Moving Capital to and from Shenzhen
This short article provides a practical introduction on three overlapping areas of interest for the foreign entity operating in a Special Economic Zone (SEZ). Shenzhen and other SEZs have a quickly developing foreign exchange, regulation, and cryptocurrency environment.
It is arranged into:
China’s capital account flow pathways for transactions, e.g. the debt/equity markets available and inbound/outbound direct investment,
China’s current account, e.g. standard business transactions like receiving payment from sale of goods abroad and issuing remittances, and
A note on new financial policy and the inbound Digital Currency Electronic Payment (DCEP) state-backed cryptocurrency
For the small-to-medium sized entity, receiving funding from abroad is priority, and so the capital account garners larger discussion.
In order to find some sense of peace with China’s systems of capital movement, a rough knowledge on the policy is necessary, and a grasp on the detailed practical regulation is ideal. Of course, though, even having a rough familiarity does not lend itself to the reality of uncomfortable delays in awaiting the arrival of much needed foreign capital.
A common story is the foreign subsidiary operating in China that does not receive payment from a Chinese supplier in time, has no cash to pay its manufacturing labour, and is left staring down administrative penalties while it waits anxiously for banks to process overseas aid.
These situations arise because, in China, entities must comply with a restricted capital account policy. Money cannot be freely moved into or out of the country. A restricted capital account policy is the application of capital account controls on the flow of money that enters and exits the country. A capital control is any policy designed to limit or redirect capital account transactions. In this context, a capital account transaction is a transaction that affects China’s accounted foreign assets and liabilities. Generally, these controls come in the form of rules, taxes, or fees that discriminate between domestic residents and those outside the country.
Every country utilizes capital controls of this sort, and even the strong use of capital controls is by no means unique to China. The European Union did in 1992-93, many Asian nations did during the crises of 1997-99, and the United States has brought them back into vogue for its trade war with China. But unlike these shorter-term policies, China’s use of capital control is long-term.This is because long-term stability is the commonly perceived goal for China’s capital account policy.
The Mercator Institute for China Studies, an institution purposed for such subjects, identified around 75 multifaceted capital control adjustments implemented between June 2016 and January 2018 alone. (1)
These capital account restrictions on the economy have prevented China from fully participating in the global financial system. And this in turn has led to imbalances. The tremendous foreign exchange reserves, domination of domestic banks in the financial sector, asset bubbles, and other symptoms characterize China’s domestic economy. But, China has been largely successful in maintaining the stability it seeks. Capital controls allowed China tofend off the economic maelstrom its geographical neighbours faced in the 1997-99 crises. When compared to the United States, China continues to be able to orchestrate its economy in a manner that returns a disproportionately high amount of capital to its middle class. (2)
However, perhaps contrary to a layman’s view, China has been indeed been moving towards a more open capital account. Beijing recognizes that there are benefits to reducing the limits on capital flows. For starters, Chinese investors are often good international investors. This benefits China, as would the pressure from international competition. China’s domestic financial markets are too comfortable for the “Big Four”, and this is generally not beneficial for the less established. (3)
As China opens its capital account, the liberalization of the Chinese Yuan follows. The volume of the Chinese current account, its balance of trade, may be benefited from a more flexible Yuan due to less seigniorage paid to US and other countries. The exchange of the Yuan into foreign currency and the reverse is a less complicated maneuver for those foreign entities operating in a Chinese special economic zone (SEZ), as these are the testing grounds for liberalized financial control mechanisms. The ‘testing’ that operators within Shenzhen, a long-time SEZ, are familiar with eventually leads to progress.
Current account foreign exchange items are freely convertible and can be processed by a designated domestic bank on the presentation of the correct documents. Capital account foreign exchange is more strictly controlled and is subject to registration and/or approval with the State Administration of Foreign Exchange (SAFE), the Customs, and qualified domestic banks under the guidelines of the People’s Bank of China (PBOC).
There are three main bodies that put forth the majority of the regulations and manage the flow of foreign exchange in China. The first is the State Administration of Foreign Exchange (SAFE), the second the People’s Bank of China (PBOC), and the third is the Customs. It is SAFE that more actively manages foreign exchange transactions in China. It is these institutions that are directing the liberalization of the Chinese capital flows. As said in an official English translation of PBC and SAFE themselves, “the PBC and the SAFE have been steadily pressing ahead with the orderly opening-up of interbank bond markets in recent years.” (4) SAFE often (but not always) does this through domestic banks that are designated to receive documents and authenticate on its behalf.
A Foreign Owned (Invested) Enterprise (FIE), whether Equity Joint Ventures, Cooperative Joint Ventures, or Wholly Owned Enterprises, must register with a designated domestic bank in order to open a foreign currency bank account to receive any capital contributed in foreign currency from abroad.
Each year, an FIE needs to submit an “Existing Right Registration” before September 30th. Generally, any inbound financing must be registered with SAFE or PBOC. Foreign investors can make capital contributions into FIEs using RMB, not just foreign currency. Foreign investors can convert registered capital, foreign debt proceeds, and repatriated funds into RMB ‘at-will’ – i.e. without needing to produce underlying contracts to support the authenticity. When the receiving FIE is an enterprise (as compared to a financial institution or real estate enterprise) it must report the loan information through SAFE’s designated capital account information system. The foreign debt contract only ‘takes effect’ once the SAFE registration has been completed.
From January 1st, 2020 onwards, FIEs in the Greater Bay Area may only register foreign debts limited to the total of two times its net assets.
Assuming that the FIE has its Existing Right Registration submitted, through cooperation with the FIEs’ domestic Chinese bank, the foreign exchange process and estimated timeline is the following:
Utilize an RMB basic account to receive the foreign funds (approx. 2 weeks)
Obtain foreign exchange registration certificate (approx. 5/10 working days)
Receive funds in foreign capital account (approx. 5/7 working days)
Inject the capital (in a manner in accordance with the FIE’s Articles of Association)
Register the foreign capital in a Foreign Capital Exchange (approx. 5/7 working days)
Once received, the registered capital must be used for the purposes it was registered for. It cannot be used freely for other more profitable purposes. It is for this reason that foreign financing should perhaps not be sent with extra ‘cushion’, as the extra capital will be left dormant once received and not directly applicable.
Now, from January 1st, 2020, non-investment FIEs may use registered capital funds to make onshore equity investment, provided that the investment does not violate China’s foreign investment “Negative List.” (5) FIEs can use converted RMB to make equity investments into other onshore entities. These equity investments have restrictions on their scope. For example, converted RMB cannot be used by FIEs to construct or purchase a non-self-use real estate unless the FIE is specifically a real estate enterprise.
An important decision for an FIE receiving foreign capital is its permanent decision regarding which cross-border financing cap it will leverage. As it sounds, this acts as a maximum allowable amount of received capital for an FIE. The options are either the ‘risk-weighted debt balance cap’, or the traditional foreign debt borrowing gap. If already decided on the traditional method, FIEs in a Free Trade Zone (FTZ) have one more chance to opt for the risk-weighted option. Once decided, it cannot be reversed.
Financing: Outbound, Stocks & Bonds
Outbound financing transactions are strictly regulated. Before any outbound financing transaction, the onshore lender must apply to SAFE to obtain a lending quote. It cannot exceed 30% of the lender’s own equity. It is reported that Beijing is largely unimpressed with outbound M&A activity and is aware of capital flight disguised as investment. (6) Its tight regulations stem from such mitigative motivations.
China monitors these capital flows rigorously through many separate investment channels. This controlled fashion allows the quick shut-down of a channel facilitating unfavourable transactions without affecting international capital flow as a whole.
The following are the avenues in which a foreign investor’s financial institution can be qualified to transact and move capital into China for equity or debt instruments:
the Hong Kong bond market (where foreigners can buy bonds in Shanghai or Shenzhen through the Hong Kong Bond Connect);
the China Interbank Bond Market Direct (where foreigners can buy bonds in China generally);
being a ‘Qualified Foreign Institutional Investor’ (QFII) (which gives access to securities trading in China);
being a ‘Renminbi Qualified Foreign Institutional Investor’ (RQFII) (also gives access to securities trading in China); and
the Hong Kong stock market (where foreigners can buy stocks in Shanghai or Shenzhen through the Hong Kong Stock Connect)
The following are the means by which financial institutions can move capital out of China for equity and debt instruments:
A (yet to be opened) Hong Kong Bond Market available to Chinese investors;
the ‘Qualified Domestic Institutional Investor’ (QDII) (which gives access to securities abroad); and
the Shanghai & Shenzhen stock markets (where Chinese can buy stocks in Hong Kong through the Hong Kong Stock Connect)
Which of these areas an investor’s financial institution has been qualified to operate in determines the investor’s options. To become qualified, financial institutions must comply with the regulation promulgated by SAFE and PBOC. Recently introduced Information Circulars, discussed below, should provide more options to foreign investors once implemented in institutions.
PBOC and SAFE are the authorities with which any Foreign Invested Enterprise in China must interact when receiving payment from abroad or remitting foreign exchange. Again, these institutions are represented through designated domestic banks. Businesses can convert relatively freely for current account items, the proof (receipts, invoices, etc.) submitted validates the authenticity of the transactions.
An FIE is required by SAFE to use its converted RMB for payments not beyond the business scope of the company. This is interpreted and determined by the domestic bank handling the transaction.
Despite the relatively relaxed ‘proof’ requirements, there are many nuances to the reporting of payments to SAFE and Chinese banks. For example, FIEs must report any overseas payment with a payment term over 90 days from the date shown on the import declaration form to SAFE, no matter the amount. Also, that if an enterprise enters into a contract that requires a repayment in a foreign exchange, the enterprise must also register the forex repayment within 15 days before the remittance. These almost ad-hoc requirements make expert counsel a necessity.
The useful discussion of Current Account exchange is limited because of this.
New Legislation & Circulars, a Note on DCEP Cryptocurrency
Two circulars, titled “Peoples Bank of China and State Administration of Foreign Exchange Facilitate Investments by Foreign Institutional Investors in InterBank Bond Markets” and “Circular of the State Administration of Foreign Exchange on Further Facilitating Cross Border Trade and Investments”, were introduced in October and brought to effect November 15th, 2019. They are another release in a chain of liberalizing documents that serve China’s opening capital markets.
The first circular allows foreign institutional investors to now invest in China’s interbank bond markets directly. It also allows for non-trading transfers of bonds invested directly with bonds invested through the QFII or RQFII program by the same foreign investor, with direct transfers also allowed between corresponding capital accounts. QFII/RQFII custodian banks apply to Chinese-based clearing houses for the direct investments in exchange for bonds that have been bought from the domestic interbank bond market. Quotas for QFIIs/RQFIIs have been removed, and filing processes have been simplified for the investors of these channels.
The second circular grants more flexibility to businesses regarding the prepayment put down for a foreign exchange. Previously it could not be exchanged into RMB – it now can. For small cross-border online goods businesses operating in the Greater Bay area, it is administratively beneficial that if annual goods trade volume is less than USD $200,000, registering on the list of companies that seek to do foreign exchange is no longer required.
Further, more flexibility has been granted to loans and collateral accounts. A foreign investor can now open more than three accounts for a loan; the investor can have more than one specialized account for earnest money (pre-payment for an exchange); investors no longer need a ‘waiting account’, where income from goods sold sits while waiting for the received payment to be converted; and foreign entities can now purchase loans from domestic banks, along with non-performing assets and other entities’ financing.
Foreign Investment Law
January 1st, 2020 is a date of significance. It is when new legislation, titled “Foreign Investment Law”, will come into effect, which is of material concern to every Foreign Owned Enterprise. The terms are broad, and this new legislation can be used to supervise seemingly any inbound foreign direct investment and financing.
The principles included in the legislation are general and it promotes foreign investment. A stated promise of the inbound law is that as long as inbound FDI does not seek to invest in one of China’s industries on its Negative List, the treatment of such FDI shall be no less favourable than that granted to domestic investment.
Upon the implementation of the new Foreign Investment Law, the current FIE laws will be abolished. A 5-year grace period will begin within which companies must comply with the PRC Company Law or PRC Partnership Enterprise Law, whichever is appropriate.
An example law that this new regulation introduces for the standard FIE that is deserving attention and preparation: an FIE will be required to contribute 10% of the after-tax profit to a statutory surplus reserve in accordance with the Company Law until the aggregate sum of the statutory surplus reserve reaches more than 50% of its registered capital. Thus, this 10% will be taken out of the funds available for outbound remittance.
Engaging expert counsel for an analysis of how the January 1st, 2020 Foreign Investment Law will affect your FIE is recommended.
Cryptocurrency and Capital Control
Cryptocurrencies play a part in the discussion of capital control in China, even when not including the soon to be implemented DCEP. After all, the quintessential cryptocurrency, Bitcoin (BTC), had a massive 2017 spike in price that was reportedly due to the volume of Yuan-to-BTC purchases (7). Commentators say 90% of the global BTC trading at that time was on Chinese cryptocurrency exchanges (8). China recognizes that cryptocurrency presents an unacceptable avenue of capital flight; Chinese financial institutions have been prohibited from handling BTC transactions since 2013.
Since BTC’s 2008 inception, a swath of cryptocurrencies have been minted based on blockchain technology. They are convertible to some fiat currencies on certain online exchanges. Central banks, being pressured by this infringement, feel the need to develop their own version of a digital currency, building-in cryptocurrency’s ease of use, transfer, and tracking characteristics.
People’s Bank of China is the pioneer in creating and implementing a serious sovereign digital currency, after years of research and patent filings. The Digital Currency Electronic Payment (DCEP) has been announced by PBOC recently as an incoming Central Bank Digital Currency (CBDC). But in its definition, DCEP is more in peerage with China’s M0– the monetary base or so-called high-power money. It appears that the DCEP’s main effects will be on the facilitation of transactions, better wielding of monetary policy, and direct access to central bank money by citizens. It is to be assumed (and hoped) that the 2020-expected implementation of DCEP will allow for an even more rapid foreign exchange process.
The growth in the usage of non-sovereign cryptocurrencies may implicitly affect countries’ capital control by acting as a substitute of international method of payment. As of November 22, 2019, the total market capitalization of cryptocurrencies reached USD$212,145,853,246, compared to the USD $3,252,830 million of the US monetary base. The total market capitalization of all cryptocurrencies is less than one-tenth of the monetary base of the US alone, thus the cross-border asset allocation effect of those cryptocurrencies is not substantial. But, of course, care should be made in the speculation of future trends.
What may to come to pass is an internationalized foreign exchange market of sovereign cryptocurrencies. Ecuador, Senegal, Singapore, and Tunisia have all launched their own state cryptocurrencies. Estonia, Japan, Russia, Sweden, and Canada are all reportedly investigating the process of doing the same (9). One can presume that the exchange of such tightly-monitored and regulated digital currencies will be simpler than systems at present. As for the economic utility derived in implementing these currencies, China will stand apart from other nations. Its uniquely mobile-dependent population is the ideal infrastructure for such an innovation, as the world will soon see.
The future interactions of un-centralized blockchain cryptocurrencies and central bank policy have yet to be properly seen. There is no easy answer to the asset movement effect of them, especially as this form of unregulated asset is (and has been) prone to runaways and crashes. But it is for certain that central banks will strive to keep their monetary market stable and will continue to explore the potential benefits of sovereign cryptocurrencies until a clear verdict is reached.
China’s restricted capital account policy is a burden for small-to-medium sized Foreign Owned Enterprises operating in the country. China is aware of this and is seemingly implementing policies that will reduce the red tape. Plenty of tape remains hanging, however, and an FIE expecting forex for financing can expect at least seven business days’ worth of scrutiny. Current account items like receiving payment for goods sold, remittances, and the like are a simpler process and require less time and action but have less predictable requirements depending on the nature of the transaction.
The combination of new “Information Circulars” (which are binding) and the new January 1st, 2020 Foreign Investment Law encourage the small-to-medium sized FIE to consult expert counsel promptly. The inbound Digital Electronic Currency Payment reminds readers to keep attuned to the medium-term outlook. China is experimenting, and merchants must go with the flow.
About the Authors:
Frank Hepworth is an International Business student and is attending the Shenzhen campus of Beijing University. He is passionate about entrepreneurship, asset tokenization, and getting better at speaking Chinese.
Siyang (Samuel) Li is a Ph.D. candidate with Peking University HSBC Business School majoring in Economics and the president of Mathematical Economics Association of PHBS.
Contact email: firstname.lastname@example.org.
 Karnfelt, M. & Zenglein, MJ. (2019, June 19). China’s Caution About Loosening Cross-border Capital Flows. CHINA MONITOR, Mercator Institute for China Studies.
 Piketty, Yang, & Zucman. (2015). Capital Accumulation, Private Property and Rising Inequality in China, 1978-2015, American Economic Review. Retrieved from https://blogs.lse.ac.uk/usappblog/2019/04/06/income-inequality-is-growing-fast-in-china-and-making-it-look-more-like-the-us/.
 Industrial and Commercial Bank of China, Bank of China, China Construction Bank, Agricultural Bank of China.
 State Administration of Foreign Exchange (2019, October 16). PBC and SAFE Further Facilitate Investments by Foreign Institutional Investors in Interbank Bond Markets. Retrieved from https://www.safe.gov.cn/en/2019/1030/1583.html.
 The National Development and Reform Commission and the Ministry of Commerce jointly issued two “negative lists” and one “encouraged catalogue”, all three of which take effect on July 30, 2019.
 Bains, Luo, Shao, & Wortley. (2017). China’s Capital Controls – Implications for PRC Focused Companies. Global Law Office. Retrieved from http://www.glo.com.cn/en/content/details_13_653.html.
 Garber, Jonathan. “Bitcoin is Going Bananas”. Retrieved from https://www.businessinsider.com/bitcoin-price-january-4-2017-2017-1.
 Linda. “CBCD: 19 Countries Creating or Researching the Issuance of a Digital Decentralized Currency”. Retrieved from https://hackernoon.com/cbcd-19-countries-creating-or-researching-the-issuance-of-a-digital-decentralized-currency-b57a609e695b.