Overview of regime
In recent years, a number of reforms have been rolled out that significantly relax the regulatory regime for foreign investment across China. The new Foreign Investment Law, which came into effect on 1 January 2020, demonstrates China’s clear determination to level the playing field for foreign investors and attract more foreign investment.
Outline of applicable legislation and relevant authorities
Major laws and regulations governing foreign investment in China include the following.
Foreign Investment Law and regulation of its implementation
The Foreign Investment Law (FIL) unifies China’s legal regime on foreign investment under a single, consolidated piece of legislation. Foreign invested enterprises (FIEs) established after 1 January 2020 now need to comply with either the Company Law or the Partnership Enterprise Law (as applicable) in areas such as organisational form, corporate structure and governance. FIEs established under the previous legal framework have a five-year transitional period to comply with the new regime, during which time they can retain their original organisational forms.
Special administrative measures for market access of foreign investment
China adopts a negative list regime restricting foreign investment in sectors listed in the negative list jointly published by the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM). For industries outside the negative list, foreign investors will receive national treatment, meaning that they will be subject to the same qualifications and requirements as are applicable to Chinese investors.
Measures for reporting of information on foreign investment
Under the previous regime, foreign investment falling outside the scope of the negative list needed to go through a record-filing process with MOFCOM. The FIL has replaced this with a foreign investment information reporting regime. This requires foreign investors and FIEs to report investment information to MOFCOM through the Enterprise Online Registration System and China’s National Enterprise Credit Information Publicity System (each administered by the State Administration for Market Regulation (SAMR)). The content, scope and frequency of reporting is determined by MOFCOM and SAMR based on actual needs and in the spirit of minimising the burden on foreign investors and FIEs.
Administrative measures for verification and approval and filing records of foreign investment projects
These measures require prior approval for certain foreign investment projects involving investment in, or construction of, fixed assets, and for others, compliance with record-filing procedures administered by the NDRC.
National security law and measures for security review of foreign investment
The National Security Law was introduced in July 2015 as the top-level legislation providing for a national security review of investments into China. An acquisition of a domestic company by a foreign investor may be subject to a national security review if the Chinese government considers that the transaction involves state security. The Measures for the Security Review of Foreign Investment came into effect in January 2021. They updated the foreign investment national security review requirements and formalised certain pilot regimes to expand their application nationwide.
This is the main legislation on merger control, which gives SAMR jurisdiction over merger control enforcement. It is supplemented by additional implementing regulations, including the Rules on Notification Threshold for Concentrations of Undertakings, which were issued by the State Council in August 2008 and amended in September 2018.
Several administrative authorities (or their local counterparts) at the provincial, municipal or district level may be involved in reviewing foreign investment in China. The key ones are the following:
- MOFCOM, which is responsible for macro guidance on foreign investments across the country. It is the government agency in charge of foreign investment information reporting and the administration of complaints by foreign investors and FIEs in China;
- SAMR, which is the key regulator in market supervision, covering a wide number of business areas, including business registration, market regulation, product safety, food safety, quality inspection, certification and accreditation. SAMR is responsible for the registration of FIEs and for reviewing whether foreign investment projects fall under the negative list and meet the relevant requirements. SAMR also regulates all anti-monopoly matters. Its Anti-Monopoly Bureau handles merger control filings. It is also the authority responsible for investigating monopoly agreements, abuses of dominant market position and abuses of administrative powers used to eliminate or restrict competition;
- sector-specific regulators, which are in charge of pre-approving foreign investments falling within certain regulated industries pursuant to the negative list (such as telecommunications, mining, banking and insurance, public utilities and domestic transportation). For example, foreign investment in the banking, securities or insurance sectors requires additional approvals from the China Banking and Insurance Regulatory Commission or China Securities Regulatory Commission;
- NDRC, which is responsible for formulating China’s macro-economic policies and has overall responsibility for ensuring that foreign investment aligns with the state’s industrial policy. It is in charge of the approval of, and record-filing for, foreign investment projects that involve new constructions. The NDRC also works jointly with MOFCOM to promulgate the negative list and the catalogue of encouraged industries for foreign investment;
- a new MOFCOM-led and NDRC-led working mechanism office, located within the NDRC, which is responsible for organising, coordinating and guiding national security reviews of foreign investments. In practice, transactions requiring a national security review are normally in sectors such as national defence, military, information technology or agricultural products. Given this, it is likely that the new working office will adopt similar consultation processes to those previously in place with the relevant administrations (for example the Ministry of National Defence and the Ministry of Industry and Information Technology) to solicit professional opinions; and
- the State Administration of Foreign Exchange (SAFE), which supervises and manages foreign exchange in connection with foreign investments. Banks processing foreign exchange are primarily responsible for reviewing and carrying out the foreign exchange registration of inbound and outbound direct investment. SAFE indirectly supervises the foreign exchange registrations of direct investments by banks.
Types of investors and transactions covered by FIL regime
Investment activities implemented directly or indirectly by foreign investors in China are subject to the FIL regime. Foreign investors include:
- individuals who are not Chinese nationals;
- enterprises or partnerships established under foreign laws;
- governments of foreign countries or regions or their departments; and
- international organisations.
Investment activities caught by the FIL regime include where:
- a foreign investor, independently or jointly with others, sets up an enterprise in China via foreign investment;
- a foreign investor obtains shares, equities, property shares or other similar rights and interests in a Chinese domestic enterprise;
- a foreign investor, independently or jointly with other investors, invests in new projects in China; and
- there is investment through other means as stipulated in laws, administrative regulations or provisions of the State Council.
Key policy considerations underpinning FIL
The FIL was enacted during the strained US–China trade war negotiations, in part as a good faith gesture in response to a number of complaints from the US business community. These included the need for enhanced protection of the intellectual property rights of foreign investors, fair treatment of foreign and domestic investors and expanded public fundraising channels available to FIEs. The FIL clearly demonstrates that China is maintaining its commitment to further opening up its market and economy and trying to boost foreign direct investment into China.
The key features of the FIL regime include:
- national treatment and a level-playing field for foreign investment;
- strengthened intellectual property protection;
- a discontinuance of mandatory transfers of intellectual property rights;
- liberalisation of foreign exchange control, in particular to permit non-investment FIEs to convert foreign exchange capital into Chinese yuan for equity investments in China;
- further streamlined approvals and registrations for FIEs; and
- all FIEs being required to comply with the corporate governance structures in China’s business law, subject to a five-year transitional period.
The legislative changes are an encouraging development for foreign investments. Foreign investors need to understand the major changes and benefits that have been introduced and are encouraged to keep a close eye on future regulatory developments to find ways to take advantage of new investment opportunities in China.
Review process: procedures and substantive assessment
Investment project approval and record-filing
If a foreign investment project involves granting or transferring land use rights or requires any construction activity, it will be subject to a project approval or record-filing process (depending on the size and nature of the investment) supervised by the NDRC. This will be determined by reference to the Notice of the State Council on Promulgating the Catalogue of Investment Projects Subject to Government Verification and Approval (2016 Version).
The NDRC will assess whether the project complies with China’s industrial development regulations and policies. It will also evaluate whether there is likely to be an adverse effect on national security, economic security, public interest or China’s foreign exchange management policies.
For a project subject to its approval, the NDRC will generally issue a decision within 20 business days of accepting a foreign investor’s project application report, excluding any time required for expert consultation or appraisal. This can be extended by up to 30 business days in certain situations. Foreign investment projects that do not require approval need only comply with the local NDRC record-filing obligations. This is a much simpler procedure, taking only several days.
Sector-specific review and approvals
Sector-specific reviews and approvals may be required for foreign investment projects in certain sectors. Checking the foreign investment negative list is often the first step. The negative list identifies activities and sectors that require a Chinese partner, in some cases with a controlling interest or relative controlling interest as compared to that held by the foreign investor.
Before the FIL came into effect, MOFCOM approval was required for foreign investment in a sector on the negative list. Now, as part of the business registration process, SAMR will review whether a foreign investment project is deemed to be on the negative list and meets the relevant requirements. However, if the foreign investment project is subject to any sector-specific regulatory pre-approval, that regulator will carry out the negative list review instead of SAMR.
Most industry approvals are obtained post-establishment of the FIE in China, although some are required in advance. The Catalogue of Business Registration Matters Subject to Prior Approval issued by SAMR sets out details of those foreign investments that require industry-specific pre-approval (for example, a foreign-invested securities company requires pre-approval from the China Securities Regulatory Commission).
Business registration with SAMR
All FIEs have to be registered with SAMR to be incorporated. On completion of the registration, SAMR will issue a business licence to the newly established FIE. SAMR has up to 15 days to complete a registration after a full set of application documents has been accepted, although in practice registration is completed in a shorter time. The issue date of the business licence is also the date of establishment of the FIE or partnership. If any information registered with SAMR (such as the shareholder, legal representative and directors of an FIE) is subsequently changed, the FIE must register that change with SAMR.
Information reporting with MOFCOM
In parallel with the SAMR registration, foreign investors are required to report certain information to the local branch of MOFCOM, including basic information about the FIE, its investors and ultimate controlling shareholders. The process is quite straightforward, as most of the information can be shared with the local branch of MOFCOM using SAMR’s online systems (the Enterprise Online Registration System and China’s National Enterprise Credit Information Publicity System).
Investment in publicly traded companies
MOFCOM’s prior approval is no longer required for strategic investments by foreign investors or foreign-invested listed companies in Chinese listed companies that engage in industries not on the negative list. Instead, a filing must be made with MOFCOM either before the investment is registered with the stock exchange or within 30 days of registration. MOFCOM’s prior approval is still required for a strategic investment in a Chinese listed company that is active in industries on the negative list.
State-owned assets approval
State-owned assets must be valued by a qualified institution. If the transaction price is less than 90 per cent of the valuation, government approval will be required.
National security review
The scope of investments caught by the national security review regime includes investments in (1) industries such as military and military support that concerns national defence and security, as well as investments in locations near military installations and military facilities, and (2) any other important non-military fields that concern national security (for example, important agricultural products, energy and resources, infrastructure, cultural products and services, and information technology) if the foreign investors obtain actual control over the enterprise. Nominee holdings, trusts, multiple levels of reinvestment, leases, loans, agreements granting control and offshore transactions can also fall within the scope of the regime.
The national security review process can be initiated in two ways: either (1) the foreign investor or the relevant domestic party can submit a filing to the working office before implementing an investment, or (2) relevant authorities, enterprises, social organisations or the public can request a review if they consider that a foreign investment could affect national security.
The national security review process is in three stages:
- preliminary review: within 15 working days of receiving materials that meet the filing requirements, the working office will decide whether to commence a national security review;
- general review: within 30 working days of starting a national security review, the working office will either approve the transaction or proceed to the next review stage; and
- special review: foreign investments that fail to pass the general review will be subject to a special review for 60 working days (subject to extension).
Factors to be considered during a national security review include how the transaction will affect (1) national defence security, including the ability to produce domestic products and provide domestic services required for national defence and relevant equipment and facilities, (2) the stability of the state economy, (3)social order and (4) research and development capacity for key technologies relating to national security.
Where the effects of foreign investment on national security can be mitigated by certain measures, the working office may approve it on the basis that written undertakings are given to comply with those measures.
Merger control review
A transaction will only require notification to SAMR if it qualifies as a ‘concentration’, which is defined as:
- a merger;
- an acquisition of control over another undertaking by acquiring equity or assets; or
- an acquisition of control or the ability to exert decisive influence over another undertaking by contract or other means.
A concentration must be notified to SAMR if it meets either of the following sets of thresholds in the previous financial year:
- the combined worldwide turnover of all undertakings exceeded 10 billion yuan and the China-wide turnover of each of at least two undertakings exceeded 400 million yuan; or
- the combined China-wide turnover of all undertakings exceeded 2 billion yuan and the China-wide turnover of each of at least two undertakings exceeded 400 million yuan.
Complaints by FIEs
For the first time in Chinese law, the FIL clearly provides for a complaint mechanism to be established by the state to promptly deal with complaints reported by FIEs or foreign investors and to coordinate and improve relevant policies and measures. The Measures on Complaints by Foreign-invested Enterprises were updated with effect from 1 October 2020 and now provide recourse for foreign investors against China’s administrative agencies and officers.
Scope of complaints
FIEs and foreign investors can file complaints with MOFCOM (or the competent local authority) for the following:
- to apply for coordination to resolve cases in which an FIE or foreign investor believes that its rights and interests have been infringed by any administrative act of an administrative organ or its staff; or
- to report existing problems in the investment environment and to suggest improvements to relevant policies and measures. Chambers of commerce and associations may also make this type of report.
Process and timeline of filing a complaint
Coordination is prescribed as the main method for handling complaints. As such, the handling authority can only communicate and coordinate between the parties but cannot directly solve or handle the complaint.
By law, MOFCOM (or the complaint handling authority as applicable) is required to close the complaint within 60 days, except where it involves several departments or is a complicated situation; if this is the case, the timeline can be extended. When a complaint is not resolved within a year, the authority is required to report details to the people’s government at the same level with proposals to resolve the situation.
The legislation also permits FIEs and the foreign investors to file administrative proceedings against the relevant government bodies. Unlike the coordination procedure, these are statutory remedies that existed before the new FIL.
Impact of the covid-19 pandemic
Just as China’s new foreign investment regime took effect in January 2020, covid-19 emerged. Economic activity across China was adversely affected and the Chinese government responded with tax cuts, financial aid, low-interest loans and other support. The central government, MOFCOM, the NDRC and other local governments published measures to mitigate the effects of the pandemic. Most of the measures supporting foreign investment are temporary, however, and do not substantially affect the existing foreign investment regime.
Insights into recent enforcement practice and current trends
National security review
China’s new rules controlling foreign investment in areas concerning national security now provide more clarity for companies wanting to do business in China. The new regime is linked to the gradual opening up to more foreign investors in recent years, with the revamped FIL and fewer restrictions on sectors in which foreign investors can invest.
In some respects, the new regime has formalised what existed before. However, one of the concerns is that national security is very broadly defined in the new rules, which is inconsistent with China’s stated goals of further opening up. Article 2 of the National Security Law defines ‘national security’ as a status in which the regime, sovereignty, unity, territorial integrity, welfare of the people, sustainable economic and social development, and other major interests of the state are, relatively, not faced with any danger and not threatened internally or externally and has the capability to maintain a sustained security status.
Foreign companies should review their plans for investments going forward and recognise that a national security review may be an additional hurdle that will need to be cleared.
Practical insights and strategic guidance for investors
As a result of the new FIL regime, new opportunities and challenges are emerging for FIEs and multinational companies operating in China.
Shortened negative list
The ever-shortening negative list under the FIL regime creates more opportunities for foreign investment in China. In recent years, China has been liberalising and has shortened the negative list, opening up more industries to foreign investment, such as financial institutions, medical institutions and the automobile, telecommunications and education industries. Foreign investors are seizing these opportunities to enter the Chinese market or expand their businesses in China. Having said that, certain industries remain closed to foreign participation, including mobile and video games and the production and publication of media.
Liberalisation of foreign exchange control
The FIE regime affects investment strategies and structures in China. One of the most notable recent developments has been the liberalisation of foreign exchange control. As a result, there are now more alternative funding options for China investments and businesses.
With the aim of attracting and fully utilising more foreign investment, SAFE issued new rules that came into effect on 1 January 2020. These rules liberalised certain foreign exchange control restrictions and now allow non-investment FIEs to use their capital to make downstream equity investments in China, subject to certain conditions being met. Investee companies can also make subsequent downstream equity investment in China following the same rules. These conditions include that the equity investment project is genuine, compliant and is not restricted by the negative list for foreign investment. Banks acting on behalf of SAFE have a key role in verifying that the projects meet these conditions. The banks will need to see supporting documents before they will facilitate the remittance of funds.
This liberalisation now gives foreign investors another choice of investment platform in China that can avoid the more stringent requirements for establishing an ‘investment’ FIE. However, ‘investment’ FIEs may still be a preferred structuring option in certain circumstances as they continue to enjoy certain advantages, such as a higher quota for borrowing foreign debt.
Corporate governance structure conversion under FIL
As mentioned above, the FIL requires all FIEs to comply with the corporate governance structures in the Company Law, subject to a five-year transitional period starting from 1 January 2020. There are considerable differences between the FIL and the old regime in corporate governance; for example:
- under the old regime, the board of directors functioned as the highest authority of a joint venture, whereas under the new regime, the shareholders’ meeting is the highest authority;
- under the old regime, certain fundamental matters (such as amending the articles of association, changing the registered capital, or carrying out mergers, demergers, dissolutions or liquidation) required unanimous board approval, whereas under the new regime, these only require approval of two-thirds of the voting rights; and
- the Company Law also provides different rules in terms of management nomination provisions and requirements for a supervisory board (or supervisors for a smaller company), more flexibility on profit-sharing mechanisms between or among shareholders, and more relaxed conditions on the transfer of joint venture equity interests to third parties.
Foreign investors need to understand the changes that need to be made to corporate governance structures under the FIL and the effects of the new regime on existing shareholder agreements and constitutional documents.
A careful self-assessment to compare the new FIL regulatory requirements against the articles of association and, if applicable, joint venture contracts is needed to identify whether any gaps exist and determine how they should be dealt with.
Support from internal stakeholders will be needed for the FIE conversion. Some issues may be purely legal and others will require consideration of a mixture of both legal and commercial aspects needing input from broader business units and internal functions. Thus relevant business units and internal functions will need to be fully engaged when planning the FIE transition and during the related document review process.
For joint ventures, the conversion is likely to open the door for renegotiation with the joint venture partners and could have a major effect on the dynamics of the relationship between the joint venture partners.
The transition process also creates opportunities for joint venture parties to resolve any legacy issues.
From 1 January 2025, when the transitional period expires, if an FIE fails to convert its corporate governance structures, the company registration authority will reject any registrations by the FIE and will publicise its non-compliance in China’s National Enterprise Credit Information Publicity System. In practice, company registration authorities in some localities have started reminding companies to review and revise their constitutional documents in line with the Company Law. Although revisions are not mandatory until the transitional period expires, foreign investors are strongly recommended to start preparing as early as possible to ensure there is sufficient lead time for the legal analysis, internal alignment, renegotiation, document preparation and filing formalities.
Practical issues resulting from FIE registration and reporting processes
The FIL regime is affecting the execution and timeline of mergers, acquisitions and investment projects in China. In general, the approval and registration process is now more streamlined. However, companies are encountering practical issues during the implementation phase as local company registration authorities get up to speed with the new regime. Foreign investors should be prepared for potential procedural uncertainties or delays at the local level. Some of the most common practical issues are described below.
Tax payment as a pre-condition to SAMR registration
By law, the payment of tax in connection with an equity transfer of an FIE is not a pre-condition to SAMR registration. However, in some localities (for instance, some cities in Guangdong province), the local SAMR office may require sight of a tax clearance certificate from the local tax authority evidencing the tax payment (or confirming that no tax is payable) before they will process the registration of an equity transfer. As SAMR registration would normally be a condition precedent in an equity transfer agreement, this means that the transfer cannot be completed before obtaining tax clearance (which can be time-consuming and not straightforward).
Early communication with the local tax authority and SAMR office is advisable to understand the requirements so that they can be factored into the transaction documentation and execution timeline.
Notarisation and legalisation requirements
When a foreign investor is registered as a shareholder in an FIE, it is common for the local SAMR office to require the notarised and legalised incorporation documents of the foreign investor (such as the certificate of incorporation) as part of the application documentation. The incorporation documents must be notarised by a notary public and legalised by the Chinese embassy (or consulate) in the investor’s home country.
The notarisation and legalisation process usually takes two to four weeks in normal circumstances. However, logistical difficulties in some jurisdictions, in particular resulting from the covid-19 pandemic, may lead to delays. It is also crucial to confirm the specific requirements of the local SAMR office for the notarised and legalised documents to avoid having documents returned.
Authorised representatives of foreign investors
Another practical issue often encountered by foreign investors is that SAMR requires them to authorise a representative to sign documents or take action on their behalf in respect of the FIE. Generally, the local SAMR requires a power of attorney, shareholders’ resolution or board resolution to evidence the representative’s authority. A copy of the passport and a specimen signature of the authorised representative will also be required. Some local SAMR offices may require these documents to be notarised and legalised in the investor’s home country. Again, the foreign investor should confirm the specific documentary requirements up front.
Once the authorised representative of the foreign investor has been recorded with SAMR, SAMR will check and ensure that all the submitted documents that are required to be signed by the foreign investor (such as the articles of association of the FIE) have been signed by the authorised representative on record. If the foreign investor wishes to change its authorised representative, it must apply to SAMR to do so with the aforementioned documentation.
Consistent implementation of FIL regime and national treatment across government authorities
Despite the developments with respect to the foreign investment regime, Chinese law still differentiates foreign investments from purely Chinese domestic investments. Uncertainties still remain in practice and there are still direct and indirect restrictions imposed on FIEs under laws that may need to be lifted to ensure equal treatment.
Uncertainty remains as to how the FIL will be implemented at the local level, including details around company structures and ownership. National security reviews are still required for foreign investment deemed to be related to national security, including in the area of key technologies, important energy and agricultural products, infrastructure and heavy equipment manufacturing. Moreover, certain industries remain closed to foreign participation, including mobile and video games and the production and publication of media. Foreign investors and FIEs do have rights to file complaints or administrative proceedings.
Areas for future reform that are being considered include proposals to:
- further decrease the number of industry sectors on the negative list for which foreign investment is either restricted or prohibited, and to abolish laws and regulations that impose investment restrictions only on foreign investors;
- adhere to the principle of national treatment across all government levels and nationwide;
- define a clearer scope for the national security review to prevent it from becoming a market access barrier at the discretion of government authorities, and to increase the transparency of the national security review process by making the records of national security review cases publicly available; and
- ensure a workable and efficient complaint and remedy system for foreign investors in cases of investment discrimination.
Coordination between different government authorities and improved transparency, clarity and integrity of foreign investment regulations
Despite the recent reform, FIEs still face long-standing difficulties, as challenges remain with respect to the interpretation and enforcement of the laws and policies in different regions across China. The localisation of certain policies also affects FIEs’ competitiveness and ability to provide uniform services countrywide.
China’s regulatory regime and licence approval system, particularly at the implementation level, still create added difficulties for foreign investors. As an example, an FIE’s business scope in China is subject to approval, needing to be examined by SAMR, as well as industry regulators when sector-specific licensing is required. Furthermore, although some licences can, in theory, be legally obtained by FIEs (such as school operation permits), in practice, the relevant approval authority may refuse to approve these applications from FIEs.
Reform is needed in these areas. Currently under consideration are proposals to:
- make administrative procedures more transparent, consistent and predictable, and to ensure that different regions within China consistently implement the FIL and other legislation and adopt consistent standards;
- implement a ‘one-stop’ system among regional government authorities to support all investors in complying with the regulations and fulfilling the regulatory obligations;
- further develop official online platforms for foreign investors to fulfil their regulatory obligations and to provide comprehensive, coherent and timely information to foreign investors; and
- lessen administrative burdens for FIEs by reducing further the number of government approvals required and simplifying the approval and filing procedures.
1 Gavin Guo is an international partner, Angela Zhao is a counsel and Alvin Zheng is an associate at Herbert Smith Freehills Kewei (FTZ) Joint Operation Office. Weili Zhong is an associate at Herbert Smith Freehills.