Since the foundation of the People’s Republic of China (PRC) in 1949, China has been through two ‘thirty-year periods’.
During the first, up until 1978, China had been isolated from the world and operated a form of planned economy, with barely any real foreign direct investment (FDI). Over the second, from 1978 onwards, China gradually opened up to the West, carried out reform policies and started the process of merging with the global economy. Foreign direct investment has formed a critical part of China’s expanding economy since the establishment of the very first Sino-foreign joint venture, Beijing Aviation Food Co Ltd, on 1st May, 1980. In this article Cody Chen gives an overview of the legislation that has guided FDI in China up to the present day.
During the 80s and 90s, foreign (including Hong Kong, Macau and Taiwan) investors often found themselves in a position where a specific legal issue they were facing was not touched upon in any Chinese statutory law. Basic FDI legislation at the time included the Sino-Foreign Equity Joint Venture Law, the Sino-Foreign Contractual Joint Venture Law, the Wholly Foreign-Owned Enterprise Law and their respective implementing regulations (FIE Laws). Government authorities maintained substantial discretionary power over FDI projects.
Foreign direct investment legislation can be broadly divided into the categories of market access-related and corporate regulatory-related.
Before embarking on an FDI project the very first thing for a foreign investor and the China legal counsel to do is to check the Foreign Investment Industry Guidance Catalogue (Catalogue). Jointly issued by the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM), the first catalogue appeared on 28th June, 1995, implying that prior to this FDI project approval was based on an internal review and assessment processes carried out by the relevant authorities.
Amendments to the Catalogue have coincided with major shifts in market access liberalisation, such as China’s accession to the World Trade Organisation in 2001, and the opening up of trading to foreign-invested enterprises (FIEs) in 2004. In general, amendments have resulted in a reduced number industries in the ‘restricted’ and ‘prohibited’ categories and an increased number in the ‘encouraged’ category.
By law, any industry not featured in the Catalogue should be viewed as being ‘permitted’ to foreign investment. In practice, though, foreign investors in industries that are not clearly defined in the Catalogue and that are not clearly understood by approval officials may find that approval is not immediately forthcoming. It is these kind of approval process issues that triggered the most recent development in FDI legislation – the negative-list approach.
In 2013, the China (Shanghai) Pilot Free Trade Zone (CSPFTZ or Zone) launched its FDI market access administration model in the form of a negative list, which has been reviewed and updated a couple of times since. In early 2015, the CSPFTZ was expanded and three new free trade zones in Tianjin, Fujian and Guangdong were approved by the central government. On 20th April, 2015, the MOFCOM issued the integrated Pilot Foreign Investment Filing Measures in Pilot Free Trade Zones. This suggests that the pilot scheme—including the negative-list approach to FDI administration—has been successful to date and could be gradually rolled out nationwide.
In the latest draft Foreign Investment Law, Chinese lawmakers appear to have widely adopted the negative-list approach. The draft expressly says that any restrictions towards foreign investors must be stipulated in only national laws, State Council regulations or decisions and compiled into a special catalogue. Foreign investment in an area which does not fall under such a catalogue shall be exempt from market entry approval. This is a great step forward in terms of foreign investment market entry liberalisation, though practical implementation rules are still required.
In addition to thoroughly reviewing the Catalogue, foreign investors—particularly those seeking to enter the Chinese market via acquisition—need to undergo the national security and antitrust reviews, both of which were only recently introduced into the Chinese legal system.
Before the PRC Company Law was first issued in 1993, establishment and operation of a FIE seemed to be subject to separate legislation with respect to prior approval, company names, business scope, capital requirements and foreign exchange control. However, there has been a general trend towards slowly liberalising the company registration regulatory system for FIEs and providing national treatment for all companies registered in China.
It has been a standard procedure that establishment of a FIE is subject to prior approval by the MOFCOM and its local branches. The same also applies to major corporate changes, including capital increase, change in business scope and equity fluctuations. In practice, such prior procedures should take just a few weeks to a few months to complete. However, in a 2009 absorption merger between two Shanghai affiliates of a European company, approval procedures took more than two years. In the CSPFTZ such FDI prior approvals have been replaced by a much simpler online filing procedure, unless the respective industry is included in the Negative List.
The business operations of a FIE are strictly limited to the permitted business scope, as approved and displayed in its articles of association and on its business licence, with the possibility of administrative penalties being brought to bear if a FIE goes beyond its permitted scope. It is therefore critical that foreign investors formulate a business scope that is as broad as possible prior to approval.
Before the amended PRC Company Law was released in 2005, capital requirements for domestic companies were totally different to those of FIEs. Domestic companies followed strict paid-in capital rules where the registered capital had to be fully paid in and capital verification was completed before the business licence was issued. On the other hand, in China’s very first FDI laws the subscribed capital rule was adopted under a common law system for FIEs. A ‘total amount of investment’ concept was also adopted for FIEs with respect to the quantity of the overall required capital investment for a foreign investment project. The difference between the total amount of investment and the registered capital of a FIE—known as the debt equity ratio—was then used by the foreign exchange administration to restrict the financing of FIEs using foreign exchange. The recent liberalisation of the conversion of foreign currency capital into renminbi again, brings back the voice to abolish the concept of debt equity ratio. However, this was not touched on in the draft Foreign Investment Law so it will be interesting to see if and how this develops in the final Foreign Investment Law and its implementing regulations.
Draft Foreign Investment Law
The long-awaited draft Foreign Investment Law was issued by the MOFCOM on 19th January, 2015. According to the draft, market entry review will be based on a special administration category, which basically contains lists of restricted industries and prohibited industries for foreign investment. Foreign investment generally shall enjoy national treatment, with exceptions to be stipulated in national laws, State Council regulations or special decisions. This means ministerial authorities will not be able to set up foreign investment market entry restrictions or any measures contrary to the national treatment principle.
The draft Foreign Investment Law seems, for the first time in the Chinese law-making history, to be adopting the concept of actual control. It provides rules on differentiating ‘foreign-invested enterprises’ actually controlled by Chinese nationals and ‘domestic companies’ actually controlled by foreign investors.
Cody Chen is a Shanghai-based lawyer with a strong focus on corporate, M&A, real estate and construction sectors. He has over 12 years’ experience in advising European and international clients in their China investment and business related legal issues. For more information please contact him via firstname.lastname@example.org.