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4 Jan 2020

China Releases Official Implementation Rules of Foreign Investment Law

On 31 December 2019, the PRC State Council published the official Implementation Rules of the Foreign Investment Law (“FIL Implementation Rules”), which took effect on 1 January 2020. Compared to the previous draft implementation rules that were published in November 2019 concerning China’s new Foreign Investment Law (“FIL”) (for more details, please see our previous newsletter regarding the draft version), the official FIL Implementation Rules have brought some material changes. In particular, some of the key changes include the following:

Removal of “Round-trip Investment” Exemption. One of the groundbreaking revisions that had previously been envisioned under the draft rules proposed that investments that both: (i) are made by foreign entities which are wholly owned by PRC citizens or PRC domestic entities; and (ii) have been reviewed by a designated PRC governmental authority and also approved by the State Council, would no longer be subject to the restrictions and prohibitions set forth in China’s so-called “negative lists”, which serve as the primary source of foreign investment restrictions and prohibitions under PRC law (“Negative Lists”).[1] However, the FIL Implementation Rules have now removed this exemption, possibly as a result of inherent difficulties in reviewing or supervising the (relatively few) entities that would have actually been entitled to it. At the same time, the removal of this language is also likely an indication that the Chinese government is still generally reluctant to shake up its longstanding approach to VIE structures or regulations that would have a direct impact on Chinese companies pursuing foreign financing or listings on overseas securities exchange markets in particular. Generally, as with the FIL itself, the FIL Implementation Rules remain silent on regulations that would govern the use of VIE structures in China.

Clearer Roles for Foreign Investment Regulators. Under the new FIL regime, the main PRC governmental authorities tasked with regulating foreign investment in China include the State Administration for Market Regulation (“SAMR”), the Ministry of Commerce (“MOFCOM”), the National Development and Reform Commission (“NDRC”) and the primary regulators in specific industries. In particular:

  • SAMR and its local branches are responsible for registrations of foreign-invested entities (“FIEs”), including, e.g., registrations for FIE establishment, corporate changes, dissolution, etc. Unlike the draft rules, the FIL Implementation Rules do not specify that SAMR is responsible for review and examination procedures in order to determine whether a foreign investment meets special regulation requirements under the Negative Lists. However, based on responses from senior officers of MOFCOM, the NDRC and the Ministry of Justice,[2] as well as notices issued by some of MOFCOM/SAMR’s branches (e.g., Shanghai and Guangdong) and our own communications with MOFCOM, MOFCOM will no longer be responsible for determining whether a foreign investment meets special regulation requirements under the Negative Lists, and will no longer be responsible for accepting filings or grant approvals for FIE establishment or the registration of corporate changes.
  • MOFCOM is jointly responsible alongside the NDRC for formulating and promulgating updates to the Negative Lists, which will be subject to approval from the State Council. In addition to the Negative Lists, MOFCOM and its local branches are also responsible for reviewing investment reporting information which will be directly forwarded by SAMR through its “National Enterprise Credit Information Publicity System” or its company registry system.[3]
  • In addition to formulating and promulgating updates to the Negative Lists with MOFCOM, the NDRC’s major roles in regulating foreign investment seem to remain those under the status quo arrangement, i.e., overseeing certain project examinations and filing procedures for foreign investments.  
  • Finally, the primary regulators in specific industries are also envisioned under the FIL Implementation Rules as being responsible for reviewing relevant industrial entry qualifications for FIEs and issuing industry operating licenses or permits. It is worth noting that the FIL Implementation Rules specify that regulators in specific industries should supervise whether a foreign investment actually meets special regulation requirements under the Negative Lists. This would seem to require a degree of coordination between those regulators and SAMR concerning FIE registrations, which may require further clarifications.

Clarification on Chinese Joint Venture Participation. Under the old PRC legislation governing joint ventures, “Chinese natural persons” were not listed among the Chinese parties legally entitled to establish joint ventures with foreign investors. Accordingly, Chinese natural persons have not been able to establish joint ventures with foreign investors in China for a long time (though in recent years, this restriction has been gradually lifted in some local jurisdictions). The FIL Implementation Rules now explicitly clarify that Chinese natural persons will be able to set up JVs alongside foreign investors. 

Removal of Buffer Period following Five Year Transition Period. The prior draft rules granted existing FIEs a six-month buffer period beyond the five-year transition period in which FIEs are required to update their organizational forms and governance mechanisms to comply with the unified forms supplied under the PRC Company Law and the PRC Partnership Enterprise Law (i.e., a six-month buffer following the formal transition deadline of 1 January 2025). The FIL Implementation Rules do not adopt this six-month buffer period and stipulate a hard registration/modification deadline of “1 January 2025”.  If FIEs fail to handle such updates by this deadline, then SAMR will not accept any registration applications from such FIEs and may choose to publish such failures.

Clarification on FIE Reinvestment. Prior to the promulgation of the FIL Implementation Rules, the treatment of investments made by FIEs within the PRC (i.e., “reinvestments”) differed depending on whether the particular sectors being invested in were restricted under the Negative Lists. In particular, if an FIE investment in China fell into a restricted sector under the Negative Lists, then the special administration measures (e.g., foreign ownership restrictions) set forth in the Negative Lists would apply to such reinvestments, and additionally, any further establishment of entities or changes of ownership (e.g., equity transfers) would be subject to approval by MOFOCM or its local branches. However, the FIL Implementation Rules now clarify that the FIL and its wider regulatory regime will apply to all investments by FIEs within the PRC. This clarification indicates that reinvestments by FIEs within the PRC will still be subject to any restrictions provided in the Negative Lists, however the establishment of entities and changes of ownership will not be subject to MOFCOM approval, but will instead be subject to the ordinary SAMR registration process. That said, there are still other important matters relating to FIE reinvestment that have yet to be clarified, including whether SAMR and regulators in specific industries will consider multiple layers of ownership in FIE group companies in order to identify ultimate foreign shareholders (i.e., when assessing foreign shareholder levels), as well as what percentage of foreign ownership will constitute FIE status, etc.

Clarification on Prevailing Law. In general, when it comes to regulating foreign investment in China, various PRC regulators have long provided an array of many specialized and intricate policies in the form of circulars, rules, administrative measures and regulations. The FIL Implementation Rules specify that both the FIL and the FIL Implementation Rules will prevail if there is any discrepancy between their provisions and any rules concerning foreign investment made before 1 January 2020. This provision signals that a large number of specialized foreign investment management measures and policies will be abolished, including, for example: the concept of “total investment amount” and the regulatorily significant difference between a FIE’s total investment amount and its registered capital; prohibitions against using registered capital for equity investments by FIEs;[4] special requirements for the establishment of foreign invested companies limited by shares;[5] and other specialized requirements that target specific industries which do not fall under the Negative Lists.

In light of this, MOFCOM recently issued notices to officially abolish 56 specialized foreign investment regulations, followed by the abolishment of six more specialized foreign investment regulations and notices, which were collectively abolished as of 1 January 2020. Following these actions, we expect that more specialized foreign investment regulations issued by various regulators will be abolished in the near future, to the extent that they conflict with the FIL or the FIL Implementation Rules.[6]

Taken together, although the FIL Implementation Rules have addressed many pending issues relating to the treatment of foreign investment under the FIL, there are still several major issues that remain to be resolved or clarified in the future. To take one example, the FIL Implementation Rules follow the FIL in stipulating that PRC government departments and their staff should face legal liabilities in the event that they violate certain investor-friendly safeguards against regulatory overreach (specifically: the principle of equal treatment between domestic and foreign investors; the legal remittance of funds both into and out of China for foreign investors; and prohibitions against forced technology transfers). However, the FIL Implementation Rules fail to specify which laws/regulations or specific penalties should apply in the event of such violations, which leaves considerable debate and uncertainty in practice. Additionally, PRC regulators have yet to clarify the ultimate scope of the national security review system that is envisioned as being applied to foreign investments that potentially affect PRC national security, it is still unclear whether SAMR will also be responsible for approving certain special matters historically governed by MOFCOM (e.g., the establishment of foreign invested telecoms enterprises, i.e., “FITEs”), and it is uncertain whether the existing method of calculating foreign debt (based on gap between total investment amount and registered capital) for FIEs will remain in place.

It is expected that PRC governmental authorities may issue additional implementation rules or guidance on these particular issues in order to amplify the impact of the FIL at some point in the future.  

[1] The Negative Lists system currently in force is composed of two lists jointly issued by the Ministry of Commerce and the National Development and Reform Commission. Namely, the Negative Lists include: (1) the Special Administrative Measures for Access of Foreign Investment (Negative List) (2019 Edition), which was issued on 30 June 2019 and which applies to the PRC except for in pilot free trade zones (“FTZs”); and (2) the Special Administrative Measures for Access of Foreign Investment in Pilot Free Trade Zones (Negative List) (2019 Edition), which was issued on 30 June 2019 and applies to FTZs. Please see our previous newsletter for more information concerning such Negative Lists.

[2] In an official press release held on 31 December 2019, government officials representing MOFCOM, the NDRC and the Ministry of Justice responded that all approvals and filing requirements concerning FIE establishment and other matters provided under the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures, the Law of the People’s Republic of China on Foreign-invested Enterprises, and the Law of the People’s Republic of China on Sino-foreign Cooperative Joint Ventures, will no longer implemented, as these laws are abolished. See: http://www.gov.cn/zhengce/2019-12/31/content_5465599.htm.

[3] See the Measures for Reporting of Information on Foreign Investment, jointly issued by SAMR and MOFCOM on 30 December 2019, and effective since 1 January 2020.

[4] The  Circular of the State Administration of Foreign Exchange on Further Promoting Cross-Border Trade and Investment Facilitation, issued by the State Administration of Foreign Exchange and effective since 23 October 2019, provides that FIEs may use any capital-account funds (either their original currency or RMB after conversion)—including registered capital as well as foreign debt—for investments in PRC equity.

[5] Additionally, the Interim Provisions concerning the Establishment of Foreign-invested Companies Limited by Shares has been expressly abolished under a circular issued by MOFCOM on 1 January 2020.

[6] For example, SAMR issued a notice on 25 December 2019 that would require all of its local branches to report their policy clearance work by the end of June 2020.

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