Provisions on the Administration of Foreign Exchange Used in Direct Outbound Investments by Domestic Institutions

A month after it liberalized the rules governing loans by Chinese enterprises to foreign subsidiaries, China's State Administration of Foreign Exchange (SAFE) has enacted another set of regulations likewise designed to encourage domestic companies to invest abroad. Effective as of August 1, 2009, the Provisions on the Administration of Foreign Exchange Used in Direct Outbound Investments by Domestic Institutions (Direct Outbound Investment Provisions) make it easier and less expensive for Chinese firms to invest in or acquire foreign companies by loosening regulatory requirements and liberalizing the rules governing the source of foreign exchange funds for such investments.

The Direct Outbound Investment Provisions are the most recent of several efforts by the Chinese government to encourage domestic companies to "go abroad." Last month, for example, China Law Update summarized the Circular on Several Issues Concerning the Administration of Foreign Exchange in Outbound Lending by Domestic Enterprises, which made it easier for Chinese companies to loan money to overseas enterprises in which they have a financial stake. In April, we likewise summarized the Measures for the Administration of Outbound Investments, which generally streamlined the approval process for foreign ("outbound") investments, albeit without liberalizing the rules that govern funding.

One obvious factor driving these moves by the Chinese government is the country's huge store of foreign exchange reserves—more than US$2.1 trillion as of mid-2009, according to figures from the People's Bank of China.

The Direct Outbound Investment Provisions define direct outbound investment as the establishment of offshore enterprises or projects by a domestic Chinese entity through incorporation, merger, acquisition, equity participation, or another type of transaction in which the domestic enterprise obtains an ownership or controlling interest or operation and management rights of an existing enterprise or project.

Expanded Scope of Foreign Exchange Funding Sources

The Direct Outbound Investment Provisions significantly expand the potential sources of foreign exchange funds that Chinese enterprises can use to fund direct investments abroad. Under the new regulations, domestic companies may use their own foreign exchange funds; money obtained from a foreign exchange loan; foreign exchange funds purchased with Renminbi; tangible or intangible assets; or profits retained overseas. SAFE nevertheless reserves the power to adjust policies relative to funding sources on an "as needed" basis, depending on China's balance of international payments and statement of direct outbound investment.

Filing of Foreign Exchange Funding Sources

Another substantial change in the Direct Outbound Investment Provisions is the lifting of requirements for the prior examination and approval by SAFE of funding sources, which were contained in SAFE's Measures on the Administration of Foreign Exchange Used in Outbound Investments (effective since March 1989). In place of prior approval, the Direct Outbound Investment Provisions instead contain much simpler filing and registration procedures. (The outbound investment itself, if not the source of funding, is still subject to government approval, usually from the Ministry of Commerce.)

Remittance of Early Stage Expenses

Under the Direct Outbound Investment Provisions, companies have greater freedom to pay for preliminary expenses before getting full government approval for the outbound investment. Such early-stage expenses are defined in the provisions as expenses associated with the direct outbound investment (such as deposits and market research costs) and paid outbound before the full establishment of an enterprise or project by the Chinese company. Chinese businesses may remit such preliminary expenses after submitting the written application for direct outbound investment to the competent authority, but before receiving full approval for the investment. In general, early-stage expenses must not exceed 15 percent of the total amount of the direct outbound investment. If preliminary expenses of more than 15 percent of the total investment are necessary to fund the investment, an application must be filed with the local SAFE branch for approval.

Joint Annual Inspection for Direct Outbound Investment

All domestic institutions (excluding financial institutions) are required to participate in the Joint Annual Inspection for Direct Outbound Investment conducted annually by the Ministry of Commerce and SAFE along with their respective local counterparts.

Conclusion

SAFE's timely issuance of the Direct Outbound Investment Provisions reflects the Chinese government's strong intention to promote and implement its "go abroad " strategy, enhancing the ability of domestic enterprises to make outbound investments. With more allowable sources of foreign exchange, simplified approval procedures, and greater freedom to remit funds for preliminary expenses, more Chinese investors are expected to engage in cross-border transactions and investments.