A major reform of the Foreign Investment Law took effect this month.
The new Foreign Investment Law that took effect on January 1 is a response to a slowing economy and pressure from other governments, particularly the United States, to ‘level the playing field’ for foreign investors.
What next
The reform will make it easier and less risky for foreign investors to enter and operate in China over the coming years – it is more than a cosmetic change. However, its ability to reassure foreign investors is constrained by the lack of independent and transparent judicial and dispute resolution procedures in China, a feature of a political system that rejects rule of law and a major reason why it has not convinced Washington to relax its tariffs.
Subsidiary Impacts
- There will not be a flood of new investment as a result of the law, but it will make a difference over time.
- Companies will have five years to prepare for structural changes as rules specific to foreign-invested companies disappear.
- The regulations contain few specifics on enforcement, indicating that Beijing is not yet ready to give teeth to the law.
Analysis
The new Foreign Investment Law took effect on January 1, along with two related sets of regulations: • the Implementation Regulations of the Foreign Investment Law, specifying how the law will be implemented; and • the Business Environment Enhancement Regulations, which lay out the government’s plan for improving China’s business environment and opening its market.
Objectives
The Foreign Investment Law’s main objective is to attract more foreign investment in order to sustain economic growth amid a long-term slowdown.
China is still the world’s second-largest recipient of foreign direct investment (FDI), but flows fell sharply between 2013 and 2017. They have risen again since then, but remain below their average level for the past ten years.
The government worries about capital flight and divestment in the context of the trade war with the United States. China is also undergoing a structural slowdown in economic growth and its competitiveness compared to ASEAN countries is decreasing due to rising labour costs.
Another strong motivation for passing the FDI law was to address international criticisms in order to facilitate a resolution of the trade war with the United States. This explains why the government rushed the law through in January 2019, two days before important trade negotiations.
Levelling the playing field
The Foreign Investment Law adopts a system of ‘national treatment’ for foreign-invested enterprises, including at the pre-entry stage. This means that foreign-invested enterprises (a generic term for Chinese legal entities wholly or partly funded by a foreign company) must be treated equally to domestic companies in all respects.
The law explicitly requires equal treatment for foreign firms
In particular, the regulations stipulate that foreign-invested companies must receive equal treatment in terms of:
- permits and licences;
- land supply;
- tax policies;
- public procurement; and
- freedom to participate in drafting local and national industry standards.
In addition, the Implementation Regulations note that foreign-invested enterprises investing in specific industries and regions may enjoy preferential treatment in areas such as public finance, tax, finance and land use.
Local governments are to be penalised for discriminating against foreign-invested firms.
‘National treatment’ clauses are common components of bilateral investment treaties and are mentioned in the three main WTO agreements. The new law brings China into line with the very open foreign investment regimes of the United States and the EU, at least in theory.
Negative lists
Foreign-invested firms will still be limited by ‘negative lists’, namely:
- a national general negative list that applies to all enterprises nationwide;
- a general negative list for enterprises in free trade zones;
- a national negative list for foreign-invested enterprises in particular; and
- a negative list for foreign-invested enterprises in free-trade zones.
Sectors included on the latter two lists will either remain entirely inaccessible to foreign investment, or be accessible to joint-ventures only, not to wholly foreign-owned companies.
However, the lists have shrunk over the years. The latest version of the national foreign investment negative list, which took effect in July last year, includes only 40 items, down from 48 previously. The sectors that were liberalised include oil and gas, transportation and telecommunications. The lists will likely be reduced again this year or next.
More sectors will probably be opened to foreign firms over the next few years
Intellectual property and technology
The Foreign Investment Law promises greater protection of intellectual property for foreign firms.
It stipulates that government officials who become aware of trade or intellectual property secrets will face criminal liability if they divulge them.
It also prohibits compulsory technology transfers that were encouraged under previous laws. Previously, the government required foreign companies to contribute advanced technology to joint ventures and permitted technology licensing to count as in-kind capital contributions.
The new Foreign Investment Law does not mention these practices, and explicitly bans technology transfer by administrative means such as requiring the investor to disclose technological know-how as part of registration, approvals or filings procedures for investment projects, in the course of inspections or as an administrative punishment.
‘Uniformisation’
Another major objective of the new law is to homogenise the rules for domestic and foreign-invested companies. It replaces existing laws that distinguished between different kinds of foreign-invested enterprises:
- wholly foreign-owned enterprises;
- contractual joint ventures (CJVs) between Chinese and foreign firms; and
- Chinese-foreign equity joint ventures (EJVs) between Chinese and foreign firms.
As a result, the special rules that applied to these companies will cease to exist and companies will need to align with a unified regime within five years.
This will be straightforward for wholly foreign-owned enterprises, because their structure is already very similar to domestic limited liability companies.
For joint ventures, the new rules will require adjustment. For example, the CJV and EJV regimes gave the board of directors the highest authority, whereas the new unified regime gives it to the shareholders. Voting rules will change from unanimity among all directors to a two-thirds majority of shareholders.
Limits of the law
The reforms will not assuage all the concerns of foreign investors.
Expropriations
In the new Foreign Investment Law, as in the previous laws, expropriations “for the public interest” are allowed, and “public interest” is undefined, giving large leeway to government discretion. The Implementation Regulation only requires that “fair and reasonable compensation shall be promptly given”.
In principle this brings China into line with common international practice. Even in the United States the federal government has a right to take private property for public use, as long as it pays compensation.
Retaliation
Another concern for foreign investors is Article 40 of the Foreign Investment Law, which allows Beijing to retaliate against countries that discriminate against Chinese investment. This provision was likely added in order to deter unilateral discrimination against Chinese FDI abroad in a context of increasing trade tensions, particularly (but not only) on the part of the United States.
Implementation
The Foreign Investment Law and even its implementation regulations offer little detail regarding how the principles will be implemented.
More details regarding intellectual property theft and technology transfers were included in the ‘phase one’ trade agreement signed by China and the United States on January 15, but the agreement leaves unanswered questions and calls for China to release an “Action Plan to strengthen intellectual property protection” within 30 days.
This article was first written for the Oxford Analytica Daily Brief, which is the copyright holder.