MOFTEC Changes FIE Approvals: Headway or a Headache?

An analysis of the various levels of approval authorities and the methods used to identify the appropriate one can be found at CLP [1997] No 8 p64. However, it should be noted that a new Foreign Investment Industrial Guidance Catalogue (effective January 1 1998) has been issued (the Catalogue), replacing the 1995 version.

THE CATALOGUE

The Catalogue (local versions of which, such as in Shanghai, also need to be considered) expresses official PRC government policy towards foreign investment by dividing the listed industrial sectors into three categories, namely encouraged, restricted and prohibited. The restricted category is further sub-divided into Restricted Category A and Restricted Category B projects, each with differing approval requirements.

Anything not listed in the Catalogue is, in theory at least, within a sweep-up category of permitted projects, although in practice, projects often fall into two categories or do not fit neatly within one. The Catalogue is, nonetheless, often one of the first documents one looks at to assess the likelihood of a proposed foreign investment project being approved.

The Catalogue will need to be amended in due course if China becomes a member of the World Trade Organization (WTO) to reflect its WTO commitments (see CLP [1999] No 10 p69-70 for an examination of the issues in this regard).

THE LOCAL APPROVAL THRESHOLD

In this context, local means provincial, autonomous region, directly controlled municipality, special economic zone and cities like Guangzhou, which have separate plans.

The local approval threshold for foreign investment projects with a TIA of less than US$30 million has become the stuff of legends among the foreign investment community, as has the high number of Local Approval Authorities claiming to have special authorization from the central government to exceed the threshold. However, the relevant thresholds remain internal and have never been openly promulgated.

Until recently, all foreign investment projects (regardless of categorization) involving a TIA of US$30 million or above were required to be approved by the State Development Planning Commission and MOFTEC in Beijing. Further, projects with a TIA of US$100 million or above needed approval from the State Council.

However, as part of a bundle of incentives to boost foreign direct investment (which has flagged in the last couple of years), this approval regime recently underwent significant reform. This reform amounts to a devolution of approval jurisdiction down to the local level for foreign investment projects in the encouraged category.

A NEW APPROVAL POLICY

The new approval policy is set out in two circulars (the Circulars):

a) Further Encouraging Foreign Investment Opinion (the Opinion) co-issued by the MOFTEC and no less than eight other ministries dated August 3 1999; and

b) MOFTEC, Relevant Questions Concerning the Record Filing with the MOFTEC of the Examination and Approval by Local Authorities Themselves of FIEs under the Encouraged Category Circular (the Notice), issued on October 15 1999 (a digest of which can be found at CLP [1999] No 10 p04).

The Circulars deal with examination and approval from foreign economic and trade departments of provinces, autonomous regions, centrally-governed municipalities or cities with a separate plan1 (the Local Authorities).

Under the Circulars, the general principle is that establishment of FIEs under the encouraged category in the Catalogue may be examined and approved by the Local Authorities on the face of it without any stated upper financial limit.

However, the Notice expressly prohibits the Local Authorities from delegating such authority to any lower level authorities. It also carves out FIEs ¡®which require overall balancing by the State¡¯, which is a rather vague expression. While this is consistent with earlier legislation promulgated in the days when China had a more orthodox centrally-planned economy2, it is open to interpretation.

The issue it raises is whether this provides a back-door through which the central authorities could, if they so wished, claw-back approval jurisdiction over a project. Although the Notice is silent in this regard, the implication is that such FIEs are still subject to full central approval of the substantive documents rather than filing for the record (see below).

STEP-BY-STEP DEREGULATION

As is often the case in China, the central authorities have taken a cautious, step-by-step approach to deregulation. The right for Local Authorities to exercise their devolved powers of approval pursuant to the Circulars comes with certain strings attached.

Under the Notice, the Local Authorities are required to send out the following documents to MOFTEC ¡®for the record¡¯ on the day that the Local Authorities decide to approve the Contract and/or Articles of the relevant FIEs:

a) feasibility study approval letter;

b) approval letter for the Contract and Articles (which must set out certain specific information such as the parties, TIA and business scope and must refer by name to any technology import contract attached to the Contract);

c) explanation by the Local Authority as to why the foreign investment project does not require overall balancing.

MOFTEC is required, under the Notice, to provide a written response in respect of the approvals to be issued by the Local Authorities within a month of receiving a complete set of the relevant documents, stating whether or not it has any objections. In other words, MOFTEC has a month in which to review and presumably veto any approval proposed to be issued by the Local Authorities counting from receipt of a full set of documents.

MOFTEC STILL IN THE DRIVING SEAT

It is clear from the above that the filing ¡®for the record¡¯ in reality amounts to a form of quasi-approval, albeit based on limited documentation (there is no requirement to send the substantive documents for the record filing procedure).

The Circulars also establish certain mechanisms designed to avoid record filing becoming a mere formality or, even worse, having an approval issued by the Local Authority in relation to a project that is subsequently objected to by MOFTEC and has
to be withdrawn.

In particular, the Local Authorities may only issue FIE approval certificates upon expiration of the one-month period as specified under the Notice, provided that MOFTEC does not have any objections.

While the Notice states clearly that Local Authorities may not issue FIE approval certificates to establish FIEs in relation to which MOFTEC has raised objections, it is silent on the procedures for dealing with such objections. The question arises as to whether MOFTEC takes control over the approval process in such cases.

The Notice also does not specify any procedures or timeframe for communication of such objections to the parties involved or for resolution of such objections. Presumably MOFTEC needs to be satisfied that any objections have been satisfactorily resolved before it gives the Local Authority the go-ahead to issue the approval certificate. This could lead to delays in issuing approvals.

In addition, any material amendments to the Contract and/or the Articles and any applications for increases in capital of FIEs so approved needs to be put through the same quasi-approval, record filing procedures.

TIME LIMITS FOR APPROVALS

While the Circulars represent a clear step forward in terms of the processing time for larger projects in the encouraged category, the 30-day MOFTEC review period could lead to practical difficulties for Local Authorities in keeping to their own statutory timetables.

One such example can be found in the Shanghai Municipality¡¯s Examination and Approval of Foreign Investment Enterprises Regulations promulgated on August 23 1996 (the Shanghai Approval Regulations). Under the Shanghai Approval Regulations, the authorities must decide whether or not to approve a project within 30 days of receiving the feasibility study report, the Contract and the Articles.

What this will probably mean in practice is that the approval letter will still be issued within the statutory period stating that the FIE has been approved by the Local Authority but that the definitive approval letter will only be issued subject to final MOFTEC approval.

It should be noted that it is the approval certificate that cannot be issued by the Local Authority where MOFTEC has objections, so in theory the approval letter could be issued and subsequently withdrawn prior to the issue of the definitive approval certificate. Given these timing issues, as a precautionary measure, it is not advisable to take any action based on an approval letter issued by a Local Authority in relation to projects covered by the Circulars until the MOFTEC review period has expired.

FAILING TO OBTAIN MOFTEC APPROVAL

It is interesting to note the unusually precise nature of the central reporting procedures set out in the Notice compared to many similar regulations. Local Authorities are required to report on a monthly basis to MOFTEC by faxing a list of all encouraged FIEs approved in the previous month. Local authorities must make a follow-up telephone call to confirm the fax has been received. This suggests a fairly rigorous control process.

The Notice states that MOFTEC will cross-check the list with record filings. In the event that no record filing has been received in relation to a FIE or where record filing procedures have not seen duly completed, MOFTEC will notify:

a) the Local Authority;

b) the State Administration of Industry and Commerce (which issues the FIE¡¯s business licence);

c) Customs;

d) the State Administration of Foreign Exchange; and

e) any other relevant authorities.

Such bodies should refuse to grant the FIE registration or allow it to carry out other procedures in such circumstances.

This raises a couple of issues for FIEs. Firstly, FIEs depend on the Local Authority to communicate with MOFTEC and resolve any objections. Secondly filing the records is not a matter within the control of the parties investing in that FIE, but if the records are not filed, it could work to their detriment. In either case, the result could be a delay.

IMPLICATIONS OF THE NEW POLICY FOR FOREIGN INVESTORS

The new policy is obviously of great practical significance to foreign investors.

First of all, foreign investors in China have, for many years now, complained that obtaining central government approvals for foreign investment projects takes much longer than local approvals.

As a matter of statute, MOFTEC is required to approve an equity joint venture within 90 days upon receipt of a complete set of required documents. In contrast, many local regulations such as the Shanghai Approval Regulations require FIE approvals to be issued within a much shorter period.

In practice, many foreign investors can expect to obtain approvals from the Local Authorities within an even shorter period than the statutory limit, while central approvals frequently take six months or even a year or more to obtain.

It is therefore not altogether surprising that foreign investors have historically sought to avoid seeking central approval where possible, even to the extent of trying to artificially split up foreign investment projects to bypass the need for central government approvals (not a recommended strategy).

The new policy should help to resolve these timing issues, at least in relation to projects in the encouraged category, by effectively reducing the statutory period for central government approval from 90 days to a month.

Moreover, given that the Circulars imply that Local Authorities may issue approval certificates upon expiration of the one-month period in the event of no objection being raised, MOFTEC should be under some pressure to take a more pro-active approach to make its position known within the specified time-limit. However, the period or means for resolving any Local Authority or MOFTEC objections is not stated.

Another benefit the new policy should bring to foreign investors is to reduce the amount of time spent by foreign investors in dealing with the central authorities. This should, in turn, allow them more time to focus their resources on the locality where the project is based and reduce part of the cost of investing in China.

Local Authorities, particularly those in the more remote or investment-starved regions of China tend to be acutely aware of the need to attract foreign investment to their particular region. They tend to be more flexible in terms of what they will approve within the current legislative framework and work harder to facilitate the investment process, as compared to the central government authorities. The central authorities usually remain more focused on their regulatory functions and responsibilities.

FURTHER LIBERALIZATION EXPECTED

Clearly, the Circulars represent a significant step forward in terms of encouraging foreign investment in China and will have a positive impact, particularly on the timing of approvals for larger projects in encouraged sectors.

Further liberalization of the foreign investment regime seems likely in the near future. This is particularly so, in light of China¡¯s progress towards becoming a member of WTO and the message spelled out in the Opinion to departments under the State Council and local People¡¯s Governments to ¡®further simplify the approval procedures for establishing FIEs and speed up their approval schedule¡¯.

The Circulars clearly do not amount to a complete devolution of power to approve encouraged projects down to the Local Authorities. MOFTEC still reserves its right to veto any approvals proposed to be issued by the Local Authorities if it objects to any of the terms of the proposed project.

This creates uncertainty for foreign investors, in that even where the project has the full support of the Local Authorities, it may still be necessary to obtain some degree of central government support. This undermines some of the benefits that might otherwise flow from the more liberalized regime.

What is also unclear is just how the new regime will interface with the existing legal regime. No indication is given in the Circulars as to whether the new rules take precedence over or are subordinate to other existing PRC laws and regulations governing approvals.

ENDNOTES:

1. It is not clear whether the omission of a reference to the Special Economic Zones (SEZs) is accidental or deliberate. The State Council, Delegating Authority for the Approval of Wholly-owned Foreign Enterprises to People's Governments of Provinces, Autonomous Regions, Centrally Governed Municipalities, Special Economic Zones and Municipalities with Independent Development Plans Circular promulgated on June 9 1988 (the State Council Devolved Approval Notice) referred to in the Notice specifically refers to SEZs.
2.. Under Article 6 of the PRC, Sino-foreign Equity Joint Venture Law Implementing Regulations promulgated on September 1983 (and as subsequently amended and supplemented), devolution of approval authority jurisdiction down to the local level in relation to an equity joint venture is premised on, inter alia, ¡®no additional allocations of raw material by the State are required and the national balance of fuel, power, transportation and foreign trade export quotas is not affected¡¯. The same reservation is expressed in the State Council Devolved Approval Notice, which refers to FIEs whose ¡®construction conditions and production and operational conditions do not require overall balancing by the State¡¯.