China Amends Its Foreign Investment Approvals (Ⅰ)

A New Era for the PRC Foreign Investment Regulation Regime (Ⅰ)
This past National Day holiday of 2016 in China has been most remarkable as it marks the start of a new era for the PRC foreign investment regulation regime, pursuant to which over 90% of foreign investment activities will no longer need prior approval from the Ministry of Commerce, or MOFCOM, the ministry in charge of foreign investment matters among other things. Instead, other than those captured by a "negative list", all foreign investments are now subject to a record filing requirement. On October 1, 2016, amendments to the so called "Three FIE Laws" (defined below) officially took effect, and on October 8, rules detailing other aspects of the record filing system were published by MOFCOM and the National Development and Reform Commission, or the NDRC, and the record filing system is officially ready for rollout. The new system affords foreign investors "pre-establishment national treatment" and represents a significant step of the PRC government towards the establishment of a "new open economy system". This essay aims to present a review of the legislative background that leads to this reform and our understanding and analysis on some of the features of the new record filing system.
I. The Approval Based Regime
The old regulatory regime was established with the promulgation of the Sino-foreign Equity Joint Venture Enterprise Law in 1979. In 1986 and 1988, respectively, the Foreign Owned Enterprise Law and the Sino-foreign Cooperation Joint Venture Enterprise Law were promulgated, thereby completing the trio of the so called "Three FIE Laws", which constitute the three pillars of the foreign investment regulatory regime that governed foreign investment matters for the past three decades (and will continue to be effective under the new system). The abbreviation "FIE" stands for foreign invested enterprises. Under the Three FIE Laws, all foreign investments into China and their subsequent changes require prior, case-by-case approval from MOFCOM or its local branches. In its deliberation of each case submitted for approval, MOFCOM will review not only the background of the foreign investor, the industry and project that the foreign investor intends to engage in, but also the corporate governance terms of the FIEs to be established. Joint venture contracts and articles of associations of FIEs are to become effective only after MOFCOM approval is granted. As a result, FIEs have been subject to a parallel series of regulations in addition to the PRC Company Law (which was promulgated in 1993). In addition, starting from 1995, the PRC government has also published catalogues (the "Catalogues") for guidance of foreign investment industries once every three to four years. The Catalogue lists industries in which foreign investments are encouraged, restricted and prohibited. Industries that are not listed in the Catalogue are deemed as permitted industries for foreign investments. Foreign investments in encouraged industries are subject to lower level of scrutiny, while investments in restricted industries are subject to higher level of scrutiny and may also be subject to other restrictions. Over the years with the gradual opening up of the Chinese market, the lists of restricted and prohibited industries are getting shorter and shorter, and the latest Catalogue, the 2015 version, includes over 300 industries in the "encouraged" bucket and merely 36 industries in the "prohibited" bucket.
Nevertheless, despite the development of the Catalogue and the removal of more and more industries from the "prohibited" bucket, prior to October 1, 2016, formation of all foreign invested enterprises, and their subsequent material changes (including without limitation business scope, increase or decrease of registered capital, share transfer and liquidation) were subject to prior approval of MOFCOM regardless of the industries that they fall into and the investment amount involved. Such an extensive approval system, which played a pivotal role in the initial opening up of China to the external world and in bringing in foreign capital and technologies into the Chinese market, now seems excessive and inefficient. It prolongs the approval process, increases regulatory costs for foreign investors and to some extent, impedes free competition and liquidity flow.
II. Test Water - Negative List of Free Trade Zones
The PRC government has acutely realized the restrictions of the old approval based regulatory regime and has, over the past few years, explored ways of reformation. One most laudable endeavor in this regard is the "negative list" system that was first introduced and tested on a pilot basis in the Shanghai Free Trading Zone ("FTZ"). In August 2013, the Standing Committee of National People's Congress ("NPC") authorized the State Council to temporarily adjust implementation of certain clauses of the Three FIE Laws within the Shanghai FTZ for a period of three years. As a result, a significant number of matters that require approvals under the Three FIE Laws only require a filing within the Shanghai FTZ. In June 2014, as authorized by the State Council, the Shanghai municipal government promulgated a negative list applicable within the Shanghai FTZ. Pursuant to the list, in accordance with the principle of equal treatment for domestic and foreign investors, foreign investments in fields not covered by the negative list are subject to the record filing system (excluding investment projects for which approval requirement is maintained even if conducted by domestic investors), while investments in fields covered by the negative list will continue to be subject to the approval procedures. In 2015, the Shanghai FTZ experience was replicated in Guangdong, Tianjin and Fujian FTZs, and the General Office of State Council promulgated a negative list that applies to all four FTZs.
III. Attempt at an Ambitious Overhaul - the Discussion Draft Foreign Investment Act
On January 19, 2015, MOFCOM published a discussion draft of the proposed new Foreign Investment Law ("Draft FIL") on its official website for public comments.
The draft immediately attracted tremendous attention and extensive discussions as it, if adopted, would represent a complete overhaul of the existing regime and would replace the trio of the Three FIE laws in its entirety. Revolutionary changes proposed by the Draft FIL include:
Entry clearance management of foreign investment: the Draft FIL proposes to abolish the case-by-case approval requirement and to afford foreign investors pre-establishment national treatment subject to a "negative list" control. The government will only approve investments made by foreign investors in areas that are listed in the "negative list", and all other investments of foreign investors can be implemented without prior approval from foreign investment regulators. In addition, with respect to investments captured by the negative list, the focus of the approval review will be on the background of the foreign investor and the investment activities, rather than the joint venture contracts or the articles of association, and all FIEs will, same as domestic companies, be governed by the Company Law, Securities Law, the Partnership Law and etc. with respect to corporate governance matters.
Information reporting system: with the revocation of prior approval for most foreign investment activities, Draft FIL contemplates that the focus of the foreign investment regulator will be shifted to ex post supervision, monitoring and service provision. To this end the Draft FIL proposes a comprehensive information reporting and filing system that includes not only ad hoc filing for each establishment of an FIE and its subsequent reportable changes, but also annual reporting obligations of foreign investors. Data generated by the information reporting system as contemplated by the Draft FIL will be used for various purposes including supervision and monitoring by the regulators, assessment of creditworthiness of foreign investors, and as basis for compilation of official foreign investment reports and formulation of state policies.
Concept of "actual controller": Under the Three FIE Laws, a foreign investor refers to a foreign individual or an entity that is incorporated in foreign countries. While there is no fundamental change to this definition, the Draft FIL introduces the concept of "actual controller" of a foreign investor, and allows a foreign investor whose actual controller is a Chinese company or individual to, upon presentation of sufficient proof, be treated as a Chinese investor in investments in areas that fall within the scope of the negative list. In addition, control over domestic entities via contract or trust is deemed a form of foreign investment subject to the law. As a result, foreign investors will not be able to circumvent the restrictions set forth in the negative list by entering into viable interest entity, or VIE, contracts.
The Draft FIL also contains chapters devoted to national security review, investment facilitation system protection system, and dispute resolution mechanism for disputes that foreign investors and FIEs may have with regulatory authorities. If adopted, the Draft FIL will provide a comprehensive regulatory framework for foreign investment activities within China.
Due to the radical changes proposed by the discussion draft and the potentially revolutionary impact it could have on the market if adopted, the draft, albeit merely a "discussion draft", already affected the decision making by many market participants in evaluating investment opportunities and structures in China. The Hong Kong Stock Exchange even required listing applicants with operations located in China to provide risk factor analysis with respect to the impact that the draft may have on them once adopted.
Nevertheless, there are obvious signs which indicate that the discussion draft is a draft that is at a fairly early stage. For one thing, all Three FIE Laws were promulgated by the NPC, the highest level of legislative body in China, and the Foreign Investment Law would need to be promulgated by the NPC as well or at least its standing committee, while the discussion draft was prepared by MOFCOM, which is just a ministry of the State Council. Before being codified into law, it would need to go through several stages of deliberation and review. For another, the draft as published is incomplete. Article 158, the article intended to address the regulation of the VIE structure, is merely a placeholder. MOFCOM did not include a draft clause, but instead in its drafting note set forth its proposed approach towards the regulation of this particularly sensitive issue.
IV. A More Modest and Practical Approach - The Record Filing System as Adopted
As the market has seen after the National Day holiday, instead of replacing the Three FIE Laws in their entirety by a comprehensive foreign investment law, the PRC government has decided to take a more modest and practical approach that involves minimum changes to the existing set of laws and regulations but still effectively grants a pre-establishment national treatment to foreign investors in most of their foreign investment activities in China. This is achieved by the following three steps:
Amendment to the Three FIE Laws: On September 3, 2016, the Standing Committee of NPC passed amendments to the Three FIE Laws[1]. Each law is amended by adding an article which provides that, with respect to matters involving wholly foreign owned enterprises, Sino-foreign equity joint ventures and Sino-foreign cooperative joint ventures that are not captured by the special administrative measures specified by the State, a record-filing requirement, instead of the approval requirement otherwise provided in the laws, will be applicable. The special administrative measures are to be promulgated, or authorized to be promulgated, by the State Council. These amendments took effect on October 1, 2016. These amendments laid the legislative basis for the record filing system and also authorized the State Council to promulgate "special administrative measures", a.k.a. the "negative list".
Filing Measures Promulgated by MOFCOM: On September 3, 2016, MOFCOM published Provisional Measures for Filing Administration of Establishment and Changes of Foreign-invested Enterprises (Draft) and solicited comments from the public. Then on October 8, 2016, immediately after the National Day holiday, the Provisional Measures (having incorporated certain amendments based on comments received) were officially enacted and became effective. The Provisional Measures set forth detailed guidance with respect to the scope of application of the filing system, the timing, process, and information requirement of the filing, authorities in charge of the filing, and etc.
"Negative List": As the filing system only applies to matters outside of the "negative list", the content of the negative list is a critical element of this reform, as it would indicate the depth of the reform and the actual effect of simplification of red tape. Therefore this is probably also the element that was subject to most anticipation in the market. The anticipation was answered on October 8, 2016 by a brief joint announcement issued by NDRC and MOFCOM (Announcement No.22 of 2016), according to which the "special administrative measures" shall be the restricted and prohibited categories, as well as items that are subject to special requirements with respect to equity holding and executives in the encouraged categories as set forth in Catalogue (the 2015 version). While the market was somewhat taken by surprise by this announcement which, instead of publishing a new list, merely refers to the restrictions included in the existing Catalogue, this approach does make a lot of sense under the current circumstances. Compilation of a negative list that applies nationwide takes time, and in any event it would probably be better to compile such a list when the negotiations of bilateral investment treaties with the US and EU are finalized. From a substance point of view, the restrictions contained in the 2015 Catalogue largely coincide with the negative list that is currently implemented in the four FTZ zones. Even if a new list were to be complied at this point in time, it probably would not be significantly different from the restrictions in the 2015 Catalogue.
注释
[1] A fourth law, the Law on the Protection of Investment by Taiwanese Compatriots was also amended by adding a similar article.