SAFE leaves room for doubt

Investors in China have greeted the newly effective Circular 75 with relief but continue to exhibit wariness about the regulation’s practical impact on the registration of offshore investments by PRC residents.

China’s new law regulating offshore investments by PRC residents has generated mixed reactions among local investors and the private equity industry. While investors expressed relief when the final version of Circular 75 was published two weeks ago, they have continued to be skittish about the practical implications of the new regulation.

McGinty: Investors remain wary

While these rules primarily impact PRC residents’ investments in offshore special purpose companies, the private equity community had expressed concerns prior to the publishing of the finalized Circular 75 on how the new law would regulate the use of these types of companies for fundraising activities. The uncertainty surrounding this issue “indirectly chilled much China-related venture capital activity along with many foreign listings of China-invested companies” this year, according to a client memo released by the China offices of Coudert Brothers law firm.

By issuing Circular 75, China’s State Administration of Foreign Exchange (SAFE) is seeking to regulate a traditionally “grey area”, bringing “individual PRC residents (corporates and individuals) within the regulatory net for overseas investments”, according to a client memo provided by the Beijing office of Lovells law firm. The memo also pointed out that the circular dictates “certain offshore transactions involving PRC individual residents in particular must now be disclosed and registered with SAFE.”

On the one hand, the new regulation – which became effective as law on Tuesday – has been perceived as being much clearer and more investor-friendly than the previously proposed Circulars 11 and 29, as well as the earlier drafts of Circular 75 circulated by SAFE.

“Overall, Circular 75 provides much better guidance than Circulars 11 and 29. It is better documented, better drafted, and more workable,” says Andrew McGinty, a partner at the Beijing office of Lovells. “Many of the more onerous provisions in the previous drafts have been removed, and Circular 75 will probably represent a more stable position going forward.”

McGinty points out that the final version of Circular 75 provides clearer definitions of key terms such as “PRC resident” and “round trip investments”, although some questions remain about the exact scope of what constitutes a “special purpose company”. At the same time, the regulation refrains from including the worrisome “administrative hurdles” – such as mandatory valuation of assets not state-owned, mandatory repatriation of the proceeds of an offshore financing and a short timeframe for retrospective compliance – that had been mentioned in previous drafts of the regulation and had fuelled anxiety among investors.

However, while Circular 75 is universally viewed as an improvement over its precursors in terms of clarity and feasibility, investors are still reserving judgement on how well the regulation will hold up in practice. The new law has yet to be tested, and investors remain concerned about the process of registering offshore investments, both in terms of the timing and the standard of review that will be applied, says McGinty.

“What the VC community ultimately wants is something practical and workable that can easily be ‘sold’ to the Chinese founders on whom the SAFE registration obligations ultimately fall,” according to McGinty. And while many consider Circular 75 to be SAFE’s best effort to date since the agency took it upon itself to regulate these offshore investments, investors are likely to continue to be wary of doing transactions regulated by the new law until anecdotal evidence of its practicability emerges.