22 January 2015

China Unveils Draft New Foreign Investment

Law

Contents

The Draft New Law

The Ministry of Commerce (the MOC) published a draft law on foreign
investment on 19 January 2015 (the Draft New Law) for public comment,
which aims to make significant changes to the foreign investment regime.
The Draft New Law proposes to standardise the market entry requirements
and procedures for foreign and domestic investors, replacing the existing
requirements for approval of all foreign investments by the MOC or the
competent local authority in charge of foreign investment (the Foreign
Investment Authority), on a case by case basis. The Draft New Law also
aims to consolidate and simplify the various regulatory requirements on
foreign investment. By abolishing the Sino-foreign Equity Joint Venture Law,
the Sino-foreign Cooperative Joint Venture Law and the Law on Wholly
Foreign-owned Enterprises, the Draft New Law proposes to remove all
differences between the corporate governance requirements that apply to
foreign invested and domestic enterprises. At the same time, the Draft New
Law proposes to apply foreign investment approval, reporting and national
security review requirements to a range of new investments and structures,
which is expected to have a profound impact in the planning of future
transactions.

The Draft New Law ........... 1

Reform of corporate
governance ....................... 1
National treatment and
removal of MOC approval
requirement....................... 2
New scope and
requirements of foreign
investment review ............. 2
Reporting based
supervision........................ 5
National security review .... 5
How the Draft New Law
applies to VIE structures ... 6
Reference ......................... 8

In accordance with the normal Chinese law-making process, the Draft New
Law is expected to undergo further revisions by MOC following its public
consultations. MOC is then expected to provide the draft to the State Council,
whose Legal Affairs Bureau will undertake further revision following
consultation among various government departments. The revised version of
the Draft New Law will then need to be submitted by the State Council to the
National Peoples Congress where it will need to complete at least three
readings before becoming law. Accordingly, there is no definitive timeline for
the coming into effect of the Draft New Law, and the current draft may need to
undergo significant amendment before the law is finally passed.

Reform of corporate governance

The Draft New Law proposes to abolish the specific organisational
requirements which apply to foreign invested enterprises, leaving only the
China Unveils Draft New Foreign Investment Law

requirements of the PRC Company Law (with which all foreign invested and
domestic enterprises must comply). This is expected to considerably simplify
the governance of a foreign invested enterprise. For example, under the Draft
New Law a Sino-foreign joint venture could have the shareholders meeting
rather than the board of directors as its highest decision-making authority,
and the unanimous approval of the board of directors to changes in its
registered capital, mergers, liquidation and amendments to its articles of
association would no longer be required.

National treatment
requirement

and

removal

of

MOC

approval

The Draft New Law proposes a principle of national treatment, in which all
investments that do not fall within a negative list will no longer require the
approval of the Foreign Investment Authority and will not be subject to
restrictions specifically applied to foreign investment, with the exception of the
financial sectors where the foreign investment-specific requirements and
restrictions under the existing rules continue to apply.
Whilst the Draft New Law sets national treatment as a general principle, the
negative list (which is yet to be formulated by the State Council) still needs to
be reviewed in order to determine the real impact of the Draft New Law.
The negative list is expected to provide certainty by consolidating the various
requirements contained in Chinas laws, regulations and decisions in relation
to foreign investment, as well as applicable international treaties. The list is to
be divided into:

a prohibited investment list, being a list of sectors in which no direct or

indirect foreign investment is permitted, regardless of percentage or
nature of the interest held; and

a restricted investment list, which sets out restrictions on foreign

investments above a certain amount and in certain sectors, where the
relevant foreign investment is subject to the applicable conditions set
out in the restricted investment list and the prior approval of the
Foreign Investment Authority. Of note is that these amounts would
include all financing with a term of one year or more, in addition to
equity investment, and be applied to all investments (including
financing) made in relation to the same project over a two-year period.

New scope and requirements of foreign investment review

The Draft New Law proposes to bring a new range of activities and
transaction structures (as set out below) within the scope of the foreign
investment review regime (if they fall within the negative list) and these
investments may also be subject to national security review and reporting
obligations.

Foreign investment: in addition to greenfield establishments and

acquisitions of domestic equity and assets which are covered by the

China Unveils Draft New Foreign Investment Law

existing foreign investment review regime, the Draft New Law

proposes to regulate additionally:
- the provision of financing to domestic entities (in relation to which a
foreign investor has made an investment) of a term of one year or
more;
- concessions to prospect for or develop natural resources and to
build/operate infrastructure;
- the acquisition of real estate; and
- the acquisition of control of, or interests in, domestic entities by way
of contract or trust.
Furthermore, any offshore transaction resulting in the actual control of
an onshore entity being transferred to a foreign investor shall be
deemed an onshore transaction and be subject to the new foreign
investment regime (see further below). The new proposals emphasise
the principle that China's new approach is intended to cover "foreign
investment" in the broad sense of the word.

Foreign investor: in addition to non mainland Chinese enterprises and

individuals as is the case under the current regime, a "foreign
investor" under the Draft New Law also includes a domestic PRC
entity controlled by a foreign investor, expanding the existing foreign
investment regime which still characterises certain types of
investments within China made by foreign invested enterprises as
domestic investments.
The Draft New Law proposes to prohibit all investments by foreign
investors and any PRC incorporated entities in which a foreign
investor has any direct or indirect equity, voting or other interests in
areas that are covered by the prohibited investment list.
Whether the Draft New Law will eventually cover investments within
China made by non-controlled foreign invested enterprises in areas
that are covered by the restricted investment list, including by way of
clarifying the restrictions in the restricted investment list, remains to
be seen.
Yet another potential extension of the foreign investment regime
concerns the status of a Chinese national who acquires foreign
nationality after making an investment within China. While the current
regime would not require Foreign Investment Authority approval to
such investments, the Draft New Law leaves open this possibility by
characterising all investments within China by such foreign national
(whenever made) as foreign investments.

Control: a key change introduced by the Draft New Law is the use of
the concept of foreign control in ascribing foreign investor status.
The Draft New Law includes all of the following as control by one
entity over another:

China Unveils Draft New Foreign Investment Law

(i) direct or indirect holding of 50 per cent. or more of the equity,

assets, voting or other similar rights;
(ii) any such direct or indirect holding of less than 50 per cent., but:
- with the right to, directly or indirectly, appoint half or more of the
board members;
- with the power to procure the appointment, directly or indirectly, of
half or more of the board members; or
- with ability to exert significant influence on the resolutions of the
shareholders meeting or board of directors or other decision making
bodies;
(iii) decisive influence over business operations, finance, human
resources or technology whether by contract, trust arrangements or
otherwise.
Further clarification of the definition of control would be welcomed; for
example, it is unclear whether a package of veto rights in the
overseas holding vehicle of a domestic entity (as is common in preIPO financing transactions) would be viewed as control under this
definition, or if only positive control is intended to be covered.

Conditions to approval: in granting its approval for foreign investment,

the Foreign Investment Authority may impose one or more conditions
to approval, including asset or business disposal, shareholding
restrictions, term limits, geographical limits or minimum local labour
percentages or numbers.

Extraterritoriality: the Draft New Law proposes that an offshore

transaction resulting in a transfer of actual control to a foreign investor
will be treated as foreign investment. This potentially brings a wide
range of transactions between entities outside China within the scope
of the foreign investment approval (to the extent within the negative
list), national security and reporting regimes.
However, the Draft New Law does not specify if the transfer of actual
control to a foreign investor from another foreign controlled investor is
intended to fall within the scope of the provision, or if it is only
intended to cover the transfer of actual control from an ultimately
Chinese investor-controlled foreign investor.

Chinese investor treatment: when an ultimately Chinese investorcontrolled foreign investor applies for foreign investment approval of
an investment which falls within the restricted investment list, the Draft
New Law would enable the investor to apply to the Foreign
Investment Authority for Chinese investor treatment (note that this
does not apply to the prohibited investment list). If the application is
successful, the investment will be regulated as a domestic
investment, without being subject to restrictions on the making of the
foreign investment. However, the implications of being regulated as a

China Unveils Draft New Foreign Investment Law

domestic investment need further clarification in the final version of

the Draft New Law and it is at this stage uncertain if this means that
the investor will be exempt from all restrictions in the negative list that
would otherwise be applicable, as well as the national security review
process.

Self assessment: the Draft New Law would require foreign investors
to make a self assessment and include a statement in the application
documents for foreign investment approval on whether their
investments will trigger national security review or antitrust review
requirements, as well as a confirmation that all statements,
representations and information in the application documents are true
and complete.

Reporting based supervision

The Draft New Law would impose certain obligations to report to the Foreign
Investment Authority on all foreign investors or foreign invested entities in
relation to all foreign investments (whether or not in areas within the negative
list). These appear to be more extensive than the current filing requirements
of the State Administration for Industry and Commerce with which both
domestic and foreign invested entities are required to comply.
The key additional items include information on the actual controllers of the
foreign investor and the invested entities, as well as operational information
and details of litigation (which are to be supplied in an annual report).
The reporting obligations are required to be discharged within 30 days after
foreign investment approval is obtained (for investments falling within the
restricted investment list), and at the latest by the 30th day after the
investment is implemented (for investments not falling within the negative
list). Annual filing of prescribed information and post-investment filing of
material changes relating to the investment also apply. A foreign invested
entity whose controlling foreign investor has total assets, sales volume or
revenue of more than RMB10 billion or more than 10 subsidiaries is
additionally required to submit a quarterly report within 30 days from the end
of each quarter.
All of the above information is to be made publicly available, other than
information relating to trade secrets or personal privacy of the foreign investor
or the investment. The process by which an investor can ensure that this
exempted information is not put on public record, and the exact scope of this
exception, remain unclear.

National security review

As a counterpoint to the general relaxation of foreign investment restrictions
and MOC approval requirements, the Draft New Law proposes to ascribe a
more extensive role to the national security review regime in the regulation of
foreign investment and has expanded the scope of the existing regime in the
following key areas.
China Unveils Draft New Foreign Investment Law

Broader scope of application: under the existing regime, national

security review will only be initiated in relation to a foreign investors
acquisition of actual control of domestic enterprises or assets, and
greenfield investments that do not involve asset acquisitions are
excluded. Under the Draft New Law, national security review could
apply to any foreign investment that endangers or may endanger
national security, regardless of structure and degree of control by the
foreign investor.

Veto jurisdiction: under the existing regime, the Joint Ministerial

Committee is the authority having discretion to veto a transaction on
national security grounds. Under the new law, veto decisions by the
Joint Ministerial Committee will also need to go through the State
Council.

Conditional clearance: at the same time as veto decisions are made

more stringent by the need for State Council approval, discretion is
given to the Joint Ministerial Committee to impose conditions in the
clearance of a transaction for national security review.

How the Draft New Law applies to VIE structures

As mentioned above, the changes to the Draft New Law would extend the
existing foreign investment regime to include foreign-controlled entities,
where control is broadly defined and includes contractual control. This in
turn requires consideration of how the Draft New Law, when passed in final
form, would apply to variable interest entity (VIE) structures and a
placeholder for the treatment of contractual control arrangements has in fact
been reserved in the Draft New Law. By way of background, VIE structures
are typically used by foreign investors when there are regulatory restrictions
in place in China which prevent or restrict foreign investment. A VIE structure
allows a foreign investor to control and derive the economic benefits of a
restricted business in China via contractual arrangements rather than direct
ownership which would be in breach of Chinese regulations.

New VIE investment: applying the wide definitions of foreign investor

and control, the Draft New Law would regulate new VIE investments
in the same way as other types of foreign investments, such that a
VIE investment in the prohibited investment list would not be
permitted, and a VIE investment in the restricted investment list would
be subject to foreign investment approval. Treatment as a domestic
investment would only be available to a VIE investment in the
restricted investment list (but not the prohibited investment list) where
the controlling foreign entity is in turn controlled ultimately by a
Chinese investor, and has successfully applied to the Foreign
Investment Authority to be treated as a domestic investor. On its face,
this appears to be a limited exception given that it does not apply to
the prohibited investment list, though it must however be emphasised
that the restricted and prohibited investment lists will only be set out in
the negative list which is to be separately issued.

China Unveils Draft New Foreign Investment Law

Existing VIE investment: the Draft New Law is silent on the treatment
of VIE investments which have completed before its coming into
effect, indicating the wish of the authorities to tread carefully given the
widespread use of VIE structures in the Chinese economy (for
example, in the internet, education, media, real estate and financial
sectors) and the number of VIE structures listed on overseas stock
exchanges. In the notes accompanying the release of the Draft New
Law, MOC proposed and solicited public opinion on at least three
possible means of regulating existing VIE investments:
(i)

reporting the structure being permitted to continue following

notification to MOC of the VIE investment being actually
controlled by a domestic investor;

(ii)

verification - the structure being permitted to continue

following confirmation, on the application of the foreign
investor, by MOC of the VIE investment being actually
controlled by a domestic investor; and

(iii)

approval - the structure being permitted to continue following

the approval of MOC.

Important clarifications to the Draft New Law are also awaited on

whether any grace period applies within which existing VIE
investments must be made compliant, as well as any special
requirements that will apply to foreign-controlled (as opposed to
Chinese-controlled) existing VIE investments, both in the restricted
and the prohibited sectors of the negative list that is yet to be issued.
The general intent of the Draft New Law in standardising market entry
requirements and procedures for foreign and domestic investors, and
consolidating and simplifying the various regulatory requirements on foreign
investment, is to be welcomed. At the same time, the Draft New Law clearly
indicates the desire of the Chinese government to regulate and monitor a
wide range of investments, which under the current rules do not specifically
fall within its jurisdiction. Though only a first draft for public consultation has
been released, it is already apparent that the Draft New Law will have a
significant impact on foreign investment regulation in China.

China Unveils Draft New Foreign Investment Law

Reference

Contacts

Foreign Investment Law of the Peoples Republic of China (Draft for

Discussion) , 19 January 2015

For further information

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Richard Gu
Senior Consultant
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richard.gu@linklaters.com
Simon Poh
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(+86) 21 2891 1828
simon.poh@linklaters.com
Judie Ng Shortell
Partner
(+86) 10 6535 0653

Authors: Bryan Chan, Zhirong Zhou, Benran Huang

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China Unveils Draft New Foreign Investment Law

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