China Begins Major Overhaul of its Foreign Investment Regulatory Regime

October 10, 2016

It has been close to two years since China announced that it would make major changes in its foreign investment related laws and regulations.  The first step of such changes took effect on October 1, 2016, after the Standing Committee of the National People’s Congress (China’s parliament) passed resolutions (the "NPC Resolutions") to amend certain provisions of the FIE Laws (as defined below).  On October 8, 2016, in implementing the NPC Resolutions, the PRC National Development and Reform Commission ("NDRC") and the PRC Ministry of Commerce ("MOFCOM") issued Public Announcement No. 22 [2016] ("Announcement 22"), and MOFCOM issued the Interim Measures for the Record-filing Administration of the Incorporation and Change of Foreign Invested Enterprises (the "Interim Measures").  In essence, Announcement 22 and the Interim Measures have changed the regulation of certain matters relating to foreign investments in China from one that requires "prior approval" to one based on "subsequent filing".  This is consistent with the Chinese government’s stated goal to adopt a more market-based regulatory regime for foreign investments and to accord foreign investors a greater degree of national treatment in China.


China currently has three major pieces of legislation governing foreign investments (the "FIE Laws") and related implementing rules (the "Implementing Rules"):  the Sino-Foreign Joint Venture Law passed in 1979 (the "Equity JV Law"), the Foreign Enterprise Law passed in 1986 (the "WFOE Law") and the Sino-Foreign Co-operative Joint Venture Law passed in 1988 (the "Co-operative JV Law").  A particular form of entity is allowed to be set up in China under each of these laws.  Under the WFOE Law, for example, a foreign investor can set up a wholly foreign owned enterprise (a "WFOE").  Similarly, under the Equity JV Law and the Co-operative JV Law, foreign investors can set up equity joint ventures or co-operative joint ventures with Chinese partners (the "Joint Ventures").  WFOEs and Joint Ventures are collectively called foreign invested enterprises ("FIEs").

There are three fundamental features of this regulatory regime.  First, foreign investors can only invest in sectors that are not prohibited to foreign investments.  China has and periodically updates a foreign investment catalogue (the "Investment Catalogue"), which divides foreign investments into three listed categories:  encouraged, restricted and prohibited.  Those that do not fall under any of these categories are treated as permitted.  A potential foreign investor has to find out first of all whether and under what restrictions (if any) it can make an investment in a particular sector.

Second, prior to the adoption of Announcement 22 and the Interim Measures, regardless of the form of the FIE (a WFOE or a Joint Venture) and regardless of which category was involved (permitted, encouraged or restricted), the establishment of an FIE must go through a complicated three-step approval process.  To begin with, in respect of a greenfield project, the sponsors were required to obtain project-specific approvals/filings (the "Project Approval") from NDRC (including its local counterparts).[1]  After obtaining the Project Approval (or under circumstances where the Project Approval was not required, as in the case of a consulting WFOE), the sponsors must submit the incorporation documents (such as the articles of association and, if applicable, the joint venture contract) to MOFCOM (including its local counterparts) for review and approval (the "Establishment Approval").  Finally, based on the Establishment Approval, the sponsors had to register the FIE with the State Administration of Industry and Commerce (including its local counterparts, "SAIC") and obtain a business license (the "Company Registration").  An FIE only came into existence upon completion of the Company Registration.

Third, prior to the adoption of Announcement 22 and the Interim Measures, there was a large number of matters relating to foreign investments that required prior approval or registration from various governmental authorities before they could become effective, such as any change in the business scope, amount of registered capital, pledge of registered capital, legal representative or shareholders of an FIE.  This caused many difficulties in how companies conducted their businesses.  In the first place, it often took a long time to obtain the required approvals.  While the FIE Laws and the Implementing Rules required that the relevant authorities issue or reject application for approvals within specified periods of time, such requirements were often ignored in practice, and the parties involved almost never complained for fear that they might not receive the approvals if they did.

In addition, the approval authorities often engaged in substantive review of the commercial contracts entered into between the relevant parties.  For instance, MOFCOM sometimes required parties involved in a Joint Venture to change the commercial terms already agreed between them if such terms in its view were prejudicial to the Chinese party’s interests.  Another example was that MOFCOM officials often preferred simple templates for commercial contracts such as the joint venture contracts and equity interest transfer agreements.  To the extent the parties involved had agreed to terms that were not contained in such templates, MOFCOM officials often demanded that those terms be deleted or amended, even if they were among the most standard provisions in international transactions (such as adjustments in purchase price in an M&A transaction and the right by one party to a Joint Venture to put its shares to the other parties).  This forced parties in many cases to deal with these issues in parallel offshore agreements governed by non-PRC law even though the enforceability of such agreements in China was questionable.

Moreover, the approval requirements added complications to commercial transactions and resulted in unnecessary transaction costs.  For example, because transfer of interest in an FIE required governmental approval and registration and such approval and registration themselves constituted transfer of title, parties in an M&A transaction often spent a long time negotiating when the purchase price should be paid.  A buyer would be reluctant to pay the price before obtaining the approval and registration because there was a risk that the approval and registration may not be granted.  Similarly, a seller often would not be willing to submit documents for approval and registration before it received the payment due to the concern that the buyer may not pay the purchase price after its interest in the FIE was already transferred.  In other words, it was basically impossible to have an M&A closing where transfer of title and payment of purchase price could happen simultaneously.  As a result, the parties often ended up negotiating escrow or security arrangements that were unnecessarily complicated and costly.

New Changes

The major changes adopted in Announcement 22 and the Interim Measures include:

  • Negative List; Filing

One primary change is the division of foreign investments into two categories: those that require special permits (commonly known as the "Negative List")[2] and those that do not.  Pursuant to Announcement 22, the Negative List consists of (i) sectors under the prohibited and restricted categories in the current Investment Catalogue and (ii) those sectors under the encouraged category that have special shareholding or management restrictions (such as requiring Chinese parties to have a controlling interest in a Joint Venture).  Foreign investments in any sectors on the Negative List are still prohibited or require prior approvals.  Procedures for applying for such approvals under the current FIE Laws and the Implementing Rules shall continue to apply without being affected by Announcement 22 or the Interim Measures.

On the other hand, if a sponsor wishes to set up an FIE in a sector not on the Negative List, instead of applying to MOFCOM for the Establishment Approval, it can now submit the required documents and proceed with a filing procedure through an online FIE Information Comprehensive Administration System (the "Comprehensive Administration System").  The same filing process also applies to any amendments to the incorporation documents, including transfer of interests in an FIE.

  • Filing Procedures

To establish an FIE, the sponsors can make the filing through the Comprehensive Administration System either before the Company Registration or within 30 days thereafter.  This is a significant change, as the sponsors can now elect to set up an FIE without having to submit any documents to MOFCOM first.

In case the documents filed with MOFCOM are subsequently amended (as in the case where there is a transfer of equity interest in an FIE), the FIE is required to file such amendments through the Comprehensive Administration System within 30 days thereafter.  Importantly, such amendments will become effective not upon filing with MOFCOM but upon the adoption of the relevant resolutions by the FIE.

 Within three working days after receiving the filing materials, MOFCOM should complete the filing and publish the results through the Comprehensive Administration System or, if applicable, inform the filing parties that the relevant matters are not subject to filing.  The sponsors or the FIE can then obtain a filing receipt from MOFCOM. 

  • Supervision

As part of the filing process, the sponsors of an FIE or the FIE are required to warrant (among other things) that all information submitted through the Comprehensive Administration System is complete, true and accurate and that the FIE’s business activities do not involve any activity on the Negative List.

If a party fails to make the required filing or if any false or misleading information is submitted, it will be ordered to take remedial actions.  It may also be subject to a fine not exceeding RMB30,000.  If other laws or regulations are also violated, other governmental authorities will enforce related remedies as well.  

More Reforms Required

There is little doubt that Announcement 22 and the Interim Measures represent a significant liberalization of China’s foreign investment regulatory regime.  Foreign investors now should find it much easier to set up an FIE and negotiate and execute M&A transactions.  On the other hand, it is important to point out that Announcement 22 and the Interim Measures are only a first step.  For instance, Announcement 22 specifically provides that the filing procedures under the Interim Measures do not apply to acquisitions by foreign investors of non-FIEs in China, which seriously restricts the scope of the Interim Measures and is a disappointment to market practitioners.  In addition, Foreign investments in China are subject to regulations by a number of agencies in addition to NDRC and MOFCOM, such as the State Administration of Foreign Exchange ("SAFE").  These agencies will need to adopt corresponding changes in order for Announcement 22 and the Interim Measures to achieve their intended results.  Furthermore, there are still many provisions in the FIE Laws and the Implementing Rules that are not "standard" compared with many other jurisdictions; nor do they apply to non-FIEs in China.  One example is that, under the Implementing Rules, certain matters relating to a Joint Venture are required to be decided by its board on a unanimous basis, including amendments to its articles of association, its termination or dissolution and the increase or decrease of its registered capital. More changes in these laws and regulations are obviously required to bring the Chinese system more in line with the international norm.

In January 2015, China published a draft Foreign Investment Law (the "Draft Law") for public comments, which specifically provides that, except in cases where special entry permits are required, FIEs shall enjoy national treatment just as the non-FIE domestic companies.  The Draft Law is intended to replace the FIE Laws entirely such that FIEs will be governed by the PRC Company Law in the same way as all the non-FIE domestic companies.  However, currently there is no indication as to when the Draft Law will be adopted.

  [1]  The Project Approval requirement has not changed as a result of Announcement 22 or the Interim Measures.

  [2]  In recent years, China has experimented with a similar negative list-based system in a number of free trade zones where sponsors of an FIE can go through a simplified "filing" (as opposed to "approval") process to establish FIEs in sectors not on the negative list.  Announcement 22 and the Interim Measures essentially have made this system applicable to the whole country.             

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about this development.  Please contact the Gibson Dunn lawyer with whom you usually work or the following:

Yi Zhang – Hong Kong (+852 2214 3988, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Joseph M. Barbeau – Beijing, Hong Kong, Palo Alto ([email protected])

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