Article

by Daniel Arthur Laprès

This article discusses China's exchange régime governing international current account transactions as well the role of the State Administration of Foreign Exchange (SAFE) in its formulation and implementation.

On 1 December 1996, China accepted the regime of Article VIII of the International Monetary Fund (IMF) and undertook to implement the convertibility with respect to current account trans actions of the "people's currency" (the "renminbi" - RMB) that is measured in units called "yuan" (CNY).

The current exchange rate régime fulfilling the China's IMF Commitments was originally instituted in 1996 and was last revised in August of 2008 with the adoption by the State Council of the Regulations on Foreign Exchange Administration. The PRC has opted for a market-oriented, managed floating exchange rate. On 21 July 2005, the PBOC, with the authorization of the State Council, departed from the peg to the US dollar initiated in 1996 and moved toward a determination with respect to a basket of currencies. The daily trading price of the US dollar against the RMB in the interbank foreign exchange market is allowed to float based on market supply and demand within 0.5 percent around the central parity published daily by the PBOC. The trading prices of non-US dollar currencies against the RMB are allowed to move within bands announced separately by the PBOC. In fact, the RMB has been trading close to 6.80 to the US dollar since July 2008.

Several Hong Kong banks already settle their clients' transactions with Chinese parties in Chinese currency. Vibrant markets, both lawful and underground, arise and disappear in Hong Kong depending on official rates of exchange of the local and the mainland currencies.

International current transactions

The RMB is convertible on current account, which refers to transactions involving goods, services, income and current transfers, etc. Foreign exchange refers to payments and assets denominated in foreign currencies and used in international settlements, including:

- foreign currencies in cash, including banknotes and coins;

- documents or instruments payable in foreign currencies, including negotiable instruments, bank deposit certificates, bank cards, etc.;

- securities denominated in foreign currencies, including bonds, stocks, etc.;

- Special Drawing Rights; and

- other assets denominated in foreign currencies.

The Regulations apply to all receipts and payments of foreign exchange involving domestic entities, Chinese citizens and foreigners who have continuously lived in China for more than one year as well as to all exchanges carried out within the PRC by foreign entities or individuals. Foreign exchange operations must be based on bona fide and legal transactions. Financial institutions are subject to investigation and supervision of the SAFE to ensure that they exercise due diligence in checking the authenticity and consistency of documentation with receipts and payments.

In principle, foreign currencies are prohibited from circulation and may not be quoted for pricing or settlement within PRC territory. Since the 2008 revisions to the Foreign Exchange Regulations, domestic entities and individuals are free to repatriate or not their overseas receipts of foreign exchange, though the SAFE retains the power to modulate their flows in response to economic conditions. They may hold foreign exchange receipts on current account or sell them to financial institutions. Foreign exchange payments on current account transactions must be carried out with foreign exchange owned by the payers or purchased from authorized financial institutions, and they must be based on valid documents.

Regulatory role of the SAFE

Under the 2008 Foreign Exchange Regulations, the SAFE and its local offices retain their responsibility for the regulation of foreign exchange operations and of the interbank foreign exchange market. The SAFE is mandated to conduct its activities in accordance with the principles of "safety, liquidity, and profitability". Based on conditions in the foreign exchange market and the requirements of the monetary policies, the SAFE may adjust excessive fluctuations in the foreign exchange market in accordance with the law.

The exchange administration agencies carry out comprehensive supervision over financial institutions' foreign exchange positions. Financial institutions must avoid mismatching their assets denominated in domestic and foreign currencies, and the SAFE overseers can order adjustments.

The SAFE enjoys broad powers to conduct investigations of foreign exchange operations. It may enter places of suspected foreign exchange violations to obtain evidence. It may address enquiries to entities and individuals about cases under investigation. It may enquire about any accounts other than individual savings accounts of parties involved in cases under investigation, and it also entitled to use information held by other government agencies. Where property has been or might be transferred or concealed, or important evidence concealed, forged or destroyed, the SAFE can apply to the People's Court for orders freezing assets or placing them under seal.

Upon learning of any violation foreign exchange regulations, financial institutions are obligated to denounce their customers to the SAFE. The Regulations provide anonymity and rewards for whistle blowers. Sanctions for violations of the Foreign Exchange Regulations include fines in amounts up to 100 per cent of the foreign exchange involved and, when warranted, criminal proceedings can be initiated.

Illegal transportation of foreign exchange across the PRC's borders may give rise to warnings and fines not in excess of 20 per cent of the foreign exchange involved, but more serious penalties are applicable under Customs Laws and Regulations. Carrying on unauthorized foreign exchange trading may entail fines of up to CNY 2 million, suspensions or cessations of business activities. In appropriate cases, authorities can institute criminal pursuits. All those with management responsibility for violators of the Foreign Exchange Regulations are exposed personally to fines and, in appropriate cases, to criminal prosecution. Decisions of the SAFE are subject to administrative reconsideration as well as suits before the people's courts.

Outlook

Much as occurred during the Asian financial crisis of 1997, the effects of the 2008 global financial crisis have so far impacted China mostly through international trade. In April 2009, in order to support the country's contracting exports and for reasons of international status, the State Council announced that the cities of Shanghai and Guangzhou, Shenzhen, Zhuhai and Dongguan in Guangdong Province would be allowed to use the people's currency, the renminbi, to settle trade with Hong Kong and some other neighboring trade partners. In June 2009, the China Construction Bank, the second largest bank in China, announced that it was exploring offering renminbi-denominated credits to finance international trade.

The SAFE's 2009 policies were in stark contrast with those promoted in 2007 to stem the inflow of "hot" funds anticipating a depreciation of the dollar that were being disguised as trade-based to avoid the exchange controls remaining in effect on capital transfers. Some 5,300 export firms were suspected and identified for investigation of these violations. Between November and April 2007, annual growth in accounts receivable by all trade-related firms had dropped 44 percentage points compared with the first ten months of 2007.

In November 2008, the SAFE required Chinese companies to register advance payments on imports and deferred payments on exports and began monitoring payment flows through a mandatory electronic reporting system. In April 2008, the SAFE reportedly ordered foreign banks to cut their short-term foreign debt by 1015 per cent, and local banks theirs by 5 per cent.

In a reversal of attitudes and in order to curtail the global financial crisis' potential effects on foreign banks' local subsidiaries and branches - as well as crises of confidence of local banks in their foreign counterparties on the domestic markets - in November 2008 the PBOC announced that it would make available a short-term lending facility for foreign banks in the country to help them through the liquidity crunch.

The current policy thrusts of the Chinese authorities are (i) to encourage the development of the local foreign exchange markets, interbank and retail, as well as their opening to foreign participants; (ii) to combat the use of fraudulent current transactions to disguise transfers of capital, whether inward or outward; (iii) to loosen controls on exports of Chinese capital as a way of easing the pressure upward on the country's currency; and (iv) to funnel some of the country's foreign reserves into the domestic economy.

Daniel Arthur Laprés is Avocat au barreau de Paris and Barrister & Solicitor (Nova Scotia). He is the co-author of Business Law in China, available at www.iccbooks.com. His e-mail is daniel@lapres.net