China Adopts the Foreign Investment Law

1.Background
On March 15, 2019, the lasted draft of Foreign Investment Law of PRC was deliberated and passed by the Second Session of the 13th National People's Congress and will come into force on January 1, 2020. This newly promulgated law shows China's determination to deepen opening-up, and upon coming into fore, will shake the current pattern of foreign investment in China. As what the Deputy Chairman of the Standing Committee of the National People's Congress (“SCNPC”) said, “in the new era, China will implement the new concept of development, adhere to opening up to the foreign investment and implement a proactive opening policy to promote to forming a new pattern of overall opening-up”.
Since the Reform and Opening-up in 1978, China has been adopting three different laws to govern foreign investment into China based on the nature of the foreign investment namely Law of PRC on Sino-foreign Equity Joint Venture, Law of PRC on Sino-foreign Co-operative Enterprises and Law of PRC on Wholly Foreign-owned Enterprises (“Three Laws”). Due to the overlaps and conflicts between the Three Laws and the PRC Company Law which is latest updated in 2018, in practice it causes confusion on the application of laws. As China is deepening its opening-up and more investments are coming into China, it is highly necessary to formulate a unified foreign investment law to replace the Three Laws. After years of discussion, the State Council put the revision of the Three Laws on agenda for the first time in 2014, and following that, Ministry of Commerce published Law of PRC on Investment from Foreign Countries (Draft) on January 19, 2015 (“2015 Draft”) which attracted constant attention and triggered heated discussion. However, the 2015 Draft was put on hold due to its excessive controversy.
After three years, due to the increasing trade friction between China and United States, the Ministry of Commerce has been accelerating the legislative process of foreign investment law. On December 26, 2018, the SCNPC published the first draft of Foreign Investment Law of PRC for public comments and on January 29, 2019, the SCNPC had another meeting to deliberate the revised second draft. On March 8, 2019, the latest draft was submitted to the Second Session of the 13th National People’s Congress for final deliberation and eventually, it is voted to pass on March 15, 2019 (“Final Version”).
[This article will focus on the highlights of revisions to the Final Version and two drafts in 2018 and 2019, by reference to the 2015 Draft, and thereby provide a comprehensive analysis and interpretation of the contents and highlights of Foreign Investment Law of PRC to be effective. The discussion will cover the following four aspects: the definition of foreign investment, promotion of foreign investment, protection of foreign investment and management of foreign investment.]
2.Definition of Foreign Investment
There has been a long-standing debate over the title of this comprehensive foreign investment law. The 2015 Draft named it as Law of Investment from Foreign Countries, while the Finalized Version and two drafts in 2018 and 2019 all name it as Foreign Investment Law and re-define “Foreign Investment” by replacing the former explicitly-listed four categories with a catch-all clause, which leaves room for the development of new category of foreign investment in the future.
It is worth noting that the Finalized Version has removed the Variable Interest Entities (“VIE Structure”) from the definition of foreign investment and cancelled the standard of “actual controlling” to identify the foreign investment which was first mentioned in 2015 Draft.
2.1 Removal of VIE Structure
In practice, VIE Structure is initially designed for circumventing the restrictions imposed on foreign investors regarding the market access to certain industries, such as telecommunication, education, medical treatment and culture. The 2015 Draft for the first time incorporated VIE Structure into the definition of foreign investment, which means that the domestic companies controlled by foreign investors via agreements would also be treated as foreign-invested companies. Therefore, such companies would be subject to industry restrictions imposed on foreign investors. Such modification arose widespread concerns and anxiety among foreign investors.
The Final Version removes VIE Structure from the definition of foreign investment, which means that the nature of VIE Structure is still vague. It still needs to be further clarified and detailed on whether it will be interpreted to fall into the scope of newly added catch-all clause in the Final Version – “other forms of investment by foreign investors prescribed by laws, administrative regulations or the State Council within China”.
Despite this uncertainty, at a press conference held by the National Development and Reform Commission (“NDRC”), the speaker announced that “China will further open the market to foreign investment and promote foreign investment in the fields of education, medical care and culture industry.” It can be expected that, with the deepening of opening-up and reduction of restrictions on foreign investment, the need for foreign investors to circumvent the barrier of market access through setting up a VIE Structure will decrease accordingly.
2.2 Abandonment of Actual-Controlling Standard
The 2015 Draft adopted the standard of nationality of the actual controller to identify foreign investment. Domestic company actually controlled by foreign investor would be treated as a foreign-invested company and bound by foreign investment laws; by contrast, foreign-invested company actually controlled by Chinese investor would be treated as a domestic company, thereby receiving the same treatment as domestic companies. However, such arrangement brought controversy in practice since there was no clear definition of “Controlling” in the 2015 Draft. Once identified as foreign investment, the investor will face a series of difficulties such as restricted market access and more stringent foreign exchange policy.
According to the Final Version, the actual controller’s nationality is no longer a criterion for determining whether a company is considered as a foreign-invested company; instead, foreign investment will be characterized according to the nationality of the investors. This makes it much easier in practice for foreign investors to determine whether they are regulated by the foreign investment law or not.
3.Promotion of Investment: Implementing Pre-establishment National Treatment and Negative List
In 2015, the Negative List was first trialed in four Free Trade Zones of China. In 2018, the Pre-establishment National Treatment Plus Negative List scheme was adopted in the first draft and became a highlight in the Foreign Investment Law of PRC.
It is worth noting that after the release of the second draft in 2019, the Ministry of Commerce and NDRC issued a notice on requesting public comment on the Catalogue of Encouraged Industries for Foreign Investment (Draft) on February 1, 2019. This Draft revised the current Catalogue of Industries for Guiding Foreign Investment which was published in 2017. This is a systematic modification following the publishing of Negative List on June 26, 2018, conductive to a better convergence of different foreign investment laws and regulations. The key industries encouraged opening-up include modern agriculture, advanced manufacturing, high-technology, modern service industries etc., among which the automotive manufacturing, software and information technology services industries have a relatively higher degree of openness.
Another highlight of Foreign Investment Law of PRC is the clarification of implementing the Principle of Equal Treatment to Both Domestic and Foreign Investment (the “Principle”). The Final Version not only makes it clear that the Principle applies to the industries which are not included in the Negative List, but also defines the content of this Principle. For example, the national policies to support business development are equally applicable to foreign-invested enterprises (Article 9), foreign-invested enterprises take part in the standardization work equally and apply the national compulsory standards equally (Article 15), foreign-invested enterprises participate in government procurement activities through fair competition (Article 16), foreign-invested enterprises can finance through public offerings of stocks, securities including bonds and other means (Article 17) and etc.
4.Protection of Investment:
Prohibiting Compulsory Technology Transfer and Protecting Trade Secrets of Foreign Investors
In 2018, the United States criticized China's compulsory technology transfer in its Section 301 Investigation, which put China under mounting international criticism. Intellectual property is one of the core issues in the China-U.S. trade friction. Since there still exist restrictions on the ratio of foreign-invested equity in some industries in China, some foreign investors shall look for domestic partners for joint venture when trying to enter such industries. During this process, some foreign investors may be at a sticky wicket and required by their Chinese partners to transfer technology, which is misinterpreted as compulsory technology transfer.
The published Foreign Investment Law of PRC clearly provides the protection of the intellectual property of foreign investors. The drafts in 2018 and 2019 and Final Version all add a provision stating that “the conditions for technology cooperation in the process of foreign investment shall be determined by the parties through negotiation, and administrative authorities shall not use administrative methods to force the transfer of technology”. In addition, the Final Version also add a brand-new provision to emphasize the legal liability arising from the infringement on intellectual property right.
In addition to protection for intellectual property right, the Final Version proposes for the first time that “the administrative authorities should keep confidential the trade secrets of foreign investors and foreign-invested companies that come to its knowledge in the course of performing duties”.
Offering adequate protection for the rights of foreign investors plays a significant role in encouraging and attracting foreign investment. China's protection for intellectual property right is a process of continuous development and improvement. The new provisions added to the Foreign Investment Law of PRC help dispel the misunderstanding of compulsory technology transfer and ease concerns among foreign investors, which will eventually boost foreign investors’ confidence on Chinese market.
In addition, this revision especially emphasizes the requirement of compliance with laws and regulations. Words like “according to the laws”, “complying with the laws”, “pursuant to the legal authorities and procedures” etc. appears frequently in the Final Version. Though such revisions are mostly made to legal principles, it demonstrates the attitude and determination of Chinese government to protect foreign investors’ interests from a legal perspective, which will enhance the confidence and sense of belonging for foreign investors to enter China.
5.Management of Investment
5.1 Form of Foreign-Invested Enterprises
The Foreign Investment Law of PRC provides that the organization form of foreign-invested enterprises shall be regulated by the PRC Company Law and PRC Partnership Enterprise Law, which means a newly established foreign-invested enterprise will be registered as a limited liability company, joint stock limited company or partnership enterprise, without distinguishing as wholly foreign-owned, Sino-foreign joint ventures or Sino-foreign cooperation. It is worth mentioning that the Foreign Investment Law of PRC provides a five-year transition period, that is, a foreign-invested enterprise established in accordance with the Three Laws can maintain its original organization form (such as wholly foreign-owned, Sino-foreign equity joint venture or Sino-foreign co-operative joint venture) within five years after the Foreign Investment Law of PRC come into force.
For guaranteeing the smooth of five-year transition period, the Final Version further authorizes the State Council to formulate specific rules to regulate the organization form of foreign-invested enterprises within such transition period.
5.2 Reporting System of Foreign Investment Information
The draft in 2018 proposed for the first time to establish reporting system of foreign investment information and specified the report by the foreign investors and foreign-invested enterprises shall follow the “Principle of Necessity”. The draft in 2019 and the Final Version further stipulates the legal liabilities for failing to report in accordance with the requirements. After the Foreign Investment Law of PRC comes into force, the reporting system will need further elaboration through formulating detailed regulations. It can be expected that, the information required to be reported may be more simplified than that required to be filed currently, which will to some extent contribute to simplifying the procedure of foreign investment and improving efficiency.
5.3 Review of Concentration of Undertakings
Moreover, Foreign Investment Law of PRC provides that foreign investors acquiring domestic enterprises in China or participating in concentration of undertakings in other ways shall be subject to the review of concentration of undertakings in accordance with Anti-monopoly Law of PRC. This not only reflects the Principle of Equal Treatment to Both Domestic and Foreign Investment in the field of merger and acquisition, but also embodies China’s emphasis on establishing fair and just market competition.
6. Conclusion
Just as President Xi Jinping stressed in his speech at the 2019 Spring Festival Reception, the Reform and Opening-up policy has come to a new era and will be further deepened. The boost of foreign investment legislation not only shows China's emphasis on promoting foreign investment and protecting the interest of foreign investment, but also reflects China's determination and courage to deepen opening-up. As the new fundamental law of foreign investment, Foreign Investment Law of PRC is expected to guide, promote and standardize the foreign investment in China. As a result, it will further facilitate legalization and internationalization of China as well as create a healthy, fair and efficient business environment.