Since China initiated its policy of 'openness' and 'reform' in 1979, regulators of the People's Republic of China (PRC) have continuously refined their approach to regulating foreign investment.2 Following China's entry into the World Trade Organization, the pace of reforms accelerated, and sectors of China's economy previously closed to foreign investment, such as logistics, telecommunications and finance, are now partially open to foreign investors. According to the Ministry of Commerce (MOFCOM), 60,533 foreign-invested enterprises (FIEs) were established in China in 2018, an increase of 69.8 percent from the previous year, and the actual use of foreign capital amounted to 885.61 billion yuan.
Some of the more prominent foreign investment trends of recent years are as follows:
- China is opening up more of its economy to foreign investors and wants to increase foreign access to its market. In June 2018, the State Council issued the Notice of the State Council on Several Measures for Active and Effective Utilisation of Foreign Investment to Promote High-Quality Economic Growth, which emphasises that the use of foreign investment is an important part of China's basic policy of opening up to the outside world and building a new system of open economy, and calls for significant relaxation of control over market access and an improvement in investment liberalisation, among other things.
- Recent significant revisions to many PRC laws and certain PRC policy developments are facilitating foreign investment in China. In March 2019, the Standing Committee of the National People's Congress promulgated the Foreign Investment Law of PRC (the Foreign Investment Law). The Foreign Investment Law will come into effect as of 1 January 2020, and would then replace the Law of the PRC on Wholly Foreign-Owned Enterprises (the WFOE Law), the Law of the PRC on Sino-Foreign Equity Joint Ventures (the EJV Law) and the Law of the PRC on Sino-Foreign Cooperative Joint Ventures (the CJV Law) as the fundamental regulation of foreign investment affairs. On 30 June 2019, the National Development and Reform Commission (NDRC) and MOFCOM jointly issued the Special Administrative Measures for Foreign Investment Access (2019 Edition) (the 2019 Negative List) and the Catalogue of Encouraged Industries for Foreign Investment (2019) (the 2019 Catalogue), which further reduce the restricted or prohibited industries to be invested and expand the scope of industries encouraged to be invested by foreign investors.
- PRC regulators are simplifying foreign investment approval procedures. The regulatory scrutiny of foreign investment in China has been shifting from an ex ante focus to a more ex post focus. The State Council has further cancelled or adjusted downwards the number of administrative approvals. For example, the MOFCOM approval process for the establishment or change of FIEs whose business is not included on the Negative List (see Section II for more details) has been greatly simplified into an online record-filing procedure since October 2016.
- China is initiating and introducing more preferential policies in pilot free trade zones (FTZs). Currently, there are 12 FTZs in China. Early in March 2015, the Chinese government started trying out the negative list model in pilot FTZs, resulting in a blossoming of foreign investments in FTZs. In November 2018, the State Council issued the Notice of the State Council on Several Measures for Supporting the Deepening of Reform and Innovation in Pilot Free Trade Zones, which endows much stronger reforming power to the FTZs in terms of administrative approval, taxation, intellectual property regulation, trade policies, etc. In June 2019, NDRC and MOFCOM also issued Special Administrative Measures for Admission of Foreign Investments in Pilot Free Trade Zones (2019 Edition) (the 2019 FTZ Negative List).
II FOREIGN INVESTMENT REGIME
Foreign investors entering the Chinese market must comply with PRC investment policies, national industrial policies and the laws and regulations governing foreign investment.
i National industrial policies
National industrial policies provide guidance to foreign investors regarding the types of industries and regions in China that are open to foreign investment and the restrictions that may accompany that investment. Foreign investors should ensure that they are in compliance with China's national industrial policies when investing in China.
The national industrial policies governing foreign investment include the 2019 Negative List, the 2019 FTZ Negative List, and the 2019 Catalogue. The 2019 Negative List, which came into effect on 30 July 2019, sets out the industries in which foreign investment is restricted or prohibited. Foreign investors are not allowed to invest in industries where foreign investment is prohibited, but are able to invest in the industries where foreign investment is restricted, as long as they are willing to be abide by certain restrictions and have obtained the relevant investment approvals. For industries not included on the 2019 Negative List, foreign investors who invest in such industries shall enjoy the same treatment as the domestic investors.
Compared with the 2018 version of the Negative List, the number of industries on the 2019 Negative List has been cut to 40 from 48. It also removes ownership caps on industries such as domestic multi-party communication, store-and-forward systems, and call centre in the value-added telecommunications sector. Furthermore, the Negative List provides a transition period for some industries to abolish or ease the foreign investment access limits, which demonstrates China's determination to offer greater market access to foreign investors.
The 2019 FTZ Negative List only applies to pilot FTZs. Though most industries in both negative lists are similar, compared with the 2019 Negative List, there are fewer restricted or prohibited industries in the 2019 FTZ Negative List. For instance, in the 2019 FTZ Negative List, the investment of printing publications does not need to be controlled by the Chinese investors, and foreign investment to cultural and artistic performance groups is not prohibited.
The 2019 Catalogue, which came into effect on 30 July 2019, consists of two sub-catalogues: the national catalogue of encouraged industries for foreign investment that applies to China, and the catalogue of priority industries for foreign investment in central and western China that mainly applies to the mid-western and north-eastern China. The number of industries on the 2019 catalogue has been significantly increased, and foreign investors can enjoy preferential policies in more industries and fields accordingly, especially in manufacturing and the productive service industry. The encouraging policies mainly include the taxation preferential policies and the land transfer price preferential policies for industrial projects. To clarify, some industries in the 2019 catalogue overlap with the restricted industries in the 2019 Negative List.
ii Foreign investment-related laws and regulations
The most relevant foreign investment laws and regulations are:
- the Foreign Investment Law of the People's Republic of China, issued in 2019 and will take effect on 1 January 2020;
- the Company Law of the People's Republic of China (the Company Law), revised on 26 October 2018 and effective since 26 October 2018;
- the Partnership Enterprise Law of the People's Republic of China (the Partnership Law), revised in 2006 and effective since 1 June 2007;
- the Law of the People's Republic of China on Wholly Foreign-Owned Enterprises (the WFOE Law), revised on 3 September 2016 and effective since 1 October 2016 (will be repealed on 1 January 2020);
- the Law of the People's Republic of China on Sino-Foreign Equity Joint Ventures (the EJV Law), revised on 3 September 2016 and effective since 1 October 2016 (will be repealed on 1 January 2020);
- the Law of the People's Republic of China on Sino-Foreign Cooperative Joint Ventures (the CJV Law), revised on 4 November 2017 and effective since 5 November 2017 (will be repealed on 1 January 2020);
- the Provisional Regulations on the Establishment of Foreign Investment Joint Stock Companies Limited, revised in 2015 and effective since 28 October 2015;
- the Provisional Measures on Administration of Filing for Establishment and Change of Foreign Investment Enterprises, revised in 2018 and effective since 30 June 2018;
- the Measures for the Administration on the Establishment of Partnership Business by Foreign Enterprises or Individuals in China, revised in 2009 and effective since 1 March 2010; and
- the Administrative Measures for the Confirmation and Recordation of Foreign-Investment Projects, revised and effective since 17 June 2014.
The two major pieces of legislation regarding mergers and acquisitions (M&A) are the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the M&A Regulations), and the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors (the Measures for Strategic Investment).
In addition, there are regulations specifically tailored to particular industries or sectors, such as:
- the Provisions on the Administration of Foreign-Invested Telecommunications Enterprises; and
- the Provisions on Foreign Investment in Civil Aviation and its supplementary provisions.
A foreign investment will be subject to review if it is considered to be a threat to national security or triggers antitrust review thresholds. Regulations on national security review include the National Security Law of the People's Republic of China (the National Security Law) and the Notice of the General Office of the State Council on the Establishment of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the Security Review Notice). Regulations on antitrust review include the Anti-Monopoly Law of the People's Republic of China (the Anti-Monopoly Law).
Chinese regulations regarding state-owned enterprises (e.g., the Law of State-Owned Assets) apply to foreign investors with the intention to acquire a Chinese state-owned enterprise.
If foreign investors want to invest in a publicly traded company or if an FIE is listed on a PRC stock exchange, PRC regulations regarding publicly traded companies and the rules governing PRC stock exchanges, such as the Measures for Strategic Investment, shall apply.
III TYPICAL TRANSACTIONAL STRUCTURES
It is important to select a suitable transaction structure to ensure the success of a foreign investment in China.
Under current PRC law, foreign investors may include foreign companies, enterprises, other types of commercial organisations and individuals. Investors from Hong Kong, Macao and Taiwan are treated as foreign investors.
i Investment vehicles
Under current PRC law, foreign investors may choose, inter alia, one of the following foreign investment vehicles:
- wholly foreign-owned enterprises (WFOEs);
- Sino-foreign equity joint ventures (EJVs);
- Sino-foreign cooperative joint ventures (CJVs);
- representative offices (ROs);
- investment or holding companies;
- partnership enterprises;
- foreign investment companies limited by shares; and
- regional headquarters.
The most common forms of FIEs are ROs, WFOEs, EJVs and CJVs.
Many foreign investors choose to establish an RO when entering the Chinese market. Normally, an RO in China is not a legal person and is forbidden from undertaking any direct business activities, such as the distribution of goods manufactured by its foreign parent company. Moreover, the business scope of an RO may be limited to conducting business liaison activities (such as consultation, coordination and information collection and exchange) on behalf of its foreign parent company, which makes it unattractive as an entry vehicle in many cases.
Wholly foreign-owned enterprises
WFOEs are limited liability companies in which all the equity is owned by one or more foreign investors. The primary advantage of a WFOE is that it allows foreign investors to retain sole control over the management and financial affairs of the company. In general, for foreign companies that understand the Chinese market and wish to operate independently in the PRC without a Chinese partner, a WFOE is a common choice.
Equity joint ventures
EJVs are limited liability companies jointly invested in and managed by both Chinese and foreign investors. The investors share profits and losses of the EJV in proportion to their equity interests. The EJV is a more commonly adopted form of foreign investment than the CJV (described below) and provides investors with greater security and certainty of their investment.
Cooperative joint ventures
Unlike EJVs, CJVs can be set up either as a cooperation entity without legal personality or a limited liability company with legal personality. CJV investors may distribute profits and bear responsibility for losses through contractual terms, rather than in proportion to their equity interests. In addition, the Joint Venture (the JV) contract of the CJV may contain provisions that allow foreign investors to recoup their investment before expiry of the JV term. CJVs may distribute dividends through cash, products or any other means agreed upon between the investors.
ii Strategic considerations for transactional structures
In addition to considerations such as time and costs, foreign investors seeking to invest in China via greenfield investments or through M&A should consider the following factors.
Restrictions on corporate and shareholding structures
In the 'Explanation' part of the 2019 Negative List, it is stipulated that overseas investors shall not engage in business activities in the capacity of an individually owned business, an investor in a sole proprietor enterprise or a cooperative member of a farmers' speciality cooperative. This measure puts restrictions on the type of entities that may be established by foreign investors in China (i.e., they shall, in the main, engage in business as companies or partnership enterprises). Besides, where a requirement regarding the ratio of equity of foreign capital applies, the form of partnership enterprise is not permitted.
The 2019 Negative List places restrictions on certain foreign investments, including but not limited to investments in:
- medical institutions, which require the establishment of EJVs or CJVs;
- pre-school, normal high school and higher educational institutes, which require the establishment of CJVs and shall be led by the Chinese party;3
- investment in a market survey is limited to EJVs or CJVs; specifically, investment in a broadcasting and television listening and rating survey must be controlled by the Chinese party;
- public air transport companies, which require the Chinese party to hold the controlling equity interest, the legal representative to be a Chinese national, and that the investment ratio of one foreign investor and its affiliates shall not exceed 25 per cent; and
- securities companies, which require that the foreign share of the ratio of securities companies shall not exceed 51 per cent, and that the ratio of foreign shares in securities investment fund management companies must not exceed 51 per cent (the foreign capital ratio limit will be lifted in 2021).
Foreign investors should consider licensing requirements when investing in certain sectors, such as drug manufacturing and operations, and seed manufacturing.
Foreign investors may establish a WFOE or a JV to acquire permits and licences for these operations. However, if it is difficult for the WFOE or the JV to obtain the required operations licences or permits, foreign investors may also consider M&A arrangements with companies that already hold licences and permits.
Local policies and the stance of local government authorities
Although the relevant laws and regulations are uniformly applicable throughout the entire territory of the PRC, interpretation and implementation of the regulations may differ depending on the local authority. Moreover, the attitudes of local authorities towards foreign investments vary from region to region. It is therefore essential that foreign investors conduct both market and legal research regarding the local policies and the attitude of the local government authorities before deciding to invest in China.
Tax planning and foreign exchange policies
Tax planning and foreign exchange policies are always key issues when structuring a foreign investment. Foreign investors must carefully plan the structuring of their investment to optimise their tax status and to comply with PRC law. The government authorities have been trying to reassure foreign investors about capital controls. In March 2017, the State Administration of Foreign Exchange announced that FIEs are free to handle profit remittance through normal procedures.
IV REVIEW PROCEDURE
Foreign investment may be subject to the following review process by the PRC government authorities.
i Foreign investment review procedures
According to the circular issued by NDRC on Effectively Implementing the Relevant Foreign Investment Work concerning Investment Project Catalogue Approved by the Government (2016 Edition), foreign investment projects will be subject to either an approval process or a record-filing process from competent government agencies. Generally, the approval process takes around 20 business days,4 and the projects are considered case by case, with reference to the specific circumstances of each project.
In practice, whether a foreign investment project requires the approval of NDRC, its local branches, State Council, or other competent government agencies depends on the gross investment amount, industry, circumstances of the individual project, etc. Therefore, it is prudent for a foreign investor to consult the relevant investment department of local governments before initiating the project.
Approval of the environmental protection authority
For foreign investments in construction projects and others that may cause environmental issues (such as pollution or impact on wildlife), a foreign investor must conduct an environmental impact assessment before starting the project and submit the assessment documents to the local environmental protection authority for the approval of the project. The length of the environmental impact assessment process depends on the extent of the environmental impact the project may cause.
Industrial approval by the pre-registration approval authority
Certain types of foreign investment, such as investment in the general aviation industry and tobacco monopoly production, may be subject to pre-registration approval by the relevant government authorities. These approvals must be obtained prior to the application being submitted to MOFCOM and before registration with the State Administration for Market Regulation (SAMR) or its local branch.
The approval procedures and the length of the approval process shall be subject to the different requirements of the government authorities concerned.
Approval by or filing with MOFCOM
All foreign investments included on the Negative List, including M&A transactions or the establishment of FIEs, are subject to MOFCOM approval. For foreign investment activities (including the establishment of an FIE and a change from a non-foreign-invested enterprise to an FIE by acquisition, merger or any other means) outwith the Negative List, only an online record filing on the MOFCOM website is required (the record filing process normally takes around three business days to complete).
Registration with the registration authority
For the establishment and change of an FIE, the FIE must register with SAMR or its local branches to obtain or renew its business licences. This registration normally takes 5 to 10 business days.5
Post-registration filing or registration with the relevant authorities
After obtaining its business licence, an FIE must complete the filing or registration procedures (i.e., registering with the tax authorities, opening a foreign currency account and registering for social insurance) with the relevant authorities. It normally takes around 30 business days to complete all these procedures.
ii Other review procedures
National security review
In accordance with both the National Security Law and the Security Review Notice, certain foreign investments with national security implications will be subject to a national security review. The new Cybersecurity Law also emphasises the importance of national security.
A joint committee led by MOFCOM and NDRC is responsible for security reviews. When conducting a security review, regulators will analyse the potential effects of any proposed merger or acquisition on China's national defence, economic stability, social order and key technologies, and will focus on the issue of control. M&A transactions resulting in more than 50 per cent foreign ownership or de facto control of a domestic enterprise in the sensitive sectors will attract the attention of security review regulators.
MOFCOM's Anti-Monopoly Bureau will be notified about transactions in which the foreign investment is, inter alia, deemed to cause a 'concentration' under the Anti-Monopoly Law and meets the statutory turnover thresholds. Details of the thresholds can be found in the Anti-Monopoly Law and other relevant laws and regulations.
Review of foreign investment involving state-owned assets
Under the Provisional Measures for the Administration of Valuation of State-Owned Assets of Enterprises, before any assets are transferred to foreign investors, a certified asset evaluation agency must issue a valuation report providing the value of the assets. The transfer price shall not be less than 90 per cent of the valuation value unless expressly approved by the relevant authorities.
Review of foreign investment in listed companies
Based on the Measures for Strategic Investment, foreign investment in listed companies will be subject to the supervision of the securities regulatory authorities.
The above-mentioned foreign investment review procedures are general practice in accordance with PRC laws and regulations. The procedure may vary slightly depending on different factors, such as the type of foreign investment, the amount of the investment, the location of the project and the different requirements of the relevant local governmental authorities.
In addition to the above, FIEs are subject to regulations regarding annual reporting to or inspection by (if applicable) SAMR or its local branches, the administration for foreign exchange or its local branches, and other relevant government authorities once established.
iii Interface with other authorities
The approval and registration procedures of each government authority follow a general sequence with respect to the approval of a foreign investment, and inter-government and intra-government consultations are very common during the approval process. Some industrial approvals are prerequisites to approval by MOFCOM and therefore must be obtained before applying for MOFCOM approval. The PRC government has started to relax the precondition requirements.
It is very rare for the PRC approval authorities to directly communicate with foreign government authorities regarding foreign investment reviews. However, in certain circumstances, application materials prepared outside China to obtain relevant approvals will be considered by PRC regulators as valid supporting documentation for a foreign investment in China.
V FOREIGN INVESTOR PROTECTION
i Protection by multilateral and bilateral treaties
The PRC has signed several regional and multilateral treaties and international trade agreements that govern matters including intellectual property (IP) protection, customs, civil aviation and dispute resolution.
According to the State Administration of Taxation, as at 12 December 2018, the PRC has officially signed 107 agreements on the avoidance of double taxation (100 agreements are in effect). Furthermore, as at 6 August 2018, the PRC has signed 16 free trade agreements (FTAs) with 24 countries or regions based on the information listed on China FTA Network.
ii Protection under PRC law
The legal rights and interests of foreign investors are protected under the WFOE Law, the EJV Law and the CJV Law. In addition, as clearly stipulated under the WFOE Law and the EJV Law, the PRC government will generally not impose nationalisation or expropriation measures on WFOEs and EJVs.
To attract foreign investment, some local governments may offer support for foreign investors through the granting of land use rights, providing financial subsidies, etc., and certain sectors, such as high-tech, research and development, and others encouraged by the government, may be eligible for preferential tax policies.
iii Legal remedies
Foreign investors who engage in business or conduct activities in the PRC have the right to protect their legal interests via litigation or arbitration. Generally, litigation allows for appeals, and arbitration is final. Foreign investors tend to prefer arbitration over litigation because it is more international and less time-consuming. Moreover, arbitration commissions in China are becoming more familiar with dealing with complex domestic and international commercial disputes.
Recognition and enforcement
Under certain circumstances, in addition to direct involvement in litigation or arbitration proceedings in China, foreign investors may request that the People's Court system recognise and enforce a foreign arbitral award or judgment.
On 22 April 1987, China became a party to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). As such, China applies the principles of the New York Convention on a reciprocal basis to enforce foreign arbitral awards from other signatory countries for disputes that are regarded as commercial disputes under PRC law. China has also entered into agreements with Hong Kong, Macao and Taiwan on the mutual recognition and enforcement of civil and commercial judgments.
VI OTHER STRATEGIC CONSIDERATIONS
In addition to the foregoing, it is imperative that foreign investors focus on the following:
- labour issues regarding, inter alia, employment contracts, non-compete agreements, occupational safety, social insurance, labour law compliance, labour litigation and arbitration;
- IP protection regarding, inter alia, IP audits and strategic IP, IP portfolio management, commercial IP transactions and IP due diligence;
- exit mechanisms;
- corporate governance and the management of FIEs;
- profit distribution and remittance;
- communication with the relevant government authorities; and
- any amendment or update of foreign investment-related laws and regulations.
In addition, foreign investors should consult a local PRC law firm to assist them with their investments in China. Local attorneys are very familiar with PRC laws, have extensive experience in dealing with foreign investment issues and generally have a good working relationship with local government officials, who can assist foreign investors to navigate through complex PRC laws and regulations.
VII CURRENT DEVELOPMENTS
On 1 January 2020, the Foreign Investment Law will come into effect and then replace the WFOE Law, the CJV Law and the EJV Law. The Foreign Investment Law is the unified basic law and sets forth the basic legal framework of foreign investment. Several highlights worth mentioning in the Foreign Investment Law are as follows.
The unified law in the foreign investment area
After the Foreign Investment Law replaces the WFOE Law, the CJV Law and the EJV Law, in terms of the organisation form, institutional framework and standard of conduct, FIEs shall comply with the applicable Chinese laws, such as the Company Law, the Partnership Law, and other laws. For example, regarding the organisation form, instead of establishing the WFOEs, CJVs and EJVs, foreign investors might choose limited liability companies, companies limited by shares, partnership enterprises and other forms of organisation specified by relevant laws, while establishing the new FIE after 1 January 2020.
For the WFOEs, CJVs and EJVs established before the effective date of the Foreign Investment Law, they may keep their original organisational forms for at most five years after the effective date of the Foreign Investment Law as a transition period. In addition, as the Foreign Investment Law does not clearly stipulate the legal liabilities of failing to change the organisation forms of the above-mentioned FIEs and the specific implementing measures of the Foreign Investment Law have not been released yet, we suggest that foreign investors continuously pay close attention to the legislative developments.
The principle of treating domestic investments and foreign investments equally
Under the Foreign Investment Law, the principle of treating domestic investments and foreign investments equally applies through all stages of foreign investment.
For the industries not included in the 2019 Negative List, the State shall give national treatment to foreign investment during the stage of investment access; the treatment given to foreign investors and their investments shall be no less favourable than that given to domestic investors and their investments.
National policies on supporting the development of enterprises shall equally apply to FIEs in accordance with applicable law. For instance, the State guarantees the participation of foreign-funded enterprises in government procurement activities through fair competition, and the equal participation of foreign-funded enterprises in setting standards.
The management system of foreign investment
Under the Foreign Investment Law, the management system of foreign investment mainly includes the negative list model, the foreign investment information reporting system, and the security review system for foreign investment.
As introduced above, the negative list model has been implemented since 2016. Under the foreign investment information reporting system, foreign investors shall submit investment information to the competent authorities through the National Enterprise Credit Information Publicity System and enterprises registration system. Currently, the contents and scope of foreign investment information reporting have not been determined, which shall be further completed and refined under the principle of necessity in the future.
The State establishes the security review system to conduct the security review over any foreign investment affecting or having the possibility to affect national security. Though the details of such security review system have not been specified, the Foreign Investment Law stipulates that the decision made upon the security review in accordance with the law shall be final, which might indicate that no further administration review will be available.
Reform of the foreign investment regime is a systematic project. The Foreign Investment Law demonstrates the PRC government's commitment to encouraging foreign investment to further open up and stimulate the economy. Meanwhile as the Foreign Investment Law is becoming the essential law of foreign investment for China, we believe we will witness the development of a more comprehensive package of foreign investment measures and implementation regulations, which shall be worthy of close attention. Because China is becoming more and more open to foreign investments, as a legal counsel dealing with foreign investment matters for years, I do hope all foreign investors will grasp the emerging opportunities, and participate in economic development.
1 Jianwen Huang is a partner at King & Wood Mallesons.
2 In this chapter, 'China' and 'PRC' refer to mainland China and do not include Hong Kong, Macao or Taiwan.
3 'Led by the Chinese party' shall mean that the principal or key administration officer in charge is a Chinese national, and Chinese party personnel shall make up no fewer than half the members of the council, board of directors or joint administration committee of a CJV educational institution.
4 The estimated lengths of the approval processes by the authorities quoted in this section are based on when all the required application documents are agreed upon and accepted by the relevant authorities and no further modification is required.
5 The estimated lengths of the approval processes by the authorities quoted in this section are based on when all the required application documents are agreed upon and accepted by the relevant authorities and no further modification is required.