CBL’s Introduction

CBL’s translation of the government’s analysis describes what the new foreign investment law changed in China. This guidance is translated to American English using the User Centered Translation approach.

Explanation of the Foreign Investment Act — A Comparison of New and Old Laws

The Second Session of the 13th National People’s Congress voted on and approved the passing of the Foreign Investment Act (hereinafter referred to as “Foreign Investment Act”) on March 15, 2019, which took effect on January 1, 2020.

The former Foreign Capital Laws, namely Law of the People’s Republic of China on China-foreign Equity Joint Ventures (“Joint Venture Act”), Law of the People’s Republic of China on China-foreign Collaborative Joint Ventures (“Collaborative Joint Ventures Act”), and Law of the People’s Republic of China on Wholly Foreign-owned Businesses (“Foreign-owned Business Act”)

(“Foreign Capital Laws”) were repealed.

In this article, we will begin with a comparison of the Foreign Investment Act and the Foreign Capital Laws, followed by an explanation and analysis of the advantages and disadvantages of the new Foreign Investment Act.

1. Overview of the Foreign Investment Act
2. The consolidation of the three foreign capital laws allows for a more defined fundamental legal system for foreign investment administration and creates a clearer path for the gradual improvement of the overall foreign investment legal system.

The Foreign Investment Act will serve as the fundamental legal system framework for foreign investment administration in China once it replaces the Law of the People’s Republic of China on China-foreign Equity Joint Ventures, Law of the People’s Republic of China on China-foreign Collaborative Joint Ventures, and Law of the People’s Republic of China on Wholly Foreign-owned Businesses (collectively referred to as the “Foreign Capital Laws”).

The Foreign Capital Laws have long governed foreign investment administration and, inevitably, certain laws overlapped and rules became complicated, including those governing entity formation, changes, and termination, foreign capital contribution restrictions, and decision-making bodies for foreign owned entities.

The consolidation of the Foreign Capital Laws effectively eliminates the previous classification criteria for China-Foreign joint venture entities, China-Foreign collaborative entities, and wholly foreign-owned businesses. From now on, they will all be categorized as foreign owned entities, and this would allow for simpler and easier standardized foreign investment administration.

Moreover, the enactment of the Foreign Investment Act switches the main focus toward the formulation of a fundamental foreign investment legal system, which would be integrated with other systems such as those used for the Company Act, Contract Act, and Securities Act of the People’s Republic of China.

Additionally, the creation of a system framework and complete legal system for foreign investment administration under the Foreign Investment Act would make it possible to gradually update administrative regulations and administrative code to create new and practical legal systems. Overall, it is a major development in the field of foreign investment that also facilitates China’s internationalization goals.

It aligns foreign owned entities’ corporate governance and operations with the Company Act, further demonstrating the Chinese government’s legislative spirit and determination to expanding internationalization and attracting foreign investment.

Article 31 of the Foreign Investment Act provides that: “The Company Act and the Partnership Act shall govern the formation, corporate governance, and operations of foreign owned entities.”

However, the Foreign Capital Laws significantly restrict investment and limit entity types for foreign owned entities (China-Foreign Joint Ventures, China-Foreign Collaborative Joint Venture, and WFOEs) to limited liability companies or joint ventures lacking legal entity status (Collaborative Joint Venture Entities only).

Despite past regulatory documents issued by the Ministry of Commerce, the State Administration for Industry and Commerce, and other agencies providing the conditions and procedures for foreign owned corporations (including the 1995 Interim Regulations on Matters Concerning Foreign owned Corporations issued by the Ministry of Foreign Trade and Economic Relations), there is still a lack of basic regulations expressly approving this at the fundamental law level.

The Foreign Investment Act provides that both the Company Act and Partnership Act would govern entity forms for foreign owned entities. This shows that the legislature is based on practical experience in the administration of foreign owned entities and also represents the equal treatment of entities formed in China (regardless of whether Chinese or foreign owned), demonstrating China’s determination to attract foreign investment and improve internationalization.

3. Implementing Pre-establishment National Treatment and the Exception List system to improve internationalization.

The foreign investment access threshold is a major indicator of China’s internationalization. The implementation of the negative list began with the issuance of the Temporary Procedures on Foreign Owned Entity Formation and Change Filing and the Special Administrative Regulations for Admission of Foreign Investments (Exception List)(2018), which led to the implementation of the Exception List as the basic framework for foreign investment under the Foreign Investment Act. Under the Foreign Investment Act, the Exception List will gradually be simplified as market internationalization continues to develop.

Despite foreign investment being governed by the Exception List, the Foreign Investment Act also provides specific regulations to manage certain investments based on national interest and other considerations:

(1) Certain foreign investments are subject to approval and filing; (2) Foreign investors or entities having foreign investors involved in industries or fields having specific license requirements must obtain the necessary licenses from the appropriate jurisdictional agencies pursuant to law; (3) Taxation, accounting, and foreign exchange matters for foreign owned entities are still subject to oversight and approval by the appropriate agencies.

This is especially the case for foreign exchange related to national and public interest. While Article 21 of the Foreign Investment Act provides that foreign investor investment income may be freely transferred in either RMB or foreign currencies, it is foreseeable that such transfers will still be subjected to stringent oversight by the State Administration of Foreign Exchange in the short-term since foreign exchange is a fundamental national interest; (4) Foreign investors’ investment in financial industries, such as banking, securities or insurance, or in the securities market, foreign exchange market, or other financial markets, shall also be governed by other applicable laws.

Pre-establishment national treatment rules also require that foreign investors and their investments be treated no less favorably than Chinese investors and investments, which would aid in resolving the challenges and issues faced by foreign owned entities during the formation stage.

The implementation of pre-establishment national treatment and exception list administration should attract more foreign investment and bolster internationalization.

Additionally, the national security review administration for foreign investment and the foreign investment information reporting system under the Foreign Investment Act shall be set up in accordance with international standards to develop a comprehensive administration system and truly achieve the legislative intent of improving internationalization and administration.

4. The Foreign Investment Act also emphasizes equal encouragement and fair treatment of both foreign and domestic investments, including protecting the rights of foreign investors and foreign owned entities in mainland China, with a particular emphasis on intellectual property protection.

In addition to encouraging foreign investment, the Foreign Investment Act emphasizes the fair treatment and equal protection of both foreign and domestic investments, in line with the principle of national treatment.

Under the Foreign Investment Act, foreign owned entities are entitled to preferential treatment (Article 14), equal participation in standards formulation (Article 15), fair participation in government procurement activities (Article 16), financing pursuant to law (Article 17), tax exemptions for foreign investments except under certain circumstances (Article 20), and the right to apply for administrative licenses under the same conditions as domestic entities (Article 29). These serve to weaken the idea of foreign owned entities as “special” entities and allows them to pursue the same development opportunities as domestic entities.

In consideration of the fact that intellectual property protection has long been a concern among foreign investors in China and in response to international criticism for inadequate intellectual property protection, the Foreign Investment Act emphasizes the protection of foreign investor and foreign owned entity intellectual property, strict enforcement against intellectual property infringement, and the prohibition of forced technology transfer.

5.As the fundamental law governing foreign investment, the Foreign Investment Act provides that foreign owned entities have the right to raise capital through public offerings, corporate bonds, or other means.

The previous foreign capital laws limited the entity form for foreign owned businesses to limited liability companies, while the Company Act restricted the type of companies eligible for listing and public offerings to corporations. Therefore, foreign owned entities could not be listed on Chinese securities markets.

The former Ministry of Foreign Trade and Economic Cooperation issued the Provisional Regulations on the Incorporation of Foreign Owned Corporations in 1995, which expressly provided the conditions and procedures for foreign owned entities to convert to foreign owned corporations, allowing foreign owned entities to go public in China.

Subsequently, the Ministry of Foreign Trade and Economic Cooperation and the China Securities Regulatory Commission (“CSRC”) issued the Guidelines for Foreign Owned Publicly Listed Companies in 2001, which provided specific conditions for foreign owned entities to go public.

In addition to complying with the Company Act and other applicable rules issued by the CSRC, foreign owned entities are also required to comply with industry-specific foreign investment policies and must hold a minimum of 10% of the total company equity after going public.

The CSRC then issued the Rules for Foreign OwnedCorporation Prospectus Content and Format in 2002, which specified content and format rules for foreign owned corporation prospectuses and information disclosure.

Despite the previous regulatory documents issued by the above agencies allowing foreign-owned entities to be publicly listed on Chinese securities markets in theory, the Foreign Investment Act is the first law that expressly provides that foreign owned entities are entitled to be listed on Chinese securities markets.

Moreover, the Foreign Investment Act also allows business entities that have foreign investors to expand their financing methods through public offerings and other means.

Recent policies issued by the NPC and the Chinese government repeatedly mentioned “Support for foreign owned entities to expand financing methods, obtain listing on main markets, SME markets, the GEM, the National Equities Exchange, and Quotations market, issue corporate and convertible bonds, and obtain financing through non-financial corporate debt instruments,” particularly in the Notice of the State Council on Measures for Expanding Internationalization and Actively Using Foreign Investment and the 2017 Government Work Report presented by Premier Li Keqiang at the fifth plenary session of the 12th National People’s Congress.

Thus, the Foreign Investment Act solidifies the guidance provided in these policies and in the practical operation of the fundamental law, which is significant.

1. Shortcomings and Matters Requiring Urgent Resolution

1.The Foreign Investment Act does not provide whether foreign investment quotas and ratios would be subject to restrictions following internationalization, which needs to be specified in specific central government regulations or administrative code issued by the State Council or appropriate agencies.

Article 4 of the former China-Foreign Joint Venture Act provides that foreign investors must invest at least 25% of the registered capital in an equity joint venture.

The same is also repeated in Article 18 of the Supplementary Rules for the Implementation of the China-Foreign Joint Venture Act issued by the State Council.

Article 3 of the Provisional Regulations on the Registered Capital and Total Investment Ratio for China-Foreign Joint Ventures (Industrial and Commercial Enterprises [1987] No.38) expressly provides the total investment and ratio for Chinese-foreign equity joint ventures, while Article 6 provides the registered capital and total investment ratio for Chinese-foreign equity joint ventures for foreign owned entities to follow.

In other words, the former Foreign Capital Laws and governmental regulatory documents issued based on the same meant to strictly restrict total investment and registered capital ratios for foreign owned entities.

However, the Foreign Investment Act superseding the Foreign Capital Laws does not expressly provide whether registered capital and total investment ratios would still be subject to restrictions.

Article 31 of the Foreign Investment Act provides that entity types for foreign owned businesses shall be governed by the Company Act and Partnership Act. Based on this, there is a significant possibility that restrictions on foreign owned entity registered capital and total investment ratios will be removed or relaxed as the current Company Act has already abolished minimum registered capital and total investment ratios.

The Notice of the State Council on Measures for Expanding Internationalization and Actively Using Foreign Investment (December 28, 2016) adopted by the 159th State Council executive expressly specified the removal of minimum registered capital requirements for foreign owned entities and provided for the implementation of a centralized registered capital system for both domestic and foreign owned entities, which needs to be further confirmed through policies issued by the State Council and other national ministries and committees.

2. While specific rules are in place for direct and indirect foreign investment, rules for other investment types, such as reinvestment (including in foreign owned entities)（including equity acquisition and asset acquisition), have yet to be specified.

Article 2 of the Foreign Investment Act defines and provides the extent of foreign investment, specifying that foreign investment refers to direct or indirect investment by a foreign natural person, entity, or other organization (“Foreign Investors”) within the jurisdiction of the People’s Republic of China, and covers: (1) the formation of Chinese foreign owned entities by individual or groups of foreign investors (direct investment);

(2) foreign investors purchasing shares, equity, assets, or other similar interests in mainland Chinese entities (direct investment through equity or asset acquisition); 3. individual or group investment by foreign investors in new projects in China (direct investment); and 4. other investments provided by law, central government regulations, or State Council administrative regulations.

From the above, it is clear that the Foreign Investment Act only provides for direct investment by foreign investors based on the former Foreign Capital Laws, and adds investments through equity or asset acquisition or new projects since the former laws only provide for investment through foreign owned entity formation (direct investment). Particularly, the inclusion of investments through mergers and acquisitions confirms the current operations taking place under relaxed policies (i.e., the Rules on the Takeover of Domestic Businesses by Foreign Investors No.10 [2006] jointly issued by the Ministry of Commerce and other government agencies amended through Ministry of Commerce Notice No.6 [2009]).

Nevertheless, Foreign Investment Act specifies that foreign investment includes direct and indirect investment, however, direct investment plays a dominant role in the investment activities listed in the Act while indirect investment by foreign investors has yet to be clearly defined.

Although clause (4) is a catch-all provision, it is limited to “laws, administrative regulations, and State Council regulations.”

In reality, Ministry of Commerce Notice No.6 allows foreign investors to form foreign owned entities through indirect investment by purchasing domestic business assets through agreements.

 

However, the Foreign Investment Act does not expressly provide for any of these two forms of indirect investment by foreign investors through foreign owned entities.

Even if the catch-all provision in Article 2 (4) were to apply, Ministry of Commerce Notices No.10 and No.6, and Administration for Industry and Commerce Notice No.6 [2000] are only governmental regulatory documents, which doesn’t fulfill the minimum administrative regulatory requirements provided in the fallback clause.

So, State Council administrative regulations (supplementary rules）are still required to resolve these issues.

3. Local Government Foreign Investment Policy-Making Rights

The Foreign Investment Act gives local governments the right to create foreign investment policies within their statutory authority. On the one hand, this decentralization facilitates the creation of policies based on local conditions to better serve foreign investment. On the other hand, it may also pose challenges for foreign investment, such as conflicting policies and abuse of power by local governments.

Therefore, more specific local government policymaking guidelines are needed, and local governments should be allowed to issue their own supplementary rules based on local conditions and under the premise of standardized policymaking and approval procedures.

4. Matter Concerning the Applicability of the Foreign Investment Act to Investors from Hong Kong, Macao, and Taiwan

Investment by investors from Hong Kong, Macao, and Taiwan is neither foreign investment nor is it treated as domestic investment. Historically, these investments were treated with reference to foreign investment, yet the Foreign Investment Act does not specifically address investment by investors from Hong Kong, Macao, and Taiwan.

On March 15, 2019, Chinese Premier Li Keqiang met with and fielded questions from both local and foreign journalists and stated that investments by investors from Hong Kong, Macao, and Taiwan would be regulated with reference to or under the newly enacted Foreign Investment Act. Certain long-standing arrangements and practices would remain unchanged, which would not have any negative impact and also serve to help attract more investors from Hong Kong, Macao, and Taiwan.

Therefore, future supporting policies will also be required for investors from Hong Kong, Macao, and Taiwan.

III. Conclusion

The Foreign Investment Act was enacted in response to China’s fundamental internationalization policy and creates the fundamental legal system and framework for regulating foreign investment administration similar to the General Principles of the Civil Law.

On this basis, the National People’s Congress, the State Council, ministries, and local governments still need to update and issue more laws, administrative codes, and regulatory documents to further improve the legal system governing foreign investment administration and successfully reform the current foreign investment systems.