Finance is the core of the modern economy，and its development has been driven by reform，innovation and regulatory guidance. Ever since the 2008 US subprime mortgage crisis evolved into a global financial crisis，the international community has been grappling with the question of how to balance financial innovation with the need for robust regulation. As the drive towards financial innovation gathers pace，more attention needs to be focused on providing financial services to the real economy while protecting the interests of consumers. In this circumstance，the prevention of financial risk must be given top priority.

In recent years，SAFE has pushed for reform and a greater opening up of the economy，speeding up the decentralization of government regulation and the transformation of government functions. SAFE has also worked to promote institutional reform，facilitate trade and reduce transaction costs. It has analyzed existing policies to improve foreign exchange management and plug loopholes in the system. And it has strengthened audit requirements of compliance and verification and stepped up its efforts to halt irregularities in an effort to maintain order in the foreign exchange market. The introduction of the Notice on the State Administration of Foreign Exchange on the Further Promotion of Foreign Exchange Management Reform to Improve Audits of Authenticity Compliance (State Administration of Foreign Exchange [2017] No. 3，or the "notice") represents another important step forward on this path. As far as policy-making is concerned，the notice adheres to the existing status of the convertibility of the renminbi on the current account. At the same time it maintains the existing openings to direct investment and securities investment，demonstrating that there will not be a turning back of the clock to the capital controls of the past.

Implementation of this policy document relies on the existing foreign exchange management policy framework. By strengthening the transaction verification process to combat illegal foreign exchange activities，there can also be a healthy and stable operation of the foreign exchange market，which complies with the requirements regarding the convertibility of the currency under the current account as stated by the International Monetary Fund.

Promoting Capital Account Reform

The Notice adheres to the principle of reform and economic opening. It permits the settlement of specific foreign exchange loans，a huge step forward compared with previous practice，and it allows foreign loans with domestic guarantees to be transferred back for domestic use in the form of debt or equity. This can reduce financial costs by aiding corporations in their overall planning as to how they make use of domestic and foreign financial resources.

The Notice also clarifies the types of documents that can be used to support offshore investment，thereby simplifying the process for banks and their customers alike. It expands the ability of banks to make domestic use of offshore deposits in support of the centralized fund management program for multinational companies. And it supports the development of free trade areas by allowing the domestic use of foreign exchange that has been settled and converted into local currency.

Trade Financing

The policy document addresses trade financing ¨C both pre- and post-shipment ¨C based on expected foreign exchange earnings. It specifies that any trade credits need not completely match the amount of foreign exchange income or exactly coincide with the timing of a shipment. Specifically，it includes letters of credit，collections under an export bill，export bill discounting，export business invoice discounting，export factoring，forfeiting，order financing，export overseas payments，"packaged" loans and other foreign exchange loans related to exports. The settlement of foreign exchange loans can be repeated many times，and that could affect supply and demand on the foreign exchange market and in turn have an impact on the exchange rate. For these reasons，authorities have been relatively strict on foreign exchange settlements related to foreign exchange loans.

The Notice allows domestic settlement of foreign exchange borrowings，but repayments are supposed to be made with export income rather than purchases of foreign exchange. However，in circumstances where companies are unable to receive expected foreign exchange income they can notify SAFE of their need to make foreign exchange purchases. It should be noted that this is merely notification and not a requirement for prior approval. The responsibility is with the bank to ensure there is a legitimate reason for the foreign exchange purchase. The bank must also keep the documentation on file for five years. Foreign exchange funds from export financing as well as export income can be moved directly into the company's foreign exchange account.

The Notice also covers the settlement of foreign exchange funds in non-resident accounts in free trade areas. It states that non-resident accounts can be used for direct domestic settlement if there is a legitimate domestic purpose for the funds. Renminbi funds resulting from foreign exchange settlement can only be used for domestic payments and cannot be transferred overseas or to other non-resident accounts.

Banks are free from the examination and approval requirements in making settlement or payment. The settlement funds are supposed to be credited to the receiving bank account within two working days and the receiving bank has examined the current account or capital account information from the enterprise in question. If the receiving bank finds there is a non-compliance issue，the renminbi funds should be returned to the settlement bank via the original route. Thus，the settlement bank would need to purchase foreign exchange on the same day it receives the returned renminbi funds. Any losses or proceeds resulting from the currency exchange need to be resolved by negotiation among the parties.

The Notice also addresses the centralized use of funds by multinationals. The Provisions on the Administration of Centralized Operation of Foreign Exchange Funds of Multinational Corporations (State Administration of Foreign Exchange [2015] No. 36) refer to the use of deposits in the main account of international foreign exchange funds at domestic banks. The regulations state that "50% of the deposits can be used for domestic purposes if this does not exceed the average daily account balance over the past six months." The Notice adjust the percentage above，from 50% to 100%，and clarify that domestic uses of the funds does not account the bank quota of short-term foreign debt.

Strengthening Compliance Audits

The Notice completes the process of ensuring authenticity and compliance with the existing regulatory framework，plugging loopholes and addressing the shortcomings of previous policies. Authenticity and compliance are the cornerstones of foreign exchange management，with anti-money-laundering，anti-tax-evasion and anti-terrorism-financing as key objectives. Cracking down on speculative arbitrage and foreign exchange transactions in violation of rules and regulations are also core areas for policy implementation. Even at some future date when there is full convertibility of the currency under the capital account，there will still be a need for ensuring transaction authenticity and compliance. As a fundamental management principle，authenticity and compliance will not change due to the short-term changes in the foreign exchange situation.

Basic Principles on the Current Account

Since 1996，China has allowed full convertibility of the currency under the current account，and according to the relevant provisions of the International Monetary Fund，it still needs to conduct verification for transaction authenticity and compliance. In accordance with the requirements of the current foreign exchange management policies，except for some special types of transactions and special regional policies，foreign exchange receipts and payments enterprises should be in accordance with the rules that "those who export receive the foreign exchange; those who import pay the foreign exchange." Export business should be completed in accordance with the underlying contract in a timely manner and with full collection of the purchase price.

In conducting its monitoring and verification effort，foreign exchange authorities have discovered a small number of enterprises that didn¡¯t actually receive any foreign exchange or received less than the amount stated in their export contracts. There were inconsistencies between customs declarations and the foreign exchange amounts received or paid without sufficient supporting documentation. This disrupted the normal order of foreign exchange transactions. In view of this，the notice has reaffirmed the need for determining authenticity and compliance and the general need to ensure that exporter receives foreign exchange payments and importers make foreign exchange payments. It should also be pointed out that there are some exceptions to this rule，such as some pilot projects.

The Notice also reaffirms management principles regarding foreign exchange earnings retained in accounts overseas，referring to the State Administration of Foreign Exchange's Printing and Distributing of the Notice on Some Problems Regarding the Management and Laws and Regulations of Foreign Exchange in the Trades in Goods (SAFE [2012] No. 38) and the State Administration of Foreign Exchange's Printing and Distributing of the Notice on the Management and Laws and Regulations of Foreign Exchange in the Trades in Goods (SAFE [2013] No. 30). These regulations make clear that domestic entities must register with authorities in advance and submit overseas foreign exchange account receipts and payments information in a timely manner. As a result of monitoring in the past，authorities have found that some companies did not meet these requirements. The notice reiterates that failure to report relevant information can result in serious penalties.

Profits of Foreign-Invested Enterprises

Profits from direct investments are classified as being under the current account. Since China already allows currency convertibility under the current account，corporate entities can go to a bank to remit these proceeds without any restrictions as long as there is documentation showing the earnings are authentic and legally compliant. The Notice has not imposed new demands for examination and verification，though it does specify that previous tax losses need to be offset before funds can be remitted. Documents need to be verified for remittances of more than US$50,000. For sums of less than US$50,000 there is no need for bank verification as stated in the State Administration of Foreign Exchange's Printing and Distributing of the Notice on the Management and Laws and Regulations of Foreign Exchange in the Trades in Goods (SAFE [2013] No. 30).

According to the provisions of the Company Law，when a company's statutory provident fund is unable to make up for losses of previous years，the company must offset those losses before it can distribute profits. If profits are distributed to shareholders before the company makes up for previous losses and takes out money from a statutory provident fund，shareholders must return the profits to the company. According to the Enterprise Accounting System，the current realized profits of a company and the balance of undistributed proceeds at the beginning of a year (or minus the uncompensated losses at the beginning of the previous year) and any other receipts can be used for profit distribution. Banks need to audit the customer's relevant documents，including audited financial statements，the board's profit distribution resolution (or the profit distribution resolution of the partners of a company)，as well as foreign payments and taxation. In the process of the audit，banks should pay attention to the losses of previous years and examine financial statements to ensure those losses have been offset. If a foreign company has trouble remitting profits it can submit documentation to the central bank for review.

It should be stressed that strengthened enforcement of regulations under the existing policy framework will not affect the normal use of foreign exchange by enterprises. Commercial banks，in accordance with international practice，need to verify cross-border transactions as part of an effort in combating money laundering and fraud. This has always been a requirement，rather than a new policy，under foreign exchange management. Compared with previous practices，when the enterprises receive or pay foreign exchange，their normal receipts，payments and currency exchange shall not be affected as long as the underlying transaction is legitimate.

In the future，foreign exchange authorities will continue to promote the reform of the regulation system，and communicate with the market to facilitate trade and investment. At the same time，authorities will continue to strengthen the monitoring and early warning mechanism for cross-border capital flows. They will also support banks in their efforts to improve compliance abilities and strictly meet the requirements for authenticity and compliance in order to combat illegal activities in the foreign exchange arena，and safeguard China's economic and financial security.

The author is director-general of SAFE's General Affairs Department