In January 2015, China’s Ministry of Commerce published a draft of what should have become a new legal cornerstone for foreign investment in China: the PRC Foreign Investment Law. Arguably the most controversial provision in that draft – and perhaps the reason why the draft never became law – was a provision that defined a Chinese entity under the “control” of a foreign company as foreign investment.
The common interpretation was that this would doom the VIE (Variable Interest Entity) structures commonly used for Chinese companies such as Alibaba, which operate in sensitive industries (including in technology, media and telecommunications) restricted or closed to foreign investment but are listed on foreign stock exchanges and therefore have foreign ownership.
In December 2018, after almost four years of waiting, the National People’s Congress released a new draft of the PRC Foreign Investment Law (the “Draft FIL”). Most noticeably, it is silent on whether “control” by a foreign company would make a Chinese entity one of foreign investment – suggesting that at least for now, the Chinese government is inclined to keep the status quo in allowing foreign-controlled VIE structures in sensitive industries for the time being.
The Draft FIL would replace the specific laws that currently still apply to wholly foreign-owned enterprises, Chinese-foreign equity joint ventures and Chinese-foreign cooperative joint ventures; and if adopted in current form it is poised to modernize the legal landscape for foreign investment. Particularly noteworthy are the provisions relating to national treatment, and the promotion of foreign investment.
Foreign investors are entitled to “national” treatment, except where subject to the Negative List for Foreign Investment. This Negative List establishes which industries are still restricted or prohibited to foreign investment; the current version was published on 28 June 2018.
Below are some of the opportunities that this new rule on national treatment means may present to Chinese-registered companies with foreign investment (often referred to as foreign-invested enterprises, “FIEs”):
- Rules and policies supporting the development of domestic companies will equally apply to those companies with foreign investment.
- FIEs can participate in bidding for government procurement projects.
- FIEs may raise equity or debt financing in China, which includes getting listed on a Chinese stock exchange, and issuing corporate bonds.
- FIEs that require special licenses to operate in a certain industry, will be subject to the same criteria and procedures as their counterparts without foreign investment – except as provided in specific regulations and rules.
It remains to be seen how (and how soon) these provisions will work in practice. There are plenty of ways that an FIE may still feel unfairly treated: in government bidding processes for example, the bidding standards could be defined in favor of companies with local investment. And as the decision on whether a company will be listed on a Chinese stock exchange typically has a strong political element, it may remain more difficult for FIE’s to get approval. On the other hand, a clear and detailed determination of the national treatment principle will only help in the years to come.
Protecting Foreign Investment
The Draft FIL also contains some encouraging notes on other subjects. For instance:
- Intellectual property rights held by foreign investors and FIEs shall be protected; and forced technology transfer to Chinese parties shall be prohibited.
- Local governments that offer commitments to or reach agreements with foreign investors on special benefits shall abide by those commitments and agreements; in case of changes due to national, social or public interests, the foreign investors and FIEs shall be compensated.
- An improved mechanism shall be introduced to deal with complaints from FIEs.
Interesting is the implied recognition that forced technology transfer has taken place (and is no longer permitted); and a very express recognition of investment benefits and their legal validity. In recent years local government promises for tax preferences, subsidies and other benefits have again gained in popularity. This provision further encourages foreign investors to try negotiating favorable terms, and then including them in investments agreements that are signed with the local government or their representatives.
Chinese Government Retaliation
The Draft FIL provides one exception to national treatment which is worth emphasizing: where any country takes discriminatory prohibitive, restrictive or other similar measures against Chinese investments, then the Chinese government may take corrective measures which presumably includes measures against investors from such country.
The Draft FIL is a welcome step in the right direction, compromising on the biggest concern in the earlier draft from 2015 and introducing rules that should benefit foreign investment in general, and foreign-invested companies operating across a broad range of sectors in particular. Hopefully the new PRC Foreign Direct Investment Law will be promulgated soon, so that we can start seeing how the new provisions will help foreign investors in practice.