The Third Plenum of the 18th Chinese Communist Party Central Committee (CCPCC), held in November 2013, culminated in the release of a high-level decision paper that laid out the Chinese Communist Party’s (CCP) blueprint for ambitious structural reforms over the course of this decade. Other than mixed-ownership reform which received significant domestic and international analysis (covered in our recent China update “Crossing the River by Feeling for the Stones: Towards a Mixed-Ownership Enterprise Renaissance”), the CCP has pledged to transform the role of government so as to reduce the hand of the state in the operation of the economy.
From a law-making and regulatory perspective, observers have witnessed an energetic 2014, with National People’s Congress legislators and government agencies promulgating a series of pro-business laws and regulations aimed at: (i) liberalizing the existing regulatory regime; and (ii) cutting red tape for market participants. This note provides a summary of key inbound and outbound legal and regulatory developments that have taken place—or are taking place—as the Year of the Horse passes and the Year of the Ram begins.
1. Draft Foreign Investment Law
If enacted, the draft Foreign Investment Law (FIL), released by MOFCOM on January 19, 2015, will gradually replace the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Cooperative Joint Venture Enterprise Law, and the Wholly Foreign-invested Enterprise Law that historically have set the parameters of foreign investment regulation in China. The FIL, once promulgated, will significantly reshape the entire Chinese regulatory landscape for foreign investors.
In the 11 chapters (170 articles) of the draft FIL, some select highlights include:
A control-based definition of foreign investor and foreign investment which will likely cause the FIL to have an extraterritorial effect and capture offshore transactions that will result in the transfer of de facto control of onshore entities to foreign investors;
Easier market access for foreign investors as a result of the replacement of the current comprehensive approval system, with a limited entry clearance system for select industries on the “negative list,” coupled with an information reporting system that is more in alignment with international practice; and
Elaboration on the treatment of variable interest entities (VIEs) adopted after promulgation of the FIL (but not VIEs created prior to the implementation of the FIL).
While the draft FIL has received significant third party analysis since its release, it should be pointed out that there is still a long way to go before the FIL is finalized and passed into law by the Standing Committee of the NPC (SCNPC). This process could take a year, perhaps even longer, given the lengthy internal procedures that must be completed before the draft FIL can be submitted to the SCNPC for its formal review and deliberation. It is also highly possible that the final version of the FIL will differ in a number of key areas from the current draft which has not been vetted by other key agencies such as the National Development and Reform Commission and State Administration of Foreign Exchange (SAFE).
2. Company Registration System
The amendments to the P.R.C. Company Law and the Regulations on the Administration of Registration of Companies taking effect on March 1, 2014, marked the shift of a paid-in capital registration system to a subscribed capital system that affords more autonomy to shareholders on matters relating to the registered capital of a company, and substantially shortens the timeframe of the incorporation process.
3. Foreign Exchange
There have been a number of material moves on the foreign exchange control front, represented by the issuance of new foreign exchange rules. These are outlined in the SAFE’s Circulars 29, 36 and 37.
Circular 29 outlines the new Rules on the Foreign Exchange Administration of Cross-border Guarantees promulgated by SAFE in May 2014.
Issued by SAFE on July 15, 2014, Circular 36 clarifies issues relating to the conversion of foreign funds in the capital accounts of foreign invested enterprises (FIE). For the purposes of foreign exchange control, activities involving cross-border transfers of funds from, or to China, are divided into two categories: (i) trade related current account activities; and (ii) capital account activities. While foreign currency received from, or required for, current account transactions are in principle freely convertible into (or from) renminbi, capital account transactions (e.g., equity investments and loan financing) are still tightly controlled and regulated.
Circular 36 seeks to, in several dozen selected areas (so-called ‘Pilot Zones’), ease restrictions on the conversion and use of foreign currency in FIEs’ capital accounts. It allows FIEs located within the Pilot Zones to convert foreign equity capital in any amount and at any time without waiting until the need for payment in renminbi actually arises from genuine underlying transactions (which is the requirement under Circular 142 applicable to FIEs incorporated outside of the Pilot Zones). The renminbi that is converted will then be transferred to a designated renminbi account and withdrawal of funds from such renminbi account is still on an as-needed basis.
It is expected that measures in Circular 36 may soon be extended to more areas outside of the Pilot Zones and eventually be implemented nationwide.
Circular 37 replaced outdated rules that were enacted almost a decade ago regarding offshore special purpose vehicles (SPVs) established by Chinese citizens for fundraising and other specialized investment purposes. Under Circular 37, funding sources for SPVs have been expanded from domestic business to cash held onshore and funds and assets lawfully held offshore by Chinese citizens. A natural inference from such expansion is that ownership of an existing business in China is no longer the prerequisite for a Chinese individual to successfully complete the required SAFE registration of the SPV (though recent practices seem to suggest that this requirement is still being enforced by SAFE).
4. Investment Project Approvals
On October 31, 2014, the State Council published the 2014 version of the Catalogue of Investment Projects Requiring Government Approval (Catalogue)—the most important legal basis for the government to impose government approval requirements on various investment projects. Compared to the 2013 version and the 2004 version, the latest Catalogue has substantially reduced the number of projects subject to approval, increased the monetary threshold triggering approval requirements, and delegated greater approval authority to provincial and municipal governments.