Opening Doors for More Foreign Direct Investment

Forms of investment

In most cases, foreign investors are free to select the form of entity which they prefer for their particular business purpose. The wholly foreign-owned enterprise (WFOE), equity joint venture (EJV) and cooperative joint venture (CJV) have been the structures most commonly used by foreign investors over the 40 years since China opened its doors to the world in 1978. The other available options include partnerships, QFIIs and RQFIIs.

The Negative List imposes restrictions on the use of certain structures. For those sectors with a percentage limitation on foreign investors' shareholding, such as the 50% limit on value-added telecommunication operations, a partnership is not allowed. Other forms of individual business, sole proprietorship enterprise and farmers' specialized cooperative which are available to domestic investors are restricted in respect of foreign investors.

The acquisition of a Chinese domestic enterprise is another available option for a foreign investor. But this is subject to the Provisions for the Acquisition of Domestic Enterprises by Foreign Investors (关于外国投资者并购境内企业的规定) (2009), whereby an investor will face an anti-monopoly examination. The privatization of state-owned enterprises will also open new avenues for acquisition by foreign investors.

Sectors for investment

For those foreign investors interested in restricted sectors in the Negative List, a thorough and locally-minded understanding of the provisions in the Circular and the Negative List is a must. The Chinese government encourages foreign investors to invest in those sectors listed in the Encouraged Catalogue. This leads the government at all levels, and most foreign investors to – misguidedly – focus mostly on such sectors. Meanwhile, the Negative List delivers the message that foreign investors can freely conduct any business which is not restricted or prohibited by this list. However, the real opportunities for investment substantially lie in the restricted sectors of the Negative List (although some of those sectors are under a monopoly to some extent). The economic transformation and further reforms implemented by the Chinese government will have the overall effect of loosening those restrictions, and this is where the opportunities lie. Stepping into such sectors right away could be regarded as a wise strategy to ensure a solid presence in the China market.

Automotive sector

Foreign automotive investors must consider their exit strategy when the term of their existing joint venture (JV) in China expires in the following decade. They may extend the JV term, increase their equity percentage or convert to a WFOE by acquiring their existing Chinese partner(s)' shares or establishing a brand new enterprise.

In the Negative List, each foreign investor is limited to establishing two JVs with one or more Chinese partners. The equity percentage held by the Chinese partner(s) may not be less than 50%. The foreign-investment percentage in a commercial vehicle manufacturing JV will be eliminated in 2020. However, the two-JV limit may remain if JV structures are still taken by the foreign investors. In 2022, the foreign-investment percentage in a passenger-car manufacturing JV will be eliminated and the restriction on two JVs will be lifted. Foreign investors should start preparations for these changes in the coming years by adopting a clear China market strategy, with amendments to existing JV agreements being at the core.

By way of an example, foreign investors are now free to invest in the special vehicle and new energy vehicle sub-sectors.

Financial sector

Foreign individuals will be allowed to buy and trade shares in mainland China-listed companies if they satisfy certain conditions to be set by the government. Foreign investors, including natural persons and legal entities, are allowed to invest in companies listed on the National Equities Exchange and Quotations pursuant to applicable rules on listed companies.

On the basis of adequate evaluation, banking institutions in the western areas and north-east industrial zones are permitted to transfer their RMB assets of trade financing to overseas banks. This is another way for overseas banks to hold RMB assets. The asset volume may be small, as the economy in these regions is lagging behind the southern and eastern regions; however, it is logical to assume that such policy may extend to other regions in the future.

The restrictions on foreign banks in the Catalogue have been removed. All business of foreign banks will be subject to the PRC Regulations for the Administration of Foreign-invested Banks (2nd Revision) (中华人民共和国外资银行管理条例 (第二次修订)). The further loosened measures, the Circular on Matters Relevant to Further Relaxing Market Access for Foreign-funded Banks (关于进一步放宽外资银行市场准入有关事项的通知), were also published by the newly combined China Banking and Insurance Regulatory Commission to lift approvals on bond issuance and cashing, as well as on government bond undertakings, among others.

New sectors open to foreign investors

Some restricted sectors have been removed from the Negative List, meaning that a number of new sectors are now open to foreign investors, including: construction and operation of trunk railway line networks; railway passenger transport companies; design, manufacturing and maintenance of general aircraft; and construction and operation of gas stations. In the State Council, Opinion on Reforming the Railway Investment and Financing System to Accelerate and Promote Railway Construction (国务院关于改革铁路投融资体制加快推进铁路建设的意见), it was stated that the government will “liberalize the ownership and management rights of intercity railways, city (suburban) railways, railways of resources development nature and branch railways to local governments and social capital, and encourage social capital to invest in railway construction”. The PPP model will be welcome in such railway projects.

Tightened sectors

Although the number of sectors in the Negative List has been reduced to 48 from 63 in the Catalogue, a few new prohibited activities have been added. Foreign investors are now prohibited from introducing or importing films to China and from investing in state-owned cultural relic museums.

New foreign investment administration regime

The Circular sets out that where foreign invested enterprises (FIEs) are involved in sectors in the Negative List and their total investment is less than USD1 billion, the relevant provincial government will be designated as the approval and administration authority for the FIEs' establishment and alteration.

The approval and registration of FIEs in sectors not covered by the Negative List has also been simplified. For those FIEs, the Circular encourages use of the so-called “one-stop and one window” method of commercial record-filing and industrial and commercial registration.

On June 29, 2018, MOFCOM published the revised Tentative Measures for the Administration of the Record Filing of the Establishment of, and Changes in, Foreign-invested Enterprises (外商投资企业设立及变更备案管理暂行办法) in order to implement this simplified system of record filing nationwide. These new Interim Measures provide that the establishment or alteration of FIEs must be carried out through an online record-filing system. The applicant FIE is required to submit its application documents only once for all the relevant government authorities' approval rather than going to a number of different authorities and submitting the same documents several times. This new system will save more time, avoid duplication and make the approval system more transparent.

FIEs in the form of a partnership may not enjoy the above record-filing system. The registration of foreign invested partnership is subject to the Partnership Law, the Provisions for the Administration of the Registration of Foreign-invested Partnerships (外商投资合伙企业登记管理规定), and other laws and regulations.

More financing options

FIEs have faced a number of financing difficulties both at the point of establishment and when operating their projects or businesses in China. Their registered and working capital depends mostly on the foreign investors' cash, or in-kind contributions or loans.

Those FIEs already in operation in the western areas and north-east industrial zones are allowed to issue bonds denominated in RMB or foreign exchange abroad. The funds raised are remitted back to China for the FIEs' investment and business in the relevant province where they or their projects are located. It is thought that such issuance will get more support from the NDRC in designating the bond quota.

Financial institutions or local asset management companies established in those western and north-east regions can transfer their bad RMB loans to overseas investors, on the condition that the transfer risks are under control.

FIEs which are registered or have their major operations located in border economic cooperation zones and cross-border economic cooperation zones will be actively supported to carry out IPOs in accordance with certain conditions set out in other laws.

Conclusion

At the 40^th anniversary of China's reform and opening-up, the Circular and the Negative List provide a second, positive opportunity for foreign investors to expand their business in the Chinese market. China's economic distress has been a headache for the government to cure over the past decade. The nascent trade war with the US has had a detrimental effect on the Chinese economy by adding more tariffs on those products imported from China to the US. The Chinese government is expecting to attract more foreign investment and inward foreign exchange flows, so that investment, as the key tool in the three engines of economy growth, can set off the impact of the trade war.

With more sectors opening and a more convenient and transparent record-filing system falling into place, foreign investors need to carry out more research into relevant local sector regulations and compliance protocols applicable to the domestic investors before they make a business decision.

Finally, it should be noted that the Chinese government published the Draft Negative List for Market Access (Trial Version) (市场准入负面清单草案 (试点版）) in 2016; this is applicable to both domestic and foreign investors. When investing in China, a foreign investor must first meet not only the requirements of the Negative List, but also the Market Access Negative List.

Edwin Li, Partner

Dentons LLP Beijing Office