On March 15, 2019, China announced its new Foreign Investment Law (the “FIL”), which will come into force on January 1, 2020. The FIL will fundamentally change the existing foreign investment legal regime in China currently ruled by the Sino-Foreign Equity Joint Ventures Law, the Sino-Foreign Contractual Joint Ventures Law, the Wholly Foreign Owned Enterprises Law, and relevant implementing regulations (collectively, the “Existing Investment Laws”).
A. Overview of Existing Investment Laws
The Existing Investment Laws have been implemented since 1979 and have gradually evolved into a complicated system, where foreign investments are strictly required to be registered on a record filing system through on-line submission of prescribed information. In addition, certain categories of foreign investments are subject to special administrative measures, beyond a mere filing requirement. Such categories of investments are referred to as the “Negative List”.
The Negative List either entirely prohibits foreign investment in certain industrial areas and/or activities (such as internet news information services, compulsory education institutions, and postal services), or establish restrictions or limitations on foreign investment in other industrial areas and/or activities (for example, value-added telecommunications services, market surveying, and higher educational institutions). All restricted foreign investments are subject to relevant governmental authorities’ examination and approval on a case-by-case basis.
The Negative List was first introduced in 2016. On June 30, 2019, National Development and Reform Commission and the Ministry of Commerce jointly issued the 2019 Edition of the Special Administrative Measures for Foreign Investment Access (Negative List) and the Special Administrative Measures for Foreign Investment Access in Pilot Free Trade Zones (Negative List). Both negative lists will become effective as of July 30, 2019.
B. New Foreign Investment Law
1. National Treatment
Under the FIL, foreign investments which are outside of the Negative List will be subject to “pre-access national treatment”, meaning that, at the stage of investment access, foreign investors and their investments shall enjoy treatment not less favorable than that applied to domestic investors and their investments. For example, government policies supporting the development of enterprise shall apply equally to foreign-invested enterprises outside of the Negative List; the government shall also guarantee that foreign-invested enterprises outside of the Negative List can participate in governmental procurements on an equal footing with local enterprises.
2. Negative List
As mentioned above, the Negative List has already been established, and it consists of prohibited sectors and restricted sectors.
(a) The prohibited sectors are industrial sectors prohibited from foreign investment. No foreign investors are allowed to invest in such areas by any means (such as acquisition, joint venture, minority investment, establishment of new business, etc.), either directly or indirectly; and
(b) The rest of the industrial sectors on the Negative List have investment restrictions for foreign investors, such as the maxim percentage of equities that could be held by foreign investors, special qualifications for management personnel, and composition of board of directors. Under the 2019 Edition of the Negative List, governmental approval must be obtained to proceed with investment in restricted sectors. More detailed rules and regulations regarding the approval process are expected to be released in the future.
As mentioned above, foreign investments in Chinese businesses outside of the Negative List shall enjoy a national treatment and the principle of equality shall be applied to both domestic and foreign investment.
3. Intellectual Property Protection and Technology Transfer
The FIL emphasizes that Chinese government shall protect the intellectual property of foreign investors and foreign-invested enterprises, as well as the legitimate rights and interests of intellectual property rights holders and other relevant right holders. The Chinese government shall also pursue legal liability for infringement of intellectual property rights in strict accordance with the law.
The FIL further provides that the conditions for technical cooperation between foreign investors and domestic businesses shall be determined by the parties to the investment, through negotiation under the principle of fairness. Administrative authorities and their staff shall not force the transfer of technology by administrative means.
While it remains to be seen how the government’s enforcement of such provisions will manifests in practice, the policy direction of the FIL will be a welcoming sign to foreign investors who will share their intellectual properties with Chinese counterparts.
4. Information Reporting System
The FIL will establish a foreign investment information reporting system. Foreign Investors or foreign-invested enterprises shall submit investment information to the competent governmental authorities through the enterprise registration system and the enterprise credit information publicity system. More detailed implementation guidance regarding such information reporting system is expected to be issued.
5. National Security Review
A foreign investment security review system will also be established under the FIL to review foreign investment that affects or could affect the national security of China. Under the Existing Investment Laws, security review only covers mergers and acquisitions of Chinese business as well as investments in pilot free trade zones pertaining to sensitive industries (such as military and national defense), sensitive areas (for example, areas surrounding major or sensitive military facilities), and certain key products and services (such as important agricultural products, important energies and resources, important transportation services, and key technologies). The FIL does not provide any detailed information regarding the proposed national security review system (such as scope, content, and procedures). More detailed rules and guidelines are expected to be issued.
6. Transitional period and Corporate Governance
The FIL will become effective on January 1, 2020, repealing the Existing Investment Laws simultaneously. After the implementation of the FIL, the default governing legislations of foreign-invested enterprises outside of the Negative List will be the same as those that apply to local Chinese enterprises, such as the Company Law and the Partnership Enterprises Law of China, rather than the special rules stipulated in the Existing Investment Laws. In effect, a foreign-invested enterprises’ business affairs, such as forms of organization, organizational structures, and other general business activities will be subject to the same regulations as local Chinese enterprises.
Foreign-invested enterprises that were established per the Existing Investment Laws before the implementation of the FIL may retain their organizational structure within a transitional period of five years starting from January 1, 2020. Foreign investors shall be prepared to negotiate with their Chinese partners for necessary changes to the structure of joint ventures established before the implementation of the FIL.
As the foundation of China’s new foreign investment management legal system, the FIL covers promotion, protection, administration and legal liability of foreign investment in China. The overall aim of the FIL appears to be allowing foreign investments outside of the Negative List to fairly compete with local enterprises, by subjecting them to the same regulations and treatments, while keeping a clear record of all foreign investments and implementing policies that address foreign investors’ primary concerns (such as intellectual property protection). However, the FIL only has 42 articles and most of which are general principles rather than detailed implementation rules. It is expected that further legislation will be formulated and released by relevant authorities to provide clarification and guidance for the FIL. We will continue to follow and report on such regulatory developments.