Interim Measures and Implementation Rules for the Interim Measures on Carrying Out the Pilot Program for Foreign-Invested Equity Investment Enterprises and Management Enterprises
Interim Measures
Issuing Body: Tianjin Municipal Commission of Development and Reform
Issuing Date: October 14, 2011
Effective Date: October 14, 2011
Implementation Rules Issuing Body: Tianjin Municipal Commission of Development and Reform, Tianjin Municipal Finance Office, Tianjin Municipal Commission of Commerce, Tianjin Municipal Administration of Industry and Commerce
Issuing Date: October 14, 2011
Effective Date: November 13, 2011
In an effort to attract global private equity (PE) firms and develop Tianjin into China's PE hub, the Tianjin Municipal Commission of Development and Reform (Tianjin DRC), along with other local government agencies, has issued regulations relaxing restrictions on the use of foreign currency for PE investments. With the release of the Interim Measures on Carrying Out the Pilot Program for Foreign-Invested Equity Investment Enterprises and Management Enterprises (Tianjin Pilot PE Measures) and the Implementing Rules for the Interim Measures on Carrying Out the Pilot Program for Foreign-Invested Equity Investment Enterprises and Management Enterprises (PE Implementing Rules) on October 14, 2011, Tianjin became the third Chinese city to establish a pilot program granting some relief from foreign exchange conversion rules to foreign-invested equity investment enterprises and foreign-invested equity investment management enterprises. Shanghai and Beijing had previously instituted pilot programs for foreign-invested PE firms.
The Implementing Measures for the Pilot Program of Foreign-Invested Equity Investment Enterprises in Shanghai were summarized in the February 2011 issue of China Law Update.
Background
Foreign-invested equity investment enterprises are PE funds established in China that make equity investments in private companies. Foreign-invested equity investment management enterprises are managers of such funds. Under the Circular on Relevant Operating Issues Concerning Improvement of the Administration of Payment and Settlement of Foreign Currency Capital by Foreign-Invested Enterprises, issued in August 2008 by China's State Administration for Foreign Exchange (SAFE), foreign-invested enterprises are generally prohibited from converting foreign currency registered capital into RMB for downstream equity investments, a limitation that has discouraged the formation of foreign-invested PE funds.
In the past few years, several cities have granted foreign exchange conversion quotas to selected foreign-invested equity investment enterprises and foreign-invested equity investment management enterprises (mainly PE giants such as Carlyle, Blackstone, and TPG) under their own pilot programs to facilitate the conversion of foreign capital into RMB, within the quotas. To clarify the thresholds and documentation for qualification under pilot programs, Shanghai, Beijing, and Tianjin have all adopted local rules designed to attract global PE capital, with Tianjin being the last to do so.
Of the three pilot programs, Tianjin's rules contain the most detailed regulations and procedures. The Tianjin Pilot PE Measures clarify the concepts of pilot foreign-invested equity investment enterprises and foreign-invested equity investment management enterprises (together referred to as "Pilot Enterprises"), their legal forms, thresholds for participation in the pilot program, and the allocation of responsibilities among various oversight authorities. Tianjin's PE Implementing Rules specify the procedures and documents required to be qualified under the Tianjin Pilot Program.
Legal Forms and Thresholds
Under the Tianjin Pilot PE Measures, Pilot Enterprises may be formed either as a corporation or a limited partnership.
For foreign-invested equity investment management enterprises established in Tianjin to be qualified under the Tianjin Pilot Program, they should have at least RMB10 million (approximately US$1.59 million) or the equivalent foreign currency in their capital accounts. In addition, firms should have at least two senior management personnel with more than five years' experience in PE investment or PE management, who have also served as senior managers for more than two years and worked in China-related investment or in Chinese financial institutions. The Tianjin Pilot PE Measures also require that a certain proportion of senior management personnel be Chinese or Chinese passport holders, but without clarification of that proportion.
Foreign-invested equity investment enterprises established by foreign-invested equity investment management enterprises should meet the following criteria in order to qualify under the Tianjin Pilot Program:
- The enterprise's capital may be wholly contributed by overseas investors or contributed by both overseas and domestic investors.
- Foreign-invested equity investment enterprises should have at least RMB500 million of capital (approximately US$79 million) or the equivalent foreign currency.
- Their management enterprises should invest a certain proportion of the firm's capital, with the cap being 5 percent.
- Each overseas investor should own at least US$500 million of assets or manage over US$1 billion of assets.
- Each overseas investor should invest at least US$10 million in the foreign-invested equity investment enterprise.
As with Shanghai's pilot program PE rules, the Tianjin Pilot PE Measures specifically welcome overseas sovereign funds, pension funds, endowment funds, charitable funds, funds of funds, insurance companies, banks, securities companies, and other foreign institutional investors to act as overseas investors, since the purpose is to develop the PE industry for long-term investment in Tianjin's strategic emerging industries. Unlike Beijing's pilot rules, however, the Tianjin Pilot PE Measures do not enumerate these strategic emerging industries.
Pilot Qualification Application
Under Tianjin's PE Implementing Rules, either foreign-invested equity investment enterprises or foreign-invested equity investment management enterprises applying for the pilot qualifications should submit documents to the Tianjin DRC through the management enterprises. (Equity investment enterprises may not apply directly.) One characteristic of the Tianjin Pilot Program is that applicants must go through two procedures to receive pilot qualification.
- Pilot qualification preliminary review
Within ten working days of receiving all application documents, the Tianjin DRC will convene other members of the Tianjin Industrial Investment Fund Development and Filing Office (Filing Office) (i.e., the Tianjin Municipal Commission of Commerce, the Tianjin Municipal Administration of Industry and Commerce, the Tianjin Municipal Finance Office, etc.) to review the application. Those passing the preliminary review are able to participate in the Tianjin Pilot Program.
Unlike foreign-invested equity investment management enterprises, foreign-invested equity investment enterprises may only apply for preliminary review before they have actually been established. The Tianjin Pilot PE Measures require those foreign-invested equity investment enterprises that pass preliminary review to accomplish registration at the local administration of industry and commerce (AIC) within six months, and capital contribution agreements should be executed within that time frame as well. Failure to do so will result in loss of the opportunity to participate in the Tianjin Pilot Program.
- Pilot qualification accreditation
For foreign-invested equity investment enterprises that pass the preliminary review and complete the AIC registration, their corresponding management enterprises apply to the Tianjin DRC for pilot qualification accreditation. The Tianjin DRC will convene other members of the Filing Office to review the application within ten working days, and will report to the responsible official of the Tianjin municipal government for final decision if the Filing Office finds the applicant qualified for the pilot program. With approval from the responsible government official, the Tianjin DRC will issue the pilot qualification certificate to the Pilot Enterprise, with its foreign exchange conversion quota being determined at the same time.
Foreign Exchange Regulation
For Pilot Enterprises, foreign exchange conversion will be handled at their custodian banks, not by SAFE's Tianjin counterpart. This procedure will save time compared to normal exchange procedures for traditional foreign-invested enterprises. But Pilot Enterprises are not allowed simply to convert their foreign currency capital into RMB up to their allotted quota; foreign exchange conversion amounts will still be subject to and limited by the actual capital requirements of the project. This regulation follows project-oriented foreign exchange conversion principles adopted by Shanghai's and Beijing's pilot PE Rules.
The Tianjin Pilot PE Measures also impose a three-year "lock-up" period, so that accumulated proceeds of a pilot foreign-invested equity investment enterprise may only be remitted offshore after the enterprise has been established for at least three years.
Designated Bank Accounts
Every pilot foreign-invested equity investment enterprise should open four designated accounts at its custodian bank:
- A foreign-exchange-registered capital account to receive capital from overseas investors
- A RMB settlement account to receive capital from domestic investors
- A designated investment account to hold capital for external equity investment that is from both the foreign-exchange-registered capital account and RMB settlement account
- A designated proceeds account to collect all proceeds received by the pilot foreign-invested equity investment enterprise
Mirroring the above-mentioned rules that require foreign exchange conversion to be based on project costs, the Tianjin Pilot PE Measures stipulate that capital in the designated investment account must be used for external investment or payment within seven days after it is collected, with converted funds disbursed in accordance with the foreign currency/RMB ratio as agreed upon the firm's AIC registration. If these rules are not followed, the firm's pilot qualification will be cancelled. This seven-day disbursement period means it is not possible for foreign capital to be converted into RMB and retained for a long period.
Pilot foreign-invested equity investment management enterprises must open a foreign exchange registered capital account in order to deposit capital that is to be invested in the pilot foreign-invested equity investment enterprises.
In addition to strict oversight of these four different accounts, custodian banks are required to report foreign exchange conversions, foreign currency capital changes, external investments, and capital flow of pilot enterprises to the Tianjin DRC and SAFE's Tianjin counterpart both monthly and quarterly.
No "National Treatment"
Under World Trade Organization agreements, "national treatment" is a term meaning that foreign-invested entities enjoy the same treatment as their domestic counterparts. But purely domestic PE funds in China do not have foreign exchange issues, nor must they obtain project-level approval. Foreign PE houses want, and have focused on, this issue of "national treatment:" without it, there is no advantage to structuring foreign-invested PE funds in China.
The Tianjin Pilot PE Measures and PE Implementing Rules do not stipulate whether or not pilot foreign-invested equity investment enterprises are to be treated the same as domestic firms; the rules only mention that these enterprises' downstream investments should be in compliance with China's foreign investment industrial policies. Project verification by the local DRC and approval from the local commission of commerce also will be required. As a result, we understand that foreign-invested equity investment enterprises will actually be viewed as "foreign investors" when making downstream investments, and must go through the same time-consuming and burdensome examination and approval procedures as other foreign-invested projects. In March 2011, China's Ministry of Commerce (MOFCOM) issued the Notice on Clarifying Certain Issues Regarding Administration of Foreign Investment, which specifically states that foreign-invested partnerships focusing on external investments will be viewed as foreign investors. As the majority of foreign PE houses would prefer a partnership to structure their investments in China (mainly due to a partnership's tax pass-through advantages), this MOFCOM notice has made some of them reconsider their plans to establish RMB-denominated PE funds in China.
Conclusion
Like Shanghai and Beijing, Tianjin has successfully lobbied SAFE to grant a certain level of relief on foreign exchange conversion for pilot PE enterprises, though the city has imposed stricter supervision of its Pilot Program. Despite that relief, however, global PE houses still face the prospect that, in China, the time required for foreign exchange conversion and the unpredictability of foreign investment approval will either delay the timing of their investments or block them altogether. At the present time, there is no nationwide regulation applicable to foreign-invested equity investment enterprises and their management enterprises. It has been widely reported that China's central government is doing research on this matter and will refer to the actual implementation of these local pilot measures in Tianjin and other cities. We understand that these pilot program restrictions may be relaxed gradually in the future, so foreign PE houses are advised to keep a close eye on developments.
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