Effective Ways to Hedge Against the Rise of the RMB

- Dr. Lefan Gong, Zhonglun Law Firm

This article discusses three ways that foreign companies looking to make foreign investment in China may seek to limit their foreign currency losses against the appreciating RMB (or Chinese Yuan).

If you are a US company interested in making an investment in China in the near future, you probably have good reasons to be concerned about the continuing appreciation of the RMB against the US dollar, and the resulting currency losses you may incur in the funds earmarked for the China investment.

The challenge is that although you have earmarked the funds for the investment, it might take months – or even a year – to implement the China business plan before you put the money to use. At that point, the US dollar is likely to be even lower than it is now. Currency hedging options like ETNs and futures appear to be of limited value at this time, as the market has already factored in the likely increased value of the Chinese RMB. On the other hand, the Chinese government, still grappling with a surge in a foreign speculative capital, has been tightening control over the influx of foreign capital in areas like real estate; and, increasing scrutiny on the procedures of currency conversion for foreign invested companies.

So what can be done to prevent the purchasing power of your USD investment from being eroded in China?

The key is to get the USD funds into China and have it converted into RMB as soon as possible. But even if you inject the USD fund now, the Chinese foreign exchange regulations do not allow it to be converted into RMB unless you can submit proof to the Chinese authority (i.e., State Administration of Foreign Exchange, or “SAFE”) that such conversion is for actual use and spending, unless the requested conversion amount is less than USD $200,000. Even for amounts less than USD $200,000, any subsequent requests for conversion must be accompanied with proof (such as receipts and employee payroll) showing how any previously converted RMB has been used.

This article discusses several legitimate ways to expedite the currency conversion process to maximize the purchasing power of your US dollar investment in China.

WFOE Reinvestment. If your company already has a wholly-owned foreign enterprise in China (“WFOE”), there may be ways to use this existing entity to get on a “fast track” for currency conversion. As mentioned above, such WFOE as well as other foreign invested enterprises (FIE) are only allowed to convert $200,000 into RMB at a time, and subsequent requests for conversion will require proof that the prior converted RMB proceeds were actually spent; sums larger than $200,000 will require additional documentation such as leases and sales contracts.

One option that has been used by some FIEs is to have the FIE establish a wholly-owned subsidiary, and then apply for RMB conversion in order to pay for the registered capital of the new subsidiary. Since the new subsidiary is a Chinese domestic limited liability company, its registered capital must be in RMB rather than US dollars or other foreign currency. Thus, the need for registered capital injection creates a legitimate reason for converting the WFOE’s US dollar funds into RMB. For such purposes, the subsidiary’s company formation documentation (such as its business license) will be required for the application with SAFE to convert the USD into RMB.

There is no law or regulation to date that expressly prohibits such means of converting USD into RMB, and such approach has been tried and used successfully by many companies over the past few years. However, there is no guarantee this will continue to work in every place in China, as in some locations (such as Beijing and Shanghai), the government is wary of such “creative” ways, and has been trying to tighten its control over how foreign capital (esp. USD) may be converted into RMB. There has been speculation that SAFE might issue new circular to close this loophole, but the difficulty resides in the challenge SAFE may face in distinguishing the speculative “hot money” and bona fide investment for FIEs’ legitimate business expansions.

If You Do Not Have a WFOE. If you currently do not have any foreign investment vehicle in China, such as a WFOE, then you probably should start one now. Having an entity set up in China may be the only legitimate way for most of the foreign investors to infuse foreign capital into China and then have the same capital converted into RMB for investment. Since how fast you can convert the USD into RMB has now become an important business consideration, you probably should “forum-shop” a little to pick a friendly location to set up your shop where the local SAFE would be less stringent in scrutinizing the applications for currency conversion.

Second- and third-tier cities usually are more flexible than places like Beijing and Shanghai, as they are more eager to have foreign investment to spur the local economy and less “hot” real estate for speculative hot money to chase.

Real Estate Investment. In light of the rising RMB as well as the commercial real estate prices in China, a company can also consider using its WFOE to purchase commercial real estate in China and then selling it later when it is ready to use the proceeds (in RMB) for other investments in China. Although selling and reselling real estate might appear to be a big undertaking, it actually can hedge against both the rising RMB as well as the soaring property price in China. And the economic benefits could be even more appealing if you use US borrowings to fund such purchases.

The existing WFOE can increase its registered capital then use the proceeds to buy property for its self-use, which is permissible under the PRC law. With the agreement to purchase the commercial property, getting SAFE’s approval for RMB conversion should be fairly straightforward.

With this approach, you would need to consider all the commercial implications, including the risk associated with the general economy and real estate market in China together with a 5.56% business tax on the sales price of the property and any resulting income tax.

Other Considerations. There are other ways to reduce, maybe at a smaller scale, your exposure for currency losses. Some banks in China offer products or instruments such that the customer and the bank can reach an agreement on a fixed currency exchange rate for conversion at a specified date in the future. Also, some of the smaller local banks may be more lenient in implementing SAFE’s rules in currency conversion. For instance, they may be less onerous than some of the larger banks in requiring supporting documentation for converting sums of less than $200,000.

In addition, to qualify for more conversions of sums less than $200,000, a company can gain more currency savings by managing more efficiently its revenues and expenses. For instance, instead of using the RMB revenues to pay for expenses, it can deposit such revenues into its savings account and keep making USD conversions into RMB for the expenses.

Lefan Gong ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it ) is a partner in the Shanghai office of Zhong Lun Law Firm (www.zhonglun.com). Previously, he practiced with a Wall Street law firm in New York, and with a large U.S. firm’s Shanghai office. Lefan specializes in corporate transactions. He has advised large multinational and U.S. Fortune 500 companies and other clients in a wide range of transactions, including cross-border mergers and acquisitions, private equity deals, venture investments, joint ventures, and China foreign direct investments. A frequent author on China law-related topics, he is admitted to practice in New York and in China. He received his Science Juris Doctor and LL.M. from the University of Michigan Law School.

Other articles by Lefan Gong (ZhongLun Law Firm):

• Choosing the Right Forum for Business Disputes in China
• Five Legal Tactics to Reduce Employee Disputes in China
• How to Choose a Law Firm in China

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