Out-Law Guide | 01 Mar 2022 | 3:56 pm | 6 min. read
From the beginning of China's gradual opening to the world 40 years ago, China has always exercised tight control over all aspects of FDI. It was not until 1986 that China first allowed wholly foreign-owned enterprises in a limited range of sectors. Following its accession to the World Trade Organisation (WTO), China has steadily increased the range of activities open to sole foreign investment without the need for a Chinese partner. Along the way, China has developed a robust legal and regulatory framework particular to foreign investment.
The FIL (中华人民共和国外商投资法) is the basic law governing FDI in China, establishing core principles for the promotion, protection and market access of foreign investment.
One key innovation of the FIL is that it promises foreign enterprises "national treatment", on a par with domestic enterprises, for permitted investments. However, the FIL does not provide national treatment with respect to market access. FDI is still prohibited and restricted in a number of areas, through the use of a so-called ‘Negative List’. To implement the principle of national treatment, the FIL abolished long-standing separate laws on wholly foreign-invested enterprises and Sino-foreign joint ventures. With that, in areas where FDI is permitted, foreign invested enterprises of all types will be subject to the same legal frameworks as domestic Chinese companies, e.g. the Company Law.
Under the FIL regime, the applicable Chinese FDI rules, i.e. rules for investments in greenfield ventures as well as acquisitions of all or parts of a domestic companies' equity or assets, largely depend on whether the intended investment activity is on the Negative List.
The FIL covers several types of foreign investment:
Companies registered in Hong Kong, Taiwan and Macao are treated as "foreign" for the purposes of most Chinese regulations governing foreign investments.
FDI oversight and administration is primarily managed by the following organisations:
The Negative List, officially "Special Administrative Measures for Foreign Investment Access" (外商投资准入特别管理措施), is a document that is jointly issued by MOFCOM and the NDRC. It is updated periodically and has been steadily shrinking over the years.
In addition to the national Negative List, there are two other documents relevant to foreign investors:
One of the first steps in contemplating any investment is a thorough review of the relevant investment catalogues.
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Items included in the Negative List may be either prohibited outright to foreign investment, or may be restricted. Prohibited activities include tobacco wholesale/retail, stem cell and genetic treatments, social surveys, film and TV production, compulsory education, and others. Restricted activities include automotive manufacturing, basic and value-added telecommunications services, transportation, energy, utilities, banks and financial institutions, agriculture, and others. Where an activity is restricted, approval is expressly at the discretion of the competent authorities. The authorities may approve of, ask for modification of or deny the investment. In any case, a joint venture with a Chinese party will be required for any restricted venture, often with the Chinese party holding a controlling interest.
The items in the Encouraged List include wine grape breeding, aquaculture, oil exploration, cotton yarn production, etc. Governmental incentives include, for example, tax incentives and duty free-import of production equipment. Local authorities may also offer rent reduction, local tax relief, salary subsidies and other incentives for investments in local priority industries, whether or not on the Encouraged List.
Activities not on the Negative List or the Encouraged List are in principle permitted to FDI. However, this is subject to the discretion of the local authorities. Moreover, there are a number of areas (e.g. training) where foreign investment should be permitted in practice, but in fact are not. Approvability needs to be confirmed with the local officials at SAMR and NDRC.
Besides the restrictions on FDI that falls under the Negative List, a foreign investment will also be subject to a national review if it "affects or may affect national security". The rules do not expressly apply to JVs with Chinese parties, although an analogous informal review may take place in those cases.
Under the existing review system, the security review applies to acquisitions of all or parts of domestic military industrial enterprises and tertiary enterprises, enterprises located near major and sensitive military facilities, and other entities related to national defence or security. The review mechanism is also triggered by acquisitions in other national security related sectors such as major agricultural products, major energy and resources, infrastructure, transportation services, key technologies and key equipment manufacturing.
If an acquisition by a foreign investor is likely to trigger national security concerns, the foreign investor should notify MOFCOM of the transaction. Upon receiving a notification, if MOFCOM determines that a national security review is required, it will establish an inter-ministerial panel, principally run by NDRC and MOFCOM, to conduct the review and issue a decision within 100-120 working days. Depending on the sensitivity of the transaction, the inter-ministerial panel will conduct a ‘general review’ or ‘special review’. If the inter-ministerial panel determines that the transaction is likely to have a major impact on national security, MOFCOM will require the applicant to either terminate or restructure the transaction (including transferring back equity interests or assets if the acquisition has already been closed.
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There are further approval procedures and formalities to take into consideration depending on the individual investment.
Complex approval requirements by the China Securities Regulatory Commission and MOFCOM apply where an investor intends to acquire parts of a listed company, for example in the context of major acquisitions and changes of control of listed companies. Particular care may be required to avoid the need to make a general tender offer when acquiring more than 30% of the shares of a listed company.
Foreign investors can acquire equity or assets of state-owned enterprises (SOEs) or their subsidiaries. The governmental process is administered primarily by the State-owned Assets Supervision and Administration Commission (SASAC) at central and lower levels. It is overall a quite cumbersome and burdensome process. The process is designed to ensure that state assets are not undervalued and to minimise the impact on employees.
In any transaction potentially involving SOEs or state assets, it is critical to ensure that the seller complies with the mandatory procedures for state asset transfers. These include use of a local state asset clearinghouse, internal approval and approval by the relevant SASAC, auditing, evaluation, publication of and invitation to bid, and undertaking a bidding process if two or more interested parties respond.