12th Five-year Plan is off to a good start

However, the boom in the Chinese economy did not come without defects. The imbalance between investment and consumption, slow development in technology innovation, and a defective industry structure have quickly become inevitable side effects of China's economic success. Hence, with a view to improving the quality of the economy, the past few years have seen the Chinese government giving a new dimension to its “opening-up” policy by introducing on the one hand a “selective opening-up within the nation” approach and on the other hand a “go globally” approach. Furthermore, in order to accommodate the transitioning of the economic structure, the Chinese government is also keen to establish a highly-efficient financial system to support the structural economic adjustments. It is anticipated that these two approaches will substantially increase the total amount of “national wealth”.

Selective domestic opening-up

The selective opening-up policy is embodied in the 12th Plan where seven strategic emerging industries were listed to form the backbone of China's plans to develop its high-tech industries. These seven industries include energy and technologies involving environmental conservation, new information technology, biotechnology, high-end equipment manufacturing, alternative energy, advanced materials and alternative fuel cars. It is expected that the government will foster the development of these industries by making preferential financing and tax policies, establishing relevant industry and technical standards, and constructing infrastructure to develop and support the market for new products. China is aiming for the emerging industries to contribute around 8% of its GDP by the end of year 2015.

The central government's commitment to a selective domestic opening-up approach as shown in the 12th Plan has also been reflected in the policies laid down by the government in the leading up to the issuance of the 12th Plan and in the revised draft on the Foreign Investment Industrial Guidance Catalogue
(外商投资产业指导目录) (Catalogue) published by the Ministry of Commerce (Mofcom) for consultation a month after the 12th Plan was issued.

(a) Before the 12th Plan was passed in March this year, the Chinese government via the State Council (SC) had shown its determination to optimise the structure of utilisation of foreign investments in China through theSeveral Opinions on Further Improving the Work on the Use of Foreign Investment (国务院关于进一步做好利用外资工作的若干意见) and the Circular on the Proposal on the Division of Work Among Departments for Implementing the Several Opinions on Further Improving the Work of the Use of Foreign Investment (贯彻落实国务院关于进一步做好利用外资工作若干意见部门分工方案的通知) (collectively, the Opinions).

The purpose of the promulgation of the Opinions is to improve the quality and standard of use of foreign investments, and to further promote the technology innovation and industrial structure adjustments in China. Although it is acknowledged that specific government divisions will stipulate their own detailed rules to implement the Opinions, the Opinions clearly show the central government's resolution to apply a selective opening-up policy to foreign investment. Amongst others, the following main features of the Opinions are worth noting:

(i) Amendment to the existing Catalogue

Since it was first introduced in 1995, the Catalogue has been amended three times in the past 16 years with the latest amendment being in 2007. Subject to the Opinions, the Chinese government plans to further open its doors to foreign investment in industries such as high-end manufacture, high-technology, the modern services sector, new energy, and energy-saving and environmental protection. Please see the discussion in the subsection immediately below on the consultation draft of amendments to the Catalogue.

(ii) Incentives for regional headquarters and functional centres

The Chinese government also encourages foreign investors, especially multinational companies, to set up regional headquarters and other functional centres in China. Such functional centres include but are not limited to research and development centres, procurement centres, financial management centres, settlement centres, cost and profit verification centres, etc.

(iii) Simplified approval procedures on foreign investments

The total investment threshold for foreign-invested projects that require central level approval has been raised from US$100 million to US$300 million for projects that fall under the “encouraged” or “permitted” categories. This change provides governmental authorities at lower levels with more powers and duties in relation to the examination and approval of foreign investment.

(b) Consultation draft of the amended Catalogue

Mofcom published a consultation draft of the amended Catalogue one month following the promulgation of the 12th Plan. The proposed amendments to the Catalogue echoes the 12th Plan and the Opinions to develop the strategic emerging industries by expressly encouraging foreign investments in industries that involve research, development and manufacturing of new light-weight and environmentally-friendly materials for aviation and aerospace; manufacturing of gear transmission used for wind power, nuclear power or high-speed rail; design and manufacture of production equipment for power batteries for automobiles; key parts and components of new energy automobiles; recycling and treatment of waste plastics, electrical and electronic products, automobiles, mechanical and electrical equipment, rubber, metals and batteries; etc.

The central government's goal to develop high-tech industries as laid down in the 12th Plan has continuously been driven by its indigenous innovation policies which aim to improve indigenous innovation capabilities in technology. These policies do not necessarily work well together (rather, have usually sit uneasily) with the opening-up approach that the central government has also adopted to attract foreign investors. Some foreign investors have already found themselves potentially facing a rather skewed competitive environment versus domestic firms with the introduction of the indigenous innovation programme in China a few years ago. It remains to be seen how the central government will foster an investment environment that is capable of both attracting foreign investments and substantiating the development of its high-tech industries.

(c) National M&A security review regime

Notwithstanding the “opening-up” policy, there are signs that the Chinese government is also taking a more cautious and stringent approach with regard to foreign investment in certain sensitive sectors. For instance, the General Office of the SC issued the Circular on the Establishment of a System for Security Review of Acquisition of Domestic Enterprises by Foreign Investors (关于建立外国投资者并购境内企业安全审查制度的通知) (the M&A security review) in early February this year. The M&A security review presents new challenges for foreign investors investing in military sector or important economic sectors which are likely to affect national security for compliance.

Going global

The “going global” approach was first introduced by the Chinese government around 10 years ago in order to encourage Chinese companies to invest overseas. As a result, China's outbound investment has surged in recent years and the trend is likely to continue due to growing demand for energy and natural resources, and an increasing need for global distribution networks, technologies and a modern enterprise management system. In addition, such growth in overseas direct investment has pushed Chinese financial regulators to propose a new scheme for qualified domestic institutional investors (the QDII) seeking additional indirect investment channels in the global financial market. In this era of globalisation, China's focus on world economic matters is clearly stated in the 12th Plan.

(a) Overseas direct investment

By the end of 2010, total overseas direct investment reached around US$330 billion, of which around 80% consisted of industrial investments, which were mainly targeted to resource-rich developing countries. The 12th Plan encourages all forms of enterprises in China to systematically explore overseas investment or cooperation opportunities, especially in industries which focus on the development of international energy resources. Domestic large-scale industrial and financial enterprises are also being encouraged to go out internationally. From a legislative perspective, the Chinese government intends to establish a more comprehensive outbound investment legal regime to protect Chinese investors, and proactively negotiate bilateral treaties with other nations.

(b) QDII regime

The QDII regime was initially introduced to the Chinese market in 2006 by the People's Bank of China (PBOC), followed by other financial regulators subsequently, and represented a significant milestone to formally qualify PRC financial institutional investors as QDIIs. This allows qualified domestic institutional investors to either use foreign currency already held by participating investors or raise renminbi (Rmb) funds from domestic individuals and institutions, and convert them into foreign currency for overseas investment purposes. In principle, the QDIIs generally consist of commercial banks, trust companies, securities companies, fund management companies, insurers, social security funds or any other approved financial institutions. Although the performance of the QDIIs in recent years has not been that promising primarily due to various reasons including the most recent financial crisis, there is no doubt that the launch of the QDII regime essentially provides the channels for PRC financial institutional investors to diversify their portfolios of asset management business in a much wider global platform. Also, this has created lucrative opportunities for foreign financial intermediaries to not only play offshore advisory and custodian roles but also develop structured products that can be offered to onshore investors through QDIIs.

Deepening of the reform of the financial system

Aside from the evolving “opening-up” policy, strengthening the reform of the financial system is another one of the two approaches which will be used to substantially increase the “national wealth” under the 12th Plan. Since the PBOC was designated as being China's central bank, there has been a constant urge to reform China's financial system. From then on, the PRC legal framework for the foreign financial services industry has been systematically developing, especially since China's accession to the World Trade Organisation (WTO) in 2001.

(a) Reform of the financial business:“separate operations” vs. “mixed operations”

In adherence to the “separate operations” principle to administrate the Chinese financial market, the Chinese financial regulator divided the financial regulations among three bodies, namely the China Securities Regulatory Commission (CSRC) for securities, the China Bank Regulatory Commission (CBRC) for banking, and the China Insurance Regulatory Commission (CIRC) for insurance. On the one hand, China's adoption of the “separate operations” principle is characterised by its immature and vulnerable financial market. On the other hand, this has, to some extent, reduced the potential risks that normally originate from an unstable international financial market, for instance, during the recent financial crisis in 2007 and 2008.

However, in recent years, in order to build up a sophisticated and established financial market in China, the government has started to explore different levels of “mixed operations” models among financial institutions. As opposed to what is common practice in the international financial market which permits one financial institution to mix its banking, securities and insurance businesses, the “mixed operations” system operates in two ways: the first one allows for a mixture of different financial businesses within a whole financial group (the Inner-group Mixture) and the second introduces the financial agency business within financial institutions (the Financial Agency Business).

(i) Inner-group Mixture

Just as the name implies, the Inner-group Mixture refers to a financial institutional group providing more than one financial service by setting up subsidiaries within the group. Each subsidiary within the group assumes one function of any of the banking, securities or insurance business. In practice, we have already seen this type of Inner-group Mixture structure in banking and insurance sectors. This also explains the recent cross-sector acquisitions among various financial institutions that we have seen in the market (such as Chinese banks' investments in the securities-investment fund management companies and most recently the insurance sectors) and potential trend of further collaborations among financial institutions (for example, the long-awaited liberalisation of Chinese insurers' investment into securities-investment fund management sector).

The 12th Plan acknowledges this type of Inner-group Mixture by contemplating to draft a series of legislation on this topic, such as the Administrative Measures on Financial Holding Company (Financial Holdco Measures). It is contemplated that a financial master holding company as the head of the group will be set up, with its subsidiaries engaging in different types of financial services separately. It is of interest to be seen how such financial master holding company will be regulated and clearly integrated cooperation among various financial regulators will be necessary.

(ii) Financial Agency Business

A typical example is the cooperation between banks and other financial institutions (also commonly referred to as bank-insurance cooperation, bank-trust cooperation and bank-securities cooperation) which allows banks to gain additional profits from selling non-banking products. Recently, Chinese banks have also been eyeing investments in the insurance sector and there has accordingly been greater integration between banks and insurers in China. As a result, the CBRC has unveiled new rules and the CIRC has also released its draft guidelines further tightening-up the sale of insurance products by Chinese commercial banks. It is believed that this latest round of regulatory changes to the bancassurance market, alongside the incremental regulatory reforms to distribution channels and product types will gradually align China's bancassurance market with the more mature markets in Europe and the United States. It is also expected that other non-banking financial institutions (for example, securities companies) may soon be permitted to distribute insurance products.

(b) Reform of the financial market

Compared to mature markets, China's financial markets are still largely unexplored and bank loans to the private sector account for the lion's share. The comparatively large share of private sector credit shows that the Chinese economy remains heavily dependent on bank finance and signals that the capital markets are still underdeveloped.

As a result, one of the main priorities of the 12th Plan is to set up a framework for a multi-layered financial market. The concept of a multi-layered financial market is based around introducing more financing and investment channels to satisfy the different financing and investment needs of the private sector players. In particular, the Chinese government has emphasised its resolution to explore the establishment of an international board, the internationalisation of the Rmb, and the development of the private equity fund market, so as to support development of the Chinese pillar industries.

(i) Establishment of an international board

The feasibility to establish an international board in China was first formally confirmed in 2009 when the SC promoted Shanghai as the international financial and shipping centre by 2020. In the following years, regulators were actively advancing the construction of the international board, and making studies on the issues such as information disclosure, continuous monitoring, cross-border enforcement and investor protection.

Only one month after the 12th Plan reconfirmed the proposal to establish the international board, the Shanghai Stock Exchange announced in April 2011 that it had finished all technical preparations for launching the international board in Shanghai including the legal basis for listing, trading and clearance. It is envisaged that three types of foreign investors which will likely list on the international board include international leading companies which already have a China presence, and the blue-chip and red-chip Hong Kong-listed companies.

(ii) Internationalisation of the Rmb

Since last year, the Chinese government has shown its determination to internationalise the Rmb and this was further confirmed by the 12th Plan. In the light of the Rmb reform, commentators have renamed the Rmb as the “redback”, which can be contrasted with the “greenback”, the nickname that has been attributed to the US dollar.

One thing that will facilitate the internationalisation of the redback is to speed up the opening up of the Chinese capital account. In order to achieve this, Chinese regulators have launched a trial on cross-border Rmb businesses by entering into bilateral treaties with other nations. They are also contemplating on making Hong Kong, where China's currency meets international investors, become the offshore market for the Rmb.

(iii) Development of the private equity fund market

There are already many purely domestic Rmb funds, which are established in the PRC and wholly-managed and invested in by PRC persons. Several recent regulatory developments in China indicate that the central government is now openly encouraging the establishment of onshore Rmb funds by foreign fund managers. In practice, regulators in major cities of China promulgate their own rules to supplement and implement national regulations within each individual province. In particular, the Implementing Measures for the Launch of a Pilot Foreign-invested Equity Investment Enterprise Projects (上海市关于本市开展外商投资股权投资企业试点工作的实施办法) released by the Shanghai regulators, issued earlier this year, provide such an example.

Assurance of “people living in plenty”

The 12th Plan sets out a number of key targets aimed at improving the quality of people's lives such as an annual rate of 7% increase in people's income, a 13% annual rise in the minimum wage, the creation of 45 million jobs over the next five years, etc. By sharing the benefits of economic development among ordinary people, the Chinese government is striving to raise the general public's well-being, including, but not limited to the quality of medical and social insurance, housing, and education.

Notably, the 12th Plan has made a commitment to improve the livelihood of its people by improving public services, social welfare and the medical and health system.

Lifting of restrictions on foreign investment in medical institutions

Foreign investment in founding medical institutions in China has in the past been limited to equity or cooperative joint venture operations. In December 2010, the Circular on Further Encouraging and Guiding Social Capital to Investing in the Establishment of Medical Institutions (关于进一步鼓励和引导社会资本举办医疗机构的意见) China issued by the SC began the process of gradually relaxing the foreign equity restrictions on medical institutions in China. The position has been reflected in the removal of the joint venture requirements in the recent proposed amendments to the Catalogue, that foreign investors will be able to invest in medical institutions in China via a wholly-foreign owned vehicle. The liberalisation of the medical institution market will likely result in market competition and hopefully improve the quality of medical services and ultimately benefit the public as a whole.

Comprehensive social insurance law

Issued by the National People's Congress, the long-awaited PRC Social Insurance Law (中华人民共和国社会保险法) (SIL) will take effect on July 1 2011. This SIL consolidates previous regulations and administrative measures in this area and provides a comprehensive framework to improve the social insurance system in China. The SIL regulates five basic types of social insurance: basic pension, basic medical insurance, unemployment insurance, occupational injury insurance and maternity insurance.

The SIL removes many of the obstacles under the old regulations which restricted the free movement of the country's increasing migrant population. Under the SIL, a new national system will be established to allow basic pension, basic medical and unemployment insurance to be transferred between different qualifying locations as and when citizens move around the country. Furthermore, the SIL also has a general provision relating to social insurance for foreigners working in China which allows foreign nationals to participate in the Chinese social insurance system.

As the legal framework and social security system advance, the Chinese people can savour happiness and satisfaction by being offered equal opportunities for self-growth. Only then will the sustainability problem currently facing China's economy and social development be solved fundamentally - by not only increasing“national wealth” but also assuring “people live in plenty”.

Lynn Yang, Partner, Chuan Chuan Lai and Ai Tong, Norton Rose, Shanghai