China Further Opens its Market with New "Foreign Investment Law"
The Situation: The new PRC Foreign Investment Law ("FIL"), as well as its Implementing Regulations ("Implementing Regulations"), took effect on January 1, 2020. In addition to the FIL and the Implementing Regulations, the 2019 Special Administrative Measures for Foreign Investment (also known as the "Negative List") and the Catalogue of Encouraged Industries for Foreign Investment ("Encouraged Industries Catalogue") took effect on July 30, 2019 (collectively, the "New Law").
The Development: The FIL, as a single unified body of law has, as of January 1, 2020, replaced the three previous laws governing foreign investment and foreign invested enterprises ("FIEs") in China, and provides for greater promotion and protection of foreign investment as well as enhanced regulatory transparency. The revised Negative List has further liberalized certain Chinese market sectors and reduced restrictions, and the Encouraged Industries Catalogue identifies more key industries (such as manufacturing, technology, and agriculture) in which China further encourages foreign investment with preferential policies.
Looking Ahead: The New Law indicates that China is maintaining its commitment to further open up its market and boost inbound foreign investment. Several key changes under the New Law (such as national treatment of foreign investment subject to the Negative List, protection of foreign IP rights and trade secrets, and equal treatment of domestic and foreign companies in government procurement) address some of the "asks" from the U.S. side under its trade negotiations with China, some of which have been further reflected in the phase one trade agreement recently concluded between the United States and China. While the New Law is encouraging, foreign investors should understand the major changes and benefits under the New Law, consider where further enforcement measures and concrete steps are required, and find ways to take advantage of new investment opportunities in China.
Highlights of the New Law
Prior to the FIL taking effect on January 1, 2020, foreign investors, who have been operating in China for decades, have faced certain hurdles on business establishment and investment treatment (compared with their Chinese counterparts), and have been restricted from investing in certain sectors unless in a joint venture with a Chinese party. Further, foreign investors have needed to navigate through the Chinese-Foreign Equity Joint Venture Law, the Chinese-Foreign Cooperative Joint Venture Law and the Wholly Foreign Owned Enterprise Law (collectively, the "Old FIE Laws"), which imposed specific requirements on corporate formation, foreign ownership ratios, corporate governance and operational management. In addition, insufficient protection of IP rights and trade secrets, mandatory technology transfer and lack of participation in the legislative consultation process have been significant concerns for many foreign investors.
The New Law is designed to take steps to address such concerns. The FIL, comprised of 42 articles in six chapters, focuses on foreign investment promotion, protection and administration, and imposes legal liabilities on both foreign investors and Chinese regulators if in violation of PRC laws. The Implementing Regulations, which are key to understanding the impact of the FIL, have also been in effect since January 1, 2020.
The most significant highlights of the FIL and Implementing Regulations are summarized below.
- Investment Promotion: To further promote foreign investment in China, the FIL (Article 9) and Implementing Regulations (Article 6) stipulate that foreign investors shall be treated equally with domestic companies regarding access to government funds, land supply, tax exemptions, licensing, project applications and so on. FIEs may comment on new legislation and administrative rules concerning foreign investment (FIL, Article 10), and only published documents may form the basis for the exercise of administrative authority (Implementing Regulations, Article 7). Under the FIL, foreign investors may enjoy preferential policies in certain sectors and regions as designated by the Chinese authorities (Article 14). FIEs may participate in government procurement through fair competition (FIL, Article 16), and must not be discriminated against in such procurement processes with respect to their products manufactured, and services provided, in China (Implementing Regulations, Article 15). Further, the FIL specifically allows FIEs to raise funds through public offerings of equity and debt securities (Article 17). Clearly, such new provisions aim to encourage more foreign investment into China.
- Investment Protection: The FIL clarifies that foreign investors' capital contributions, profit, capital gains, income from asset disposals, royalties from IP rights, lawfully obtained compensation or indemnity amounts, and proceeds from liquidation, may be freely remitted in or out of China in RMB or foreign currency (Article 21); the Implementing Regulations disallow any restrictions on the currency, amount, and frequency of such remittances (Article 22). Further, the Implementing Regulations provide for a swift collaborative protection mechanism to facilitate the settlement of IP disputes, and for the protection of the IP rights of foreign investors and FIEs (Article 23). More specifically, both the FIL (Articles 22 and 23) and the Implementing Regulations (Articles 24 and 25) prohibit government officials from forcing foreign investors or FIEs to transfer their technology, and require authorities to take effective measures to protect the trade secrets of foreign investors that they have learned while performing their duties. Finally, local governments must comply with policy commitments made to, and investment agreements entered into with, foreign investors, and shall reasonably compensate those foreign investors if it is necessary to adjust those commitments or agreements due to national or social public interest reasons (FIL, Article 25).
- Investment Administration: (1) The FIL (Articles 4 and 28) works together with the Negative List in setting forth the areas where foreign investment is prohibited or restricted; thus, foreign investors proposing to invest in China should comply with the restrictive requirements regarding equity ratios (some of which will be phased out in the coming years) and top executives. (2) As the Old FIE Laws have been repealed at the same time that the FIL became effective, FIEs are now subject to the PRC Company Law and Partnership Law, which stipulate different rules on corporate governance, voting, share transfers, profit sharing and so forth. As a consequence, each FIE should, within the stipulated five-year transition period, convert to the appropriate corporate form and update its articles of association and shareholders agreement to comply with such rules which now apply to foreign and domestic investors alike. Given the complexity of the conversion process, we are expecting specific implementing rules and detailed guidelines from the commerce, market supervision and other regulatory authorities in the coming months on these topics. (3) The FIL also refers (Article 35) to the requirement for national security review of certain foreign investments in sensitive industries and sectors, a mechanism that has been in place since 2006 although not frequently invoked.
- Legal Liabilities: If foreign investors invest in prohibited industries or fail to comply with investment access restrictions, they will be required to divest and/or rectify their non-compliance, and may face other sanctions under the FIL and other PRC laws. The FIL also imposes more stringent requirements on government authorities, mandating fair, transparent, effective treatment and facilitation for foreign investors; government authorities and personnel may face legal liability for breaching certain provisions of the FIL and Implementing Regulations. On the other hand, the FIL allows for certain counter-measures to be imposed in response to prohibitive or restrictive rules against China from other countries.
The Negative List and Encouraged Industries Catalogue perform the functions of prohibiting and restricting foreign investment in certain sectors, and providing incentives for foreign investment in other fields. To further open up the Chinese market, the 2019 Negative List has removed restrictions in certain sectors. For example, a joint venture with a Chinese partner is no longer required in oil and gas exploration, and certain financial sectors (securities, futures, and life insurance) will be fully open from 51% to 100% foreign ownership in 2021. On the other hand, the Encouraged Industries Catalogue is being expanded so as to attract more foreign investment in high-end and intelligent manufacturing, advanced service industries, modern pharmaceutical and agricultural industries, advanced technology, new materials, and other promising sectors. Further, a sub-catalogue attached to the Encouraged Industries Catalogue lists those sectors in western, central, and eastern China where foreign investments are encouraged—agriculture and goods manufacturing in Yunnan province, for example, or automotive and high-end manufacturing in Sichuan province; as well as tourism, entertainment, and international shipping in Hainan province.
Foreign investors will enjoy preferential benefits in the sectors covered by the Encouraged Industries Catalogue, including: (i) customs duty exemptions on equipment imported for self-use; (ii) a preferential enterprise income tax rate of 15% for FIEs in certain encouraged sectors and regions; and (iii) qualified investments will enjoy land supply on a priority basis, plus a discount of up to 30% below the mandatory minimum price for granted land use rights.
Three Key Takeaways
- FIEs in China should take advantage of the five-year transition period under the FIL to convert to the appropriate corporate form, and update their bylaws and shareholders agreements to comply with the PRC Company Law or Partnership Law.
- Foreign investors and their FIEs in China should utilize the enhanced provisions in the FIL for promoting and protecting foreign investments and foreign IP rights as summarized above, and actively pursue lawful remedies provided by the FIL and the Implementing Regulations. It will be necessary to monitor how the general principles stated in the FIL are translated into practical outcomes.
- Existing FIEs and foreign investors targeting the Chinese market should pay close attention to the Negative List and Encouraged Industries Catalogue (including its Sub-Catalogue) in order to select suitable sectors and locations for their China investments, and should negotiate with their Chinese counterparts and local authorities to maximize the available preferential benefits.
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