14 September 2016

China to introduce major foreign investment law reform

The Standing Committee of the People’s Congress decided on 3 September 2016 to amend three important laws that form the legal framework for foreign investment in China. The Ministry of Commerce (MOFCOM) issued draft implementing measures for public feedback on the same day. The foreign investment law reforms are expected to take effect nationwide as of 1 October 2016. A significant feature is that MOFCOM approval will no longer be required for the incorporation of, or major changes related to, wholly foreign- owned enterprises and joint ventures (FIEs) unless they engage in a “restricted business”, a business included on the Nationwide Negative List.

The proposed amendments to China’s foreign investment laws will have a significant impact on investment in businesses not on the Nationwide Negative List. Setting up a new FIE and changing the governance of an existing FIE will become much more flexible and predictable.

Background
China’s four free trade zones (FTZs) have piloted foreign investment deregulation, including a negative list approach, since 2013. The government has apparently accepted the benefits brought by the pilot programmes and decided to implement deregulation across the country. The draft Foreign Investment Law (see our In context of New law brings big changes to foreign investments in China) is still pending adoption, but the introduction of the Nationwide Negative List does illustrate that the Chinese government is serious about further reform to attract foreign investment amid the continued slowdown of foreign direct investment in China.

Recap on current foreign investment administration regime
MOFCOM’s case-by-case pre-approval of foreign investment has long been perceived as one of the fundamental pillars of China’s foreign investment administration. Important corporate matters such as incorporation, share transfer, merger, spin-off, dissolution, amendment to articles of association, change in registered capital, and renewal of FIEs are all subject to MOFCOM’s approval. All major transaction documents, including joint venture contract and share transfer agreement, have to be submitted to MOFCOM for review and approval. This review can take up to three months or even longer, depending on variables such as the complexity of the transaction, the number of pending applications and officials’ discretion, making the review process unpredictable or arbitrary.

Changes introduced by the amended foreign investment laws
From October 2016, in the event of a material change – for example, amendments to articles of association or a share transfer – FIEs that do not engage in any restricted business will only have to file certain limited information with MOFCOM. They will no longer have to file supporting documents (such as the articles or the share transfer agreement). The filing can be done online and as late as 30 days after the change takes effect. Some pre-filing procedures in China may still effectively be an approval procedure in nature, but as the filing can also be made after the incorporation or change has taken effect, it is truly just an administrative filing procedure for information purposes. Consequently, the predictability and efficiency of foreign investment transactions will  improve significantly.

Parties will also have much more flexibility in negotiating the transaction documents, as none of these documents (joint venture contract, share transfer agreement, articles of association or board resolution) will be subject to MOFCOM filing, let alone approval. More sophisticated provisions customary in international transactions, such as price adjustment mechanism and payment other than in cash, while traditionally prone to being challenged by or not acceptable to MOFCOM, will now become viable options for parties.

In addition, if share transfers no longer require approval, this will mean that exit mechanisms agreed in joint venture agreements will be easier to enforce. The current unpredictability of the enforcement of exit mechanisms in Mainland China has been one of the reasons why foreign investors have preferred to establish joint ventures with their Chinese partners through a joint venture holding company incorporated outside Mainland China, for example in Hong Kong. As of October 2016, we may see more joint ventures being established directly in Mainland China.

Looking ahead
The Nationwide Negative List still needs to be published, but it is expected to be similar to the lists adopted by the FTZs. If so, the Nationwide Negative List will still be longer than most foreign investors would like it to be, but the negative list approach will certainly be a significant move towards equal treatment of domestic entities and FIEs. Given that foreign investments are administered by different authorities in China, several pieces of legislation adopted by MOFCOM as well as other authorities will probably need to be amended or repealed after the adoption of the Nationwide Negative List. How soon other governmental agencies, such as the National Development and Reform Commission, the State Administration of Foreign Exchange and the State Administration for Industry and Commerce, will amend their own administration to facilitate the reform remains to be seen.

MOFCOM approval will continue to be required for the incorporation of FIEs or changes related to FIEs which engage in restricted business. In addition, MOFCOM will continue to have authority in relation to merger filings, national security review and mergers and acquisitions of domestic enterprises by foreign investors.