Since the promulgation of the NPC Decision and the Draft Measures, various local Commerce Authorities have been adjusting their systems to cater for the record filing system. For example, the Shanghai Municipal Commission of Commerce announced on September 19, 2016 that from October 1, 2016 onwards, applications for the establishment and corporate changes of FIEs can be made by accessing this link: http://zwdt.sh.gov.cn/shen3hall/zmq/index/index.jsp. Pending applications where information or documents are outstanding, or which have not been approved by September 30, 2016, will be treated as rejected and must be re-submitted under the new system.

Balancing breakthroughs and challenges

Impact on FDI transactions

The Draft Measures provide that the corporate changes of an FIE are deemed to occur when the highest authority of the FIE passes resolutions approving the changes. This legislative intent appears to suggest that the time of internal approval refers to the moment when record filing is triggered rather than when the changes take effect. Corporate changes will still need to be compliant with the corporate governance and relevant applicable laws. For example, the record filing system does not apply to a foreign investor's acquisition of a PRC domestic company and the conversion of the domestic company into an FIE, meaning approval by the Commerce Authority will still be required.

Prudent buyers in an M&A transaction will likely require evidence of the completion of record filing and registration of the corporate changes as part of the closing conditions. However, parties of intra-group transactions may be more relaxed in requiring the same evidence as closing conditions, and therefore enhances the certainty of the timing for these transactions.

Compliance challenges

A new feature required under the new record filing system is the disclosure of information relating to the “ultimate controller” of the FIE. This accords with relevant provisions in the draft PRC Foreign Investment Law issued in early 2015 which seeks to look through to the ultimate shareholder/controller of an FIE to determine foreign ownership. However, the Draft Measures do not define the “ultimate controller”, which is normally considered to include a broad range of direct or indirect stakeholders who have sufficient power, either through holding voting shares or contractual arrangements, to exert direct influence on the operation of an entity. For certain foreign investors such as private equity funds or listed companies, it may be difficult to identify who the “ultimate controller” is.

The record filing system and the simplified documentation requirement are premised on the assumption that an FIE, its shareholders and their representatives will comply with the relevant corporate governance agreements and articles of association. While the legal representative of the FIE signing the undertaking could assume personal liability for any false declaration, the parties will need to have additional safeguards to ensure compliance with the relevant corporate governance.

Reconciliation and coordination

Given the NPC Decision only amends certain sections of the FIE laws, inconsistencies inevitably arise between the Draft Measures and other foreign investment laws, especially those that are jointly promulgated by MOFCOM and other government agencies. More legislative efforts are required to eliminate such conflicts in light of the general trend of further liberalising the administration of FIEs. In practice, however, it will take some time for regulators and their officials across the nation to uniformly implement the Draft Measures in practice, and local variations are bound to exist in the short term.

Coordination issues may also arise between the Commerce Authority and other government agencies regulating different operational matters of FIEs. Based on our practical experience in the FTZs, in the short term, the business administration and foreign exchange authorities will likely still require evidence of record filing with the Commerce Authority before effecting the registrations regardless of the new system.

Planning ahead

The NPC Decision and the Draft Measures represent China's attempts to further relax the regime for the administration of FIEs on a nationwide basis against the backdrop of the need to reform its decades-long two-step approval and registration administration regime and to offer national treatment to FIEs.

That said, considerable efforts are still required to amend existing regulations and/or for the various authorities to align their practices to ensure a smooth transition and achieve a truly simplified system for the establishment and corporate changes of FIEs.

Foreign investors should review proposed transactions relating to their FIEs in China and assess whether changes to their transaction documents might be required under this new regime. They should also be prepared for the uncertainties in local implementation and accordingly budget sufficient time and resources in the months ahead.

Tracy Wut, Partner, and Ian Chen, Associate
Baker & McKenzie, Hong Kong, and
Zhi Bao, Partner
FenXun Partners, Beijing

The recent amendment of four laws relating to foreign-invested enterprises (FIEs) by the National People's Congress (NPC Decision) and the promulgation of the draft Tentative Measures for the Administration of the Record Filing of the Establishment of, and Changes to, Foreign-invested Enterprises (Draft Measures) by the Ministry of Commerce (MOFCOM) on September 3, 2016 represent a significant step towards the further relaxation of China's regime on the administration of FIEs.

Under the NPC Decision and Draft Measures, a record filing system for the establishment and administration of corporate changes of FIEs will be implemented on a nationwide basis from October 1, 2016.

Record filing and negative list

The Draft Measures, once promulgated, means a nationwide launch of the record filing system now in place in the four free trade zones (FTZs) of China. A new “negative list” for foreign investment setting out the “industries that are subject to special administrative measures for entry” (i.e. restricted industries) will be promulgated simultaneously with the official release of the Draft Measures. It is also expected that the Negative List will be similar to the one currently being adopted in the FTZs.

Under the record filing system, only foreign investment in the restricted industries will still be subject to the examination and approval by MOFCOM and/or its local counterparts (Commerce Authority). The establishment and corporate changes of FIEs outside of these restricted sectors only need to be reported to the Commerce Authority, which traditionally serves as the “gatekeeper” in scrutinizing any formation or corporate changes of an FIE.

The entire record filing process has been streamlined and the required paperwork has been simplified. The Commerce Authority will only perform a cursory review of the documents to confirm their completeness and accuracy. The record filing will be completed within three business days after receipt of the full set of documents. The Commerce Authority has the power to conduct random spot checks to verify compliance and findings of non-compliance can be shared with other government agencies. FIEs in default will be ordered to rectify, terminate the illegal operation, divest the equity/assets in question (if applicable), and pay a fine capped at Rmb30,000.

Since the promulgation of the NPC Decision and the Draft Measures, various local Commerce Authorities have been adjusting their systems to cater for the record filing system. For example, the Shanghai Municipal Commission of Commerce announced on September 19, 2016 that from October 1, 2016 onwards, applications for the establishment and corporate changes of FIEs can be made by accessing this link: http://zwdt.sh.gov.cn/shen3hall/zmq/index/index.jsp. Pending applications where information or documents are outstanding, or which have not been approved by September 30, 2016, will be treated as rejected and must be re-submitted under the new system.

Balancing breakthroughs and challenges

Impact on FDI transactions

The Draft Measures provide that the corporate changes of an FIE are deemed to occur when the highest authority of the FIE passes resolutions approving the changes. This legislative intent appears to suggest that the time of internal approval refers to the moment when record filing is triggered rather than when the changes take effect. Corporate changes will still need to be compliant with the corporate governance and relevant applicable laws. For example, the record filing system does not apply to a foreign investor's acquisition of a PRC domestic company and the conversion of the domestic company into an FIE, meaning approval by the Commerce Authority will still be required.

Prudent buyers in an M&A transaction will likely require evidence of the completion of record filing and registration of the corporate changes as part of the closing conditions. However, parties of intra-group transactions may be more relaxed in requiring the same evidence as closing conditions, and therefore enhances the certainty of the timing for these transactions.

Compliance challenges

A new feature required under the new record filing system is the disclosure of information relating to the “ultimate controller” of the FIE. This accords with relevant provisions in the draft PRC Foreign Investment Law issued in early 2015 which seeks to look through to the ultimate shareholder/controller of an FIE to determine foreign ownership. However, the Draft Measures do not define the “ultimate controller”, which is normally considered to include a broad range of direct or indirect stakeholders who have sufficient power, either through holding voting shares or contractual arrangements, to exert direct influence on the operation of an entity. For certain foreign investors such as private equity funds or listed companies, it may be difficult to identify who the “ultimate controller” is.

The record filing system and the simplified documentation requirement are premised on the assumption that an FIE, its shareholders and their representatives will comply with the relevant corporate governance agreements and articles of association. While the legal representative of the FIE signing the undertaking could assume personal liability for any false declaration, the parties will need to have additional safeguards to ensure compliance with the relevant corporate governance.

Reconciliation and coordination

Given the NPC Decision only amends certain sections of the FIE laws, inconsistencies inevitably arise between the Draft Measures and other foreign investment laws, especially those that are jointly promulgated by MOFCOM and other government agencies. More legislative efforts are required to eliminate such conflicts in light of the general trend of further liberalising the administration of FIEs. In practice, however, it will take some time for regulators and their officials across the nation to uniformly implement the Draft Measures in practice, and local variations are bound to exist in the short term.

Coordination issues may also arise between the Commerce Authority and other government agencies regulating different operational matters of FIEs. Based on our practical experience in the FTZs, in the short term, the business administration and foreign exchange authorities will likely still require evidence of record filing with the Commerce Authority before effecting the registrations regardless of the new system.

Planning ahead

The NPC Decision and the Draft Measures represent China's attempts to further relax the regime for the administration of FIEs on a nationwide basis against the backdrop of the need to reform its decades-long two-step approval and registration administration regime and to offer national treatment to FIEs.

That said, considerable efforts are still required to amend existing regulations and/or for the various authorities to align their practices to ensure a smooth transition and achieve a truly simplified system for the establishment and corporate changes of FIEs.

Foreign investors should review proposed transactions relating to their FIEs in China and assess whether changes to their transaction documents might be required under this new regime. They should also be prepared for the uncertainties in local implementation and accordingly budget sufficient time and resources in the months ahead.

Tracy Wut, Partner, and Ian Chen, Associate
Baker & McKenzie, Hong Kong, and
Zhi Bao, Partner
FenXun Partners, Beijing