New SAFE Circular 75 Highlights the Challenging Regulatory Environment in China - PowerPoint PPT Presentation


PPT – New SAFE Circular 75 Highlights the Challenging Regulatory Environment in China PowerPoint presentation | free to view - id: c1d74-YmM2Y


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation

New SAFE Circular 75 Highlights the Challenging Regulatory Environment in China


Distinction of USD offshore holding investment ... Toning Down of New Circular. Language and tone are more 'positive' as compared to the Circulation Drafts and ... – PowerPoint PPT presentation

Number of Views:99
Avg rating:3.0/5.0
Slides: 27
Provided by: york8


Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: New SAFE Circular 75 Highlights the Challenging Regulatory Environment in China

New SAFE Circular 75 Highlights the Challenging
Regulatory Environment in China
York Chen President Managing Partner iD
TechVentures Ltd. (Acer VC) Oct. 30th, 2005
  • Good Old Days
  • SAFE Circulars 11 and 29
  • Uproar and Confrontations
  • Settling Down with the New Circular, 75
  • Life Goes On

Foreign VC Operation in China
  • Distinction of USD offshore holding investment
    and RMB local entity investment is a particular
    phenomena in China. Foreign VCs use offshore
    USD fund to invest into China deals offshore
    holding entities with all equity activities
    happening outside of Chinese jurisdiction.
  • Distinct Foreign and Local VC Groups
  • Out of 1.27 billions VC funding in China in 04,
    foreign VC contributed 70.
  • The encouraging trend of profitable exits is only
    applicable to foreign VCs. Local VCs continues to
    be depressed, and, not seeing signs of improving.
  • The disintegration of offshore and onshore
    activities post special challenges for foreign
    VCs operating in China
  • Offshore fund raising, portfolio investment and
  • Onshore deal flow sourcing and portfolio

Foreign VC Investment Kept Equity Activity
VC Mgmt (Rep. Office)
LP Fund
VC Mgmt Co.
Investment Management
Portfolios onshore entity (WFOE)
Portfolios offshore Holding
On Off Shore Shore
WFOE Wholly Foreign Owned Enterprise
Special Equity Structure for Projects Off-limit
to Foreign VCs
  • Special equity structure is required for projects
    involving portal, internet applications, mobile
    value adds, media, …. These projects would need
    a local PRC entity as a vehicle to get licenses
    (ICP, signing Monternet revenue sharing
    agreement, …) and book income.
  • Hundreds of offshore registered companies
    applying this structure. Since most of
    foreign-listed companies are involving in service
    business, so they adopt this arrangement. Cases
    in points include Sina, Sohu, Netease, Shanda,
    Kongzhong, Linktone, Ctrip, eLong, Hurray!, JRJ,
    51job, Baidu, …., as well as those being
    acquired, such as Eachnet, 3721, Joyo, …, and not
    forget the high power Alibaba.
  • From shareholding viewpoint, the PRC vehicle
    company is not owned by the portfolio. But, thru
    a complicated set of commercial agreements, the
    PRC entity is fully controlled by and revenue
    re-routing to the portfolio.
  • Refer to next slide for the relationship among
    different entities.

Special PRC Vehicle for Projects
Off-limit to Foreign Co.
VC Mgmt Co. (Rep. Office)
LP Fund
VC Mgmt Co.
Inv. Mgmt
Offshore Holding
On Off Shore Shore
(Licensing revenue booking vehicle)
Red Chips Approach
  • Offshore holding arrangement is a preferred
    structure for Chinese entrepreneurs and VCs as it
    provides a feasible and practical route for
    funding, divestment and all equity events. Its
    advantage and attractiveness to Chinese
    entrepreneurs and VC communities
  • - Go away from laws and regulations in China.
    Many of them are not friendly to venture
    activities, including lack of preferred shares,
    stock options limitation, double tax, …
  • - By passing capital account control on foreign
  • - More flexible divestment options by overseas
    IPO, MA or trade sales.
  • Red Chips vs H Shares for Chinese companies
  • - Both are Chinese companies, and listed in
    overseas markets
  • - Red Chips are offshore registered companies.
    Go away from Chinese jurisdiction as well as
    legal/regulatory/forex constraints.
  • - H Shares companies are registered in China.
    So, even listed offshore they are still under
    Chinese jurisdiction all IPO proceeds need to be
    repatriated back to China, institutional
    investors (including VCs) can not be traded
    openly, …

China Projects Restructuring into Offshore
  • Offshore restructuring involves the following
  • - The Chinese founders set up an offshore
    holding company in Cayman Island or BVI with the
    shareholding structure and management control
    mirroring those of their local company in China.
  • - With kind of swap scheme, transferring the
    equity they hold in the Chinese local company to
    the offshore holding. This will typically
    convert the local company into a WFOE (Wholly
    Foreign Owned Enterprise).
  • The offshore holding company will then be the
    vehicle seeking VC investment, future funding as
    well as for listing or be merged. All equity
    events happening offshore. Companies funding
    and IPO proceeds will be kept offshore, and remit
    into China as operation required only when
    necessary. Chinese founders assess, rights and
    proceeds stays offshore.
  • Up to Jan., 2005, above arrangement has not being
    put up for any regulatory test. And, hundreds
    of Chinese deals, including all high profile
    IPOs, went through similar arrangement, proves
    that its a feasible way for company funding and
    personal wealth creation.

Safe Circulars 11 and 29
SAFE Circulars 11 29
  • SAFE Circular 11, published on Jan. 24, 2005
    with immediate effect, has four clauses
  • - Any PRC resident setting up offshore
    enterprise, must go through the formalities for
  • - Any PRC resident who sell his asset or equity
    interests in the PRC in exchange for shareholding
    in an offshore company, must get approval.
  • - SAFEs examination and verification of the
    offshore enterprise must focus on whether it was
    established/controlled by, or whether it is under
    the same management as, the acquisition target
  • - With respect to a WFOE established by PRC
    residents through merger and acquisition of a
    domestic enterprise by an offshore enterprise,
    the approval should be done at SAFE HQ in
  • SAFE further issued Circular 29 on April 21st by
    stipulating, among others
  • - Retrospective effect (no grandfather clause)
  • - Repatriating individuals forex proceed back
    to China
  • - To declare if offshore holding company has any
    local resident as investor.

Intended to Curb Capital Flight
  • Try to stem increasing asset and capital flight
    resulting from offshore restructurings of PRC
    domestic companies. Taxmen also try to put a
    hand on PRC residents potential personal fortune
    accumulated through offshore equity events.
  • As elaborated by a government official that the
    legal measures are trying to take care of
    following six concerns
  • The asset outflow by share swap for domestic
    asset turn into foreign asset.
  • Loss of tax on corporate and personal income,
    which are from Chinese operation, but booked
    under offshore holdings
  • Government property/asset being siphoned out and
    being stole
  • Hot money inflow from tax heaven by recycling
    domestic capital and disguised as foreign
    investment to take advantage of tax incentive and
    other benefits.
  • Not fair to those law-abiding people who kept
    their asset onshore, and suffered from less
    flexible capital activities in China.
  • Huge foreign exchange being kept outside of
    government system (??????) and away from
    government macro management.

Not Targeted at Foreign VC Investment
  • Government officials have repeatedly made it
    clear that
  • Government appreciates foreign VCs contribution
    to the countrys high tech and overall economic
    development. Government welcomes foreign VC
    funds capital support to China companies.
  • By implementing the two Circulars, government has
    no intention to discourage or stop the foreign
    VCs existing funding activity in China.
  • However, the reality is that If the two Circulars
    being strictly enforced, technically all foreign
    VC activity in China would come to a completely
    halt. Furthermore, with the retrospective
    clause, existing hundreds of foreign VC-backed
    companies, including those high flier IPO
    companies Shanda, Sina, Baidu, …, will put into a
    doubtful legal test.

Issues Not being Answered
  • Interpretation to the two Circulars by government
    agencies, media, law firms and VC practitioners
    are quite different. Leave big room for
  • There is no implementation details being
    announced, no application procedure and approval
    guideline being set up. Same case approaching
    different SAFE offices might get different
  • Key terms not well defined, such as scope of
    residents, tax mechanism how much and when to
    tax, ….
  • It seems there is no consensus among different
    ministries and councils on the Circulars? Not
    all agencies agree with the tough discipline
    measures, or at least on how far it should go.
    Delaying of releasing the implementation
    procedures might due to some rumored heating
    disputes among ministries and councils.

Uproar and Confrontations
The Implications to Foreign VC
  • The legal opinion on the current offshore
    restructuring of a Chinese company (in order to
    take foreign VC investment) is that its not
    against existing Chinese laws and regulations.
    However, the so-called ??? (unwarranted,
    unwritten, but rather widely practiced ways of
    making things done in China) has neither being
    officially endorsed by government agencies,
    particularly SAFE.
  • With the two Circulars effected, government has
    put up a big NO to the prevailing offshore
    restructuring practice. Chinese way of legal
    interpretation and implications on this drastic
  • In the past if not prohibited by law, its
  • Now anything not stipulated and permitted by
    law, its not allowed and its illegal.
  • Its a fact that the two Circulars have caused a
    lot of concerns in the VC community and is
    believed to be detrimental to foreign VC's
    investment in China.
  • Furthermore, the Circulars add up the unclear,
    uncertain, unpredictable favor to the generic
    concerns of so-called country risk when doing
    business in China.

What Gathered from WEFs Dialogue with
Government Officials
  • Government officials implied that its a
    mistake to put up the Circulars, and caused so
    much argument and complaints.  Its premature to
    announce and putting effect the Circulars before
    necessary back-up measures and operational
    frameworks are in place.  
  • The two circulars will eventually be shelved
    (abolished), and to be replaced by a new
    circular, which will be more business oriented
    and easier for all concerned parties to follow,
    and be practical for government agencies to
    execute and monitor.
  • Currently, four ministries SAFE, MOC, STB (tax),
    and State Bureau of Industry and Commerce are
    working together to put up the new circular and
    implementation details.

World Economic Forum round-table discussion with
government officials, Beijing, Sept., 8th, 2005
The Confrontations
  • The two Circulars caused huge impact to normal
    VC activities in China. VC people feels not
    being fairly treated, legal councils and
    consultants are coming up legal opinions, while
    government officials are defending their
    position. The finger-pointing sometimes turned
    harsh, a rare scene in China.
  • A senior and outspoken VC practitioner its a
    30 something young guy, knowing nothing about
    venture capital, drafting the circulars and
    almost destroy the whole VC industry in China.
    (A public comment during a CVCRI/CVCA panel,
    Sept. 8th, 2005, Beijing)
  • The rebut of the government official who drafted
    the circulars why they feel so angry on the
    circulars? Because the circulars put away many
    ambiguity stuff and those uncensored practices.
    If they feel the circular is against
    constitution, they can sue me or file for
    administration review. They are not doing so
    because they know the circulars are well footed.
    If I dont know VC, I will not be able to hit
    their soring point. (Quoted in an article on
    Commerce Weekly Magazine, 11???? -
    ??????????, Oct. 20, 2005)

Settling Down with the New Circular, 75
Whats in SAFE Circular 75? (Becomes a law on
Nov. 1, 2005. )
  • Registration with SAFE is required prior to the
    establishment of, or acquisition of control of,
    an offshore Special Purpose Company ("SPC") by
    PRC residents.
  • Offshore interests held through trusts, nominee
    arrangements or other such similar methods are
    all expressly caught.
  • PRC residents receiving offshore dividends or
    income must repatriate the forex to China within
    180 days. But can either retain it in a capital
    account or convert into RMB (subject to SAFE
  • Material changes in the capital structure of SPC
    must be reported to SAFE within 30 days of
  • Retrospective compliance by PRC resident holders
    of interests in pre-existing offshore SPCs should
    be done by March 31, 2006.

Source Lovells Newsletter, Oct., 25, 2005
Toning Down of New Circular
  • Language and tone are more "positive" as compared
    to the Circulation Drafts and Circulars 11 and
  • Dropping of all references to "approval" as per
    Circulars 11 and 29 Circular 75 only refers to
  • PRC Resident is now clearly defined for the
    first time, both for corporates and individuals.
    For individuals, PRC passport/ID Card holders are
    included. But foreign passport holders can also
    qualify as a "PRC Resident" if they are
    "ordinarily resident" in the PRC due to having
    their "economic interests" in China.
  • Still no clear standard of review by SAFE or
    indications as to the level of difficulty and the
    time frame required to obtain registration.
  • SAFE still has discretion to ask for any further
    (unspecified) materials it requires to
    demonstrate the transaction is genuine.
  • As is the case with all new PRC laws and
    regulations, we expect the rules to take time to
    "bed down" and the initial registration process
    is likely to be rather unpredictable. However,
    it should become more stable over time.

Source Lovells Newsletter, Oct., 25, 2005
Life Goes On
Back to Business Coping with the Challenges
  • The VC community in China tends to believe that
    the Circulars were enacted to stem the outflow
    asset, to enlarge tax sources and to better
    manage forex. The associated negative impacts to
    the normal VC activities could be just,
    unfortunately, an unintended by-product.
  • Coping with the new environment and complying
    with the Circular 75, deal structuring in China
    becomes more complicated, takes much longer time,
    and higher legal bills. But, the life goes on.
  • As a matter of fact, the investment sentiment is
    still positive and healthy, even a bit hot, in
    China. Doubling or even tripling of VC funds are
    pouring into China to chase limited quality
    deals. For full year 2005, we could expect same
    level of VC funding as last years US1.27B (not
    counting Yahoo-Alibabas US1B transaction), if
    not more.

Thank You ! www.i
With that Mr. Stan Shih, Acer Group's Founder
Chairman, retired from computer operation and
launched iD SoftCapital Group, Acer VC is
renaming into iD TechVentures. The company
focuses on early stage tech venture investment
in Greater China.
SAFE 11???????
  • 2005?1?24????11????,????,????,????????????????
    ????? ,???????
  • 11??????
  • ?????????????,????????????
  • ????????????????????,????????
  • ?????,???????????????????????????????
  • ?????????????????????????,????????
  • ????????????????????,???????(??????????????????
  • ?????,???????,???????????
  • 2005?4?21??29 ???????????????????????????????????

???????? ????,?????
  • ??????,????????????????????,???????,?????(????????
  • ?????????????,????????????????????????????,?????,?
  • ????????????????????????, 11?29?????????????,????
  • ????????,?????????????????,???????????????????????

  • ????,????,2004?????,???????10???,VC????,????VC????
  • ??2005?,?????????,????????,????,
  • ????????,???????75?????,?????????,?????????????