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published on March 20, 2019 | reading time: approx. 3 minutes
The new unified foreign investment rules will replace three existing Chinese laws: the Law on Sino-Foreign Equity Joint Venture, the Law on Sino-Foreign Contractual Joint Ventures and the Law on Wholly Foreign Owned Enterprises. A reform of the foreign investment regulations has been under discussion since many years. However, there were hardly any visible results until a few months ago. Recently - probably as a reaction to the trade conflict with the USA and to the emerging slowdown in economic growth - the process of reorganizing the investment law gained noticeable momentum.
The scope of the new law (FIL) covers all forms of engagement, including in particular green field investments, M&A transactions and project investments. The text of the FIL expressly states that the term of foreign investment refers to both direct and indirect investment. However, there is still a lack of explanations as to which activities will be regarded as indirect investments. One of the main changes of the new investment law is the principle of equal treatment with Chinese domestic companies. Foreign investors in sectors that aren’t on the so-called "Negative List" will in future be treated on an equal footing with Chinese companies and will receive the same market access conditions. This means a decisive facilitation for foreign companies to make use of state subsidies and preferential conditions and to participate in government procurement activities and standardization procedures on an equal competitive basis. The economic sectors that are on the negative list and are therefore basically restricted or blocked for foreign investors are excluded.
A central point of the FIL is to improve the protection of intellectual property in foreign investment. In this way, China wants to make a clear commitment to secure the interests of foreign companies, not least in view of the tense trade policy situation. For example, foreign companies will in future be granted a direct legal entitlement which is intended to protect them from state interference with regard to involuntary technology transfer. Concerning capital transfer the FIL will also be more responsive to foreign investors. The new law explicitly provides that capital gains, royalties and other investment-related income can be freely transferred from mainland China. This protects against a certain arbitrariness on the part of local authorities, but does not change the fact that foreign companies are still subject to the regulations on foreign exchange and capital controls issued by the Chinese Central Bank.
In practice, there are still many open questions that will ultimately decide how and to what extent the new rules will actually lead to a tangible improvement in investment conditions for foreign companies in China. In fact, with only 42 articles, the law is unusually "slim" and consists of a lot of vaguely formulated general clauses. Accordingly, the extent to which the protective rights of foreign investors will be strengthened in a way that can be put into practice will crucially depend on the implementing provisions still to be adopted. For example, it is not clear from the present legal text whether - unlike in the past - a Chinese natural person may in future also enter into a joint venture with foreign partners.
The new law provides for a five-year transitional period during which the existing joint ventures and WFOEs must adapt their organizational form to the FIL and accordingly the Chinese Company Law. Joint ventures will be a particular focus, as the company's highest governance body will change from the Board of Directors to the Shareholders' Meeting. This could mean that, even in the case of joint ventures that have been in existence for many years, new negotiations on decision-making powers might be needed.
One of the imponderables of the FIL is an article that suggests exceptions to the principle of equal treatment depending on the country of affiliation of companies. With the new law, China now explicitly reserves the right to take "appropriate measures" against countries and regions that restrict or "discriminate" against Chinese investment. In this way, acute political conflicts could change the legal situation of foreign companies from affected countries and regions.
Xiaomei Fu, LL.M.
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