Wednesday, 6 May, 2015

Fundamental changes to foreign investment in the People’s Republic of China

On 19 January 2015, China's Ministry of Commerce (MOFCOM) released its draft Foreign Investment Law (FIL) outlining major amendments to the existing legal regulations of foreign investment into China. The draft FIL eases entry requirements for foreign investments as it unifies foreign and domestic regulations. It also eliminates existing grey areas that have allowed participation of foreign investments in otherwise restricted industries. The draft FIL is expected to be ready for implementation within two years, while foreign enterprises will be given a further three years to adjust to the new legal reality outlined in the law. 

New definition of foreign investment

China’s current regulatory regime defines foreign investment by means of three different laws: the Foreign Cooperative Joint Venture Law (CJV Law), the Wholly Foreign-Owned Enterprise Law (WFOE Law) and the Chinese-Foreign Equity Joint Venture Law (EJV Law). These three laws are all expected to be replaced by the new FIL. The new definition of a foreign enterprise as outlined in the draft FIL follows a concept of so-called actual control. This means that an enterprise will be defined as foreign if its actual controller is foreign, independent of whether the enterprise is, for instance, registered as a fully Chinese invested entity. The definition of control, however, is relatively broad. Apart from establishing an enterprise, it also constitutes controlling shares, providing financing for more than a year, obtaining rights for natural resources or infrastructure, acquiring immovable property, or obtaining holding rights or interests in a domestic enterprise.  

Lifting the veil on Variable Interest Entity structures

Actual control will also shed light on the current Variable Interest Entity (VIE) structures, which have been utilised by foreign investors to invest in otherwise restricted industries. With actual control as the determining factor on whether or not an enterprise is considered foreign, the Chinese authorities will be equipped with the legal means to deal with foreigners controlling enterprises in restricted sectors through VIE structures. This means that 100%-owned Chinese enterprises that are under the control of foreign entities will be considered foreign and therefore no longer able to invest in sectors restricted or prohibited for foreigners.

Negative list and information reporting system

The current approval system is to be replaced by a negative list, similar to that applied in the Shanghai Free-Trade Zone. This means that foreign investment in industries not included on the list will no longer need approval from MOFCOM. They will instead be offered the same treatment as domestic enterprises, while investments in industries listed as restricted will need approvals from the respective regulatory bodies within the government.

The negative list is said to be implemented alongside an information reporting system that requires enterprises to submit a report upon investment (maximum 30 days after implementation) along with annual or quarterly reports; the quarterly reports only apply to foreign-invested enterprises with revenues above 10 billion RMB or more than 10 subsidiaries in China. The content of the initial investment report is to consist of information on the foreign investor as well as the investment itself, such as geographic area, industry, amount invested, shareholding ratio, organisation type and corporate structure of the enterprise. 

While the implementation of a negative list is considered to be a significant step towards modernisation of China’s FIL, concerns have been raised over the information reporting system. The information required to be submitted in the reports could be comprehensive and often sensitive. Apart from the fact that the obligation to submit continuous reports can be burdensome for enterprises, the disclosure of detailed and sensitive company information could potentially lead to a loss of trade secrets. 

It is explicitly stated in the draft that failure to comply with the reporting obligations or any attempt to provide misleading information can result in punishments and, in severe cases, criminal charges for the people directly responsible. 

National security review

The draft FIL also outlines a national security review stating that foreign investment that is a threat to China’s national security is to be terminated. As the draft’s definition of national security is relatively loose and not explicitly limited to any particular industries, it might be difficult for foreign enterprises to know whether or not they fall under this category. However, it is possible for the foreign enterprise to request talks on any potential national security issues prior to review in order to get an understanding of any restrictions or necessary changes as early in the incorporation process as possible.

Remarks

The draft FIL displays MOFCOM’s intention to fundamentally change the landscape of foreign investment into China. The current laws implemented in the 1980s, which define the framework for foreign investors to navigate within, will now be replaced. While the draft FIL can be viewed as an attempt to modernise and ease the entry barriers for foreign investment, many uncertainties still remain, such as the practical consequences of the broadly defined terms of actual control and national security threats. Moreover, it is yet to be seen whether major amendments to the draft will be made to the final version of the FIL. 

For further enquiries, please do not hesitate to contact Vistra China.

 

Contacts

Managing Director,
+86 21 6090 0598 ext. 6606