One Step Closer to Liberalisation Formal Unveiling of the Shanghai Free Trade Zone s Free Trade Account.

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1 June 2014 One Step Closer to Liberalisation Formal Unveiling of the Shanghai Free Trade s Free Trade Account. New rules published by PBOC Shanghai on 22 May provide much needed practical guidance on the operation of the Free Trade Account (the ). The was first introduced by PBOC last December 1 as a separate bank account facility to enable residents of the Shanghai Free Trade (the ) to take advantage of the liberalisation of investment and financing capital flows outlined in the PBOC s blueprint for financial reform. The new rules represent the first piece of published official guidance on s since the December 2013 blueprint, laying the foundation for other regulators to roll out their own rules and regulations which together will help to make the promised financial reform in the a reality. The new rules are also warmly welcomed by market practitioners as a step closer to full liberalisation of cross-border capital flows in China. Contents Highlights... 1 Separate Accounting Unit... 1 Types of... 2 Breakthroughs and Limitations... 2 The potential of the is still to be unlocked... 4 Risk Management... 5 Looking ahead... 6 For further details of the and how it can be used in the to capitalise on future financial reform, please see our December 2013 client alert PBOC to liberalise capital flows in the Shanghai Free Trade. Highlights Separate Accounting Unit The new rules further develop the free trade accounting unit ( FTU ) introduced by the PBOC blueprint. The FTU is a separate accounting unit that only Shanghai based financial institutions can operate. It separates a financial institution s operation in the from its other business in China, enabling it to conduct business. All transactions through s will be provided, booked and funded by the FTU, which will be subject to separate compliance requirements which do not apply to the financial institution s other business. The new rules provide further details of the recording, accounting and reporting systems for all the business booked through an FTU, the compliance requirements applying to an FTU and the flow of funds in the FTU. Most importantly, funds in an will not be classified as foreign debt, so there is no quantitative limit on the volume of business that a financial institution may accept. 1 The Opinions on Leveraging the Role of Finance in Supporting the Building of China (Shanghai) Free Trade Account Issue 1

2 Types of s are categorised in accordance with the identity of the account holder: Type of Title of Who can apply Account prefix Remarks Enterprise enterprise enterprises Sole proprietorship enterprises established in the FTE Can be opened with any Shanghai based financial institution having an FTU Offshore enterprise Enterprises established outside the PRC FTN Can only be opened with a financial institution within the Same-industry Shanghai based financial institutions with FTUs in place FTU Offshore financial institutions Individual individual Chinese nationals who are employed in the and whose tax returns have been submitted to the PRC tax authority for at least one year FTI Can be opened with any Shanghai based financial institution having an FTU Foreign individual Individuals who hold foreign nationalities and have been employed in the for at least one year under a valid work permit FTF Can only be opened with a financial institution within the. Foreign nationals include Hong Kong, Macau and Taiwan residents Breakthroughs and Limitations Unrestricted flows: The new rules reflect the principles of the PBOC s December blueprint and clarify that RMB funds, including those borrowed outside China, can be freely remitted between accounts outside China on the one hand, and s in the as well as other onshore accounts held in China by non-residents, through the mere submission of the required settlement instructions to the bank. Controlled transfers between and non- accounts in China: The new rules reiterate the principle that the flow of funds Account Issue 2

3 between the and the rest of China are regulated in the same way as cross-border funds flows. balances placed with financial institutions in China outside the (other than for the below purposes to be discussed) will be considered as foreign debt and subject to quantitative restrictions. What the new rules clarify is how holders of s can move funds between their s, non- accounts in the and other onshore accounts held outside the. Transfers of funds between these accounts for the following purposes will be permitted: current account transactions (such as service fee payments); repayment of RMB denominated loans (for a term longer than six months) borrowed by the account holder from banks in Shanghai; industrial investment, including investment by way of new establishment, merger and acquisition and capital increase; and any other cross-border transactions that PBOC Shanghai may allow in the future. Below is a diagram illustrating funds flow between an and other various types of accounts. As discussed above, under the new rules transfers for the purposes mentioned above are now allowed between an account holder s s and non-s in the, as well as with onshore accounts outside the. It should be pointed out that although the is a multicurrency account, under the current rules only RMB funds transfers are permitted to and from s. The PBOC and the SAFE will evaluate the operation of the system and consider extending the regime to permit foreign currency transfers in six months time. Account Issue 3

4 Any offshore accounts Offshore Onshore FT Z Other s Onshore accounts held by holder holder s non- accounts Non-Resident accounts The new rules have provided much needed clarification on the operation of s, however, it also leave a few unresolved issues: Group borrowings: It is unclear whether the permitted use of funds in an to repay an accountholder s RMB loans extends to loans borrowed by its group companies. Other transactions: The new rules permit s to be opened with Shanghai based insurance and securities companies, in addition to banks. However, it is unclear which transactions can be performed using s opened with these companies as they are outside the bank clearing system. The potential of the is still to be unlocked As mentioned in the PBOC s December blueprint, the new rules reiterate that accountholders will, in the future, be able to process the following transactions, without complying with the approval and registration requirements mandated by the current framework: investments outside China without having to obtain regulatory approval in advance; investments outside China, including securities investments, by eligible individuals; investments by foreign individuals elsewhere in China, including securities investments; investments in securities within China; raising loans outside China; hedging positions and derivatives investments outside China; and Account Issue 4

5 placement and repurchase transactions in the Chinese interbank market. Details on how these transactions will be implemented are still awaited and will depend, in turn, on the pace at which rules are revised to permit s to operate within the regulatory framework established by other regulators, such as CSRC and CIRC. Risk Management Risk management rules were announced together with the FTU implementing rules to address concerns about risk and fears about hot money inflows. PBOC Shanghai will be closely monitoring capital flows and will suspend transfers if irregularities in cross-border transactions are spotted. Whilst it is encouraging that the new rules do not impose any requirement to obtain PBOC or other banking regulatory approval, institutions seeking to establish FTUs and provide facilities are still required to undertake a risk evaluation and apply to connect with the systems of PBOC Shanghai. It remains to be seen how these requirements will operate in practice. Account Issue 5

6 Looking ahead The new rules set the stage for further clarification from the PBOC and other regulators on how the financial liberalisation within the is to be achieved. It is expected that the beneficial effect of the new transactions will also be seen through the facilitation of trade and investment transactions with Chinese counterparties outside the and an eventual liberalisation of capital account transactions. However, the new rules also highlight the PBOC s cautious approach to financial liberalisation and indicate that the financial reforms in the will proceed on a gradual basis, involving much crossregulatory dialogue and coordination. Contacts For further information please contact: Fang Jian (+86) jian.fang@linklaters.com Nicola Mayo (+86) Reference: Implementing Rules on Separate Accounting Services in the Shanghai Free Trade 中 国 人 民 银 行 上 海 总 部 关 于 印 发 中 国 ( 上 海 ) 自 由 贸 易 试 验 区 分 账 核 算 业 务 实 施 细 则 ( 试 行 ) Implementing Rules on Risk Management in relation to Separate Accounting Services in the Shanghai Free Trade 中 国 ( 上 海 ) 自 由 贸 易 试 验 区 分 账 核 算 业 务 风 险 审 慎 管 理 细 则 ( 试 行 ) Issuing authority: PBOC Shanghai Head Office nicola.mayo@linklaters.com Richard Gu (+86) richard.gu@linklaters.com Annabella Fu (+86) annabella.fu@linklaters.com Zhirong Zhou Counsel (+86) Author: Bryan Chan, Eva Wang This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2014 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of the LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. zhirong.zhou@linklaters.com Linklaters LLP Beijing Office 25th Floor China World Office 1 No. 1 Jian Guo Men Wai Avenue Beijing China Telephone (+86) Facsimile (+86) Linklaters.com Account Issue 6