Channels ready for cross-border Rmb flows?

Legal framework for cross-border Rmb current account settlements

Circular [2009] No. 10 and its Detailed Rules for the Implementation of Administrative Measures for the Pilot Scheme of Rmg Settlements of Cross-border Trade (跨境贸易人民币结算试点管理办法实施细则) (the Detailed Implementing Rules), which were issued by the PBoC on July 4 2009, established the initial legal framework for using Rmb to settle current account transactions. They lay down basic regulatory elements of the Pilot Scheme, including the required eligibility of companies for participating in the Pilot Scheme, control over the total amount of Rmb for cross-border settlement and clearance, banking and clearance procedures, verification of genuineness of cross-border transactions, anti-money laundering and counter-terrorist financing, export duty and value-added tax (Vat) rebate and exemption, foreign exchange verification and registration, and the shared information network to monitor flows of cross-border Rmb funds.

Following a rapid expansion and better-than-expected outcome of the Pilot Scheme after July 2009, the Central Governmental Authorities issued a number of follow-up circulars, including [2010] No. 186 and a circular (whose reference number is unknown at present) dated August 22 2011 and reported on August 23 2011. These expand the onshore areas covered by the Pilot Scheme to all provinces and cities in the PRC and the offshore areas to all countries around the world.

Parallel to the above-mentioned joint circulars issued by the Central Governmental Authorities, each of the GAC, SAT and Safe issued separate circulars covering such matters as trade statistics, tax rebates and exemptions and customs clearance.

Legal framework for cross-border Rmb capital account transactions

To speed up the internationalisation of the Rmb as a currency to settle cross-border transactions of capital account items, Mofcom, Safe and the PBoC have issued a series of administrative circulars since January 2011. These recent developments have put jigsaw puzzles together in respect of using Rmb to settle not only such current account items as cross-border commodity trades but also such capital account items as outbound direct investment (ODI) and inbound foreign direct investment (FDI).

Outbound direct investment

Under PBoC's Circular [2011] No. 1, the Administrative Measures for Pilot Scheme of Rmb Settlements of Outbound Direct Investments (境外直接投资人民币结算试点管理办法） dated January 6 2011, PRC domestic non-financial investors that have been approved to participate in the Pilot Scheme may remit onshore Rmb funds out for their ODI projects, including payments for initial deposit and other expenses of such projects up to 15% of the approved total investment amount.

Any domestic investors wishing to use onshore Rmb funds to settle ODI project expenses are required to go through the required verification of their ODI projects by the National Development and Reform Commission (NDRC), Mofcom, or their respective local counterpart with the delegated power to verify such projects.

In applying for the verifications, domestic investors must specify the amount of Rmb funds to be remitted abroad for their ODI projects. The aggregate of remitted Rmb and foreign exchange funds for an ODI project may not exceed the amount of total investment as verified by the NDRC and Mofcom for that project. Any Rmb-denominated profits and receipts from capital reduction and liquidation from an ODI project may be remitted back to an onshore bank account and will be recorded in a relevant information network administered by PBoC.

A PRC domestic investor undertaking an ODI project or providing shareholder loans to its offshore subsidiaries may only remit Rmb funds required for such transactions through its onshore Rmb bank account, and profits from an ODI project and repayment of principal and interest on any Rmb-denominated shareholder loans must be registered with Safe. Therefore, such Rmb funds retained offshore may serve as another channel for the outflow of Rmb funds for ODI projects.

Foreign direct investment

As Rmb is not a freely convertible currency as far as capital account items are concerned, conventional FDI by way of capital contribution and acquisition of shares, equity interests or assets of existing companies in the PRC may only be made in foreign exchange. The only source of Rmb that foreign investors may use for FDI was post-tax Rmb profits derived from their existing foreign-invested enterprises (FIEs). Further, conventional FDI requires conversion from foreign exchange into Rmb, thus increasing domestic liquidity. Therefore, expanded uses of offshore Rmb funds in FDI projects will not only internationalise Rmb as a currency for FDI but also will help ease the domestic inflation pressure in the PRC.

The legal framework for Rmb FDI has been formulated under a number of signposting circulars by Mofcom, Safe and the PBoC since the beginning of 2011.

Mofcom Circular [2011] No. 72

Issued on February 25 2011, Mofcom's Circular on Issues Relevant to the Administration of Foreign Investment (关于外商投资管理工作有关问题的通知) permits foreign investors to use offshore Rmb proceeds from their cross-border trades and “legitimately raised” offshore Rmb funds to make capital contributions to newly incorporated FIEs or additional capital contributions to existing FIEs, to acquire shares/equity interests or assets of existing companies or to provide shareholder loans to their onshore subsidiaries. Under this Circular, foreign investors wishing to use offshore Rmb funds for FDI purposes must apply to Mofcom through its relevant provincial counterpart for approvals, and if Mofcom so approves, the approval documents will specify the amount of offshore Rmb funds that may be used for such FDI transactions.

Safe Circular [2011] No. 38

The April 7 2011 Circular on Matters concerning Regulating the Operation of Cross-border RMB Capital Account Business (关于规范跨境人民币资本项目业务操作有关问题的通知) lays down, among others, operating procedures for foreign exchange registrations and amendments to such registrations in respect of the following cross-border Rmb flows:

n outward remittance of onshore Rmb funds for ODI projects;

n inward remittance of offshore Rmb funds for FDI projects;

n outward shareholder loans by PRC domestic lenders to their offshore subsidiaries; and

n Rmb-denominated foreign debts to PRC domestic borrowers.

PBoC Circular [2011] No. 145

On June 3 2011, the PBoC released its Circular on Clarification of Matters Relating to Cross-border Rmb Business (关于明确跨境人民币业务相关问题的通知). From the banking settlement perspective, it:

n regulates cross-border Rmb inflows, outflows and banking settlements of such funds;

n specifies that offshore Rmb funds legitimately raised by foreign investors may be repatriated back to the Mainland for FDI projects, but to prevent “hot money” from finding its way into the PRC, such offshore Rmb funds may not be invested in industries or projects falling in the “restricted” category (国家限制类) or being key subjects of [government] intervention (重点调控类) or financial sector; and

n requires that the banking settlement of capital account transactions be subject to approval by PBoC on a case-by-case basis.

The PBoC's Circular fails to specify whether the reference to “industries or projects being key subjects of [government] intervention” includes real estate development. It is also silent on what factors the PBoC will take into account when reviewing an application for banking settlement on a case-by-case basis, which could be in conflict with the general permission under the Mofcom draft circular discussed below.

Mofcom draft circular (Draft Circular)

This Draft Circular was issued on August 22 2011 for public consultation for a period ending on September 20 2011. It sheds light on a number of crucial but previously uncertain subjects relating to offshore Rmb FDI.

Definition of cross-border Rmb FDI

The Draft Circular defines “cross-border Rmb FDI” as direct investment made by foreign investors according to law in the PRC by using offshore RMB funds legitimately obtained by the foreign investors.

Legitimacy of offshore Rmb funds

Under the Draft Circular, offshore Rmb funds that may satisfy the legitimacy requirements come from two principal sources as follows:

Offshore sources: Rmb funds that are legitimately obtained offshore by foreign investors, including without limitation:

n Rmb-denominated payments for cross-border import and export transactions; and

n proceeds from offshore issuance of Rmb-denominated bonds or shares.

Onshore sources: Rmb funds that are received by foreign investors from onshore FIEs in which they have invested, including:

n Rmb-denominated profit distributed by such FIEs and repatriated abroad by the foreign investors;

n Rmb-denominated payments received by the foreign investors from transfers of their equity/share holdings in such FIEs;

n Rmb-denominated repayments from reduced registered capital of such FIEs;

n assets liquidation proceeds in Rmb from such FIEs; and

n Rmb-denominated investment recouped by foreign investors ahead of the Chinese investors from Sino-foreign cooperative joint ventures (CJVs).

Prohibited areas for Rmb FDI

The Draft Circular expressly prohibits foreign investors from using offshore Rmb funds to:

n purchase securities listed on stock exchanges in the PRC, whether directly or indirectly, presumably because such investments have been reserved for qualified foreign institutional investors (QFIIs) under relevant PRC laws and regulations until the proposed “Rmb QFII” [Rmb Qualified Institutional Investor] or “R-QFII” regime is officially launched in the future;

n purchase onshore financial derivatives;

n provide entrustment loans; or

n repay loans from onshore and offshore lenders.

Investment in real estate projects

As a standout exception to the above prohibited areas, foreign investors are indeed permitted under the Draft Circular to invest offshore Rmb funds in real estate development projects, but must comply with approval and filing requirements generally applicable to foreign-invested real estate development projects. The Draft Circular specifies that any such investment projects that have been approved or filed with Mofcom will be announced on Mofcom's website.

Inter-bank bond market

The PBoC issued Circular [2010] No. 217, the Circular on Matters concerning Pilot Inter-bank Bond Market for Rmb Investment by Overseas Rmb Clearing Banks (关于境外人民币清算行等三类机构运用人民币投资银行间债券市场试点有关事宜的通知), on August 16 2010. It permits: (i) foreign central banks or monetary authorities; (ii) Rmb clearing banks in the Hong Kong SAR and the Macau SAR; and (iii) overseas banks participating in the Pilot Scheme to invest their R,b holdings in the PRC domestic inter-bank bond market in which pledged repos, government bonds, financial and corporate debentures are traded.

Each of these financial institutions must open a dedicated Rmb settlement account with an onshore bank before it may invest in the inter-bank bond market.

The bond transactions are conducted through a trading system administered by the National Inter-bank Lending Centre, China Foreign Exchange Trade System (CFETS) and China Central Depository & Clearing Co. (CCDC) in accordance with the Administrative Measures for Bond Exchange of National Inter-bank Bond Market (全国银行间债券市场债券交易管理办法).

Channels of cross-border settlements

Finally, successful implementation of the Pilot Scheme will depend on effective and operable channels through which cross-border payments for current account and capital account transactions can be settled and cleared. In this regard, PBoC reaffirms permitted channels in its Circular [2011] No. 145 as follows:

n a PRC domestic bank acting as an agent bank of an overseas bank participating in the Pilot Scheme;

n an overseas clearing bank designated by the PRC Central Government for implementation of the Pilot Scheme, for example, Bank of China (Hong Kong); or

n a dedicated Rmb settlement account opened by a foreign company with a PRC domestic bank; and the balance of such settlement account is “ring-fenced” and therefore may not be used for purposes other than settlement of cross-border transactions.

Anti-money laundering and counter-terrorist financing

As cross-border trade settlements and clearance inevitably involve large amounts of cash inflow and outflows, the PBoC has attached a great importance to the prevention of and combat against possible money laundering and terrorist financing since the Pilot Scheme was launched. A number of circulars issued by the PBoC, including Circular [2009] No. 10 and the Detailed Implementing Rules and Circular [2011] No. 1, require domestic settlement and clearing banks and agent banks to know their customers, to identify any natural persons or beneficiaries behind a transaction and real purposes of a transaction, and report any suspicious money flows to the relevant banking regulatory authority in accordance with the PRC Anti-money Laundering Law (中华人民共和国反洗钱法), the Financial Institutions Anti-money Laundering Provisions (中国人民银行金融机构反洗钱规定) and a number of administrative rules issued by PBoC.

Future developments and areas for improvement

Rmb QFII

During Vice Premier Li Keqiang's recent visit to the Hong Kong SAR, he gave a green light to launch the Rmb QFII (R-QFII) programme and announced that the PRC Central Government had approved a quota of Rmb20 billion for R-QFIIs. However, there have been no specific rules at present on how to implement this general policy. Until such rules are issued, the following key questions will remain unanswered:

n Is the eligibility for an R-QFII restricted to PRC financial institutions' subsidiaries in Hong Kong only?

n How does an R-QFII apply for a quota for its offshore Rmb investment in domestic securities?

n If a QFII is also qualified as an R-QFII, will it be required to open separate dedicated Rmb settlement accounts for Rmb funds converted from foreign exchange under the QFII Rules (the Measures for the Administration of Securities Investments in China by Qualified Foreign Institutional Investors (合格境外机构投资者境内证券投资管理办法), issued on September 1 2006) and for offshore Rmb funds brought back under the R-QFII rules?

n Will R-QFII's funds be permitted to invest in domestic stock index futures?

Without these rules in place, the contemplated R-QFII regime would remain on the drawing board.

Regulatory coordination

As mentioned earlier, at least six Central Governmental Authorities issued various administrative circulars to keep abreast of the rapid developments in cross-border Rmb settlement and investment over the last two years or so with a view to testing the waters during the period of implementing the Pilot Scheme. It is important that a more concerted approach be taken in the future to ensure that rules set by a regulatory authority do not duplicate or conflict with those issued by others. Preferably, a unified set of rules will be issued to upgrade and facilitate the implementation of cross-border Rmb settlement and investments.

Clearer guidelines

As mentioned earlier, it is essential for a foreign investor to satisfy Mofcom and the PBoC on the legitimacy of its sources of offshore Rmb funds. in the approval process. It would be best if the Draft Circular, when finally issued, could exemplify more legitimate sources, which have already been recognised by Safe.

Final thoughts

The PRC Central Governmental Authorities have built channels in the last few years to enable Rmb funds to flow out of and back into the PRC to settle various types of capital account transactions apart from cross-border trade and service payments. Foreign and domestic investors who wish to take advantage of these channels, however, should remain wary of practical hurdles and uncertainties in investing their offshore Rmb funds in the PRC as the history of the Pilot Scheme is not long enough to test these channels. It is generally expected that the legal framework will be upgraded and improved so that Rmb funds, like water, can flow both ways through more channels in the not too distant future – just like the Chinese saying: “When water comes, channels are ready (水到渠成)”.

Hannah Ha and Lawrence Zhou, Mayer Brown JSM, Hong Kong