Earlier this month, the National Development and Reform Commission released its latest draft revision (2014 Draft) to the Foreign Direct Investment Industries Guidance Catalogue (Catalogue).

The Catalogue is the Chinese Government’s central policy for regulating the flow of foreign investment into Chinese industrial sectors, classifying them as “encouraged”, “permitted”, “restricted” or “prohibited”.

The draft revision is open for public consultation until 3 December 2014.

The reduction of “restricted” and “prohibited” industrial sectors

When the Shanghai Free Trade Zone (FTZ) was formed in September 2013, the government adopted a Negative List approach to regulate foreign investment in the FTZ. This approach specified “restricted” or “prohibited” industrial sectors for foreign investment.

The original 2013 Negative List was widely reported to be disappointing for foreign investors as it included virtually all of the existing restrictions which applied to the rest of the country.

In response, a new version was introduced in June 2014 which reduced the number of restricted industries and activities from 190 to 139. While this was a welcome update, it still did not meet public expectation for a greater degree of reform.

The 2014 Draft now promises to offer the most considerable changes to date. It proposes to further reduce:

  • the number of “restricted” industrial sectors by more than half - from 79 to 35;
  • the number of industrial sectors currently limited to joint ventures and partnerships from 43 to 11; and
  • the numbers of industrial sectors that require a Chinese majority stakeholder from 44 to 22.

Proposed reforms for major industrial sectors in the 2014 Draft

In general, the 2014 Draft lifts restrictions on forms of foreign investment and shareholdings across a wide range of industry sectors and business activities. These changes indicate that we can expect to see a series of major reforms to the foreign investment regulatory regime in the foreseeable future.

Below is a summary of key changes for foreign investment in seven major industrial sectors.

1. Manufacturing

Under the 2014 Draft, restrictions on China’s manufacturing industry have been greatly lifted. Manufacturing sectors proposed to be removed from the “restricted” category are:

  • beverages;
  • raw chemical materials and products;
  • chemical fibre production;
  • general machine building;
  • special equipment (excluding arms and ammunition, which are still “prohibited”);
  • transportation equipment;
  • communications equipment; and
  • computers and other electronic equipment.

This implies that the manufacturing sectors above will be considered as “permitted”, where foreign investment can be carried out without restrictions on shareholdings or forms of investment.

2. Pharmaceutical and Medical

The 2014 Draft has also proposed considerable changes to the healthcare industry, tightening control in some parts while loosening its hold on others.

On one hand, it proposes to categorise certain overpopulous pharmaceutical products (such as multivitamins and calcium) as “restricted”, while narcotics and “A” class psychoactive drugs are to be classified as “permitted” allowing market screening processes instead of pure administrative regulation in the manufacturing process.

On the other hand, the government will impose tighter control over the establishment of foreign invested medical institutions. The 2014 Draft moves medical institutions back into the “restricted” category, suggesting that foreign investment will remain limited for the foreseeable future.

While medical institutions were categorised as “restricted” before in 2007 (allowing only foreign investment in the form of joint ventures), it was removed from the Catalogue entirely in 2011, suggesting that foreign investment should have been permitted without restrictions. However, in practice, the establishment of wholly foreign-owned medical institutions remains difficult in China and it has only recently been allowed in the Shanghai FTZ.

3. Auto Industry

While a number of activities under the automobile electronic device manufacturing and R&D sector are categorised as “encouraged” in the 2011 Catalogue, foreign investors are still required to form a joint venture with a Chinese partner in certain manufacturing areas, such as electronic bus network technology, electronic controllers for electric power steering systems and embedded electronic integrated systems. The 2014 Draft proposes to abolish this restriction, enabling foreign investors to establish wholly foreign-owned entities in the above sectors.

However, 2014 Draft also moves the manufacturing of complete auto vehicles, special purpose vehicles and motorcycles to the “restricted” category. It also mandates that Chinese ownership cannot be less than 50% and that a foreign investor is not permitted to invest in more than two joint ventures in the manufacturing of the same category of auto vehicles in China. It is important to note that this restriction will not apply if a foreign investor acquires or merges another automobile manufacturer in China together with their Chinese joint venture partner.

The 2014 Draft, for the first time, explicitly categorises auto manufacturing as a “restricted” industry. This signifies a trend in the attitudes of regulatory authorities towards gradually tightening foreign investment in the auto manufacturing industry, as well as their on-going support for the development of domestic auto brands. However, the 2014 Draft also signals that the foreign equity ratio in auto manufacturing joint ventures, which has drawn significant attention recently, may be temporarily halted.

4. Telecommunications and Internet

The Chinese Government is generally supportive of the development of emerging technology sectors. Currently in the Shanghai FTZ, government regulation allows up to 55% foreign investment in an e-commerce business, while it is still restricted to 50% outside of the zone.

Under the 2014 Draft, e-commerce will be listed under the “restricted” category and foreign investment will be able to exceed 50%. As such, it will be interesting to see whether the Shanghai FTZ will further lift restrictions on foreign investment to above 55%, or whether the rest of China will follow the 55% threshold set by the FTZ.

In addition, the development and application of ‘technologies related to 'the Internet of Things’ has been added to the “encouraged” category for the first time. This new addition is in line with the Chinese Government’s continuing effort to obtain a leading advantage in the mobile internet era. For certain telecommunications technologies that may potentially fall into this category (the definition is subject to the authorities’ further interpretations), such as vehicle technology, smart grid technology and mobile wearable devices technology, foreign companies can potentially access some preferential policies including tax.

However, internet publishing-related services are “prohibited activities” which is unsurprising as it is consistent with the views of the Ministry of Culture and Press and Publication Administration’s jointly issued publication “Opinions on Foreign Investment in the Cultural Sectors” in 2005, which explicitly prohibited foreign investment in internet publication.

5. Infrastructure and Real Property

Compared with the current 2011 Catalogue, the 2014 Draft lifts the restriction on foreign investment in metro and real property projects. Specifically, the construction and operation of rail transit such as city metro and light rail, listed under the “encouraged” category, are no longer restricted by the Chinese majority shareholding requirement. Therefore, once the 2014 Draft takes effect, foreign investors are permitted to establish wholly foreign-owned entities in the sector.

In addition, real property projects now fall under the “permitted” category under the 2014 Draft, which means that there are no more restrictions on foreign investment in the land development and the construction and operation of luxury hotels, office buildings and international convention centres.

6. Education

Contrary to the liberalisation trends enjoyed by other industrial sectors, the 2014 Draft generally imposes more stringent restrictions on foreign investment in the educational sector. Higher education and day care join high school education in the “restricted” category and will therefore be limited to cooperative joint ventures led by the Chinese party. Compulsory education is categorised as “prohibited,” remaining completely off-limit to foreign investors.

7. Services Sectors

For accounting and auditing services which fall under the “encouraged” sector, the 2014 Draft removes the “form of cooperative joint ventures and/or partnership” requirement. This signifies that foreign investors will be permitted to establish wholly foreign-owned entities to run accounting firms for accounting and auditing-related services in China.

Restrictions on the entertainment industry will also be relaxed. Under the 2014 Draft, the operation of performance venues under the “encouraged” category will no longer require Chinese majority shareholdings, while the construction and operation of large-scale theme parks and entertainment venues are now categorised as “permitted” activities.

However, services such as legal advice and the auction of Chinese cultural relics will be under tighter control. Under the current 2011 Catalogue, providing legal advice is categorised as “restricted”. In the 2014 Draft, however, providing Chinese law-related consulting services is explicitly listed as “prohibited”. In addition, operating auction houses and antique stores which sell Chinese cultural relics is also explicitly listed as “prohibited” under the new Draft.