Directing growth

At first glance, the number of changes contained in the 2011 Catalogue is fairly modest compared with the number of changes included in previous versions. Whereas the 2007 Catalogue substantially increased the total number of industry sectors, the 2011 Catalogue contains five fewer total industry sectors. Three new industry sectors were added to the encouraged category, seven industry sectors were removed from the restricted category, and one industry sector was removed from the prohibited category. By examining the 2011 Catalogue in greater detail, however, one can identify significant changes, some of which offer new and interesting opportunities, while others curtail or remove certain options for foreign investors.

Highlights of the 2011 Catalogue include the elimination or amendment of foreign equity ownership caps in certain industries; the addition to the encouraged category of “venture capital enterprises”, various service industries and advanced and environmentally-friendly production technologies and materials in the textiles, chemicals, building materials, new energy and machinery manufacturing sectors, as well as technologies related to clean energy vehicles; the removal from the restricted category of franchising, financial leasing, medical institutions and automobile wholesaling; and changes to the prohibited category that continue China's gradual push toward a more open economy and eliminate foreign investment in sensitive industry sectors.

The 2011 Catalogue also removes from the encouraged category industries such as “manufacturing of complete automobiles” and polycrystalline silicon, to reign in foreign investment in areas where China has achieved sufficient capacity and sectors where adequate interest from foreign investors already exists. Likewise, many of the changes to the restricted and prohibited categories reflect China's efforts to control or reduce foreign investment in lower technology and lower value-added sectors and industries that degrade the environment.

Policy objectives

The changes contained in the 2011 Catalogue are broadly indicative of China's primary macro-economic policy goals and manifest China's desire to attain a higher position in the global economic value chain, to attract technologies that promote China's goals for indigenous innovation and environmental protection and remediation, and to discourage investment in sensitive or harmful industries and industries that are viewed as sufficiently well-developed.

The 2011 Catalogue helps implement the principles laid down in the PRC Outline of the 12th Five-year Plan for National Economic and Social Development (中华人民共和国国民经济和社会发展第十二个五年规划纲要), which represents China's chief economic policy guideline through 2015. The 12th Five-year Plan stresses China's continued efforts to restructure its economy by moving away from lower value-added export manufacturing and toward higher valued-added sectors, particularly technology-based industries. To achieve this central policy objective, China is cultivating “seven strategic emerging industries”, which include new energy, energy conservation and environmental protection, biotechnology, new materials, new information technology, high-end equipment manufacturing and clean energy vehicles.

Shortly after issuance of the 2011 Catalogue, the NDRC published an official media Q&A that summarised the policy objectives of the 2011 Catalogue. According to the NDRC, the main goals for the 2011 Catalogue include continuing the policy of opening up the economy to foreign investment; “improving the standard for utilising foreign capital”, a likely reference to China's movement away from investment in lower value-added industries; encouraging the importation of advanced technologies; attracting top calibre human resources; promoting transparency and further standardising foreign investment; and encouraging foreign investment projects that use modern agriculture, high and new technologies, advanced manufacturing, new energy and modern services.

The media Q&A also stated that the 2011 Catalogue does not establish new restrictions on foreign investment in the sectors that China committed to open under its WTO accession protocol. In fact, the 2011 Catalogue includes changes to certain industries that reflect China's continuing efforts to implement its commitments under its WTO accession protocol, though some of these commitments were implemented through legislation promulgated before the issuance of the 2011 Catalogue. For example, foreign equity participation in domestic and international basic telecommunications services was increased to 49%, and the general distribution and import of books, magazines and periodicals is now permitted.

Impact on approval thresholds

Foreign investment projects in China generally are subject to government approval. The approval process normally involves a number of administrative agencies, including the relevant industry regulator (where required), the NDRC (for project approval) and Mofcom (for foreign investment approval). In addition, if a foreign investment project involves state-owned assets, the approval of the State Assets Supervision and Administration Commission also may be required. The relevant categorisation in the Catalogue of a particular industry sector determines the applicable government approval thresholds for a foreign investment project in that sector. As a practical matter, foreign investors (and their Chinese joint-venture partners) prefer to seek foreign investment approvals at the local level, as the approval procedures tend to be faster, cheaper and involve less rigorous government scrutiny.

Where the total amount of investment in an encouraged or permitted foreign investment project is at least US$100 million, but less than US$300 million, approval must be obtained from the provincial-level subordinates of the relevant government agencies. Where the total amount of investment in an encouraged or permitted project is US$300 million or more, but less than US$500 million, the project must be approved by the relevant government agencies in Beijing. Where the total amount of investment in an encouraged or permitted project is US$500 million or more, State Council approval is required. Foreign investment projects with a total amount of investment below the applicable thresholds generally may be approved at the appropriate municipal, county or district levels within China's governmental hierarchy.

By contrast, a foreign investment project in the restricted category may not be approved below the provincial level. Where the total amount of investment in a restricted project is between US$50 million and US$300 million, the project must be approved by the relevant government agencies at the central level in Beijing. Where the total amount of investment in a restricted project is US$300 million or more, State Council approval is required.

A foreign investment project that is categorised as encouraged may be eligible for tax preferences, including reduced enterprise income tax rates, business tax exemptions, import duty and value-added tax exemptions or rebates and other benefits, if it also qualifies under other rules or policies related to the geographical location or business scope of the project that are designed to attract certain types of foreign direct investment.

Timing

Based on past practices involving prior revisions to the Catalogue, an existing foreign-invested enterprise (FIE) that operates in an industry sector that has been downgraded from the encouraged category to the restricted category may be permitted to continue to enjoy the more favourable treatment offered under the prior categorisation. The duration, however, of this type of grandfathering arrangement is not yet clear. It also is not yet clear whether (or at what point in time) an existing FIE that operates in an industry sector that has been upgraded from the restricted category to the encouraged category may enjoy more favourable treatment. Where an FIE applies to amend its project approval or foreign investment approval, for example in the case of a capital increase, the authorities will apply the new industry categorisation, at least to the extent of the relevant amendment.

According to the NDRC media Q&A, the start date for applications for approval of foreign investment projects within an amended industry categorisation will be interpreted as follows:

• A project approval issued before January 30 2012 will be subject to the 2007 Catalogue;
• A foreign investment approval issued before January 30 2012 will be subject to the 2007 Catalogue; and
• Applications for project approval or foreign investment approval that are pending on January 30 2012 will be subject to the 2011 Catalogue.

Summary of changes

Carrying forward a change that began with the 2007 Catalogue, the 2011 Catalogue does not contain geographical preferences. Instead, location-based preferences are set forth mainly in the Catalogue for Guiding Foreign Investment in the Dominant Industries of the Central and Western Regions (中西部地区外商投资优势产业目录). Therefore, a foreign investor in a project located in these regions should consult the 2011 Catalogue and the Central and Western Region Catalogue (as well as applicable national and local regulations and policies) to ascertain the applicable rules. A revised Central and Western Region Catalogue is expected to be issued within the next 12 to 18 months.

Encouraged areas: Additions to the encouraged category of the 2011 Catalogue in large part promote the seven strategic industries specified in the 12th Five-year Plan, as evident in the examples shown in the box.

Other changes to the encouraged category reflect China's desire to achieve a specific policy goal, such as freeing up sources of investment capital to assist the development of small businesses and innovative technologies (for example, the addition of “venture capital investment enterprises”), promoting the protection of intellectual property rights (the addition of “intellectual property services”), improving the skills of China's industrial work force (the addition of “vocational skill training”), and facilitating the development of logistics and distribution channels (the addition of “logistics information consulting services,” “low-temperature distribution of fresh produce” and “rural chain distribution”).

At the same time, foreign investment is no longer encouraged in conventional industries in which China has mastered advanced technologies and has sufficient production capacity, as apparent in the removal of several conventional industries from the encouraged category. For example, the “manufacture of complete automobiles” is now permitted.

Restricted areas: In addition to a higher government approval threshold, foreign investment projects in industries that fall within the restricted category also may be subject to limitations on the permitted form of investment vehicle (such as a Sino-foreign equity or cooperative joint venture only) or to caps on the percentage that may be held by foreign investors, or both. For example, foreign investment in seed production, and the construction and operation of gas, heat and water supply and drainage networks for cities with populations above 500,000, each are limited to Chinese majority-held joint ventures. Moreover, foreign investors should not regard the 2011 Catalogue as an exhaustive list of the restrictions placed on foreign investment projects in the restricted category, as national rules and local people's governments and administrative agencies also may impose additional requirements.

Several industrial areas were removed from the restricted category (and therefore are permitted) in the 2011 Catalogue, including the production of carbonated beverages, financial leasing companies, franchising, commodity auctions, automobile wholesaling, medicine wholesaling and medical institutions, in a reflection of China's continued opening to foreign investment.

Many of the changes in the restricted category express China's policy of controlling or reducing foreign investment in lower technology, lower value-added industries or sectors that cause pollution. For example, new additions to the restricted category include the “production of pigments and coating by utilising backward technologies, or including harmful substances or below the designated size” and the exploration and mining of certain strategic materials, such as high aluminium refractory clay, wollastonite, graphite and “other important non-metallic minerals,” as well as the exploitation and mineral processing of lithium and pyrite and the refining of salt brine resources.

Prohibited areas: Some of the changes to the prohibited category reflect Beijing's desire to continue to open the Chinese economy to foreign investment. Other changes signify the government's intent to eliminate foreign participation in sensitive industry sectors and to discourage further investment in industry sectors that are contrary to current social and economic policy.

As examples of China's gradual opening, the 2011 Catalogue removes the establishment of video projection companies and the import of audio and video products and electronic publications, which are now permitted. Foreign investors should note that these industries still lack clear enabling regulations, and the distribution of audio and video products and electronic publications remains restricted. In addition, the 2011 Catalogue creates a narrow exception for music programming in regard to “audio and video programmes on news websites and networks, the operation of business premises for internet-access services, and the operation of internet culture business”, while foreign investment in news and video remains prohibited.

China's efforts to remain vigilant in protecting sensitive industries are evident in the appearance of new industry sectors in the prohibited category of the 2011 Catalogue, including “topographic map compilations, general map compilations and compilations of electronic maps for navigation purposes”, the “production of materials for the breeding of China's rare and special varieties”, the “development of transgenic organisms and transgenic agricultural plant seeds” and several kinds of edible oils.

Finally, examples of China's use of the Catalogue to implement current policy include measures to reduce environmental degradation (such as the addition of “production of mercury and alkalinity zinc-manganese button batteries”), to curb the development of high-end real estate (the addition of “construction and operation of villas”), and to protect domestic industries (the addition of “domestic letter delivery business”). The latter change mirrors the 2009 revisions to thePRC Postal Law (中华人民共和国邮政法), which limits foreign investment to parcel delivery businesses.

Careful steering

The Catalogue has long been used by China's government as a tool to steer foreign investment toward industries that China's policy-makers see as important to the nation's continued economic restructuring, and the 2011 Catalogue carries on this tradition. Following the lead of the 12th Five-year Plan and other major policy statements, the 2011 Catalogue includes a significant number of new additions that encourage investment in the seven strategic emerging industries. Similarly, the 2011 Catalogue is replete with examples of China's efforts to protect sensitive industries, to reduce foreign investment in lower technology and lower value-added sectors, where sufficient capacity and/or foreign investment already exists, and to limit areas that tend to lead to environmental degradation.

By Brad Herrold, Yan Zeng & Joel Stark of Orrick, Herrington & Sutcliffe, Beijing, Shanghai & Hong Kong

Additions to the encouraged category of the 2011 Catalogue

• New energy: “gear systems for wind power and nuclear power” and “thin-film solar conductive glass and solar collector glass”
• Energy conservation and environmental protection: “manufacturing of high technology green batteries,” “recycling of construction waste” and “technology for the restoration of coastal ecological environments”
• Biotechnology: “production of new vaccines (such as cervical cancer vaccines, malaria vaccines and foot-and-mouth disease vaccines)” and “production of AIDS vaccines, Hepatitis C vaccines and contraceptive vaccines”
• New materials: “resin-based composite materials (including high-grade sports products and light-weight and high-strength components of transportation), special-function composite materials and their products (including composite material products used in deep water or for diving, composite materials products for medical treatment and recuperation)” and “development and production of energy-saving, environment-friendly, waste-recycling, light-weight and high-strength, high-performance and multifunctional building materials”
• New information technology: “manufacturing of super capacitors, passive integrated circuit components,” “touch systems (touch screen and touch modules, etc.” and “development and manufacturing of next generation internet system equipment based on IPv6, terminal equipment, software and chips”
• High-end equipment manufacturing: “manufacturing of gear systems for high-speed trains” and “manufacturing of high-density, high-precision and complicated-shapes for powder metallurgy components and chains for automobiles and engineering machinery” and
• Clean energy vehicles: “key green automobile parts and components” and “construction and operation of vehicle charging stations and battery replacement stations.”