Progress or Setback? Looking at the New Approval Measures for Foreign Investment Projects

From Approval to Registration

In recent years, PRC authorities have been moving increasingly towards a registration rather than approval system. In July 2004 the State Council started implementing this policy in the field of investment approval Measures with the issuance of Reform of the Investment System Decision (State Council Decision). The State Council Decision appeared to announce a major reform to the investment approval system with the goal of simplifying the often lengthy and complicated approval procedure. In particular, the State Council decided that, except for projects financed by government funds, the approval system (审批制), which has been in place for more than two decades, would give way to a new project confirmation system (审核制) or filing system (审案制). In this way the government authorities would move from approval to registration.

As is often the case with broad brushstroke legislation, the State Council Decision quickly caused confusion and uncertainty among projects that were already under approval. As a broad framework, the Decision only lays out principles of reform but provides little in the way of defining the detailed Measures upon which the new system would be implemented. Accordingly, the State Council Decision has left investors and their advisors in a quandary as to whether the old (and understood system) or the new (and untested) rules would be followed.

After a few months of uncertainty the National Development and Reform Commission (NDRC) stepped in and in October 2004 issued implementing rules¹ for the State Council Decision. However, those observers hoping for an easier, more predictable approval system have been disappointed by the new regulations. Administration of the Verification of Foreign-invested Projects Tentative Measures (issued October 9 2004, the Measures) regulate the Measures whereby the NDRC reviews and approves foreign investment projects pursuant to the new "confirmation system". However, far from making the system simpler it appears to make the establishment process for FIEs more complicated, time-consuming and unpredictable. Although the Rules do clarify some practical issues, they seem to have led to more questions than answers.

Applicability - What Needs to be Approved?

Article 2 of the Rules provides for an extremely wide scope of applicability. The Rules purport to apply to all "equity joint ventures, cooperative joint ventures, wholly foreign-owned enterprises, foreign acquisition of domestic enterprises and capital increases of existing foreign-invested enterprises". In our opinion, the scope of application actually extends the types of projects that must go to the NDRC for approval.

It has been a common practice for years in China that only MOFCOM or its local counterpart would approve new projects or capital increases to existing FIEs that were non-manufacturing companies (such as those offering consulting or other services). Approval Measures in recent years have been straightforward and completed in one step. Approval of a feasibility study and joint venture contract and/or articles of association has occurred simultaneously. The Rules seem, however, to require that all new projects and capital increases be approved by the NDRC or its local counterpart. This additional requirement, if followed, will make the approval Measures more complicated and time-consuming.

Interestingly the Rules also require that all acquisition of domestic enterprises by foreign companies be approved by the NDRC. The Acquisition of Domestic Enterprises by Foreign Investors Tentative Provisions issued by MOFTEC (the predecessor of MOFCOM) in 2003 (the M&A Rules) is the major piece of legislation that regulates merger and acquisition activities by foreign investors. Article 6 of the M&A Rules provides that MOFTEC or its counterparts at the provincial level (now MOFCOM) shall be the approval authority for M&A projects. Accordingly, for M&A projects, no NDRC approval was necessary. The Rules, however, seem to entail NDRC approval for M&A projects, thus treating them as if they were new FIE projects. This extra requirement if implemented will create new obstacles for M&A activities, which have increasingly become a feature of the Chinese foreign investment landscape.

Issuing Authority - Who is in Charge?

The Rules were issued by the NDRC itself. It has been common for important pieces of legislation affecting foreign investment to be issued jointly by a number of authorities including MOFCOM, which is traditionally a key player in approving FIE projects, and SAIC, which is in charge of registration of FIEs. However, in this case neither of them joined in drafting or issuing the Rules. The absence of MOFCOM and SAIC may mean that there is some uncertainty over the division of responsibilities between these government authorities. This ambiguity will arguably lead to practical problems for projects and their investors.

Indeed in our view, any roadmap setting out the establishment of FIE projects Measures without reference to MOFCOM is to a degree incomplete. As the Rules provide no clear indication as to how MOFCOM and the NDRC will coordinate their requirements, investors may face difficulty in determining whose requirements must be followed in the establishment process. It is also unclear to what extent the Rules will be acknowledged and followed by MOFCOM in its approval practice. In the past, MOFCOM (or MOFTEC) had on occasion chosen not to follow regulations by other authorities that had not been coordinated with them.

Provincial Competency Level Increased

On a positive note the Rules do clarify certain issues such as the competency of state and provincial government authorities. Provincial government authorities have been granted a higher level of competency to approve foreign investment projects. The threshold has been raised to US$100 million for encouraged and permitted projects and US$50 million for restricted projects. Projects with a higher investment will need to obtain approval from the State Development Planning Commission. In addition, encouraged and permitted projects with a total investment of more than US$500 million or restricted projects of more than US$100 million will require State Council approval. It remains unclear whether MOFCOM will follow these thresholds in respect of the division of power.

Revised Approval Measures

The long-established practice for FIE projects has been that parties first submit a project proposal and obtain a preliminary approval (lixiang) that forms the basis for the project to continue. Thereafter, a more detailed feasibility study report is submitted for final approval. In the amendments to the PRC Sino-foreign Equity Joint Venture Law Implementing Regulations issued in 2001, the formal requirement for a project proposal was removed. However, in practice the lixiang is still a necessary hurdle, particularly for large-scale projects.

The major change introduced by the Rules is the combination of the traditional two steps into one. According to the Rules, the parties only need to file one "project application report" to the NDRC or its local counterpart for approval. This change will probably benefit large-scale projects that are now more likely to have a quicker approval process.

Shift in the Focus of Government Review

The State Council Decision stated that the government will shift its focus in respect of reviewing and approving projects. The government is to review projects from the perspective of protecting economic security, reasonable exploitation of resources, environmental protection, avoiding monopolies and allowing fair market access. The parties, rather than the government, shall decide upon the commercial aspects of the project, such as market prospects, economic profitability, sources of funds and technology.

It used to be the case that government officials would often actively discuss commercial aspects of a joint venture contract (e.g., levels of royalties for technology licences); admittedly this has become less prevalent in recent years. Such discussions would often appear not to have much to do with regulatory issues. The State Council Decision reflects a change in the Chinese business landscape in which the authorities have increasingly retreated from such activities.

The required contents of the "project application report" reflect this change of focus. The new requirements stress less on commercial information about the project, such as market surveys, forecast sales and profitability, and technical feasibility, which in the past constituted a major part of the feasibility study, and now look much more at the environmental impact, and pricing of public products or services (such as electricity).

Again, this change increasingly reflects changed practices in recent years. In a number of recent projects, the authorities made it clear that they preferred a shorter document that concentrated on the infrastructure requirements and environmental impact of the project.

Timeline for Approval

The Rules set clear deadlines in respect of NDRC approval that reflects an overall trend in the PRC to accountability. Under the Rules, the NDRC is required to decide whether or not to approve the project within 20 working days of receipt of the application documents. If the NDRC is unable to make a decision within 20 working days, it may extend this period for a further 10 working days and inform the parties as to the reasons for the delay.

If it is necessary for the NDRC to engage a consulting firm to evaluate the project, the above timing requirement does not include the time required for such evaluation. However, the NDRC is required to engage the consulting firm within five working days upon receipt of the application. Whether or not the deadlines will be strictly implemented will need to be seen. However, their inclusion shows again the positive development in China towards transparency and accountability on the part of the government authorities.

Conclusion

Overall the Rules and the State Council Decision clearly illustrate a willingness by the PRC authorities to move away from micro-managing foreign investment in China. However, the Rules also illustrate the reality in China that a number of authorities feel responsible for regulating foreign investment and are issuing competing regulations that make it unclear how investors should proceed in practice. It appears likely that the new "confirmation system" is the trend for China as she moves from a strict approval system to a freer registration one. However, many questions are left unanswered. The most important of these questions is how the Rules will interact with other regulations issued by MOFCOM and the SAIC.

Endnote

1 The implementing rules include: Verification of Foreign-invested Projects Tentative Administrative Measures, Verification of Enterprise Investment Projects Tentative Administrative Measures, and the Verification of Offshore Investment Projects Tentative Administrative Measures, each of which governs different types of investment projects.