A fundamental framework

China’s new Foreign Investment Law

By Dr. Stephan Rippert, Amy Yin and Catherine Jing

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On March 15, 2019, the National People’s Congress passed the Foreign Investment Law of the People’s Republic of China (new FIL) after several rounds of public consultation. This new law, which will come into effect on January 1, 2020, constitutes a fundamental framework for foreign investment in China, covering market access, promotion, protection and administration. As of its effective date, it will supersede the existing legislation governing foreign investment: the Sino-Foreign Joint-Venture Enterprise Law, the Sino-Foreign Cooperative Enterprise Law and the Foreign-Invested Enterprise Law (together: the FIE laws).

Background
There are both internal and external factors that contributed greatly to the formulation, approval and promulgation of the new FIL.

Internal factors
The FIE laws were formulated and implemented during the early period of reform after China’s opening, between 1978 and 1988. At that time, China’s legal system was still under construction, and there was no legislation generally applicable to all kinds of companies and partnerships.
The FIE laws are products of that specific period when different types of foreign-invested enterprises were regulated by disparate rules. The FIE laws only applied to greenfield investments; legal rules regarding other foreign investment activities, such as cross-border mergers and acquisitions, were scattered across many other regulations. Despite several revisions after their promulgation, the old FIE laws have been unable to adapt to the new needs generated by China’s rapid economic development.
In the context of China’s recent process of improving its legal system, it became necessary to abolish the special administrative system only applicable to ­foreign-invested enterprises under the FIE laws and to adopt a unified administrative system that applies to both domestic-invested and foreign-invested enterprises. After repeated efforts to update the FIE laws to make them conform with China’s current legal and economic environment, the Ministry of Commerce (MOFCOM) finally unveiled in January 2015 a draft of a new foreign investment law for public comment.

External factors
On March 23, 2018, US President Donald Trump officially signed the Memorandum on the Actions by the United States Related to the Section 301 Investigation, directing the US Trade Representative to impose increased tariffs on goods from China and to place restrictions on investments in the US that are directed or facilitated by China. Soon afterward, on April 2, 2018, the MOFCOM responded by imposing tariffs on 128 products it imports from the US, marking the beginning of the China-US trade war. After several rounds of talks between China and the US intended to bring an end to the trade war, both parties temporarily agreed to work together to resolve existing ­problems.
Among other endeavors on China’s side, a new draft foreign investment law was formulated and published for public comment during the negotiations in December 2018. This draft had been reviewed and discussed three times by the competent authorities over the course of a mere three months and was finally approved by the National People’s Congress on March 15, 2019.
This new FIL is designed to ease restrictions on foreign enterprises’ operations in China that the US had alleged were and explicitly addresses some major US concerns, including the practice of forced technology transfers, protection of intellectual property and market entry restrictions.

Developments
The new FIL comprises six chapters made up of 42 articles that cover general provisions, investment promotion, investment protection, investment administration, legal liability and supplementary provisions. The new developments it contains in comparison with the current FIL laws are listed as follows.

Market entry
During the investment entry period, foreign investors (including natural persons, business entities and other organizations from a foreign country) and their investments (investment activities directly or indirectly conducted by one or more foreign investors within China, including establishing a foreign-invested enterprise within China; acquiring stock shares, equity interests, interests in assets or other rights and interests of an enterprise established within China; investing in a new project within China; and investments in other forms) in sectors that are not on the negative list are accorded treatment that is no less favorable than that accorded to domestic investors and their investments.
The negative list is an official list of specific sectors that are subject to special administrative measures on foreign investment entry. In March 2016, the National Development and Reform Commission (NDRC) and the MOFCOM published a Draft Negative List for Market Access (Trial Version) for a pilot program conducted in four provinces and municipalities (Tianjin, Shanghai, Fujian and Guangdong), which marked the beginning of the negative list administration system. The negative list is updated annually. The current negative list is the Special Administrative Measures on Foreign Investment Entry (Negative List; 2019 Edition) published by the NDRC and the MOFCOM, which came into effect on June 30, 2019 (2019 Negative List). Compared with the previous year’s negative list, the 2019 Negative List contains far fewer sectors subject to special administrative measures (48 versus 40).
Foreign investors cannot invest in those sectors on the negative list in which foreign investment is prohibited. For instance, the 2019 Negative List provides that foreign investors are prohibited from investing in industries such as social surveys, compulsory education institutions, news agencies and movie production companies.
Foreign investors who invest in sectors on the negative list in which foreign investment is restricted must satisfy the requirements provided in the negative list. For instance, the 2019 Negative List provides that foreign investment in industries such as basic telecommunications, domestic waterway transportation and publication printing are subject to the restriction that the Chinese party is the controlling shareholder.

Foreign investment information reporting system
According to the new FIL, China is to establish a system for reporting details regarding foreign investments. Foreign investors or foreign-invested enterprises shall report details regarding investments to the authority responsible for commerce matters by means of the enterprise registration system and the enterprise credit information disclosure system.
Since the beginning of the negative list administration system in 2016, China has issued several relevant regulations, such as the Interim Measures for Record-Filing Administration of the Establishment and Change of Foreign-Invested Enterprises, promulgated by the MOFCOM on October 8, 2016 and further amended in 2017 and 2018 (Filing Regulation). According to the Filing Regulation, foreign investments in sectors that are neither prohibited nor restricted are subject to participation in a record-filing system with the commerce authorities through an online platform maintained by MOFCOM.
However, it is still unclear whether the Filing Regulation will remain effective after the new FIL takes effect on January 1, 2020. And it remains to be seen whether foreign investments that are not in sectors on the negative list will still be subject to record-filing through MOFCOM’s online platform after detailed procedures regarding the foreign investment information reporting system are further specified in the new FIL’s future implementation rules.

Foreign investment security review system
The new FIL reiterates the requirement to establish a security review system, which was initially provided under the Notice on Establishing a Security Review System for Foreign Investors to Acquire Domestic Enterprises, issued by the General Office of the State Council of China in 2011 (known as Circular 6).
Circular 6 provides specific requirements regarding the scope, content, work mechanism and procedures related to the security review, while the new FIL only contains a single article stating that foreign investments that affect or might affect national security shall be subject to a security review and the decision made in accordance with the law is final.
It remains to be seen whether the detailed provisions under Circular 6 will be replaced by the new FIL’s implementation rules, which have yet to be formulated and issued.

Incentives for foreign investment
Under the new FIL, the following incentives for foreign investment are provided:

Protection of IP rights. IP rights of foreign investors and foreign-invested enterprises, as well as lawful rights and interests of the holders of IP rights and relevant right holders thereof, shall be protected. Any person or entity that infringes upon IP rights shall be held legally accountable. In addition, authorities and their officers shall, in accordance with law, keep confidential the commercial secrets of foreign investors and foreign-invested enterprises they obtain while performing their duties and shall not disclose or illegally provide such information to others.

Transfer of technology. The conditions for technological cooperation in the context of foreign investment are to be determined through “equal negotiation” by the investors in compliance with the principle of fairness. Authorities and their officers shall not force technological transfer through administrative measures.

Local administration. Local governments and their departments shall not, without a basis in law or regulations, add any restriction or requirement to local regulatory documents concerning foreign investment that may derogate the lawful rights and interests of foreign-invested enterprises, augment their obligations, impose conditions for market entry and/or exit or intervene in the normal production and operation activities of foreign-invested enterprises.

Equal treatment. Foreign-invested enterprises will be treated the same as domestic enterprises, in accordance with the law, as regards the various state policies supporting the development of enterprises, their participation in the setting of standards, the application of mandatory standards and the state procurement of products and services provided by foreign-invested enterprises within China.

Financing. The new FIL also confirms that foreign-invested enterprises may raise funds in China through the public offering of shares or the issuance of corporate bonds.

Free remittance. Foreign investors may, in accordance with law, freely remit profits, capital gains and royalties from intellectual property rights, lawfully obtained compensation and the proceeds of liquidation out of China.

Further implementation rules
The new FIL is expected to bring about significant changes in future foreign investment transactions, and its promulgation marks the beginning of a long-term reform of China’s system for administering foreign investment. However, compared with the current FIE laws, the new FIL only outlines principles and contains somewhat vague provisions. Many features, such as the detailed registration, filing and reporting procedures for foreign-invested enterprises, need to be further specified by implementation rules and other ancillary regulations that have yet to be formulated and issued by the relevant authorities. Examples of efforts made so far in different regions and industries within the framework of the new FIL are enumerated below:

Free trade zone
On August 6, 2019, the State Council unveiled an overall plan (the Lingang Overall Plan) to add the new Lingang area into China (Shanghai) Pilot Free-Trade Zone. This new Lingang area, which is planned to cover 119.5 square kilometers, will double the size of the Shanghai Free-Trade Zone.
Pursuant to the Lingang Overall Plan, industries such as telecommunications, insurance, securities, science and technology, education and health will enjoy more openness in this new Lingang area.
In addition, and more importantly, all reputable foreign arbitral institutions are allowed to establish their offices in the new Lingang area. The Overall Plan suggests that these institutions, once registered, will be able to lawfully administer PRC-seated civil and commercial arbitrations in fields such as international business, maritime affairs and investment. The involved parties, both domestic and those from overseas, will be supported and provided security during the application process and enforcement of provisional measures such as preservation of property, preservation of evidence and preservation of conduct.
Just a few weeks after the promulgation of the Lingang Overall Plan, the State Council further published a series of new overall plans for free-trade zones to be established in six other provinces in China: Shandong, Jiangsu, Guangxi, Hebei, Yunnan and Heilongjiang. These six provincial overall plans, together with the aforementioned Lingang Overall Plan, all play a part in China’s new efforts to further implement the general requirements provided under the new FIL.

Banking industry
On July 20, 2019, the Finance Stability and Development Committee of the State Council announced 11 new policies aimed at accelerating the further opening of the financial sector to foreign investors.
Under the new policies, limits on foreign shareholdings in securities, fund management, futures and life insurance companies in China will be lifted earlier than previously anticipated, restrictions on foreign investment in insurance companies and insurance asset management companies will be further relaxed, and foreign financial service providers and investors will have broader and more streamlined access to China’s bond market.
For instance, the upper limit of 51% on foreign shareholdings in life-insurance, securities, fund-management and futures companies will be abolished in 2020, one year ahead of the previous time­table. Foreign investors will be supported in establishing wholly or partly owned currency brokerage companies in China. Furthermore, foreign investment in insurance asset management companies will be permitted to exceed 25%.

Practical notes
Although many details regarding the implementation of the new FIL are yet to be specified in future ancillary regulations, it is certain that the special corporate governance rules regulating foreign-invested enterprises provided in the current FIE laws will be replaced by general rules in the Company Law and the Partnership Enterprise Law.

  • For instance, this would apply for a Sino-foreign joint venture under the new FIL:
  • The highest authority will be the shareholders’ meeting, rather than the board of directors as previously provided under the FIE laws.
  • The company may have only one executive director, rather than at least three directors with distribution of the quota of directors be determined by the shareholders in accordance with the proportionate ratio of their capital contribution, as previously provided under the FIE laws.
  • Dividends may be distributed to shareholders in a proportion other than the actual capital contributions paid by the shareholders, as long as all the shareholders agree.
  • Equity interests of the company can be transferred to a third party if such a transaction is agreed on by more than half of the other shareholders, rather than all the other shareholders as provided under the FIE laws.

As such, as soon as possible after the new FIL comes into effect, existing foreign-invested enterprises in China should consider amending their articles of association or other organizational documents to bring them into alignment with their actual circumstances in order to comply fully with the requirements under the new FIL. For example, joint venture agreements and the articles of association of Sino-foreign joint ventures should be adjusted to make the shareholders’ meeting the highest authority within the company.
Furthermore, foreign investors doing business in China are encouraged to participate when the Chinese government seeks public comment on the draft implementation rules and to keep abreast of the new developments in laws and regulations.

srippert@reedsmith.com

ayin@reedsmith.com

cjing@reedsmith.com