A stock incentive plan is a type of stock-based employee compensation which is usually used by the employer to attract, retain, motivate and reward senior executives and key employees. In order to make their employment conditions more attractive and competitive, more and more foreign invested enterprises (FIEs) or representative offices (ROs) in China have tended to adopt stock incentive plans by granting their key employees stock or stock options of their overseas operations that are listed on foreign exchange stock exchanges.

However, due to the strict foreign exchange control over capital accounts in China1, domestic individuals are not allowed to use foreign exchange to invest in foreign securities. Accordingly, domestic companies’ granting of stock incentive plans of an overseas listed company (hereinafter referred to as “Stock Incentive Plans”) to domestic individuals is subject to the foreign exchange administration in China.

On 8 March 2007, the State Administration of Foreign Exchange of China (“SAFE”) issued specific regulations, Circular on Operational Rules of Foreign Exchange Administration on Domestic Individuals’ Participation in Employee Stock Ownership Plan or Stock Option Plan, etc of Listed Overseas Companies, (Circular 78) to address, for the first time in detail, domestic individuals’ participation in Stock Incentive Plans.

Recently, with the aim to establish a more complete and practical administration regime for the participation in Stock Incentive Plans, on 15 February 2012, SAFE issued a new circular, “Circular on Issues Concerning the Foreign Exchange Administration on Domestic Individuals’ Participation In Stock Incentive Plans of Overseas Listed Companies”(Circular 7”), which replaces Circular 78 as the now effective regulations in this regard.

Circular 7 provides a definition of Stock Incentive Plans, according to which, Stock Incentive Plans refers to incentive plans of overseas listed companies whereby stock is granted to domestic individuals such as directors, supervisors, senior management personnel, or other key employees, etc, of domestic companies that have an employment relationship or labour service relationship with the domestic companies. Compared with Circular 78, Circular 7 expands the scope of Stock Incentive Plans in terms of the types of stock inventive plans, the scope of domestic companies granting the stock incentive plans, as well as the scope of domestic Individuals participating in stock incentive plans.

Circular 7 expands the scope of Stock Incentive Plans to virtually all types of stock incentive plans that are permitted by law in China, such as employee stock ownership plans, employee stock option plans, stock appreciation rights plans, etc. Previously under Circular 78, only the former two plans were expressly permitted. In such sense, all types of stock incentive plans seem to be possible, as long as they duly follow the relevant requirements and formalities as set out in Circular 7.

Compared with Circular 78, Circular 7 includes more types of institutions that are eligible to grant Stock Incentive Plans to their employees, which include the following:

1) Overseas listed company’s branches in China;
2) Parent companies, subsidiaries, or partnerships, etc., with stock control or an actual control relationship with the overseas listed company; and
3) Chinese companies listed on foreign stock exchanges.

According to Circular 7, domestic individuals that are qualified to receive Stock Incentive Plans from domestic companies include not only individuals having an employment relationship as required by Circular 78 but also those who have a labour service relationship.

However, Circular 7 fails to provide clarification about the “employment or labour service relationship with domestic companies, as to whether it covers employees locally hired by domestic companies, or also includes those who are hired by an overseas entity but sent to the domestic company through international assignment.”

It is also notable that, in addition to Chinese individuals, foreigners who have successively lived within China for a full year are also qualified to participate in Stock Incentive Plans.

Both Circular 78 and Circular 7 require that domestic individuals entrust various agencies to handle the procedures involved in the participation of Stock Incentive Plans, such as handling foreign exchange registration, handling fund remittance, purchasing and selling stocks, etc.

Compared with Circular 78, Circular 7 reduces the types of entrusted agencies, which consequently simplifies the procedures for the implementation of Stock Incentive Plans. The following table illustrates the difference in agency requirements under Circular 7 and Circular 78

According to Circular 7, the domestic agency may be the domestic company itself, or other domestic institution qualified for assets custody as appointed by the domestic company. Unlike in Circular 78, Circular 7 does not permit the trade union of the domestic company to act as the domestic agency.

Circular 7 established a foreign exchange registration requirement for participation in Stock Incentive Plans. Although Circular 7 fails to provide clear time limit for completing this foreign exchange registration, as the foreign exchange registration certificate is the essential document for all the steps and procedures involved in the implementation of stock incentive plans, it implies that the foreign exchange registration should be the first step prior to the implementation of Stock Incentive Plans once the domestic agency is selected.

Circular 7 also simplifies the document requirements, and the following documents, among others, shall be submitted to a local counterpart of SAFE for the foreign exchange registration:

1) Standard application form to introduce basic information of the Stock Incentive Plan;
2) Documents evidencing the authenticity of the Stock Incentive Plan, such as a public announcement of the Overseas Listed Company;
3) Power of attorney/or agreement signed by domestic company authorising the domestic agency to handle foreign exchange registration;
4) Undertaking letter issued by the domestic company certifying the authenticity of the employment or working relationship between the parties, together with the name list of the individuals, ID numbers, etc.; and
5) Other documents as may be required by SAFE if there is any inconsistency among the aforementioned documents or any lack of authenticity of the transaction.

SAFE will issue a foreign exchange registration certificate for the Stock Incentive Plan, which will be the necessary document to be presented before SAFE and the handling bank for each step involved.

Both Circular 7 and Circular 78 require a domestic agency to open a special foreign exchange account for the stock incentive plan, which will serve as the sole interface in China for fund remittance between China and abroad. According to Circular 7, the requirement of opening a special overseas foreign exchange account under Circular 78 is removed.

The following flow chart illustrates the funds remittance and foreign exchange conversion process normally involved in the implementation of Stock Incentive Plans:

As required by Circular 7, the domestic agency and the bank opening the special foreign exchange account shall periodically file with SAFE an update about the participation in the Stock Incentive Plans.

1) Filing obligation of the Domestic Agency
The domestic agency shall conduct quarterly on-record filing to report the status of the Stock Incentive Plans, such as the quantity and price of the purchased and sold stocks, the remaining quota for purchasing foreign exchange for the participation in Stock Incentive Plans, etc.
2) Filing obligation of the bank

The bank’s periodical filing is a new requirement set out by Circular 7. The bank shall, on a monthly basis, report the foreign exchange transactions, as well as the opening and closure of special foreign exchange accounts.

Circular 7 requires that all documentation be presented as a Chinese version for legal effectiveness. If the documentation is also in other languages, the Chinese version with legal effectiveness shall prevail.

Based on the above, as a summary, under the new administration regime in Circular 7, if a FIE or RO intends to launch any stock incentive plans, usually the following procedures will be involved:

1) Retention of a domestic agency and an Overseas Institution
2) Foreign exchange registration
3) Opening a Special Foreign Exchange Account
4) Fund remittance and foreign exchange conversion for the participation of Stock Incentive Plans

For FIEs or ROs which have launched or intend to launch a stock incentive plan for their senior management or other key employees, it is worthwhile to check and make sure their stock incentive plan is in compliance with Circular 7.