China-U.S. IPOs: China’s forex crackdown locks up currency (Westlaw Business)

January 21, 2011

Chinese 100 yuan banknote is seen in this picture illustration taken in Shanghai January 19, 2011. REUTERS/Aly SongBy Helen H. Chan

HONG KONG, Jan. 21 (Westlaw Business) – Excessive liquidity is becoming a hot potato for the State Administration of Foreign Exchange (SAFE), China’s forex regulator. Recently, SAFE announced that it would continue to crack down on “hot money” inflows through vigilant monitoring of cross-border transactions. In particular, China’s currency watchdog will examine whether foreign exchange destined for the PRC are being used in compliance with Chinese laws.

In its ongoing battle against inflation, the Chinese government has been scrutinizing compliance with existing forex regulations, many of which apply to the daily operations of overseas listed Chinese companies. In response to the clampdown, Sino-U.S. companies have highlighted a number of foreign exchange transfer risks in recent disclosure filings.

Presently, investments in PRC assets, including investments for business expansion, are still strictly controlled by the Chinese government. As a result, U.S.-listed Chinese companies are routinely required to seek government permission prior to purchasing any type of asset. Similarly, the transference of proceeds from IPOs into China must also be signed off by SAFE. Without the proper government approvals, funds raised in foreign currency overseas will be denied entry into the PRC, potentially leaving foreign-invested China-based businesses high and dry.


As a part of China’s laws on foreign exchange remittance, foreign-invested enterprises (FIEs) must comply with spending restrictions on overseas capital that is transferred to China and converted into renminbi. FIEs refer to a company incorporated in China with investments from non-PRC enterprises such as an offshore parent company. Under the provisions of SAFE Circular 142, which applies to FIEs holding assets in China, foreign capital converted into renminbi can only be used for purposes that fall within a company’s business scope. Non-business investment in local enterprises and real estate is expressly prohibited.

For many FIEs, Circular 142 is no laughing matter. Consider China VantagePoint Acquisition, a Cayman Islands entity currently in the process of listing on the OTC Bulletin Board. Including an over-allotment option, VantagePoint intends to raise up to US$15 million in its upcoming U.S. initial public offering. According to its preliminary prospectus, the company intends to use a portion of the proceeds raised from its IPO to acquire businesses within Greater China.

VantagePoint, however, cautioned investors that its business plan could be derailed by China’s foreign exchange transfer restrictions, particularly, Circular 142. According to VantagePoint, SAFE maintains the authority to deny approval for capital account currency transactions such as direct investments. In addition, SAFE has “strengthened its oversight of the flow and use of registered capital,” examining whether transfers comply with the provisions of Circular 142. VantagePoint further added that violating Circular 142 posed a significant risk as “severe penalties including substantial fines” could be levied against the company. Under PRC law, penalties for changing use of capital without SAFE approval may include a fine of up to 30 percent of RMB converted from foreign capital.

Similarly, China Century Dragon Media recently warned investors that Circular 142 could ‘significantly’ limit its ability to transfer net proceeds from its upcoming NYSE IPO to BD Media Beijing, the company’s PRC subsidiary. Dragon Media further cautioned that its expansion plans could be hampered if it is not able to convert the net proceeds from the offering into renminbi to invest in or acquire other PRC enterprises.


Aside from Circular 142, Sino-U.S. companies have disclosed risks associated with the compliance of other existing forex regulations, namely Circular 75 and Circular 106.

Under Circular 75, PRC citizens, as shareholders of an offshore entity, are required to register with SAFE prior to establishing the offshore entity for the purpose of overseas equity financing. As a result, offshore companies owned by Chinese individuals are subject to this registration requirement. Circular 106 further clarifies restrictions under Circular 75 by appearing to place the filing onus on a PRC subsidiary of an offshore entity.

The confusion of both circulars has some China-based U.S. filers scratching their heads. China Dredging Group recently hinted at complications with compliance to China’s forex rules, in particular Circular 75. As part of its IPO filings with the SEC, China Dredging disclosed that the company conducts substantially all of its business through PRC subsidiaries which are owned by shareholders residing in China. As a result, the company noted that these shareholders could fall under the definition of PRC citizen in Circular 75, and as such would be required to register with SAFE, since Dredging’s PRC subsidiaries are funded with foreign-invested capital. China Dredging, however, remained ‘unclear’ whether SAFE Circular 75 would apply in this manner.

In its offering prospectus, the company informed investors that if it were found to be in violation of Circular 75, restrictions on its foreign currency transfers could be restricted, including the remittance of dividends and other foreign currency denominated funds such as IPO proceeds. Furthermore, overseas cross-border investment activities could also be restricted, which would limit the ability of Dredging’s PRC subsidiary to transfer funds for dividend or loan payments.

Investors of U.S.-listed Chinese companies may soon feel the shadow of China’s currency regulator in their own piggy bank as SAFE hones in on cross-border investment. According to Chinese media reports, SAFE has indicated it will scrutinize foreign exchange transfers to see whether funds are being used in compliance with China’s forex laws for FIEs. In particular, the watchdog has indicated it will be on the lookout for funds destined for domestic equity investment under the guise of business expansion. With legal penalties running high enough to jeopardize the livelihood of publicly listed companies, investors best beware.

This article was first published by ThomsonReuters’ Westlaw Business Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Westlaw Business Currents online at

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