Draft Foreign Investment Law: China promises security to investors and businesses

Published: 01.03.2019 Related countries:  China China

A draft of China’s new and first foreign investment law has recently been published and is available for public inspection and comment.

Surprisingly prompt draft of the first Chinese law on foreign investment

A draft of China’s new and first foreign investment law has recently been published and is available for public inspection and comment.

According to analysts, critics and the press, the new foreign investment law is being pushed through with unprecedented speed as it addresses issues raised by US President Donald Trump at last year’s summit with Xi Jinping. So it is striking that the draft law has been published while China and the US are involved in a serious trade dispute and some of the outstanding issues are likely to be resolved by this law.

Essentially, the new draft shows the Chinese government’s willingness to further open its markets to foreign companies and to address complaints raised by foreign investors.

The draft law formulates basic provisions aimed at creating a more attractive investment environment. However, the details of the implementation of the Foreign Investment Act are not clearly defined yet. The law itself will be consulted during the next session of China’s National People’s Congress starting on March 5th.

Main Highlights of the draft:

(1) Emphasis on national treatment: Unless otherwise provided in the laws and regulations, the State’s policy to support enterprise development applies equally to foreign-invested enterprises.

(2) Prohibition of compulsory technology transfer: The conditions for technical cooperation on foreign investment will be determined in consultation between the investment partners and administrative bodies and their staff will not be allowed to use administrative means to enforce technology transfer.

(3) To emphasize that the government keeps its promise: The governments of the local population at all levels and their competent departments must strictly respect the political commitments made in accordance with the law and the various types of contracts concluded in accordance with the law.

Altogether there are several parts of the new draft which invite to a closer examination and from which already now realizations for the future can be drawn:

General Provisions

The General Provisions of the draft contain the definition and scenarios for foreign investment. There is no explicit enumeration of Variable Interest Entities (VIEs) as foreign investment vehicles and the concept of “control” is not included throughout the text. VIEs are enterprises that serve to technically turn an enterprise in China into a domestic Chinese enterprise, but are de facto controlled by one or more foreign enterprises. VIE structures are usually used to allow foreign enterprises to operate in various sectors of the Chinese economy that are prohibited for foreign enterprises. The monitoring of VIEs needs to be further observed.

Investment Facilitation

In January 2017, the State Council adopted a State Council Circular on several measures to expand the active use of foreign capital. These measures should continue to create a level playing field as a policy priority and propose the promotion of fair participation of domestic and foreign companies in China’s standardization work, the promotion of fair participation of domestic and foreign companies in public tenders, support for foreign companies in developing their financing channels and other requirements.

Articles 15 to 17 serve as a law to further clarify the above requirements.

By legally protecting fair treatment that can be granted after access, this law aims to increase the attractiveness of the Chinese market for foreign investment and promote deep localization of foreign companies.

Investment Protection

Articles 20 to 24 emphasize investment protection and promise, for example, that intellectual property royalties could be transferred “freely” from China, strict protection of intellectual property rights of foreign investors, and technical cooperation based on voluntary principles and business rules. In addition, they clearly stipulate that administrative bodies and their staff must not use administrative means for violent technology transfer.

According to the draft instructions on the NPC’s official website, Article 22 embodies the legislative tendency to promote compliance with practice by local governments and makes it clear that local governments should strictly comply with their political obligations to foreign investors and foreign-invested enterprises in accordance with the law and the agreements entered into pursuant to the law; and compensate foreign investors and foreign-invested enterprises for their losses.

It also stresses that the losses for which foreign investors may be compensated should be based on legally entered into political commitments and lawful concluded contracts. However, the articles do not regulate the resolution of circumstances in which local governments have entered into political commitments or contracts beyond their jurisdiction.

Investment Management

Articles 29 to 33 address the management of investment and clarify the negative list system. They explain the areas beyond the negative list of foreign investment access should be in accordance with access to domestic investment.

This clarifies that the content and scope of information report are determined in accordance with the principles of true necessity and strict control. Currently, this report on foreign investment information mainly refers to foreign companies or their investors. They should provide the economic departments with information on the creation and change of enterprises with foreign participation.

China’s current system for foreign investment security reviews mainly consists of two general regulations, one issued in 2011 (Circular of the General Office of State Council on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors) applicable to foreign capital mergers and acquisitions of domestic enterprises, which did not include new investment.

The second regulation, issued in 2015, (Circular of the General Office of the State Council on Issuing the Tentative Measures for the National Security Review of Foreign Investment in Pilot Free Trade Zones) applies to foreign investment in pilot zones, including both foreign mergers and acquisitions, as well as new projects or enterprises, and investment methods such as VIE.

So article 33 of the new draft makes a principled provision for the establishment of a security review system for foreign investment, clearly provides a safety review of foreign investments that affect or may affect national security. The system may cover all types of foreign investment cases enumerated in article 2 of this draft in the future.

Legal Obligations

Article 35 clarifies the legal consequences of violating the negative list system for foreign investment. Compared with the current Interim Administrative Measures for the Record-filing of the Incorporation and Change of Foreign-invested Enterprises, this draft, as a law with higher levels of effectiveness, provides a basis for the competent departments to pursue legal liability, and is not limited to specifying the measures that can be taken by the competent administrative department.

In Circular of the State Council on Issuing the Outlines for the Building of a Social Integrity System (2014-2020), the State Council emphasized the need for the production, finance, taxation, and other fields to further promote the improvement of business integrity. In recent years, all industries were constantly promoting the development of the credit system. Article 36 of the draft also reflects this trend, which stipulates that the illegal acts of foreign investors and foreign-invested enterprises will be incorporated into the credit information system and the implementation of joint corrections.

Supplementary Provisions

Article 38 clarifies that the management of foreign capital in the financial industry and financial markets should apply the special regulations, which comply with current practice.

After the official introduction of Foreign Investment Law, it will replace three laws on foreign investment, and serve as the basic law in the field of foreign investment. The Foreign Investment Law no longer regulates the organization form, business activities and other contents of enterprises, and the organization form of foreign-invested enterprises. In the future, the foreign-invested enterprises will directly apply the laws and regulations governing the organizational form of various market subjects, such as the Company Law. This article provides for a transition period of five years, and we understand that the existing foreign-invested enterprises during the transitional period should adjust their organizational institutions and other laws and regulations in accordance with the Company Law.

Outlook

The draft Chinese Foreign Investment Law is a step on the way to keeping promises but leaves the Chinese state organs a wide scope of action.

As mentioned before, Article 20, for example, allows the state to take control of foreign investment in the public interest. But what defines the public interest is not clear. It is also unclear how Article 33 will be applied, which states the need for security checks on foreign companies that “affect or are likely to affect national security”.

It is not to be expected that China will offer a much more predictable environment for foreign investors with the new law than at present. On the one hand, that is because of the novelty of Chinese regulation and the associated legal uncertainty, on the other hand, because of the complexity of the Chinese regulatory network. It, therefore, remains to be seen how the law will be structured in detail and how the legislator can implement it. Despite all the criticism of the draft law, China is signaling to companies and investors that it is a safe place for doing business and that, despite all the uncertainties, the Chinese market can be expected to open up further.