It is understandable that the Standing Committee of the National People's Congress (“NPC”) chose to issue its Decision to Revise the Wholly Foreign-owned Enterprises Law (“Decision”) on September 3, 2016. It has been more than 18 months since the Foreign Investment Law of the People's Republic of China (“Draft for Public Comment”) was publicized, and shortly the trial implementation of pre-establishment national treatment and the negative list approach for foreign investment in four Free Trade Zones will expire. These all point to the fact that the basic law covering foreign investment in China has to be revised but the conditions for a fundamental change are not yet ripe.

I. Background to the Reform

It is well known that since opening up China has applied a strict admission administration and case-by-case approval regime for foreign investment under the Sino-foreign Equity Joint Ventures Law (“EJV Law”), the Sino-foreign Cooperative Joint Ventures Law (“CJV Law”), the Wholly Foreign-owned Enterprises Law (“WFOE Law”) (collectively known as the “Three FIE Laws”) and their respective implementation regulations and detailed rules, as well as a bunch of ancillary regulations and rules. These laws have controlled the establishment, change, equity transfer and other relevant matters of Foreign Invested Enterprises. Instead of approvals, the Decision provides that cases not involving the Special Administrative Measures (Negative List) in the Three FIE Laws and the Law of the People's Republic of China on the Protection of Investment by Taiwanese Compatriots (“Taiwanese Compatriots Investment Protection Law”) are only required to make an administrative filing. On the same day, the Ministry of Commerce (“MOFCOM”) published the Interim Measures on Filing Administration of the Establishment and Change of Foreign-invested Enterprises (Exposure Draft) (“Interim Measures”), to take effect with the Decision on October 1, 2016. The reform principles of administrative streamlining and power delegation, the integration of devolution and regulation as well as the coordination of supervision and regulation are fully embodied in the nationwide implementation of the pre-establishment treatment and the negative list approach for foreign investment, and in the transformation from overall case-by-case approvals to a combination of a general filing and negative list approval regime .

It should be acknowledged that though this round of reform to the law for foreign investment does not reach the expected extent and depth to be deemed revolutionary as proposed in the Draft of Foreign Investment Law, yet it is indeed an important reform of the supervision and administration system of foreign investment since China’s opening-up. From the perspectives of historical development and practical need, the background to the Decision and the Interim Measures can be summarized by the following three points:

1. The current Three FIE Laws no longer satisfy the needs of foreign investment development. Before the promulgation of the Decision, the case-by-case approval regime was adopted for foreign investment. The Guiding Catalogue on Industries for Foreign Investment (“Catalogue”) categorizes foreign investment into industries that are prohibited, restricted, encouraged and permitted. However, even if an enterprise falls within the encouraged category or permitted category, matters such as establishment and changes are still subject to the approval of MOFCOM or its local offices. Therefore these enterprises in fact enjoy no more facilitation than restricted enterprises. Despite the fact that over the last decade the state and MOFCOM introduced a series of rules and delegated approvals to new institutions so as to simplify approvals and procedures, the case-by-case approval regime remained substantially unchanged. The fact that all foreign investment matters are subject to approval and the approval time is prolonged imposes more economic and time cost on investors, limits the growth of foreign direct investment, increases the workload of the MOFCOM or its local offices, and consumes large amounts of administrative resource.

2. The success of the negative list approach in the Free Trade Zones is worthy of replication. On August 30, 2013, the NPC Standing Committee authorized the State Council to suspend the administrative approval needed in the Three FIE Laws and to use the filing and negative list approach for foreign investment set out in the Special Administrative Measures for the Shanghai Free Trade Pilot Zone. The pre-establishment national treatment and the negative list approach was extended by the NPC Standing Committee on 28 December 2014 to the Guangdong, Tianjin, Fujian Free Trade Zones and to the expansion area of Shanghai Free Trade Zone. The pilots in the four Free Trade Zones over the past three years were widely acknowledged as proving the feasibility and advantages of these reforms which greatly enhanced the efficiency of foreign investment. In addition, the pilot periods authorized by the NPC Standing Committee are about to expire, therefore it is timely to replicate implementation nationwide.

3. The reform of the foreign investment laws will be gradual. The Draft Foreign Investment Law disseminated in early 2015 evinced a comprehensive and fundamental approach to reform. In addition to abandoning case-by-case approvals and adopting specific admission of certain foreign investment and creation of a comprehensive information gathering institution, it also terminates decentralized legislation affecting FIEs. It leaves out specific FIE corporate governance and organizational forms which means that foreign-invested enterprises will be subject to the same Company Law, Securities Law, and Partnership Enterprises law as domestic enterprises, and will no longer be regulated separately. Treatment under domestic law of matters such as foreign M&A, national security reviews, investment promotion and coordination will have fundamental impact on FIEs. The Draft Foreign Investment Law will have a substantial impact on the legal supervision and administration of foreign investment, as it involves a wide range of major issues. There will be changes to massive and complicated policies and regulations and to institutions, all of which will need to be integrated and supported. With change so big and complex, it will be a challenge to formulate the detailed rules for implementation and ancillary systems in a short period of time. Since  the new Foreign Investment Law has not yet been completed, the Decision and the Interim Measures serve as a transitional reform plan for the overall reform of the law controlling foreign investment supervision and administration.

II. The Key Points of the Reform

The Key Points of the Decision

WFOE Law

EJV Law

CJV Law

Taiwanese Compatriots Investment Protection Law

Establishment

Establishment(the approval of EJV Agreement, Contract, AOA)

Establishment(the approval of CJV Agreement, Contract, AOA)

Establishment

Division, merger or other important change

Extension of term of operation

Key changes to CJV contract

/

Extension of term of operation

Termination of the EJV contract

Transfer of the rights and obligations in the CJV contract by one of the parties

/

/

/

Handover of the CJV to a third party for its operation and management

/

/

/

Extension of term of operation

/

For those entities that are not subject to special administrative measures for admission regulated by the state, the abovementioned approval matters shall be subject to filing administration after the amendment.

The Key Points of the Interim Measures

The current Interim Measures have generally taken the ideas and regulations of the Administrative Measures on the Filing of Foreign Investments in the Pilot Free Trade Zones (Trial Implementation) (hereinafter referred to as “Free Trade Zones Filing Administrative Measures”) promulgated by MOFCOM on 8 April 2015. Its core is to remove the approval requirement for those FIEs that are not subject to special administrative regulations. The procedures for FIE establishment and change can now be completed by preliminary filing and/or subsequent filing. Considering the effective date of the Decision is 1 Oct 2016 and the foundation of the Interim Measures is the Free Trade Zones Filing Administrative Measures, which has been tested and verified in practice, we anticipate that the final implemented version of the Interim Measures will not substantially deviate from the draft for public comment. 

III. Challenges in the Reform

Looking at the Decision and the Interim Measures which facilitate the Decision, it is easy to conclude that the reform is to promote the national treatment of foreign investment by approval unless in the negative list on the basis of the successful pilots in the Free Trade Zones. The reform aims to simplify the procedure for foreign investment, enhance efficiency, save administrative resources, and provide a more convenient and free investment environment for foreign investors. However, this crucial adjustment and amendment to the foreign investment administration system will bring challenges in terms of smooth integration with existing systems. 

1. The scope of either filing or special admission approval for foreign invested entities: , the state shall issue a negative list as soon as possible before Oct 1, 2016 in order to distinguish whether the foreign investment should seek filing or a special admission approval. It is very likely that the negative list will be based on a reasonable adjustment to the negative lists of the Free Trade Zones currently in force. 

2. The ancillary amendment of existing foreign investment regulations: over the years, MOFCOM has laid down departmental rules and regulatory documents to clarify approval requirements and procedures for foreign investment establishment and changes. The exposure draft of Interim Measures does not  deal with any conflicts between the Interim Measures and existing departmental rules. The reason for this is unknown (perhaps lack of time or other aspects are being considered), and it is likely there will be subsequent clarification. 

3. Reconciliation with other regulations and systems:

1) In accordance with the Provisions on Foreign Investors' Merger with and Acquisition of Domestic Enterprises, foreign investment in a domestic enterprise and establishment of an FIE is subject to approval by MOFCOM or its local offices. The Interim Measures does not make it clear whether the new process of filing administration plus the negative list also applies to a foreign investors’ M&A. It is noted that the Notice of the General Office of State Council on Promulgation of the “Special Administrative Measures (Negative List) for Admission of Foreign Investments to Pilot Free Trade Zones” (Guo Ban Fa [2015]No.23) explicitly provides that acquisition of domestic enterprises by foreign investors, strategic investments by foreign investors in listed companies, capital contributions by overseas investors using the equity of a domestic enterprise in China which involves a foreign investment project and establishment and change of an enterprise shall be dealt with pursuant to the existing provisions, and that acquisition of domestic enterprises by foreign investors not only involves industry admission issue but also frequently involves national security review, concentration of undertakings and protection of well-known trademarks. Bearing this in mind we consider that it is not feasible to apply the mode of filing administration plus the negative list to the acquisition of domestic enterprises by foreign investors in the short run. 

2) In accordance with the Interim Provisions on Investment Made by Foreign-Invested Enterprises in China, investments made by FIEs in encouraged or permitted sectors is not subject to approval by MOFCOM or its local offices; while investments made by FIEs in restricted sectors is subject to approval by MOFCOM or its local offices. The Interim Measures does not make it clear whether filing administration applies to investment made by foreign-invested enterprises or differentiate its application based on whether the industry of the FIE falls under the negative list or not.

3) In accordance with the Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors, strategic investment in listed companies made by foreign investors is subject to approval by MOFCOM. The Interim Measures does not touch upon whether filing administration applies to strategic investment in listed companies made by foreign investors. Similarly, in accordance with Guo Ban Fa [2015] No.23, we think it is unlikely that filing administration will apply to strategic investment by foreigners in listed companies. 

4) The Administrative Measures on Approval and Filing for Foreign Investment Projects provides the thresholds for approval and filing based on the Catalogue. Considering the many years of joint-management of foreign investment projects by both NDRC and MOFCOM and the conflicts caused by this mechanism, the integration of the Interim Measures and Negative List with the Administrative Measures on Approval and Filing for Foreign Investment Projects will be a challenge for regulatory authorities and practitioners. 

5) The approval of MOFCOM or its local offices is one of the required application documents for the establishment, change and foreign exchange registration with the State Administration for Industry and Commerce (“SAIC”) and the State Administration of Foreign Exchange (“SAFE”). SAIC and SAFE did not participate in formulating the Interim Measures. If they fail to make corresponding regulations, for those FIEs not involving negative lists, it will be uncertain whether they can successfully complete business and foreign exchange registration simply with the filing receipt of MOFCOM. 

6) The implementation of the Interim Measures and Negative Lists will also affect approvals for other specific industries (e.g. Interim Provisions on the Administration of the Establishment of Sino-foreign Joint Venture and Sino-foreign Cooperative Job Referral Agencies) which require approval of MOFCOM or its local offices as a precondition. Reconciling establishment and registration treatment of special entities must be further considered by relevant authorities as well.

It is foreseeable that together with the implementation of the Decision and Interim Measures, quite a number of regulations and rules in the foreign investment area may be need to be amended or even repealed. This will involve many aspects. If this central-to-local legislation work cannot be completed within a short period of time and local governments cannot be informed in a timely manner, then establishment and changes in the foreign investment sector will face three difficulties, namely implementing rules being made by MOFCOM, the administration practices of regulatory authorities and  execution by market participants (including practitioners like us).

In summary, compared with the Draft of Foreign Investment Law, the Decision and Interim Measures have taken the legislative objective of the Draft Foreign Investment Law by removing case-by-case approval and adopting an administrative filing plus negative list regime. The Decision and Interim Measures have provided detailed regulations on practical operation. This can be regarded as a major step in the gradual reform of the foreign investment regulatory system. The method adopted has been recognized and verified by pilots in the Free Trade Zones. The state is determined and confident in making this amendment. Nonetheless, it is expected that a period for adaption and adjustment will occur after official implementation, and it may bring many challenges to investors, regulatory authorities and practitioners. 

It is encouraging to see that the era of case-by-case approvals for foreign investment has ended, and that the mode of filing administration plus negative list has been adopted. In order to honor China’s commitments upon its accession to the WTO and create a freer investment environment, the reform of the regulatory system for foreign investment law still has a long way to go. 

Editor’s note: this article was simultaneously published on Chinalawinsight.com