New direction in overseas restructuring and financing

On 14 July 2014, the State Administration of Foreign Exchange (SAFE) issued the Notice on Issues Relevant to Exchange Control in Connection With Offshore Investment/Financing and Investment Round Tripping Carried Out Through Special Purpose Vehicles by Persons Resident in China (document No. 37) and two attachments: Operational Guidelines for Matters Relating to Exchange Control in Connection with Investment Round Tripping; and Application for Foreign Exchange Matters Relating to Direct Investment on the Capital Account.

Document No. 75, which had a material impact on the seeking of financing and listing abroad by domestic enterprises, was repealed by document No. 37 and the operational rules relating to exchange control in connection with investment round tripping of document No. 59 were superseded accordingly by the operational guidelines. Document No. 37 makes relatively large revisions compared to document No. 75.

Major changes

1. Revision of the definition of special purpose vehicle (SPV). The definition of SPV in document No. 37: (1) is no longer restricted to having “offshore financing” as its objective, and has now expanded to investment and financing as objectives, having added “investment”. In practice, in addition to companies established through investment round tripping with the objective of a listing, there are companies established through investment round tripping for other purposes (for example, purely carrying out offshore bond financing or establishment of an offshore holding platform), and such unlisted companies will be subject to administration by way of document No. 37; and (2) is no longer limited to “the assets or equity of a domestic enterprise”, but has been expanded to include “offshore assets or equity”.

2. Clarification and simplification of the definition of “investment round tripping”. Document No. 37 simplifies and specifies that the direct method of investment is the establishment of a foreign-invested enterprise by way of “new establishment, acquisition or other such method”, which gives such rights and interests as ownership, control, or the right to operate and manage the enterprise. This gives enterprises that were newly established as foreign-invested enterprises, which previously fell in the category of registration of a company that is not an SPV, and for which a listing is applied for after three years of operation, and enterprises established through a variable interest entity (VIE) arrangement the opportunity to be registered as an SPV.

3. Directors, supervisors, senior management personnel and employees permitted to carry out foreign exchange registration in respect of the employee stock ownership plan (ESOP) of the unlisted SPV. This provision may effectively resolve the problem of the registration of the ESOP of numerous unlisted SPVs and the exercise of their rights. Under document No. 37, if an unlisted SPV uses its equity or options as an equity incentive for the abovementioned personnel of the domestic enterprise directly or indirectly controlled by it, the relevant individual resident in China may carry out foreign exchange registration procedures for the SPV before exercising his or her rights.

4. Simplification of registration matters. Document No 37: (1) sorts out the scope of jurisdiction for registration by natural persons and non-natural persons, with document No. 37 limited to provisions for the carrying out of registration by individuals, whereas the carrying out of registration by legal persons and other organisations is governed by current regulations applicable to domestic organisations; (2) expressly abolishes the requirement for offshore financing and business plans, lightening the burden on enterprises; (3) specifies that only top-level offshore SPVs are subject to registration, and no longer requires the registration of other subordinate SPVs; (4) revises the scope of material matters for which amendment of registration is required, no longer requiring amendment of foreign exchange registration in connection with offshore investment for such matters as financing, capital increase, capital reduction, equity swap or transfer, provision of security for a third party, equity or debt investment, etc., by an SPV. The changed information mainly focuses on the general particulars of a shareholder who is an individual resident in China, and that relating to changes in shareholding, additionally, the time allotted for carrying out registration is shortened, expressly specified as being 10 working days; and (5) specifies the procedure for retroactively carrying out foreign exchange registration and adopts the practice of “penalty first, then registration” where a violation of regulations is suspected.

5. A domestic enterprise controlled by a person resident in China may, on the basis of genuineness and lawfulness, extend a loan to the offshore SPV, and the person resident in China may also purchase foreign exchange to be used for a capital contribution, buyback, delisting, etc. This opens a channel for an offshore SPV to secure financing in China, and will be beneficial for further cross-border investment or cross-border M&A integration by an offshore SPV.

6. The mandatory provision on the repatriation of funds stating that “the profits, dividends and foreign exchange revenues derived from changes in capital that a person resident in China obtains from an SPV shall be remitted back to China within 180 days from the date of obtaining the same” is abolished, and the retaining of offshore financing proceeds and other relevant funds offshore for use there is permitted. SPVs have changed into investment and financing entities, and the expansion of the channel for fund outflows makes the cross-border transfer and flow of funds more convenient and, likewise, is conducive to satisfying the demand of enterprises for investment abroad.

Connected acquisitions

In short, document No. 37 makes cross-border capital transactions by persons resident in China more convenient. However, document No. 10 specifies that connected acquisitions need to be reported to the Ministry of Commerce (MOFCOM) for approval. In practice, with the exception of certain round-trip acquisitions by offshore listed companies and wholly Chinese-owned state-owned holding companies, MOFCOM has yet to approve a single case of a connected acquisition by an individual in China, or by a private enterprise.

Now, the offshore investment/financing and investment round tripping activities regulated by document No. 37 involve connected acquisitions, and as to whether the situation can be resolved by a red-chip listing, attention still needs to be paid to how documents 10 and 37 will dovetail, and the opinions of the relevant authorities.