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China’s new foreign investment law unpicked

Beijing-based Norton Rose Fulbright partner Barbara Li explains what China’s new foreign direct investment rules mean for foreign companies entering one of the world’s biggest marketplaces

1 minute read
Following gradual economic liberalisation, China is now one of the most attractive destinations for foreign direct investment in the world. The latest is a new foreign investment law, which will take effect in January 2020. Here Beijing-based Norton Rose Fulbright partner Barbara Li explains what foreign investors and market participants need to know about the new law and the investment landscape in China.

China has become one of the most attractive destinations for foreign direct investment (FDI) in the world, consistently ranking among the top five FDI host countries over the past years, because of the huge market, availability of infrastructure, resource and skilled workforce – and the government's support for FDI. Since China adopted an open door policy in the 1980s, the government has implemented a wide array of laws and regulations to attract and promote FDI in China. The most recent significant regulatory change in this field is the issuance of the Foreign Investment Law, which was passed on March 15 2019 at the National People's Congress held in Beijing.

The Foreign Investment Law will take effect on January 1 2020 and the Sino-Foreign Joint Venture Law, the Sino-Foreign Cooperative Joint Venture Law and the Wholly Foreign-Owned Enterprise Law and their implementing rules (collectively three FIE laws) will be replaced. This change has significant implications for international investors and their business operations in China.

This Foreign Investment Law is the result of legislative actions taken by Chinese authorities over the past four years. The Ministry of Commerce of China issued two versions of the Foreign Investment Law for public consultation in 2015 and 2018 respectively. There were 170 clauses in the 2015 draft containing certain controversial provisions (such as variable interest entity (VIE) rules) as well as national security review requirements. But the 2018 draft significantly shortened and simplified the provisions. The final draft of the Foreign Investment Law passed in March 2019 adopts the same approach as the 2018 draft.

Key terms and their implications

The Foreign Investment Law aims to create a more level playing field for foreign investors in China. Key provisions include:

  • China will adopt pre-entry national treatment, and if foreign investors make investments in industries which are not on a prohibited or restricted list, investment made by foreign investors should be treated in the same way as investments made by Chinese investors. Therefore, no Chinese governmental approval is required before foreign investors invest in a project or set up a business presence in China if they are not covered in the negative list;
  • FIEs will take part in formulating industry standards, and the industry standards shall apply in the same way to FIEs and domestic Chinese companies;
  • FIEs will be allowed to raise financing in China through the public offering of shares or corporate bonds;
  • The Foreign Investment Law guarantees the free cross-border transfer of a foreign investor's capital contributions, profits, capital gains, asset disposal proceeds, technology transfer royalties and legal compensation, in accordance with the applicable legal procedures.

The Foreign Investment Law includes important provisions that will give better protections for foreign investors and their subsidiaries in China, including:

  • Technology cooperation shall be conducted on the basis of fairness, equity, free will and progressive business practices. Forced technology transfer is banned. Chinese governmental agencies and their officials shall protect the confidentiality of trade secrets and they will be liable if they disclose the trade secrets to others or otherwise violate confidentiality provisions. The Foreign Investment Law requires local governments at all levels to honour the policy commitments given to, or perform the contracts entered into with, foreign investors and their Chinese customers. If local governments change the policy commitments or contract terms due to national or public interest reasons, foreign investors and FIEs shall be compensated for their loss and damage;
  • The Foreign Investment Law confirms that China will establish a compliance mechanism to promptly address the issues raised by FIEs and their foreign investors. When FIEs and their foreign investors consider that their legal rights have been infringed by governmental authorities or their officials, FIEs and their foreign investors may apply for administrative review or initiate legal actions in courts, in addition to lodging compliants via the compliant mechanism.

The Foreign Investment Law sets out that the corporate governance and organisational structure of FIEs shall follow the Company Law and the Partnership Enterprise Law (as the case may be). This means that FIEs should follow the same corporate governance rules as Chinese domestic enterprises and the more rigid corporate governance requirements imposed under the three FIE laws will cease to apply. Key provisions in this regard include:

Shareholders' meeting to be highest authority According to the three FIE laws, board directors have the highest authority in Sino-foreign joint ventures and have the power to decide all major matters relating to FIEs. This structure is different from that envisaged in the Company Law, which provides that shareholders shall be the highest authority for the company and that the board of directors must be established according to the articles of association of the company. The structure provided in the Company Law actually leaves more room for shareholders' deliberations.

The new law clearly addresses certain difficulties facing foreign companies investing in China

Shareholders to have more control over decision-making The three FIE laws require that important matters such as (a) amendments to the shareholders' agreement and articles of association; (b) an increase or decrease of registered capital; (c) termination or liquidations of the FIE; and (d) merger and division of the FIE, must be approved by unanimous board resolutions. This requirement cannot be contracted out by parties. This requirement has in practice raised many difficulties for majority shareholders, because a minority shareholder can abuse its position to block major decisions, which is not desirable from a commercial perspective.

The Company Law does not have such rigid requirements, so after the Foreign Investment Law becomes effective on January 1 2020, the shareholders of FIEs will have more flexibility in discussing and negotiating how their business decisions can be made.

Appointment of directors, legal representative and senior management The three FIE laws require that the directors must be appointed by the parties in proportion to their equity ratio and the chairman and vice chairman must be appointed by different parties. After the implementation of the Foreign Investment Law, the parties will only need to follow the Company Law, which will give the parties much more room to decide how to appoint board members and senior management in accordance with the articles of association, without being subject to extra mandatory requirements.

Distribution of profit/liquidation proceeds not required to be in pro rata to equity ratio The three FIE laws provide that profits and liquidation proceeds of FIEs shall be distributed in proportion to the equity ratio respectively contributed by the shareholders. The only permissible exception is that foreign investors in cooperative joint ventures may recoup early its capital contribution by receiving a larger share of profit if certain conditions are satisfied, but in practice such structure often meets with resistance from local authorities.

The Foreign Investment Law provides that the operation of FIEs shall comply with the Company Law, which allows for the distribution of profits and liquidation proceeds to be not in proportion to their respective equity ratio if the distribution plan has been unanimously agreed by all shareholders.

Areas requiring further clarification

  • The Foreign Investment Law removes the comprehensive provisions in the 2015 draft with respect to national security reviews for foreign investment. However, the final version does contain a generic statement that China will establish a security review regime, giving no details about the conditions, criteria and processes for that to happen;
  • VIE is a contractual arrangement used by foreign investors to invest in industry sectors which are subject to foreign ownership restrictions and also widely adopted by Chinese domestic companies for seeking initial public offerings in the capital markets outside China. The 2015 draft expressly provided that contractual arrangements such as a VIE structure may not be used to circumvent the China's regulatory requirements. But the final version of the Foreign Investment Law discreetly walks away from the controversial provisions in the 2015 draft in relation to VIE structures. This seems to indicate that there is no immediate urgency from the government to regulate VIE structures. However, given that the Foreign Investment Law seeks to regulate indirect foreign investment, the door seems to remain open for Chinese authorities to tighten up regulation over VIEs later;
  • The Foreign Investment Law provides for an investment retaliation mechanism, under which China may take retaliatory measures if a country adopts any prohibitive or restrictive measures against China investments. This is the first time China has included this kind of reciprocity in its foreign investment regime. It will be interesting to see how this Damocles' sword will be used in practice.

Next steps

According to a recent report issued by the UN Conference on Trade and Development (UNCTAD), China attracted a record $142 billion worth of FDI in 2018, remaining the world's second-largest FDI recipient in 2018. While geopolitical risks such as the China/US trade war may bring some uncertainties, we expect that China FDI will maintain a reasonably strong growth momentum.

Since 2018, the Chinese government has further relaxed restrictions on foreign investment such as further opening banking and financial and high-end manufacturing sectors to international investors, and the new Foreign Investment Law clearly addresses certain difficulties facing foreign companies investing in China, such as the market access and technology transfer issues.

The Foreign Investment Law is significant for China, and can affect all foreign investors and their investments in all industries. Its issuance demonstrates the Chinese government's endeavors to further open up its market and build a more business-friendly environment.

The Foreign Investment Law sets out a number of new principles for promoting and protecting foreign investment in China, but there may be challenges ahead during the implementation phase. It is expected that Chinese authorities will promulgate further implementing rules, and international companies should keep monitoring the progress.

FIEs established before January 1 2020 should continue to follow the three FIE laws. After that date, all existing FIEs have a five-year transitional period to restructure themselves according to the new regime. This means that foreign investors and their FIEs will be required to review, revise and update key documents such as their shareholders agreements, articles of association, technology licensing agreements and their corporate governance structure, in compliance with the new regime. Given the great flexibility the new regime provides, international investors are advised to take this opportunity to review and optimise their foreign investment strategies in China.

Barbara Li
Norton Rose Fulbright,

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