Opening doors in China Incorporation of foreign banks

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1 BANKING Opening doors in China Incorporation of foreign banks January 2007 ADVISORY With effect from 11 December 2006, foreign banks have new opportunities to provide a full range of Renminbi (RMB) retail banking services in China. More than 70 foreign banks operate branches in mainland China 1. Now, for the first time, the China Banking Regulatory Commission (CBRC) has set out regulations allowing them to obtain a licence for offering a full range of banking services, including RMB retail business. At present, foreign banks can only operate branches within China, providing services to corporate clients with minimum deposits of RMB 1 million. These foreign banks will now be able to extend their number of retail branches across the country and access to the vast RMB retail market. The CBRC will only allow incorporated banks to do this, as this will afford greater protection to local customers than exist under branch arrangements. While this development has been keenly awaited by many banks, the planning, application process and subsequent conversion to a locally-incorporated structure entails significant costs and effort. Banks need to fully understand and anticipate these issues at the outset period. Getting a licence: What you need to know To obtain the licence, the CBRC requires foreign banks to incorporate a banking subsidiary or wholly foreign-owned enterprise (WFOE) in China. Foreign banks should meet the following criteria for setting up the WFOE: International track record Evidence of continual profit-making ability Effective internal policies and procedures, including anti-money laundering measures Approvals from home country regulators. 1 Source: EIU China Hand, March 2006

2 2 Opening doors in China: Incorporation of foreign banks Under the new regulations the government will revert within six months on whether it accepts or rejects the preliminary application for a WFOE. If it rejects an application, formal explanation for that decision will be given. Formal approval from the CBRC should then take a further two months following the submission of all formal application materials. Once the CBRC has granted formal approval for the establishment of WFOE, it will issue a licence to the bank. The minimum registered capital for a wholly-owned foreign bank or an equity joint venture bank should be an amount, in a freely convertible currency, equivalent to no less than RMB 1 billion. Wholly-owned foreign banks or equity joint venture banks intending to set up branches in China should allocate a working capital in a freely convertible currency equivalent to no less than RMB 100 million per branch. The total capital used for setting up these branches should not exceed 60 percent of the WFOE.

3 Opening doors in China: Incorporation of foreign banks 3 Steps in setting up a WFOE and its challenges 1 Planning The key activities include: Establishing a project team Determining objectives Tax planning Developing a comprehensive business/operations plan Developing a detailed implementation plan The significant challenges include: Limited resources Determining the approach Determining the impact across various business functions Developing a comprehensive plan Devising a WFOE entity/bank branch structure 2 Application The key activities include: Communicating with CBRC and various authorities during the course of the application process Setting up the desired WFOE entity and branch structures Establishing the WFOE and register with the various authorities Capital verification Preparing pro-forma financial statements Determining tax effectiveness and regulatory compliance Regulatory approvals The significant challenges include: The existence of multiple regulators and bureaucratic hurdles Limited internal resources 3 Conversion The key activities include: Appointing key management and board of directors Capital injection Implementing effective risk management structure Transfering assets, liabilities, contractual arrangements to the new entity Integrating individual branches into new entity Communicating with the CBRC and other authorities Regulatory compliance of new entity with regulations The significant challenges include: Agreeing on and implementing management/director structures Ensuring effective risk management structure Determining the basis of assets transfer Assessing the tax implications arising from conversion Assessing the accounting issues arising from conversion Ensuring compliance with regulations

4 4 Opening doors in China: Incorporation of foreign banks Illustrative application process With so many steps in the application and different requirements for each submission, it is important to conduct proper planning and maintain dialogue with the regulatory authorities all the way through. In this illustration, we assume that a foreign bank already has operations in China and has opted for a full transfer of all its existing branches business into the WFOE. To commence the application process, a number of documents will be required by the CBRC for its preliminary examination. These documents include a feasibility study report, articles of association, and all the application forms and other documents as required by the regulators. Once a preliminary proposal is accepted by the CBRC, the bank will be given a formal application form, which should be submitted together with a number of documents within the preparatory period of six months. These documents include the list of key executives, power of attorney granted to these executives, letter of guarantees, internal procedural and accounting manuals, capital verification report, the pro-forma financial statements of the new WFOE and other any documents which the CBRC may require.

5 Opening doors in China: Incorporation of foreign banks 5 Formal approval from the CBRC will be given within two months after the submission of formal application materials. Once the CBRC grants formal approval, it will issue the licence to the bank. Upon issuance of the licence, public announcements of the commencement of the WFOE will need to be made in the newspapers designated by CBRC. The application process for creating a joint venture typically entails a similar length of time for CBRC approval. However, unlike the conversion from branch to WFOE there is no need to give a specific notice for the conversion under the joint venture process. Tax considerations and the transfer of existing operations Once a bank receives formal approval from the CBRC, it needs to register the new WFOE with the State Administration for Industry and Commerce (SAIC) and other government authorities, including tax authorities. These procedures should be completed within three months after the issuance of financial licence. Banks would be well-advised to discuss with the tax authorities the status of the WFOE with particular regard to the following issues: The possibility to potential claw-back tax holiday benefits The need for a consolidated filing mechanism for the WFOE The service level agreement arrangement and allocation of internal management fees. As a bank pursues the incorporated structure, it is assumed that the businesses of the existing branches established in China will also be transferred to the new WFOE. The existing branches should then be closed, except for a booking branch engaging in foreign currency business, if so intended. The transfer of existing branch businesses to the WFOE may give rise to PRC tax issues and sometimes exposures. Bank will need to understand the potential tax implications on the conversion. Examples of the tax issues may include the following: Availability of branch tax losses to the WFOE Entitlement to tax holiday by the WFOE Valuation basis (net book value versus fair market value) for the business and asset transfer.

6 6 Opening doors in China: Incorporation of foreign banks These issues will need to be handled carefully by banks. Dialogue with the PRC tax authorities at the central and local levels should be maintained to ensure the tax policymakers are fully aware of the potential tax issues that will need to be addressed when promulgating the relevant tax rules and that they make appropriate interpretations of the relevant rules when handling the transfers. Conclusion The process of incorporating is complex, but with so much potential for growth in China s retail banking market it is sure to be an attractive option for many foreign banks. The application process is not only multi-staged but also multidisciplinary it requires collaboration from legal, tax, audit and risk advisory professionals. These functions should all be brought together through a clear project management structure. The success of the application hinges on identifying issues at early stage, developing a thorough work plan and communication with the authorities all the way through the process.

7 Opening doors in China: Incorporation of foreign banks 7 Contact us For more details on the new CBRC regulations, or information on how KPMG professionals can help your company, please contact: Edwina Li Partner, Financial Services KPMG in China Tel. +86 (21) Fax. +86 (21) edwina.li@kpmg.com.cn Lewis Lu Partner, Tax KPMG in China Tel. +86 (21) Fax. +86 (21) lewis.lu@kpmg.com.cn Stephen Lee Partner, Risk Advisory Services KPMG in China and Hong Kong SAR Tel Fax stephen.lee@kpmg.com.hk

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