Written by Elaine Lo (Partner) and Hannah Ha (Solicitor) of Johnson Stokes & Master (11 Apr 2003)


The State Administration of Foreign Exchange ("SAFE") recently issued a notice entitled "Notice of Relevant Issues for Perfecting the Management of Direct Foreign Exchange Investment by Foreign Investors" (the "Notice") which became effective on 1 April 2003.  The Notice facilitates foreign investors to invest foreign exchange directly by (i) allowing foreign investors to open a "Special Purpose Foreign Exchange Account" in their own name with a local bank; (ii) allowing foreign investors to use certain foreign exchange deposited with a local bank for their contributions to the registered capital of foreign investment enterprises ("FIEs"), and (iii) increase the methods of capital contribution to FIEs by foreign investors. In addition, the Notice also sets out certain operational procedures and requirements in relation to foreign exchange investments.

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1. Opening Special Purpose Foreign Exchange Account

(a)  According to the Notice, before the establishment of a FIE, foreign investors may apply to the local administration of foreign exchange ("LAFE") for opening a foreign exchange account (the "Account") in their own name with a local bank for the purpose of funding their investment in the PRC.  Such Account, according to the usage of the funds, may be categorised into:

(i)  Investment Account - for the purpose of depositing or paying the foreign exchange required by foreign investors to undertake contracted projects, to engage in co-operative mining and exploration of natural resources, and as investment in venture capital businesses;

(ii)  Acquisition Account - for the purpose of depositing or paying foreign exchange required by foreign investors for purchasing real property, equipment or other assets during the pre-incorporation stage of FIEs;

(iii) Expenses Account - for the purpose of depositing or paying foreign exchange required by foreign investors to conduct market research, planning and preparatory work during the pre-incorporation stage of FIEs; and

(iv) Security Deposit Account - for the purpose of depositing or paying the security deposit to PRC domestic entities in order to comply with the relevant regulations or contract prior to making an investment in the PRC.

Previously, foreign investors were allowed to open foreign exchange accounts with local banks for the purpose of preparing for the establishment of FIEs.  However, the purpose of such accounts and the amounts which could be deposited into such account were very limited. With the promulgation of the Notice, apart from what is equivalent to the Expenses Account, foreign investors may also open other types of the above accounts with the approval of LAFE.

(b)  All funds in the Account must be deposited by telegraphic transfer but not by cash, and each item of expenditure to be paid from the Account must be approved by the LAFE.

(c)  Regarding the accounts mentioned in items 1(a) (ii), (iii) and (iv) above, once a FIE is set up by the foreign investor, the remaining balance in those accounts may be transferred to the capital account of that FIE. All the funds being settled or transferred from those accounts may be treated as capital contributions by the foreign investor to the FIE and are entitled to be verified as such.

If no FIE is set up, funds remaining in those accounts may be remitted out of the PRC.

2. Using Funds in an Offshore Account and Non-resident Individual Cash Account

(a) Offshore Account - Foreign investors may use funds deposited in an offshore account opened with a designated foreign exchange bank, which has been approved by People's Bank of China to carry on offshore banking business, for their contributions to FIEs.  No approval from LAFE is required for such use of funds from the offshore account.

(b) Non-resident Individual Cash Account - Foreign investors may use funds deposited in such "Non-resident Individual Cash Account" for their contributions to FIEs. However, approval from LAFE is required.

  "Non-resident Individual Cash Account" means foreign currency cash account opened with a local commercial bank in the PRC by an individual holding a foreign passport or identity certificate of Hong Kong, Macau or Taiwan.

3. Methods of Capital Contribution and Sources of Funds

Apart from cash, equipment, intellectual property and Renminbi profits earned from PRC investments, foreign investors may also, with the approval of LAFE, use the following funds and assets as additional contributions to the registered capital of a FIE:

(i) The Development Fund, Reserve Fund (or Capital Provident Fund, Provident Reserve Fund) of that FIE;

(ii) Undistributed profits or dividends on shares of that FIE due to the foreign investor;

(iii) The principal of, and interest accrued on, loans granted by the foreign investor to that FIE, provided that such loans have been duly registered with the relevant LAFE; and

(iv) Funds and assets obtained from the recovery of investment, liquidation, sale of shares or equity interest, or reduction of capital of that FIE.

4. Acquisition of PRC Domestic Enterprises by Foreign Investors

Any acquisition of shares or equity interests in PRC domestic enterprises by foreign investors, or by investment holding companies set up by foreign investors in the PRC, should be registered with the relevant LAFE within 5 days after the payment of the acquisition price, in order that the use of foreign exchange from foreign investors for such acquisition can be verified.  The certifying document issued by LAFE will constitute evidence of payment of the acquisition price by the foreign investor.

5. Registration for all Domestic Enterprises in which Foreign Investors contribute or hold less than 25% Equity

The Notice confirms that all domestic enterprises in which foreign investors contribute or hold less than 25% of the registered capital have to carry out foreign exchange registration and capital contribution verification according to the relevant regulations.

6. Foreign Exchange Management of Re-investment by FIEs

The Notice confirms that when a FIE (excluding PRC investment holding companies) makes an investment in an enterprise in the PRC ("Investee Enterprise") and if such investment does not involve any foreign capital, then the Investee Enterprise is not required to carry out foreign exchange registration, capital contribution verification and foreign capital foreign exchange registration.

On the other hand, if the Investee Enterprise has a business licence marked with "Investment by Foreign Investment Enterprise", SAFE may regulate the borrowing of external debts by such Investee Enterprise as if it were a FIE.  This means that such Investee Enterprise will have to comply with the debt to equity ratios prescribed for FIEs, but will not need to obtain SAFE's approval for external borrowings.

7. Others

The Notice also sets out some detailed requirements for foreign exchange registration and capital verification procedures.

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