State Administration of Foreign Exchange (SAFE) and central bank, the People’s Bank of China (PBOC), are the main regulatory bodies administering FX controls.
The Chinese government has enacted a number of regulations, including the Foreign Exchange Regulations, issued on January 29, 1996 and amended on January 14, 1997 and amended again on August 1, 2008.
This regulation lays out the basic framework of China’s FX regime.
Under the regulations, for a Foreign-Invested Enterprise (FIE), cross-border flows of foreign currencies must be made through its FX accounts opened with commercial banks designated by SAFE to handle FX transactions.
An FIE’s FX accounts are classified as either a current account or a capital account, and they must be used to carry out current account transactions and capital account transactions, respectively.
Under the SAFE regulations, current account transactions are generally those that recur with some degree of frequency during the ordinary course of business of a company.
These include – without limitation: imports and exports of goods (including intangible assets); cross-border trade in services; repayment of interest on foreign debts; payment of royalties; payment of expatriate salaries; and payment of after-tax profits and dividends to foreign shareholders.
It is arguable under the regulations whether a dividend should be treated as a capital account item or as a current account item, but they are – in practice – administered as current account, hence SAFE approval is not normally required for a dividend by an FIE. Conversion of the RMB on the current account has been liberalized.
These examples of current account receipts and payments involving foreign currencies, and the related conversion from RMB into a foreign currency and vice versa are generally only subject to verification of the underlying transaction’s lawfulness and genuineness by banks delegated by SAFE.
Chinese banks usually process receipts or payments of foreign currencies upon being shown genuine invoices or contracts and other relevant documents submitted by the onshore recipient or payer.
RMB settlement for cross-border trade
In April 2009, China launched a pilot scheme to allow pilot enterprises in Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan to use RMB to settle cross-border trading transactions with Hong Kong, Macao and the Association of Southeast Asian Nations (ASEAN) countries.
The pilot scheme was launched to alleviate the impact of the international financial crisis on: the Chinese economy; to promote the exports of goods and services; reduce reliance on traditional settlement currencies; lower currency conversion costs; and control risks of exchange rate fluctuation faced by Chinese importers and exporters.
This pilot scheme was a crucial first step toward RMB internationalization.
From its launch up until February 2012, the pilot scheme was progressively expanded to cover all importers and exporters at the onshore level and the rest of the world at the offshore level.
The scheme also covered cross-border trade in both goods and services and other current account transactions.
Compared with the rapid expansion of RMB settlement for imports of goods, cross-border trade in services and other current account transactions under the pilot scheme, the availability of RMB settlement for exports of goods was treated with greater caution.
Before February 3, 2012 only those Chinese exporters that were enlisted on the trial were able to use RMB to settle exports of goods.
Initially, only 365 pilot enterprises were allowed to use RMB to settle trading transactions involving exports of goods. Up to the opening-up of RMB settlement for exports of goods to all Chinese exporters on February 3, 2012, over 67,000 pilot enterprises were allowed to make this type of settlement.
This gradual policy may have resulted from the China’s concerns over fraudulent claims for value-added tax refunds given that the opening-up of RMB settlement for exports of goods could expand the scope for such fraudulent claims.
Since February 2012, the China has developed a mechanism to exert intensified supervision on key targets.
Under this mechanism, an enterprise listed on the "List of Enterprises Subject to Intensified Supervision" – those thought to represent a higher risk of engaging in VAT refund fraud – will be subject to intensified supervision when settling cross-border trades in RMB.
The RMB derived by them from RMB settlements for cross-border trading transactions cannot be deposited offshore. As of June 12, 2012, this list covered 9,502 enterprises.
To facilitate the pilot scheme, China has – since October 2010 – allowed offshore entities to open non-resident RMB bank settlement accounts (NRAs) with onshore banks and use NRAs for lawful cross-border RMB business.
NRAs cannot be used for cash operations, except with the PBOC’s approval, and the RMB in NRAs cannot be converted into a foreign currency.
The RMB in NRAs is essentially treated as being offshore and can be remitted to offshore accounts, paid to Chinese exporters of goods or services or to Chinese payees under other current account transactions. It is used for RMB foreign direct investment purposes.
NRAs provide a new settlement channel for cross-border RMB business, and a new tool for the Chinese government to indirectly regulate offshore RMB.
However, bankers in China that offer NRAs are finding they are more in the nature of a transitional device to fill in the gap while foreign countries work out bilateral arrangements and create the infrastructure for having RMB accounts in overseas countries.
Once it becomes possible to have an account in RMB in a foreign country other than in an NRA – hedged with all the restrictions on what you can and cannot do with the RMB held in it – it essentially becomes redundant given the liberalization and internationalization of the RMB as a payment currency for current account transactions.
Part II of the series will examine China’s efforts to promote the usage and acceptability of RMB offshore, grow foreign direct investment, expand the qualified foreign institutional investor program, examine the suitability of Hong Kong as a testing ground and provide outlook on the RMB as a freely convertible currency.
Authors: Jun Wei, Andrew McGinty, Kitty Y Zhang and Xi Liao, Hogan Lovells