China Issues Draft Foreign Investment Law

To solve this often complained about issue and also to continue to carry out liberalizing reform of the legal regime governing foreign investment in China, the Ministry of Commerce (MOFCOM) published the draft Foreign Investment Law for public comments on January 19, 2015, with a deadline for comment of February 17, 2015. The proposed version, pending further revisions to be made after the comment period and the legislators’ review and approval, suggests a radically different regulatory landscape for future foreign investment in China.

I. Unified Code for Foreign Investment

The proposed Foreign Investment Law will govern all investment activities of foreign investors in China. Foreign investors include not only foreign persons that are domiciled outside China (foreign nationals or entities registered outside China), but also domestic entities that are controlled by such foreign persons. This extended definition covers the following two types of entities that are currently not within the purview of foreign investment regulations but are commonly used by foreign investors as vehicles to structure certain transactions. One of them is the second-level foreign invested company (i.e., companies invested in by foreign invested enterprises), and the other is the entity controlled by foreign investors via contractual arrangement (also known as a VIE entity).

Investment activities covered under the proposed Foreign Investment Law include (a) establishment of enterprises, (b) acquisition of shares, equity interest, assets, voting rights, or other similar rights and benefits of a domestic enterprise, (c) provision of long-term financing to companies with foreign interests, (d) acquisition of natural resources exploration rights, or right to construct and operate public utilities, (e) acquisition of land use rights or ownership to real property, and (f) control of interest in domestic companies through contracts, trust or other arrangement. Each of these activities is currently subject to separate rules and regulations. For example, the establishment of enterprises are mainly subject to the Sino-Foreign Equity Joint Venture Law (EJV Law), Wholly Foreign Owned Enterprise Law (WFOE Law), the Sino-Foreign Cooperative Joint Venture Law (CJV Law), Notification on Administration of Settlement of Foreign Exchange in Capital Account of Foreign Invested Enterprises (Circular 142), and the Tentative Rules on Domestic Investment by Foreign Invested Enterprises. The acquisition of shares, equity interests and assets is mainly covered under the Rules on Acquisition of Domestic Companies by Foreign Investors (also known as Circular 10), Several Rules on Change of Equity Ownership in Foreign Invested Enterprises and the Administration Rules of Strategic Investment in Listed Companies by Foreign Investors. The provision of long-term financing to companies is mainly governed by the EJV Law, the WFOE Law or the CJV Law. The acquisition of natural resources exploration rights is mainly covered under the Several Opinions on Further Encouraging Foreign Investment in Exploration of Mineral Resources; acquisition of land use right was mainly governed by the Tentative Rules on Development of Land by Foreign Investors (which was rescinded in 2008, with no new regulations published to replace it). The acquisition of ownership to real property is mainly covered under Opinions regarding Regulation of Foreign Investment in Real Estate Industry and 20 other rules and regulations published by government authorities including Ministry of Commerce, State Administration of Foreign Exchange, State Administration of Taxation and Ministry of Housing and Urban-Rural Development. Contractual control arrangement is discussed under Circular 10.

In proposing the Foreign Investment Law, the Chinese government seems to be following the examples of western countries such as Canada and Australia in having its own comprehensive foreign investment law that governs major aspects of foreign investment in China. However, the current draft only proposes to replace the EJV Law, the CJV Law and the WFOE Law (collectively, the FIE Laws), despite the fact that its coverage, as indicated in its definition to investment activities, is far broader than what used to be covered under those Laws. It still remains uncertain how the proposed Foreign Investment Law will interact with the various other current laws and regulations governing foreign investment activities.

II. National Treatment for Foreign Invested Enterprises

Besides attempting to unify foreign investment regulations, the draft law also provides national treatment to foreign investors except for investment in industries specified under the Foreign Investment Special Administration Catalogue discussed below.

Under the current legal regime, equity joint ventures and, in most cases, wholly foreign-owned enterprises and cooperative joint ventures all take the form of limited liability companies. However, according to the policies issued by the company registration authorities, the organization and management of wholly foreign-owned enterprises are governed by the PRC Company Law while the equity joint ventures and cooperative joint ventures are governed by the EJV Law and CJV Law, respectively. Foreign invested partnership and foreign invested companies limited by shares are also governed by independent sets of rules instead of the Partnership Law and the Company Law. Hence foreign invested enterprises are subject to different requirements, in terms of minimum registered capital, total investment, corporate management and taxation, depending on the entity form a foreign invested enterprise takes. By replacing the FIE Laws with the Foreign Investment Law, the Chinese government intends to grant foreign invested enterprises national treatment and to embrace them into the current legal system that applies to Chinese companies in general.

We applaud the efforts indeed; after all, not only foreign investors, but also Chinese entrepreneurs and scholars, have been advocating for national treatment to foreign investors for many years. We, however, remain suspicious on how far national treatment can go if we take the entire legal and economic system in China into consideration. For example, foreign exchange under capital account is still under strict control by the government, and the entire foreign exchange control system—including remittance of foreign exchange outside of China, exchange of foreign currency into RMB, and the usage of foreign exchange capital—is, to a large extent, based on the current rules on establishing foreign invested enterprises, contributing and increasing registered capital, borrowing foreign shareholder loan, equity transfer and dissolution, to mention but a few. If national treatment will blur the distinction between foreign invested enterprises and purely Chinese companies, then it will definitely bring a far more extensive challenge to the current foreign exchange administration and control system. Will this mean that foreign exchange control over foreign investment in non-restricted and non-prohibited industries will be lifted? Will this mean Circular 142 (which prohibits FIEs using its capital funds to acquire domestic companies) will be repealed in its entirety? These and many other questions remain unanswered.

III. The Foreign Investment Special Administration Catalogue

The proposed Foreign Investment Law also creates a Foreign Investment Special Administration Catalogue (the Special Catalogue), which will be used to identify industries in which foreign investment is restricted or prohibited, much like the Negative List issued by the Shanghai Free Trade Zone. This function is currently fulfilled by the Foreign Investment Guidance Catalogue (the Guidance), but the Guidance also includes industries in which foreign investment is encouraged. No Special Catalogue has been published yet, but considering that the National Development and Reform Commission and MOFCOM just jointly released a draft version of the updated Guidance for public comments in November 2014, we have reason to believe that the two authorities will consult each other to determine whether the Special Catalogue will replace the Guidance entirely and, if not, see to it that the Special Catalogue be consistent with the “Restricted” and “Prohibited” sections of the Guidance.

IV. Elimination of Examination and Approval of Foreign Investment Projects

Currently, the establishment of all foreign invested enterprises must be examined and approved by MOFCOM or the local Commission of Foreign Trade and Economic Cooperation (collectively, the Approving Authority), and registered with the State Administration for Industry and Commerce or its local branches (collectively, the Registration Authority).

The proposed Foreign Investment Law no longer imposes approval requirements over foreign investment in industries that are not restricted to foreign investors. This is even a bigger step than the current practices in the Shanghai Free Trade Zone, which, though all approval requirements for non-restricted foreign investment have been suspended, still require filing with competent authority and results in an uncertainty over whether the filing is merely for information purposes or is subject to substantive examination. The proposed Foreign Investment Law takes a clearer position that substantial examination is no longer required.

One laudable improvement is that joint venture agreements and equity (or asset) acquisition agreements no longer require government approval before taking effect. This improvement gives the parties to a transaction more freedom to choose their own transactional structure and more control over the timing of their transaction.

A foreign investor wishing to invest in a restricted industry must apply for a permit. Even in this case, the approval requirement is different from the current system. The proposed Foreign Investment Law places more of an emphasis on information relating to foreign investors and the effect of such investment on the environment, employment, local development, technological innovation and, last but not least, competition and national security. The proposed law specifies that a foreign investor must include in its application for a permit to invest in a restricted industry a statement whether the investment will trigger national security and anti-monopoly reviews.

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