DC now applies to:

(i) non-financial domestic enterprises in all provinces, autonomous regions and municipalities, including domestically-funded and foreign-invested enterprises (FIEs); and

(ii) FX capital funds, foreign debt proceeds, proceeds issued from securities listings outside China, as well as FX proceeds from other capital account transactions.

Currently, enterprises may convert 100% of their FX capital account proceeds into renminbi, but the percentage may later be adjusted by SAFE based on macroeconomic conditions.

Unified discretionary conversion rules

Regardless of the source of the capital account funds, renminbi proceeds under DC must be deposited into a specific renminbi “payment pending account”. Circular 16 permits an enterprise to use a single renminbi payment pending account for all FX capital accounts opened with the same bank branch.

The bank is required to conduct authenticity checks to verify the transaction based on the “know your customer”, “know your customer's business” and “due diligence” principles. Furthermore, the bank must review documents relating to prior payments if it were to pay funds out of the payment pending account. The document review requirement still applies if the enterprise switches to PDC for its next payment.

Where an enterprise wishes to use all of its balance in the account (whether via DC or PDC), the bank must review the underlying documents before processing the payment. If an enterprise seeks to circumvent the documentation verification requirement by requesting to convert just slightly less than the entire balance in its account, the bank must actively examine the true purpose behind the request.

The only exemption from the verification requirement is where the funds are required for petty cash payment. An enterprise can now use up to $200,000 as petty cash in a single calendar month (either through DC or PDC). This is an increase from the original cap of $100,000 under Circular 19.

Negative list for use of settlement proceeds

Circular 16 provides that a domestic enterprise can use both the FX income from capital account transactions and the relevant renminbi proceeds (either from DC or PDC) for the payment of current account transactions within its business scope as well as those permitted by laws and regulations.

Current account transactions within an enterprise's business scope include expenditures incurred during its daily operations. Payroll, office rental, raw material procurement and service fees typically fall under this item.

However, what amounts to a transaction allowed by laws and regulations appears to be less clear. A rather far-fetched assumption could mean that an FIE can rely on this provision to carry out equity investments. That said, it is advisable to take a more prudent interpretation so that payments are only made in accordance with the business scope of the enterprise.

Circular 16 also contains a negative list that sets the following restrictions:

• No direct or indirect payments and expenditures outside the enterprise's business scope or otherwise prohibited by laws and regulations are allowed;
• Unless otherwise permitted, no investments in securities or asset management products (except for principal-protected bank wealth management products) are allowed;
• Unless permitted by the business scope, no loans to non-affiliated companies are allowed; and
• No real estate construction or purchases (except by property developers or for self-use) are allowed.

Compared with Circular 19, the new negative list has removed certain items that were previously prohibited, including the extension of renminbi entrustment loans to affiliates, repayment of inter-company loans (including third-party advances), and repayment of renminbi bank loans (including entrustment loans) that have been on-lent to third parties. SAFE is expected to reconcile all the rules on cash pooling programs.

Enhanced supervision

While Circular 16 relaxes currency conversion controls, it also brings increased monitoring and inspections so as to crack down on non-compliant settlement activities. Local SAFE bureaus may carry out onsite and offsite inspections by requesting information and materials, interviewing the relevant persons in charge, as well as taking copies of relevant materials. Circular 16 also imposes substantive penalties for violations.

Money management implications

Currency risk

Under PDC, an enterprise may only convert its FX funds into renminbi when there is a demand for external payment. If the renminbi appreciates against the currency of the FX funds, the enterprise may suffer from currency conversion loss. Conversely, DC, as adopted by Circular 16, allows a domestic non-financial enterprise to choose the timing and amount of currency conversion regardless of whether there is an immediate payment demand. It therefore allows an enterprise to better manage its currency risk, and provides an additional tool for currency risk hedging.

Treasury

Theoretically, Circular 16 enables an enterprise to aggregate all of its renminbi positions from capital account transactions into one single payment pending account. This means an enterprise no longer needs to check all of its capital transaction accounts and/or go through separate procedures to draw money through these accounts. In addition, Circular 16 clarifies that investments in principal-protected bank wealth management products are permitted. With these initiatives, the new rule offers the treasury of an FIE more flexibility in managing its cash positions.

Cross-border renminbi coordination

According to the rules and regulations promulgated by the Ministry of Commerce, PBOC and SAFE, cross-border renminbi under capital account transactions should be treated equally as FX under capital account transactions. Cross-border renminbi remitted into China under capital account transactions should be managed through special renminbi accounts, although the credit and debit rules for these accounts are not entirely identical to the payment pending accounts. It remains to be seen how these two sets of rules are to fully complement each other and whether these accounts will be consolidated in the future.

TieCheng Yang, Partner
Clifford Chance, Beijing

The State Administration of Foreign Exchange (SAFE), China's regulator tasked with monitoring foreign exchange (FX) flows, has long held a tight control on currency conversion. It has slowly relaxed its grip in recent years, however, releasing a series of liberalizing measures as a means of facilitating cross-border investments and financing. And on June 9, 2016, it issued the Circular on Reforming and Regulating the Policy for the Control of the Conversion of Foreign Exchange on the Capital Account (Hui Fa [2016] No.16) (Circular 16), as the latest step to smoothen the process for foreign and domestic enterprises to convert their funds.

China's FX conversion regime

For a long time, enterprises in China were only able to convert their FX proceeds from capital account transactions into renminbi by presenting a genuine demand of payment to their account banks. This scheme was referred to as conversion upon payment demand (PDC).

In July 2014, SAFE introduced a new scheme through the Circular on Issues Relevant to Launching a Pilot Project for Reform of the Administration Method for the Settlement of the Foreign Exchange Registered Capital of Foreign-invested Enterprises in Certain Regions, under which foreign-invested non-financial enterprises in designated regions were able to convert FX capital funds (i.e. capital contributed by foreign shareholders) at any time. This was referred to as the discretionary conversion (DC) method. Currency conversion under DC is not contingent upon a genuine payment demand, and the use of proceeds would only be verified at the payment stage. The scheme was applied nationwide in March 2015, pursuant to the Circular on Reforming the Management Approach regarding the Settlement of Foreign Exchange Capital Funds of Foreign-invested Enterprises (Hui Fa [2015] No.19) (Circular 19).

Based on its experience from implementing DC, SAFE subsequently extended the scheme for converting foreign debt FX proceeds to the four pilot free trade zones in Shanghai, Tianjin, Guangdong and Fujian.

And in a move to continue opening up capital account transactions nationwide, Circular 16 expands the scheme to all domestic and foreign-invested non-financial enterprises in China. In line with the People's Bank of China (PBOC)'s recent initiative to reform the cross-border financing regime and to combat the country's shrinking FX reserves (China burned through $612 million in foreign currency since January 2015), Circular 16 simplifies the foreign debt regime even further and allows enterprises to convert FX funds into renminbi at their own discretion.

What Circular 16 brings

Expanded discretionary conversion application scope

DC now applies to:

(i) non-financial domestic enterprises in all provinces, autonomous regions and municipalities, including domestically-funded and foreign-invested enterprises (FIEs); and

(ii) FX capital funds, foreign debt proceeds, proceeds issued from securities listings outside China, as well as FX proceeds from other capital account transactions.

Currently, enterprises may convert 100% of their FX capital account proceeds into renminbi, but the percentage may later be adjusted by SAFE based on macroeconomic conditions.

Unified discretionary conversion rules

Regardless of the source of the capital account funds, renminbi proceeds under DC must be deposited into a specific renminbi “payment pending account”. Circular 16 permits an enterprise to use a single renminbi payment pending account for all FX capital accounts opened with the same bank branch.

The bank is required to conduct authenticity checks to verify the transaction based on the “know your customer”, “know your customer's business” and “due diligence” principles. Furthermore, the bank must review documents relating to prior payments if it were to pay funds out of the payment pending account. The document review requirement still applies if the enterprise switches to PDC for its next payment.

Where an enterprise wishes to use all of its balance in the account (whether via DC or PDC), the bank must review the underlying documents before processing the payment. If an enterprise seeks to circumvent the documentation verification requirement by requesting to convert just slightly less than the entire balance in its account, the bank must actively examine the true purpose behind the request.

The only exemption from the verification requirement is where the funds are required for petty cash payment. An enterprise can now use up to $200,000 as petty cash in a single calendar month (either through DC or PDC). This is an increase from the original cap of $100,000 under Circular 19.

Negative list for use of settlement proceeds

Circular 16 provides that a domestic enterprise can use both the FX income from capital account transactions and the relevant renminbi proceeds (either from DC or PDC) for the payment of current account transactions within its business scope as well as those permitted by laws and regulations.

Current account transactions within an enterprise's business scope include expenditures incurred during its daily operations. Payroll, office rental, raw material procurement and service fees typically fall under this item.

However, what amounts to a transaction allowed by laws and regulations appears to be less clear. A rather far-fetched assumption could mean that an FIE can rely on this provision to carry out equity investments. That said, it is advisable to take a more prudent interpretation so that payments are only made in accordance with the business scope of the enterprise.

Circular 16 also contains a negative list that sets the following restrictions:

• No direct or indirect payments and expenditures outside the enterprise's business scope or otherwise prohibited by laws and regulations are allowed;
• Unless otherwise permitted, no investments in securities or asset management products (except for principal-protected bank wealth management products) are allowed;
• Unless permitted by the business scope, no loans to non-affiliated companies are allowed; and
• No real estate construction or purchases (except by property developers or for self-use) are allowed.

Compared with Circular 19, the new negative list has removed certain items that were previously prohibited, including the extension of renminbi entrustment loans to affiliates, repayment of inter-company loans (including third-party advances), and repayment of renminbi bank loans (including entrustment loans) that have been on-lent to third parties. SAFE is expected to reconcile all the rules on cash pooling programs.

Enhanced supervision

While Circular 16 relaxes currency conversion controls, it also brings increased monitoring and inspections so as to crack down on non-compliant settlement activities. Local SAFE bureaus may carry out onsite and offsite inspections by requesting information and materials, interviewing the relevant persons in charge, as well as taking copies of relevant materials. Circular 16 also imposes substantive penalties for violations.

Money management implications

Currency risk

Under PDC, an enterprise may only convert its FX funds into renminbi when there is a demand for external payment. If the renminbi appreciates against the currency of the FX funds, the enterprise may suffer from currency conversion loss. Conversely, DC, as adopted by Circular 16, allows a domestic non-financial enterprise to choose the timing and amount of currency conversion regardless of whether there is an immediate payment demand. It therefore allows an enterprise to better manage its currency risk, and provides an additional tool for currency risk hedging.

Treasury

Theoretically, Circular 16 enables an enterprise to aggregate all of its renminbi positions from capital account transactions into one single payment pending account. This means an enterprise no longer needs to check all of its capital transaction accounts and/or go through separate procedures to draw money through these accounts. In addition, Circular 16 clarifies that investments in principal-protected bank wealth management products are permitted. With these initiatives, the new rule offers the treasury of an FIE more flexibility in managing its cash positions.

Cross-border renminbi coordination

According to the rules and regulations promulgated by the Ministry of Commerce, PBOC and SAFE, cross-border renminbi under capital account transactions should be treated equally as FX under capital account transactions. Cross-border renminbi remitted into China under capital account transactions should be managed through special renminbi accounts, although the credit and debit rules for these accounts are not entirely identical to the payment pending accounts. It remains to be seen how these two sets of rules are to fully complement each other and whether these accounts will be consolidated in the future.

TieCheng Yang, Partner
Clifford Chance, Beijing