FOREIGN INVESTMENT LAW UPDATE
Mar. to Jun. 2015 China Bulletin

The PRC Foreign Investment Law (Draft for Comments)released in January,  promises to substantially change the foreign investment regime in China (see Feb 2015 China Bulletin).  The revised law, when issued, will level the playing field by effectively eliminating “foreign invested enterprises” (FIEs) as a separate category in many industries in China. It will allow an FIE to be registered almost as quickly and governed by the same laws (e.g., the Company Law) as a company established by local investors. On the other hand, FIEs will remain prohibited in certain industries and restricted in others. The scope of the national security review will also be expanded, and foreign investors should be aware of the enhanced and potentially uncertain range of industries within such scope.

Below, we briefly discuss the negative list and security review.

Negative List

Under the revised law, a negative list will be published in a Catalog of Special Administration Measures to replace the current Catalog for Guiding Foreign Investment in Industry. If an industry is not listed as prohibited or restricted in this new catalog, then a foreign company or individual may register an FIE in that industry with the local Administration of Industry and Commerce (AIC) without prior approval from the Ministry of Commerce or a local investment commission (MOFCOM). It is required only to file basic information and the FIE formation documents with MOFCOM for the record.

If the FIE’s proposed business is in a “prohibited” industry on the negative list, then no foreign investment is permitted. If it is in a “restricted” industry or exceeds an investment threshold specified by the State Council, then the foreign investor must apply for an access permit. The permit may be granted provided certain specified conditions are met, such as having a Chinese partner or majority Chinese ownership of the FIE.

A negative list is already in place in the Shanghai Free Trade Zone (FTZ) and was supplemented in May by special management measures applying in all FTZs. While they do not apply outside the FTZs, the FTZ measures indicate how the negative list is likely to be implemented under the revised Foreign Trade Law when it comes into effect.

Under the FTZ measures, a foreign investor submits the FIE’s articles of association (or contract, if applicable) for the record to the FTZ management and completes an online form no later than 30 days after implementing its investment. If the FIE is not on the negative list and requires no other reviews, the filing should be acknowledged within three working days. If the FIE is on the negative list or requires review, the FTZ management will instruct the foreign investor to undertake relevant approval procedures. MOFCOM or the local investment commission should fulfill a similar role outside the FTZs.

The time and cost savings from eliminating approval for many FIEs should not be underestimated. Bear in mind, however, that even an FIE not on the negative list must still obtain an industry-specific license, permit or approval required of all companies to operate (e.g., a value-added telecom service license to engage in e-commerce) and must complete procedures that apply to all companies (e.g., post-registration filings with the tax, finance, public security bureau).

National Security Review

As a separate matter from filing or obtaining approval from MOFCOM, the revised Foreign Investment Law includes a new chapter on the national security review – Chapter 4. A foreign investor may request a security review, MOFCOM may refer a project for security review, or the inter-ministry committee that conducts the review may initiate one ex officio.

Chinese regulations have provided for a national security review since 2011. Incorporating the review into the revised Foreign Investment Law will raise it from a departmental regulation to a national law. The scope of the review will also likely be expanded from focusing on foreign control of domestic industries related to national security or having an impact on national security to covering a wider range of industries and forms of investment.

The State Council recently issued the Trial Measures on National Security Review of Foreign Investment in the Pilot Free Trade Zones.  Although these measure apply only in the FTZs, they offer insight as to the likely scope of review under the revised Foreign Trade Law when it is finalized and promulgated. Those measures cover foreign investments that may affect national security or the State’s ability to maintain national security, as well as investment in sensitive industries, companies, technologies or regions. They reach not only military industries and industries located near sensitive military facilities, but also any industry affecting national security, such as agricultural products, energy and resources, infrastructure, transport services, cultural services, information technology, equipment manufacturing and key technologies. Indeed, unless further details regarding scope are issued, it appears almost any product affecting production, communication or daily necessities arguably falls within the scope of the security review.

Although the focus of the FTZ measures is on foreign “control” over the investment, minority stakes are also subject to review. “Investment” includes not only equity and asset ownership, but also control through intermediaries, trusts, by contract, indirect ownership, reinvestment, lease or subscription of convertible bonds. Further, determinations regarding scope, control and investment by the review board are final and not subject to administrative or judicial review.

Certainly security interests are paramount, but given the broad scope and lack of detail regarding the enhanced security review in the FTZs, such review has the potential to expand beyond core national security issues and be used to implement protectionist policies or be coopted by powerful commercial interests to serve their own ends, such as fending off or eliminating competition. This risk is particularly troublesome where there is no provision for review.

At the end of the day, the effect of an enhanced national security review will be determined by how it is implemented. It may turn out that companies not involved with expressly military applications have no cause for concern.  Still, given its scope and ambiguity, investors contemplating setting up or acquiring an interest in a company in China are well advised to acquaint themselves with government policy trends related to national security, the make-up and record of the national security review committee, and the influence competitors could potentially have on such body.

Questions?  Please contact Allan Marson at china.desk@ishimarulaw.com or +1 408-738-0592 #719 for a complimentary consultation regarding the draft Foreign Investment Law, negative list or security review.