出海经纬 | RMB Funds Outbound Investment

There are several pathways for RMB funds to invest in offshore entities, including direct overseas investment, Qualified Domestic Limited Partner ("QDLP"), Qualified Domestic Institutional Investor ("QDIE"), and RMB international investment and loan funds. However, given the complex procedures and requirements for obtaining QDLP/QDIE qualifications, as well as the distinct differences in the overseas investment filing process and quota management compared to standard RMB funds, this article will not delve into these details and we will cover them in a separate series.

Considering China’s capital project foreign exchange controls, RMB funds investing directly in overseas holding entities are subject to regulation by multiple departments, including Ministry of Commerce of the PRC ("MOFCOM"), National Development and Reform Commission ("NDRC") and State Administration of Foreign Exchange ("SAFE"). Necessary filings and registrations for overseas investment ("ODI Filing") shall be completed according to regulations such as the "Regulations on Overseas Investment Management" (NDRC Order No. 11), the "Regulations on Overseas Investment Management" (MOFCOM Order No. 3 of 2014), and the "Foreign Exchange Administration Regulations of the People's Republic of China". The specific filing process is as follows:

During the ODI Filing process, there may be variations in the local competent authorities, procedures, review timelines, and requirements across different regions. For example, for funds established in Shenzhen, if the fund directly invests in non-sensitive overseas projects^[2] and the investment amount does not exceed USD 300 million, the fund must file with the Shenzhen Municipal Bureau of Commerce (or the Qianhai Authority if registered in the Qianhai Free Trade Zone) and the Shenzhen Development and Reform Commission, followed by foreign exchange registration at the local bank where the enterprise is located. This entire process typically takes about three to four months, with stricter review standards compared to regions like Beijing and Hainan. If the overseas project involves sensitive categories or other situations that may attract regulatory attention (e.g., large-scale non-core business investments), it is advisable to communicate with the competent authorities in advance and anticipate a review period of more than six months.

In practice, due to various financing rounds, RMB funds may invest overseas either jointly or sequentially with other investors across different time points and/or investment stages. In such scenarios, RMB funds may encounter complexities, such as identifying the domestic lead entity responsible for the ODI Filing and coordinating with existing domestic investors whose ODI Filings may not align with the new RMB fund's location. Pursuant to NDRC’s requirements, projects involving multiple investment entities must be approved and filed by the party making the largest investment and NDRC’s reviews for differents rounds of investments are generally treated independently. Conversely, the MOFCOM determines the application entity based on shareholding ratios and considers prior investors in the ODI Filing. Consequently, RMB funds may face intricate coordination challenges with various regulatory bodies to ascertain the appropriate approval and filing entities, necessitating efforts to encourage other investors to spearhead the ODI Filing. This may impact the timeline for overall investment. As a result, RMB funds have gradually developed the following alternative models^[3]:

Before completing the ODI Filing, the RMB fund first invests directly in the domestic operating entity of the Chinese enterprise, acquiring a certain proportion of equity to lock in the current round's valuation. Simultaneously, the fund subscribes to the newly registered capital of the overseas holding company equivalent to the investment amount, obtaining warrants of the Cayman companies or similar documents in other jurisdictions. 

After completing the ODI Filing, the domestic operating entity will proceed with a capital reduction procedure, paying the repurchase consideration to enable the RMB fund to exit domestically, while the fund exercises its overseas warrants to acquire equity in the overseas holding company.

This approach, compared to the previous method, substitutes direct investment with convertible bonds issued to the domestic operating entity, thereby circumventing the complexities of capital reduction. Concurrently, the RMB fund secures warrants in the overseas holding company equivalent to the investment amount. Upon completion of the ODI Filing by the fund, the domestic operating entity repays the corresponding amount of the convertible bonds, and the fund exercises its overseas warrants to acquire equity in the overseas holding company.

According to the Q&A on the China Securities Investment Fund Industry Association's website and relevant regulations, while private equity and venture capital funds may invest in non-publicly traded convertible bonds, when such investments involve convertible bonds of unlisted companies, the investment proportion specified in the fund contract generally shall not exceed 20% of the fund's total size. If the agreed investment proportion exceeds 20%, private fund managers must provide special explanations, taking into account factors such as bond maturity, interest rate, and conversion terms. Therefore, when RMB funds utilize this method, they need to carefully assess the investment amount relative to the overall fund size in advance and explicitly detail the terms of the convertible bonds in the transaction documents.

As an alternative when RMB funds cannot complete the ODI filing, some fund investors directly hold equity in the domestic operating entity, paying the investment amount directly to the domestic operating entity, while the RMB fund's overseas affiliates or designated third parties hold the shares of the overseas holding entity on their behalf.

Although this method is commonly used as an alternative, it requires careful assessment of related risks. On one hand, this method may impact the overseas holding entity's listing and require additional explanations to regulatory authorities about the rationale for third parties or affiliates holding shares abroad. On the other hand, in the event of fund exit, the lack of registered capital contribution in the overseas entity results in a lower deductible investment cost, leading to a certain tax base loss. Additionally, the absence of ODI Filing may create barriers for repatriating exit proceeds to the domestic funds.

With the gradual internationalization of Chinese industries, the demand for overseas funds has increased. In recent years, the State Council and the People's Bank of China have successfully launched RMB international investment and loan funds in key regions such as Shanghai, Shenzhen, and Beijing. RMB international investment and loan funds approved and established by the People's Bank of China can directly allocate RMB funds raised domestically to overseas sub-funds to support their investment and loan activities abroad.

Compared to conventional RMB funds and QDLP/QDIE, RMB international investment and loan funds have the advantage of exempting the ODI Filing, facilitating the cross-border flow of funds. Although the number of the pilot funds is still limited, they primarily invest in high-potential transnational enterprises, providing funding support for their global development through direct RMB overseas investments and loans. It is anticipated that RMB international investment and loan funds will become a key channel for cross-border investment in the future.

When the parent company of an outbound enterprise is still based in China and directly establishes or acquires a subsidiary abroad, the Chinese enterprise is required to complete the ODI Filing to facilitate the legal remittance of funds and the repatriation of profits. The process is generally consistent with what was described in the section II of this article. However, compared to RMB funds, direct overseas investments by Chinese enterprises often involve larger amounts of capital. For certain projects that may fall into sensitive industries or regions, Chinese enterprises need to assess whether the proposed investment falls within the scope of approval by the NDRC. If there is uncertainty, it is advisable to consult with the relevant local authorities before commencing the ODI Filing. Additionally, for overseas investments involving state-owned enterprises, it is necessary to obtain approval from the relevant state-owned asset management departments and complete the required registration.

For overseas holding companies that reinvest profits earned abroad or use self-raised funds for further investments, the SAFE has abolished the foreign exchange filing requirements for overseas reinvestments since 2015. The MOFCOM requires that reinvestments involving sensitive projects undergo approval procedures; otherwise, a post-investment reporting process applies. The NDRC mandates approval for reinvestments in sensitive projects, while non-sensitive reinvestments are handled based on specific circumstances: (1) if the domestic enterprise directly contributes assets, equity (including currency, securities, physical assets, technology, intellectual property, equity, debt, etc.), or provides financing or guarantees, filing procedures are required; (2) if no assets, equity, financing, or guarantees are involved, investments exceeding USD 300 million must be reported through the National Overseas Investment Management and Service Network System, while investments under USD 300 million do not require submission. ^[4]

Furthermore, when Chinese enterprises establish or acquire overseas subsidiaries, they need to pay close attention to special requirements for foreign investment in the other countries. For example, when an Chinese enterprise directly or indirectly acquires a U.S. company, especially in sensitive sectors or key technology areas, it may face scrutiny by the Committee on Foreign Investment in the United States ("CFIUS"). The jurisdiction and rigor of CFIUS reviews may be influenced by international relations. Similarly, the European Union scrutinizes direct investments by Chinese enterprises in the EU, particularly those involving critical infrastructure, key technologies, supply chain security, or other sensitive areas, to assess whether they pose a threat to EU security and public order. Therefore, Chinese enterprises must thoroughly understand and comply with relevant review requirements to avoid potential legal and compliance risks.

As mentioned earlier, domestic enterprises planning to list overseas or establish international headquarters abroad often set up intermediate shareholding platforms in offshore jurisdictions such as the Cayman Islands or the British Virgin Islands, which actually hold the equity/assets of domestic operating entities. However, some countries and regions adopt a more cautious approach towards foreign investment structures that use offshore companies, particularly when involving sensitive industries or sectors. These may trigger additional scrutiny or disclosure requirements. Therefore, when enterprises consider choosing this structure, they need to consider the nature of their business and the regions they operate in.

When adopting an offshore holding structure, the actual controllers or domestic enterprises need to establish offshore holding entities in advance and determine the preliminary procedures based on the organization form/identity of the shareholders. Generally, if a Chinese enterprise directly holds the structure, it must complete the ODI filing procedures, as previously discussed. 

If a Chinese national holds the structure, they could only legally and compliantly hold offshore company equity after completing the foreign exchange registration in accordance with the "Notice of the State Administration of Foreign Exchange on the Administration of Foreign Exchange Concerning Offshore Investment and Financing and Round-Trip Investment by Domestic Residents through Special Purpose Companies" (SAFE Circular [2014] No. 37) ("Circular 37"). However, the foreign exchange registration under Circular 37 requires meeting specific conditions such as establishing a special purpose offshore company, contributing domestic and foreign legal assets or equity, having a clear intention for overseas institutional investment, and ultimately forming a round-trip investment structure. Therefore, Circular 37 registration primarily applies to scenarios involving indirect overseas listings or obtaining foreign financing by Chinese enterprises. If the outbound enterprise mainly conducts business activities through an offshore holding structure, such as establishing international headquarters to expand markets abroad, it may not meet the requirements for a round-trip investment structure. In such cases, it is necessary to coordinate with appropriate overseas funding partners to arrange corresponding round-trip investment paths, complete Circular 37 registration, or plan for other suitable offshore individual shareholding structures in advance to meet the regulatory requirements for compliant individual shareholding.

RMB funds play a crucial role in supporting Chinese enterprises' overseas expansion efforts. By designing a well-structured equity framework, RMB funds can offer critical financial support to outbound enterprises, enabling them to establish a solid foothold in the global market. By navigating the complex regulatory landscapes both domestically and internationally, RMB funds can effectively assist outbound enterprises in their global ventures while maximizing investment opportunities.