China’s (Shanghai) Pilot Free Trade Zone: Widening the Outbound Investment Pipeline

by K&L Gates LLP
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The launch of the China (Shanghai) Pilot Free Trade Zone (FTZ) last September attracted a lot of attention both inside and outside of China. Since then, the lack of progress implementing stated goals for the FTZ as a destination for foreign investment, coupled with logistical challenges of getting to and from the FTZ’s remote location, have attracted considerable comment. As a result, the discussion about the FTZ has so far focused almost exclusively on inbound investment and associated impediments to execution, which have led to some skepticism as to the significance of the FTZ.

Interestingly, little has been said with regard to the FTZ’s potential in relation to outbound investment despite the fact that this is identified as one of the key initiatives associated with the launch of the FTZ. With record high China foreign exchange reserves and the appetite of Chinese companies for acquisition in a broad range of industries in mind, this Legal Insight examines how the FTZ has already adopted key measures and the potential significance for outbound investment.

The high level of foreign-direct investment (FDI) from the United States (U.S.) into China each year is well known. Less well known, is that in 2013, the level of Chinese FDI into the U.S. actually exceeded the level of investment by U.S. companies in China[1] and it appears this is likely to be the case again in 2014. The measures described below are expected to widen the outbound investment pipeline.

Companies should be thinking about how they and their industry may benefit (or otherwise) from this emerging trend.

Administrative Measures[2]: Streamlined Project Approval

Previously, outbound investment projects required approvals from China’s National Development and Reform Commission (NDRC) and its Ministry of Commerce (MOFCOM) before the project could proceed[3]. If the investor was a state-owned enterprise, the endorsement of the State-Owned Assets Supervision and Administration Commission was also needed. The Administrative Measures have substantially streamlined this process, converting what was a substantive approval process to a mere filing requirement; the catch is that the simplified filing requirements are available only to would-be investors based in the FTZ.

Companies in the FTZ are only required to file the proposed overseas project and investment with the FTZ Administrative Commission (Commission). Project filings in the FTZ no longer require the applicant company to prepare a detailed project report; instead, they are asked to simply fill out a Record-Filing form and submit relevant supporting documents, such as a business licence, articles of association, resolutions approving the outbound investment, proof of operation, assets and credit standing and a letter of intent relating to the overseas project.

The Commission will then issue a project filing opinion and a certificate within five working days after the applicant has submitted all the required materials. This streamlined process could create time savings of several months compared to the existing outbound investment approval process applicable to companies registered outside the FTZ. Once the applicant receives the certificate from the Commission, it can then proceed to handle the foreign exchange, customs and tax matters for its overseas investment.

Investment in sensitive countries and regions (eg countries without diplomatic relations with China and countries in a state of war or civil disorder), or in sensitive sectors (eg basic telecommunication operation, media, large-scale land development, energy and minerals) remain subject to the existing outbound investment regulatory approval regime.

Despite the NDRC’s recent amendment of its outbound investment rules (which apply to companies outside the FTZ), the NDRC can still take seven working days, or up to 20 working days to review a submission upon acceptance of all application documents for complicated cases or cases where the investment amount is above US$300 million.

Compared to the requirements stipulated in the Administrative Measures, the time savings that can be achieved for companies in the FTZ wishing to conduct outbound investment is significant.

PBOC Opinion[4]: Flexible Flow of Funds

One of the groundbreaking aspects of the PBOC Opinion is the creation of free trade accounts (FTAs). Funds flowing between FTAs and offshore accounts will not be subject to existing restrictions on the movement of funds between China and overseas accounts.[5]  FTAs open up the possibility of free transfers of funds for companies in the FTZ, enabling these companies to use their Chinese Yuan (RMB) more flexibly for outbound investment.

Currently, in order to transfer funds for outbound investment, companies are required to provide evidence to the remitting bank in China of a genuine, lawful underlying transaction. This requirement is waived for transfers from FTAs, and companies can spend RMB abroad freely and benefit from improved efficiency in funds utilization. 

In addition, the PBOC Opinion specifically encourages outbound investment by enabling companies in the FTZ to process currency exchanges, payments and receipts for direct outbound investment with banks inside the FTZ without further requirements.[6] This means that a company will no longer be required to seek approval from the local State Administration of Foreign Exchange (SAFE) branch before sending capital funds abroad for outbound investment.

On May 21, 2014, PBOC issued implementing rules[7] for FTAs aimed at clarifying unclear aspects of the PBOC Opinion and creating the framework for implementing FTAs. However, as foreign investment involves various agencies and procedures, we expect it will take some time to assess how these simplified procedures can assist FTZ based companies’ outbound investment initiatives.

PBOC Notice[8]: Alternative Financings
The PBOC Notice permits offshore RMB loans and outlines the scale and scope for using these loans.

Companies in the FTZ are allowed to borrow RMB funds offshore. The term of the loan should be more than one year and it must be used for establishing or operating projects either in the FTZ or outside of China. [9]

The amount of offshore RMB loans is capped at an amount calculated by multiplying the actual paid-in capital (for enterprises), or 1.5 times of the actual paid-in capital (for nonbanking financial institutions) by the macro-prudential policy parameter. The macro-prudential policy parameter is determined by the Shanghai PBOC and is based on the level of national credit control. Currently, the macro-prudential policy parameter is set at one. As a result, the amount of RMB that a foreign-invested enterprise (FIE) can borrow is increased. For example, assuming the FIE’s registered and paid-in capital is RMB10 million, the amount of offshore RMB it can borrow will be RMB10 million based on the existing parameter. Whereas, a FIE registered outside of the FTZ with the same capitalization can only borrow a maximum of RMB4 million –the difference between its total investment amount and its registered capital.

Thus, the PBOC Notice facilitates outbound investment for companies in the FTZ by making offshore funding more accessible, available and attractive. Given lower interest rates may be available in other jurisdictions, companies in the FTZ may also be able to enjoy access to less expensive funding from overseas.

SAFE Notice[10]: Provision of External Guarantee

Under China’s general foreign exchange regime, a People’s Republic of China-registered company wishing to guarantee the economic performance (such as a borrowing) of an overseas company (eg a subsidiary of the guarantor) must obtain approval for the guarantee from the SAFE. The SAFE Notice eliminates this administrative approval for companies registered in the FTZ. Additionally, when providing external guarantees, companies in the FTZ are not subject to requirements relating to the proportion of net assets owned by the guarantor and guaranteed entity, the guarantee’s profitability status or equity affiliation between the guarantor and guarantee. The simplified formalities for foreign exchange registration eliminate yet another regulatory hurdle for outbound investment.

Seen in their totality, the changes summarized here have the potential to significantly impact the foreign-investment ambitions of companies registered in the FTZ.


[1] According to China’s Ministry of Commerce, the value of China FDI into the US exceeds investment by US companies into China in both 2013 and the first half of 2014: In 2013, Chinese investors invested about US$4.23 billion in the US, while US investment in China was about US$3.353 billion.
[2] Administrative Measures for the Record-Filing of Overseas Investment Projects of the FTZ promulgated by the Shanghai Municipal Government on September 29, 2013, which came into effect on October 1, 2013. Administrative Measures for the Record-Filing of the Investment in and Establishment of Enterprises Overseas by Enterprises within the FTZ promulgated by the Shanghai Municipal Government on September 29, 2013, came into effect on October 1, 2013 (both administrative measures are collectively referred to as the “Administrative Measures”).
[3] Outbound investment projects with smaller scale can obtain approval from provincial-level NDRC and MOFCOM without the need for national-level approval. Projects carried out by local enterprises for an amount less than US$10 million and not involving any sensitive countries or sectors can be filed with the provincial-level MOFCOM. The filing time is only three working days. However, such projects still need to be filed with the provincial-level NDRC and the filing time for this is seven working days. Therefore, the time to obtain approval from both provincial-level NDRC and MOFCOM is still longer than that required in the FTZ.
[4] Opinions of the People’s Bank of China on Providing Financial Support for the Development of the FTZ promulgated by the People’s Bank of China on December 2, 2013 and effective on the same date (“PBOC Opinion”).
[5] Clauses 4 and 5 of the Opinion.
[6] Clause 8 of the Opinion.
[7] Detailed Rules of the China (Shanghai) Pilot Free Trade Zone on Prudent Risk Management of Separate Accounting Business (Trial) promulgated by the Shanghai Head Office of People’s Bank of China on May 21, 2014 which became effective on the same date. 
[8] Notice of the Shanghai Head Office of the People Bank of China on Supporting the Expanded Cross-Border RMB Use within the FTZ promulgated by the Shanghai Head Office of the People’s Bank of China on February 20, 2014 and effective on the same date (PBOC Notice).
[9] The Q&A section of the Shanghai PBOC website shed more light on what the Shanghai PBOC considers to be 'establishing or operating' projects outside China: eg outbound investment in the form of greenfields investment, mergers and acquisitions, etc.
[10] Notice of the Shanghai Branch of the State Administration of Foreign Exchange on Printing and Distributing the Detailed Rules of Implementation on Providing Foreign Exchange Administrative Support for the Development of the China (Shanghai) Pilot Free Trade Zone promulgated by the Shanghai branch of the State Administrative of Foreign Exchange on February 28, 2014 and effective on the same date (“SAFE Notice”).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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