What draft foreign investment law means for investors

January 21, 2015 10:24
China's aerospace industry is likely to be one of the sectors in which potential foreign investment must continue to be reviewed. Photo: Bloomberg

On Monday, the Ministry of Commerce released a draft foreign investment law for public comment.

The law is intended to replace three existing laws that regulate foreign investment in China.

The following is a quick overview of the draft and what it means for investors.

Q: What are the major changes proposed in the draft?

A: The biggest difference is its adoption of the negative-list regulation system. Foreign investment will no longer need to be approved case by case. 

Overseas investors will, in general, be given pre-entry national treatment (that is, they will be treated like domestic investors). They will need to have their projects and companies approved only if the investment is on a negative list, which specifies sectors that are off-limits to overseas investors.

The draft doesn’t have a negative list attached to it. If clues are needed to its composition, the negative list released by the Shanghai Free Trade Zone may be a good reference, because the FTZ is designed to pilot national reforms, including the reform of foreign investment regulations.

The proposed law also highlights the concept of the "actual controllers” of a company.

Whether a firm is a foreign-invested company can be determined by looking at those who really control it. If they are Chinese nationals, the firm can apply to be treated as a domestic company.

But Chinese firms that are in fact controlled by foreigners -- through methods such as setting up a variable interest entity, in which a wholly foreign-owned firm controls a wholly domestic-owned firm via contractual arrangements -- will be treated as foreign firms and hence be subject to possible review with respect to the negative list.

The draft does not explain how the authorities will treat existing Chinese companies of this kind that conduct businesses that appear on the negative list.

The ministry said it will further discuss this issue based on the opinions it receives from the public.

The draft establishes a reporting system that requires foreign firms to report basic information about themselves to the authorities upon registration and any major changes thereafter.

A quarterly report of business operations and financial information is required if the company’s total assets, sales or revenue exceeds 10 billion yuan (US$1.61 billion) or if it has more than 10 subsidiaries.

And if a foreign firm buys shares of a domestically listed company, the foreign firm needs to report the transaction.

Q: In what areas are foreign companies more likely to be restricted?

A: The restrictions on foreign investors lie mainly in two areas.

Firstly, they may be affected by anti-monopoly regulations, which are governed by another law.

Secondly, in the case of general investments, national and industrial security will be factors restricting foreign businesses.

The draft lists the following sectors as examples of industries to be specially safeguarded: national defense, key technologies, information and cybersecurity, energy, food and resources.

Whether a foreign firm is controlled by a foreign government is also a factor that will be considered.

This is apparently in retaliation against the US government, which often cites Chinese private companies’ alleged links with the Chinese government in deciding to block their investments in the United States.

Q: What organizational changes should an overseas company make to conform to the draft?

A: After the new foreign investment law takes effect, a foreign-invested company will be obliged to adjust its organizational structure to conform to the Company Law within a grace period of three years.

The major alterations could include installing a supervisory board, a trade union and a Communist Party unit, if the firm has enough Party members.

Q: When will the draft law take effect?

A: The Ministry of Commerce is seeking opinions from the public on the draft.

After the ministry revises the draft, it will be subjected to review by the State Council.

The State Council will then submit it to the National People’s Congress (NPC), which will further review the draft before it is considered by the NPC Standing Committee.

For such an important law, three rounds of deliberation by the Standing Committee may be needed. It really depends on how fast the central government wants the law to take effect.

The foreign investment law has been put in Category II of the NPC’s legislation agenda, meaning “the law could be subject to NPC review when conditions are ripe”.

Three rounds of deliberation alone usually take a year, so the entire process could take several years.

But given that the 12th NPC's term ends in March 2018, it is possible that the law can be passed by then.

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The writer is an economic commentator. He writes mostly on business issues in Greater China.