Forming And Operating A Special Purpose Vehicle

State Administration of Foreign Exchange (SAFE), a Chinese government agency, recently published internal implementing rules about the foreign exchange registrations. Registration with SAFE is necessary for any resident or PRC citizen that attains equity in an offshore SPV (special purpose vehicle) for the purpose of attracting overseas financing for an onshore or domestic company.

SAFE offers comprehensive guidelines of the complex registration requirements for the various stages of special purpose vehicles financing. The Implementing Rules gives equivalent registration procedures for Chinese enterprises who wish to convert a legally established offshore subsidiary into an Offshore SPV.

The Implementing Rules comprise a comprehensive list of materials to be submitted, including:

1. Detailed information about the offshore SPV that includes relevant industry, history of the Onshore Company as well as controlling shareholders and management
2. Financial information about the Onshore Company for the most recent three years
3. Term sheet or signed financing documents
4. For registrations by individuals, audited financial statements of the Onshore Company for the most recently completed audit period.
5. Formation or control of an Offshore SPV by a Chinese enterprise other than venture capital enterprises requires approval from central SAFE
6. The Onshore Company is responsible for coordinating the SAFE registrations of its shareholders and must report any non-compliance by them
7. Employee option plans must be registered collectively through an 'entrustment arrangement.'

The registration of SPV financings are established or controlled by a 'legal person' or a 'domestic resident natural person.' Individuals who purposes of registration are the following:

1. A person having a PRC identification card, passport or other PRC identification documents
2. An individual who has a residence inside China or provisionally left China for definite reasons
3. An individual who has interest in a domestic enterprise
4. An individual who has an interest in a foreign-invested enterprise which is converted from a domestic enterprise.

For the first time of registration, the Operating Procedures need certain preconditions at different stages.

(1) For obtaining a registration of acquisition or incorporation of the offshore SPV, the offshore SPV and the PRC onshore target company must have a general shareholding and a common management structure. That means the SPV may not be capable of performing any financing activities before the registration is completed. Because any front loaded financing activities may lead to the SPV's shareholding structure deviating from that of the PRC onshore target. As a result of the common shareholding requirement, the financing of the SPV may be significantly delayed.

(2) The contents of the business proposal must be sufficient and complete. The offshore financing institution and PRC onshore target company must have a signed letter of intention and a private placement memorandum.

(3) The Operating Procedures seem to indicate that, in order for the offshore SPV to obtain the registration for the round-trip investment, the SPV must have been in continuous operation in the approved scope of business for at least three years.

(4) Documents evidencing the legitimate sources of foreign exchanges over US$50,000 to be paid to set up the offshore SPV

Also, for the first time, the Operating Procedures have imposed a clear confidentiality obligation on SAFE authorities.

Documentation Required For Registration

For the first time, the Operating Procedures require the following information be disclosed to and registered with SAFE:

1. The financial reports of the PRC target company in the past three years
2. Employee or management incentive plans
3. Offshore financing agreements
4. Private placement memorandums
5. Documents evidencing the legitimate sources of foreign exchanges over US$50,000 to be paid to set up the offshore SPV.

Additional clarifications and requirements

If an SPV has finished a round-trip investment earlier than March 31, 2006, but did not succeed to register with SAFE before that date, SAFE may inflict foreign exchange evasion penalties for any funds paid by the onshore subsidiary to the SPV after April 21, 2005. Such payments can take the form of profit distributions; dividends; capital reductions or capital recoupments; share transfers; proceeds of liquidation; and loan repayments. To avoid this risk to reputation and financial penalties, venture capital and private equity firms should make a due diligence priority for conforming that the SPV's they plan to fund have complied with all requirements and have successfully obtained the SAFE registrations.

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