SAFE Plugs Holes for China/Offshore Round-trip Investments

¡P requirements to warrant the legality of previous transactions;

¡P a broadened definition of “equity financing”; and

¡P coverage of assets and interests already held outside China by domestic residents.

The above changes have been implemented by China's State Administration of Foreign Exchange [SAFE] through its May 29 2007 [internal] notice [Hui Fa [2007] No. 106] containing expanded new operating rules [New Operating Rules], replacing previous operating rules issued in November 2005,² relating to implementation of the SAFE's Circular on Issues Relevant to Foreign Exchange Control with Respect to the Round-trip Investment of Funds Raised by Domestic Residents Through Offshore Special Purpose Companies [Hui Fa [2005] No. 75] [October 2005 Circular].³

The October 2005 Circular, and its original operating rules, left a number of issues open to interpretation, which reduced predictability and increased the complexity and duration of consultation needed with local SAFE offices. But eventually those investors with reasonable projects have in general been able to obtain the necessary SAFE foreign exchange registration. In contrast, over the past year, investors have faced a greater challenge in working through or around the reluctance of local offices under the Ministry of Commerce to issue merger or acquisition approvals under the August 2006-issued “Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors”.⁴ MOFCOM is understood to be close to issuing clarifications which should increase the flow of those approvals, and which are likely to be coordinated with the SAFE's New Operating Rules.

The New Operating Rules are composed mainly of seven “Annex Tables”, each addressing procedures for a different type of registration [each referred to below as a "Round-trip Registration"], including those involving:⁵

[1] domestic equity or assets;

[2] foreign interests held by domestic individuals;

[3] foreign interests held by domestic legal persons;

[4] inbound mergers or acquisitions;

[5] capital changes;

[6] unregistered SPVs; or

[7] fund repatriation to China.

Each table is divided into four columns, headed:

[A] “Law & Regulation Basis”;

[B] “Examination/Approval Materials”;

[C] “Examination/Approval Principle Essential Points”; and

[D] “Items for Attention”.

[References to specific provisions will refer to the relevant table as "T-_", the relevant column as "C-_" and the relevant Item as I-_"]

This table format requires local SAFE offices to work through each column for each type of registration, and the public availability⁶ of
the New Operating Rules enables applicants to do the same in order
to obtain advance understanding of how their applications will be handled.

NON-REGISTRATION CONSEQUENCES

Non-registration consequences that are specified by the New Operating Rules include prohibitions on equity transfers and on loan repayments to an offshore SPV, in addition to the October 2005 Circular's prohibitions on “profits, dividends, liquidation proceeds, equity transfer proceeds, capital proceeds, etc.” [T-1; C-D, I-14; and T-2; C-D, I-3; and T-3; C-D, I-4].

LATE REGISTRATION TIMING & CONSEQUENCES

Supplemental make-up registrations are no longer subject to the previous deadline of March 31 2006. No penalties are mentioned in the New Operating Rules if the domestic investee entity has not made remittances to an offshore SPV. But if such remittances have been made, an investigation is required in order to determine and impose liability, which the New Operating Rules indicate will be in amounts “within the occurring amount” of such remittances [T-6; C-D; I-2].⁷ In contrast, no particular limit on liability or punishment is indicated for prior foreign exchange registrations that fraudulently concealed round-trip transactions [T-6; C-D; I-3], although concerned parties can take some comfort from the neutral tone of the relevant text, and from the general mood at the SAFE at present, which does not appear to be inclined towards heavy punishment.⁸

REPRESENTATIONS & WARRANTIES

Representations and warranties are required to accompany new applications as follows:

¡P By a resident individual applicant