Entering the Chinese Market: recent developments in China’s FDI regulatory framework
Dr Qianlan Wu
Inward Foreign Direct Investment (IFDI), as one of the driving forces of China’s economic boom, has been under government regulation since China’s market-oriented reform in 1978. However, the regulation has been piecemeal and fragmentary. It was in the 13th five-year Development Plan adopted by the National People’s Congress (legislature) of China, in 2017, that China established a foreign investment regulatory framework, which among others was oriented towards fostering China’s strategic development interests on the one hand and continuing to attract inward foreign investment on the other hand. The adoption of the Foreign Investment Law in March 2019 signals the installation of the last major building block for the framework. (view the text of the Law in Chinese).
The framework, equipped with policy and legal instruments, exerts a far-reaching influence on foreign investors as far as market entry is concerned. A foreign investor can, potentially, be subject to reformed sectoral licence requirement, national security review and competition related merger regulation.
The granting of a sectoral licence for foreign investors is based, primarily, on the Foreign Investment Catalogues issued by the NDRC and the MOFCOM since 1995. Up until 2015 foreign investors were subject to a compulsory ex-ante scrutiny. The 2017 Foreign Investment Catalogue and the 2018 Foreign Investment Negative List, published by the NDRC and the MOFCOM, revealed China’s reformatory intentions.
Pursuant to the 2017 Catalogue and the 2018 Negative List, sectors outside the Negative List have been expanded and deregulated, while sectors within the Negative List are subject to government imposed regulatory barriers and ex-ante scrutiny, including the national security review. The government imposed regulatory barriers include, but are not limited to, the following: prohibition for foreign investment entry; the requirement of Chinese investors as controlling shareholders; foreign investment percentage; and a foreign presence on the management board. In the meantime, foreign investors satisfying certain turnover thresholds will be required to notify the Chinese market regulator for approval, if entering into the Chinese market via mergers.
A fully fledged, nationwide, foreign investment market entry regulatory practice is yet to be developed. The practice by the Shanghai Free Trade Zone (FTZ) may be useful in pointing in this direction. In summary, the requirement for 116 incumbent sectoral licenses for foreign investors were reviewed and divided into revocable or irrevocable licenses. Revocable licenses were further divided into sub category 1 and 2 (sub 1 and sub 2).For category sub 1, a foreign investor attempting to enter a specific sector faces no administrative hurdle, according to the Foreign Investment Catalogue. Provided the foreign investment business does not come under China’s national security review nor the merger review, it can operate in the relevant sector without hindrance. It will be subject to self-regulation, supervised by the relevant Chinese industrial associations which supervise domestic Chinese investors. For category sub 2, foreign investors can obtain licenses through self-registration. This process is not subject to scrutiny. However, a foreign investor is subject to random ex-post supervision by the relevant sectoral and market regulators.
With respect to sectors with irrevocable licenses, foreign investors continue to be subject to an ex ante scrutiny with three possibilities. First, for licenses which cannot be revoked in the short term but can, nevertheless, be regulated with ex-post supervision, foreign investors can undertake commitments as an alternative to a sectoral license. Foreign investors are subject to supervision regarding the enforcement of the commitment and can only start operating in the sector once they have materialized their commitment. Second, for sectors where licenses cannot be revoked in the short term, yet it is inappropriate for the regulator to enforce the investor commitment scheme, foreign investors are required to apply for sectoral licenses for market entry, if no national security issues are triggered. The reforms attempt to provide a set of simplified and transparent rules on license application. Third, for sectors directly relevant to national security; public security; the ecological environment and human health; and human property security, the regulators, by referring to international practice, aim to strengthen control based on risk assessment and management.
The practice of the central regulators and the Shanghai FTZ reveal China’s intentions of transforming China’s IFDI entry regulatory framework. The regulatory framework attempts to transform the all-inclusive ex-ante scrutiny, into a framework where foreign and domestic investors will be subject to non-discriminatory regulation in most sectors outside the Negative List. It also shows China’s renewed efforts to build up an institutionalized, rules-based framework firmly embedded in an administrative system where foreign investors, entering into sectors within the Negative List, will be subject to systematically organized scrutiny regarding their impact on the sectors, national security and competition.
However, it remains to be seen how the above-mentioned regulatory approaches, already in practice in the Shanghai FTZ, will be applied to the sectors, nationwide, by central government regulators. The market and sectoral regulators of China’s State Council (central government) went through an institutional reshuffle in March 2018. The sectoral license, national security review and merger review falls under the competence of different regulators, which are nonetheless under the unitary regulatory system overseen by the State Council. It remains to be seen how the relevant regulators would coordinate among each other, on the one hand, and strike a balance between achieving regulatory effectiveness, safeguarding due procedure, transparency and certainty, on the other.
April 2019