New Foreign Investment Law Takes Shape

By David Tang and Li Jun 1

It would appear that the decades-old foreign investment classification scheme which divides foreign investments into three entity types each governed by separate regulatory rules has run its course. 2The new Foreign Investment Law (public comment version) was issued by the Ministry of Commerce （" MOFCOM"）on January 19, 2015, signaling what may be the most sweeping change to the regulatory landscape for foreign investment in China since the Open Door policy in 1978. Several significant reforms are proposed under the Foreign Investment Law.

First, foreign investment is no longer recognized simply as direct foreign investment, but will cover various forms of investment, including through equity or debt, and the resulting domestic interest can be equity, property ownership or merely contractual. Foreign invested enterprises will no longer be distinguished as WFOEs, EJVs or CJVs, but will instead be recognized in the same manner as domestically-owned enterprises, which includes limited liability companies, partnerships and sole proprietorships. The Foreign Investment Law makes it clear that it will regulate the legally dubious variable interest entity （" VIE”）structure, although its status under the new law has yet to be made clear. In the law’s explanatory notes, MOFCOM discusses the current mainstream views on this scheme, including how it may regulate the VIE structure. MOFCOM states that the performance of VIE contracts may be permitted if the de facto controller is Chinese, and that the continuing validity of a VIE which has a foreign de facto controller may be subject to the issuance of an “entry permit” under a new approval process as discussed below. MOFCOM has indicated that it will finalize its position on the VIE structure following additional analysis and a review of public comments on the issue. Undoubtedly, regulating the VIE structure will elicit many comments from investors and legal practitioners alike.

Second, entry restrictions on foreign investment have been restructured to follow the “negative list” model currently on trial in the Shanghai Free Trade Zone. The long-practiced case-by-case approval regime has been removed. Generally speaking, foreign investments will enjoy national treatment, meaning new FIEs （ either by way of formation or acquisitionwithin “permitted areas” can directly apply for business registration with the AIC. 3“Categories Subject to Special Administrative Measures” resembles the “Catalogue of Industries for Guiding Foreign Investment,” promulgated by the NDRC, 4in terms of distinctions made between restricted and prohibited categories. For restricted category investments, an “entry permit” instead of an “approval certificate” will be issued upon MOFCOM’s approval of the application. Notably, the focus of the application review will be on the foreign investor and the substance of the investment itself rather than formation documents such as articles of association or joint venture agreements. During the review process, MOFCOM will also have discretion to grant conditional approvals in a manner similar to what is currently done for antitrust reviews. Conditional approvals may be contingent upon certain material aspects of the investment which MOFCOM will monitor on an ongoing basis through an annual reporting process discussed below.

Third, the Foreign Investment Law introduces national security review clearance, which expands the applicability of the review from only foreign investment acquisitions to all types of foreign investment under the new law. It is worth noting that no appeal procedure is available for final decision made as a result of a national security review.

Fourth, echoing the recent shift in government function from making merit-based decisions to promoting transparency and accountability through disclosure, information reporting becomes an important compliance aspect for foreign investment under the new law. In contrast with past mandatory pre-reporting requirements, enterprises will now generally have discretion to submit reports on either a pre- or post-event basis within 30 days of the occurrence of a reportable event, which will include modifying or initiating an investment. Periodic reporting is also required, including annual reports for all foreign investments and quarterly reports for key investments.（ with assets or annual revenue exceeding RMB10 billion, or having more than 10 subsidiaries）

These changes present a quite different landscape for foreign investment in China going forward. Changes to the concepts of foreign investor and foreign investment, the removal of a “case-by-case” approval regime, the introduction of a national security review system and enhanced reporting requirements, will all have a significant impact. It is quite unusual in China for such wide-reaching reforms to be made within one new law, but it is also inevitable in order for China to continue to attract and retain foreign investment and to promote efficient government administration. The draft of the new law is open for public comment until February 2015, and additional time will still be required before the new law is formally issued. But, in any event, this is a welcome change as the new law brings more clarity and certainty in what can sometimes be an uncertain regulatory environment.

___________________________________________________________________________________________________________

1.David Tang is a partner at AllBright in Shanghai. Li Jun is of counsel at AllBright in Shanghai.
2.WFOEs (wholly foreign owned enterprises), EJVs (equity joint venture enterprises), and CJVs (contractual joint ventures) are the current designated foreign investment entity structures, each of which is subject to its own set of rules. 
3.Administration for Industry and Commerce.
4.National Development and Reform Commission.