The Most Important Points of China’s Foreign Direct Investment Law
By Ping Chen, Leader of Advisory Services China
China’s Congress passed the Foreign Investment Law in its most recent session. The law takes effect January 1, 2020, and will supersede three existing laws governing foreign businesses in the world’s second-largest economy.
The law was passed in part to address U.S. concerns over perceived unfair and unbalanced treatment of U.S. companies operating in China, including Chinese requirements to share technology with local companies and restrictions that leave large portions of the economy inaccessible to foreign-owned companies. This post summarizes some of the key articles of the law and indicates what businesses operating in China should do now to prepare for the law’s implementation.
The Law’s Important Points
China’s Foreign Investment Law is comprised of 42 articles and is remarkably short — the official, reference-only English translation has fewer than 3,000 words. The broad aim of the law is to “further expand opening-up, vigorously promote foreign investment, protect the legitimate rights and interests of foreign investors, [and] standardize the management of foreign investment.”
Here are some of the notable particulars of the new law.
- The law applies to all foreign investors. A foreign investor is defined as “a foreign national person, enterprise or other organization” making investments in China. As a result, any foreign company operating as a wholly foreign-owned enterprise (WFOE), Sino-foreign equity joint venture (EJV) or Sino-foreign cooperative joint venture (CJV) must comply with the new law.
- Foreign investors will be treated equally with domestic investors during the investment-access stage, that is, during the initial stages of investment (Article 4). China will continue to use the negative list — which is issued or approved by China’s State Council — as a basis for prohibiting foreign investors from operating in certain sectors. Foreign investors that violate the provisions of the negative list will be legally liable and subject to penalties (Article 36).
- Foreign investors will be treated equally with domestic investors when applying for licenses in industries and fields where licenses are required (Article 30).
- Foreign-funded enterprises will be treated equally when applying for government procurement contracts in China (Article 16).
- The intellectual property rights of foreign investors and foreign-funded enterprises are protected under the law. Moreover, “no administrative department or its staff member shall force any transfer of technology by administrative means” (Article 22). In other words, local officials cannot force a foreign-funded enterprise to transfer technology to a local firm. Forced transfers have been a major concern of foreign investors in China and their respective governments.
- Chinese authorities will implement a new foreign investment information reporting system (Article 34). The current draft of the law does not specify what information must be reported, indicating only that “the contents and scope of foreign investment information to be reported shall be determined under the principle of necessity.” Companies that fail to report required investment information in a timely fashion will face a penalty of between CNY100,000 and CNY500,000 (Article 37).
- Foreign-funded enterprises must be organized and governed in accordance with China’s Company Law, Partnership Law and other laws (Article 31). This means that organizations formed under the three existing laws governing foreign-funded enterprises in China —the Law of the People's Republic of China on Sino-Foreign Equity Joint Ventures, the Law of the People's Republic of China on Wholly Foreign-Owned Enterprises, and the Law of the People's Republic of China on Sino-Foreign Cooperative Joint Ventures — will have to update their corporate governance structures and perhaps joint-partner contacts. Article 42 of the new law stipulates that foreign-funded enterprises established under the three existing investment laws will have five years to update their “organization forms and other aspects” so they’re compliant with China’s Company Law.
Reactions to the Law
Two days before China’s new Foreign Investment Law was passed, the nonprofit American Chamber of Commerce in China released a statement praising the legislative effort but voicing concern over among other things the draft law’s lack of details and susceptibility to being “overridden by industry-specific regulations.” An article in CNBC echoes this, indicating that “[critics] note the new law is vague and that what happens in practice in China is often more restrictive than what is stated up front.”
A statement about the final version of the law from the European Union Chamber of Commerce in China is also mixed. The statement recognizes the law’s “important role in formalizing the legal foundation for the shift from the old foreign investment catalogue to the new-market access system.” At the same time, it derides one article’s “vague wording,” which “further adds to the legal uncertainty that the law creates for foreign companies.” The statement ends by noting the EU Chamber of Commerce will “closely monitor the [law’s] implementation to ensure that it is fully respected at all levels of government and in all corners of this country.”
The vagueness of the law’s provisions is almost certainly intentional and part of a wider strategy on the part of China. The Wall Street Journal says that in recent rounds of trade talks with the U.S., “Beijing has offered up broad language that it will pursue structural changes … [but] it has rejected U.S. demands for more details about implementation, including identifiable timelines.” The Journal also points out that the legislation doesn’t address — even broadly — some significant concerns, including state subsidies and “many other industrial policies that the U.S. says favor [Chinese] companies.”
Steps Multinationals Should Take Now
Given the broad language of China’s new Foreign Investment Law, multinationals should keep abreast of related updates and official guidance over the coming months and even years. Despite the legislation’s room for interpretation, it’s worth remembering that it will replace three critical existing laws that govern hundreds of thousands of Chinese foreign-funded enterprises.
There are at least two articles in the new law that require attention now. One is Article 36, which stipulates that Chinese authorities will implement a reporting system. Unfortunately, the law doesn’t indicate what information must be reported beyond the fact that it “shall be determined under the principle of necessity.” In the near term, multinationals operating in China should comply with new digital reporting requirements explained in a joint statement recently issued by the Ministry of Finance and four other bureaus. The deadline for reporting 2018 information on the required system is June 30.
Multinationals should also keep close watch on evolving guidance related to Article 31, which addresses corporate governance. Under the new Foreign Investment Law, foreign-funded enterprises must be structured to comply with China’s Company Law. This means, for example, that a wholly foreign-owned enterprise now operating in China will have to update its articles of association to require shareholder meetings, which are not currently required when operating as a WFOE. Fortunately, the law provides a transition period; it indicates that foreign-funded enterprises “may retain their original organization forms and other aspects for five years” from January 1, 2020.
Despite this substantial transition period related to implementing corporate governance requirements, it’s not too early for multinationals operating in China to start developing policies and practices to comply with the new law. These should include mechanisms to ensure your organization keeps abreast of related guidance. Many multinationals will seek professional help to monitor these announcements and ensure ongoing compliance.