On March 15, 2019, President Xi Jinping signed into law China's Foreign Investment Law (the "Law") that was passed by China's National People`s Congress on the same day. The Law is to take effect from January 1, 2020.
The Law represents a significant step for China to roll out a corner-stone legislation to boost international investor confidence amid the complex and sensitive international environment faced by China especially in light of China's tension with the Trump Administration. China hopes that the Law would help facilitate its transition from an investment-driven economy to an innovation driven economy.
The Law purports to cover all types of direct and indirect foreign investment in China, from green-field investment to mergers and acquisitions. Among other things, the Law aims to substantially strengthen China’s legal regime governing foreign investment by:
- creating a uniform foreign investment law to consolidate the various prior laws governing different forms of foreign investment, e.g., those governing, respectively, Sino-foreign equity joint venture enterprise ("EJV"), Sino-foreign cooperative joint venture enterprise ("CJV") and wholly foreign-owned enterprises ("WFOE"); and
- creating a more stable, transparent and predicable investment environment, and offering a level playing-field for foreign investors vis-a-vis Chinese investors.
Below is a high-level summary of certain highlights of the Law:
The Law stresses the principle of "national treatment" for foreign investors. For example, foreign investors would enjoy the same treatment as applicable to Chinese investors in the following aspects:
- equal market entry, whereby foreign investor would be offered the same treatment as applicable to Chinese investors, save for any specific market entry restrictions expressly set out in the "negative list" applicable to foreign investors issued by the Chinese government (the "Negative List" );
- equal access to government-backed enterprise development incentive schemes applicable to non-foreign-invested enterprises, save where relevant laws expressly provide otherwise;
- equal opportunity for foreign-invested enterprises (the "FIEs") to participate in government procurement projects and in the making of laws, regulations and technical standards.
Intellectual Property Rights ("IPR") Protection
The Law purports to protect foreign investors' legitimate interests. In particular, it emphasizes that China protects the IPRs of foreign investors and FIEs, and encourages "voluntary and fair" technology collaboration between foreign players and any Chinese counterparts.
It is noteworthy that the Law expressly prohibits any governmental authorities from forcing the transfer of technology (to Chinese stakeholders) via administrative measures. China has not admitted that it has engaged in practices that aim at forcing the transfer of technology from foreign investors to Chinese stakeholders, an accusation vigorously made by some of her key trading partners including the US. It is not clear at this point how the Law (and any implementing rules) will aim to enforce the above prohibition; it is possible the US-China trade negotiations may shed some light on this enforcement issue.
Restricion On Government Authorities
The Law also purports to facilitate the creation of a more business friendly environment in China, by introducing certain explicit requirements on local authorities to address some long-standing concerns of foreign investors, e.g., governments of all-levels are explicitly required to:
- keep confidential foreign investors' trade secrets which become known to government officials in the discharge of their official duties;
- honor their policy and contractual commitments that are duly made pursuant to the law to foreign investors and FIEs, and changes to such commitments may only be made on national and public interest grounds upon compensation being made to cover losses suffered by foreign investors and FIEs;
- abide by national laws and regulations in making any local government documents, and not prejudice the lawful rights of FIEs or impose additional obligations on them, nor create additional market entry/exit conditions;
Here again, the Law's implementing regulations will need to address foreign investors' concern about enforcement. Many foreign investors have not had much positive experience enforcing their rights against local government authorities.
National Security Review
The Law briefly makes references to China's national security review regime, but is unclear as to under what circumstances such review would be triggered.
By way of background, China's national security review regime (a concept to some extent modeled on the U.S. CFIUS approach for reviewing projects “where foreign investment infringes upon, or may infringe upon, national security”) was first introduced by the State Council in 2011, covering acquisition by foreign investor of "control" in domestic Chinese companies engaged in certain key sectors (such as sectors relating to manufacturing in the defense sector, important agricultural products, important energy and resources, important infrastructure, important transportation services, key technologies and major equipment manufacturing) under the Circular of the General Office of the State Council on Establishing the National Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors. As a matter of practice, there have been very few cases since 2011 where such review has been invoked.
It remains a question as to whether that foreign-invested greenfield projects would be subject to the national security review.
Prominently missing from the Law is a policy treatment of the so-called variable interest entities ("VIEs") and other similar arrangements commonly used by Chinese and foreign investors to bypass restrictions on market entry applicable to foreign investors; such arrangements play a critical role to enable Chinese high-growth companies to raise international financing. An earlier draft of the Law in 2015 had contained a blanket prohibition of such arrangements, the removal of such outright prohibition is believed to signal the government's continued tolerance of such arrangements. As China's Negative List grows shorter over time, it is possible such arrangements will be deployed less frequently by Chinese start-up companies when they raise financing internationally.
While the Law will replace the existing foreign investment regime governing EJVs, CJVs and WFOEs as of January 1, 2020, it provides for a five year transition period during which the existing EJVs, CJVs and WFOEs will be required to migrate to a new unified corporate regime governing all domestic and foreign-invested enterprises. Such new corporate regime will be based on China's Company Law which currently only governs domestic enterprises.
Interestingly, the Law contains a provision that reserves China's right to retaliate, where any foreign state or region should adopt discriminatory, restrictive or similar measures against Chinese investment.
As a whole, the Law represents China's refreshed commitment to further open its market to foreign investment, to level the playing-field for all investors, and to enhance protection of foreign investors' intellectual property rights. Coupled with the other major initiatives, such as the new Science and Technology Innovation Board in Shanghai and the Greater Bay Area initiative near Hong Kong, the Law can play a positive role in helping China stabilize foreign investor sentiment as well as bringing China's corporate legal regime to a much higher standard for all investors.