Assets Manager and Custodian Bank
Circular 78 requires that the Domestic Agent engage a qualified assets manager and an offshore bank with custody business qualifications to hold all offshore assets owned by participating employees under the ESPPs. However, an exemption from these requirements exists for overseas-listed companies that have existing arrangements in place to administer their ESPPs (e.g., a global stock plan administrator/broker).
Application for Annual Foreign Exchange Conversion and Payment Quota
Circular 78 requires the Domestic Agent (on behalf of participating employees) to apply for an annual quota for foreign exchange conversion and payment (the "Quota") with SAFE by submitting the following documents:
| (a) |
written application describing the relevant stock plan; |
| (b) |
agreement with the assets manager and/or custodian bank (or the global stock plan administrator/broker); |
| (c) |
board resolutions (or other equivalent authorization/approval documentation) of the overseas-listed company approving the stock plan; |
| (d) |
sample stock plan documents; |
| (e) |
summary of the risk management and internal control systems of the Domestic Agent; |
| (f) |
a confirmation letter issued by the foreign company's PRC affiliates/subsidiaries confirming the labor relationship with employee participants; and |
| (g) |
other information as required by SAFE. |
The initial Quota application for ESPPs is submitted to central SAFE (through a Local SAFE) for central SAFE's approval. Subsequent annual Quotas for ESPPs will be approved by Local SAFEs.
Monitored Foreign Exchange Accounts
Simultaneously with the initial Quota application, the Domestic Agent needs to apply to central SAFE (through a Local SAFE) for the opening of an onshore special foreign exchange bank account with a bank in China (the "Onshore Account") and an offshore special foreign exchange account with a custodian bank (the "Offshore Account"). Foreign companies with existing stock plans that are managed on a global basis are exempted from having to apply for the opening of the Offshore Account, but they are required to establish an Onshore Account.
The Onshore Account should be solely used for: (1) remitting foreign currency for purchasing the stock of the overseas-listed company; (2) receiving sale proceeds from selling stock of the overseas-listed company; (3) receiving dividends; (4) transferring the received funds into the foreign exchange bank accounts of participating employees or converting the funds into Renminbi and transferring the Renminbi to employees' individual Renminbi bank accounts; and (5) other purposes as may be approved by SAFE (e.g., converting and transferring the received funds to the bank accounts of other PRC affiliates/subsidiaries for subsequent distribution to participating employees).
Importantly, Circular 78 requires the repatriation of all foreign exchange derived from participation in ESPPs (and SOPs) into the approved Onshore Account for periodic monitoring (although no specific timetable for repatriation is required). This means that when shares acquired through the ESPP are sold by current or former employees, the proceeds of the sale must be repatriated to China through this Onshore Account. Within the first ten (10) days of each calendar quarter, the Domestic Agent must report to Local SAFE the implementation status of the ESPP by submitting a Recordal Form in Connection with the Status of Domestic Individuals' Participation in Employee Stock Purchase Plan of Overseas Listed Companies attached to the Circular 78 as an appendix (reporting on information such as the amount of payroll deductions held, status of share purchases and sales and funds held in Onshore Accounts and Offshore Accounts, as applicable).
Procedures for Participating in Stock Option Plans
Circular 78 regulates the requirements applicable to SOPs which permit cash exercises and require the conversion of Renminbi into foreign exchange to purchase shares in substantially the same manner as ESPPs. Unlike the approval for an ESPP which must be at the central SAFE level, however, the approval for an SOP can be obtained at the Local SAFE level. Circular 78 suggests that companies may be able to delay seeking such Local SAFE approval until such time as employees wish to send funds out of the PRC to exercise their options. The Domestic Agent will need to obtain an approved annual Quota as well as the Onshore Account to remit payment abroad. PRC individuals must engage a Domestic Agent, which again is likely the PRC affiliate/subsidiary of the overseas-listed company, to participate in an SOP. The Domestic Agent will apply for the Quota at a Local SAFE on an annual basis through the same process mandated for ESPPs (as described above). Foreign exchange gains from SOPs shall be handled in the same manner as those described for ESPPs above (e.g., remitted to the Onshore Account and further distributed from such account).
Circular 78 also requires Local SAFE approval for cashless SOPs. Although no funds leave the PRC for the exercise of the option, the local affiliate/subsidiary of the overseas-listed company must obtain Local SAFE approval for the opening of an Onshore Account to receive and distribute plan gains in the same manner as the regime described above for ESPPs. It is not clear under Circular 78 when the Domestic Agent is obligated to file for such approval. However, based on the regime outlined in Circular 78, it would appear that the Domestic Agent must at least apply for Local SAFE approval before any funds from SOP gains are repatriated back into China. Circular 78 also requires that for SOPs, within the first ten (10) days of each calendar quarter, the Domestic Agent must report to Local SAFE the implementation status of the SOP by submitting a Recordal Form in Connection with the Status of Domestic Individuals' Participation in Employee Stock Option Plan of Overseas Listing Companies attached to the Circular 78 as an appendix (reporting on the quarterly status of stock purchase and sales and the amount of funds held in the Onshore Account).
While Circular 78 does not exactly detail the documentary requirements for the approval for the opening of an Onshore Account by the Domestic Agent for cashless SOPs, we anticipate that Local SAFEs will impose substantially similar documentary requirements as those required for ESPPs described above.
Impact on Existing Stock Plans
Circular 78 imposes a so-called rectification procedure for companies with existing ESPPs and SOPs, requiring the Domestic Agent of the participating company in China to seek approval for their plans within three (3) months from the issuance of the circular, i.e., by July 6, 2007. Because Circular 78 has not been made publicly available (as it is not published on any official PRC government websites) and has only been distributed internally to Local SAFEs, it is unclear how companies can comply with a regulation that is not made publicly available. It can be argued that at this juncture this circular is only an internal directive without the binding force of an administrative regulation.
While it is unclear how Local SAFEs or SAFE itself can enforce Circular 78's July 6, 2007 filing deadline for existing plans implemented prior to or even after April 6, 2007, multinational companies in China with existing ESPPs and SOPs will likely face pressure to obtain SAFE approval for their plans in the coming months, although the exact timing of any sort of enforcement action remains unclear given SAFE's limited resources. PRC banks which handle inward remittances of stock plan gains (particularly when such gains are remitted into the payroll accounts of local PRC affiliates/subsidiaries) may face pressure from SAFE to refuse conversion requests of those received funds until companies apply for and obtain SAFE approval and those funds are handled through the Onshore Account.
It is also not clear whether Circular 78 will be applied in practice to restricted stock, RSU plans and phantom stock plans, but given the similarities between these types of plans and cashless SOPs (and given that SAFE has not indicated that the monitoring of the inflow from gains from those plans should be regulated in a more flexible manner), SAFE will likely require approval for implementation of stock plans other than ESPPs and SOPs.
Conclusion
Regardless of the fact that Circular 78 is not publicly available, its impact on companies offering employee stock plans in China is already being felt. Overseas-listed companies offering equity programs to employees of their PRC affiliates/subsidiaries should be aware that the SAFE approvals will likely disrupt current stock plans and delay the implementation of new stock plans in China. In addition, SAFE likely will attempt to require all companies to restructure thier stock plans to comply with the repatriation and monitoring requirements of Circular 78.