A look at fund use by foreign-invested investment companies

With a view to promoting investment in China by foreign investors and bringing in advanced foreign technologies and management expertise, the then Ministry of Foreign Economic Relations and Trade issued the Interim Provisions for the Investment in and Establishment of Investment Companies by Foreign Investors in 1995, permitting foreign investors to establish investment companies in China in accordance with relevant Chinese laws and regulations. The issuance of these provisions opened “foreign-invested investment companies” as a new avenue for foreign investors to participate in domestic investment.

Pursuant to the Provisions of the Ministry of Commerce (MOFCOM) for the Investment in and Establishment of Investment Companies by Foreign Investors (order No. 22, 2004), the term “foreign-invested investment company” means a company established in China by a foreign investor, either in the form of a wholly foreign-owned enterprise or of an equity joint venture with a Chinese investor, which engages in direct investment. The differences in acquisitions by foreign-invested investment companies and by ordinary foreign-invested enterprises are:

1. With respect to the acquiring entity, both foreign-invested investment companies and foreign-invested enterprises are enterprise legal persons established in China and, based on the principle of the place of registration, have PRC legal personality. However, China has special policies for foreign-invested investment companies, e.g. when a foreign-invested investment company invests in and establishes an enterprise in China, it is required to obtain separate approval in line with the authority for the approval and the procedure for the approval of foreign-invested enterprises; and when a foreign-invested investment company acquires a domestic enterprise, it is deemed a foreign investor and the regulations for the acquisition of domestic enterprises by foreign investors apply.
2. With respect to the acquisition and investment sectors, in addition to complying with the Catalogue for Guiding Foreign Investment in Industry in lawfully investing in those sectors where foreign investment is permitted, foreign-invested investment companies are required to comply with the Notice of the General Office of the State Council on the Establishment of a System for Security Reviews of Acquisitions of Domestic Enterprises by Foreign Investors. This makes them subject to security reviews by MOFCOM when an acquisition involves domestic military armament enterprises and suppliers to military armament enterprises, enterprises adjacent to key and sensitive military installations and other entities that are crucial to national defence and security, and important agricultural products, important energy and resources, important infrastructure, important transport services, key technology, major equipment manufacturing and other such enterprises that are crucial to national security. In contrast, the sectors open to acquisition and investment by ordinary foreign-invested enterprises are broader.
3. With respect to the total amount of investments, Chinese laws specify that the total amount of domestic investment by an ordinary foreign-invested enterprise may not exceed 50% of its net assets; whereas for a foreign-invested investment company that engages in direct foreign investment, laws are silent on the total amount of its investments, and its short-term foreign debt balance, and medium and long-term incurred foreign debt may be four to six times its paid-in registered capital. Accordingly, in practical operation, a foreign-invested investment company may use both its capital and foreign loans in their original currency to make investments in domestic equity.

With the opening of the entire country to foreign investment and the continuing expansion of policies to attract investment, multinationals, including some Fortune 500 companies, have scrambled to invest in China, establish regional headquarters and research and development centres, etc. The figures on direct foreign investment attracted nationwide between January and September 2013 released by MOFCOM show that, as of September 2013, 16,351 foreign-invested enterprises were established nationwide, with a total of US$88.609 billion in foreign investment actually used, representing an increase of 6.22% over the same period in 2012.

However, while the continuous entry of foreign investment has driven the adjustment in China’s economic structure and enhanced the efficiency with which economic resources are used, it has revealed, from the edges, the flaws and inadequacies in China’s exchange control system. Taking only acquisitions by foreign-invested investment companies as an example: as mentioned above, due to its “investment” status, a foreign-invested investment company is treated as a foreign investor when investing in and establishing an enterprise or conducting a domestic acquisition and investment. However, the approval certificate issued to the foreign-invested investment company by the commerce authority does not expressly indicate the foreign-invested investment company’s “investment” status. Accordingly, in practical operation, if a foreign-invested investment company does not actively state its nature as an investment company, the foreign exchange and the industry and commerce authorities often may not have any means of determining its special status. This can lead to the foreign-invested investment company being unable to effectively use its status to avail itself of the special treatment offered by state policies and regulations.

In terms of foreign debt limit and use, because foreign borrowings made by ordinary foreign-invested enterprises may not exceed twice their registered capital – whereas those of foreign-invested investment companies may be as much as four to six times their registered capital – and because foreign-invested investment companies may use their foreign borrowings to invest in sectors open to foreign investment or to assist their investee enterprises in carrying out procurement and sales, or do the same on their behalf, in practical operation, a foreign-invested investment company could circumvent the exchange control policies that apply to it, giving it an avenue to convert funds and have them flow back through transactions with affiliates.

In terms of capital use, if the scope of business of a foreign-invested investment company that has carried out direct investment-related foreign exchange registration includes non-investment -related business, its capital can either be used in the original currency to acquire and establish wholly foreign-owned enterprises, or converted into renminbi for its non-investment business. Accordingly, in practical operation, if a foreign-invested investment company intended to run counter to its main business scope by mainly using its capital for non-investment purposes, it would run counter to the original intent of the state in approving the establishment of foreign-invested investment companies.

Sun Yunzhu is a partner and Zhong Ming is an associate at Concord & Partners