The Chinese Government on October 14, 2019 released an advance copy of the Draft Regulations on the Implementation of the Foreign Investment Law for comment (Draft Implementing Regulations) 《中华人民共和国外商投资法实施条列（征求意见稿）》to several foreign chambers of commerce and trade associations. The Draft Implementing Regulations are to take effect on January 1, 2020 and will provide the basis for implementation of the Foreign Investment Law (FIL) adopted by the National People’s Congress on March 15, 2019 which also takes effect on January 1, 2020.
Relatedly, the State Council on October 8, 2019 (released on October 22, 2019) issued the Regulations on Optimizing the Business Environment (the Business Environment Regulations)《优化营商环境条例》which also take effect on January 1, 2020.
Together, these two sets of regulations, one of which is still in draft, constitute a substantial regulatory commitment by the Chinese Government to lower market entry barriers, establish a level playing field for all market participants regardless of shareholder nationality, reduce government interference in markets, and raise the efficiency of government services to businesses. They also address some of the key concerns which the US Government and others have expressed with respect to the protection and enforcement of Intellectual Property Rights (IPR).
There are, however, a number of issues that are unaddressed and continue to raise concern. Among them are:
- the absence of any clear commitment to address the favoritism enjoyed by state-owned enterprises relative to domestically and privately-owned enterprises, let alone foreign-invested enterprises (FIEs), at a time when the leadership of the country embraces state-owned enterprises as the foundation of Party rule;1
- the need for follow-on regulations from relevant ministries and provincial and local governments to ensure that the State Council’s regulations are promptly and effectively implemented in detail across the economy and nationwide, and the lack of clarity as to how or when this will happen;
- the failure to specify timelines for government action to lower market access barriers;
- the failure to clarify whether FIEs registered in special economic zones are eligible to conduct business nationwide on an equal footing with other businesses or whether the exercise of their special status will be confined to such zones;
- the role of Party committees in FIEs relative to boards of directors and management which will now be more clearly mandated as FIEs will be governed by the Company Law replacing the Equity Joint Venture Law, Cooperative Joint Venture Law and Wholly Foreign-Owned Enterprises (the Three Foreign Investment Laws) over a five-year implementation period commencing January 1, 2020;
- the implications of the social credit system for determining such matters as the eligibility to engage in different lines of business, compete for government contracts, and obtain financing;
- the continued absence of clear enforcement mechanisms and practices; and
- the continued fear that enterprises which perceive that they have been treated unjustly will risk retribution by availing themselves of formal avenues of redress.
I. Draft Implementing Regulations
The new Draft Implementing Regulations consist of 45 articles across five chapters, and aim to widen market access for FIEs, actively encourage foreign investment, protect the legitimate rights and interests of foreign investment and raise the efficiency of government services. The principal features of the draft are:
A. Promotion of foreign investment
To promote foreign investment, Chapter II would provide the following:
- The negative list applicable to foreign investment will be adjusted from time to time based on the principle of further opening-up and liberalization (Art. 6);
- Various national policies on investment preferences to promote the development of business shall be applied equally to FIEs (Art. 9);
- The comments of FIEs and foreign chambers of commerce shall be considered when promulgating laws, regulations and rules concerning foreign investment (Art. 10);
- Foreign investment will be encouraged and guided in particular industries and regions in China by establishing special economic zones and formulating “encouraged” industry investment catalogues, and re-investment of profits in China will be encouraged through preferential treatment to foreign investors (Arts. 12-14);
- FIEs will be eligible to participate in the setting of standards on an equal footing with their domestically-invested counterparts; although FIEs will be subject to national mandatory standards as well as their own more stringent standards, if published, FIEs, will not be obligated to comply with recommended or industry standards (Arts. 15-16);
- FIEs will be eligible to participate in government procurement competition on an equal footing and will not be subject to variant or discriminatory treatment (Arts. 17-18).
- FIEs may make public offerings of their shares or issue bonds domestically or overseas pursuant to law under conditions and procedural requirements applicable equally to FIEs and domestically-invested enterprises (Art. 19). While no law currently prohibits FIEs from engaging in public offerings in China, in practice only a few FIEs have done so because of their foreign ownership. This clause likely paves the way for FIEs to raise funds in China’s domestic equity and debt markets.
B. Protection of foreign investment (including Intellectual Property Rights)
To protect foreign investment, Chapter II of the Draft Implementing Regulations includes several clauses intended to further strengthen the protection of IPRs and other rights of FIEs:
- Expropriation will be prohibited unless authorized by law or in accordance with the public interest and fair and reasonable compensation is provided, but the criteria for determination of the public interest and what is fair and reasonable are unclear (Art. 22);
- Foreign investors’ legitimate income generated in China (e.g., return on capital, investment proceeds, dividends, IP license royalties, and residual assets) may be freely repatriated in either RMB or foreign exchange without interference from any entity or individual (Art. 23).
- Protection of IPR will be strengthened by establishment of a punitive damages system against IPR infringement and a rapid collaborative protection mechanism (Art. 24); (ii) the provisions on prohibiting the use of administrative measures to force technology transfers are to be further refined (government agencies will be barred from invoking their authority with respect to registration, investment filing, administrative licensing, and administrative penalties to force technology transfers) (Art. 25); and administrative personnel will be mandated to strictly protect FIEs’ commercial secrets in the process of carrying out their duties (Art. 26).
- To ensure legality and fair competition and not to discriminate against foreign investors, a legal review and fair competition review will be carried out before regulatory documents are issued to regulate foreign investment; policy commitments (e.g., commitments on investment preferences) made to FIEs and foreign investors will be honored to and may not be changed unless a change is necessary for reasons of the state or social and public welfare (undefined) (Arts. 27-29).
- A working mechanism to receive and respond to complaints made by foreign investors and FIEs will be established (Art. 30).
- FIEs will have the right to join or withdraw from such social institutions as chambers of commerce and trade associations without interference or penalty (Art. 33).
C. Investment management
To manage foreign investment, Chapter III would provide the following:
- Investment from overseas enterprises or other entities wholly owned by Chinese individuals (but excluding FIEs) approved by relevant government institutions will not be subject to the negative list, essentially treating such entities as domestically-invested (Art. 35);
- Industry regulators would be required to apply the same conditions and procedures for both FIEs and domestically-invested enterprises when reviewing applications for administrative licenses and may not impose additional or more stringent approval conditions on FIEs (Art. 36).
- The examination mechanism for foreign investors investing in sectors and fields in which foreign investment is restricted in the negative list is further clarified, including the removal of repetitive administrative licensing requirements for foreign investments (Art. 37).
- Foreign investors and FIEs are required to provide relevant foreign investment information through the enterprise registration and public credit disclosure systems, provided that government agencies are to formulate rules on the scope and frequency of such disclosure based on the principle of necessity to minimize the burden on foreign investors and FIEs (Art. 38).
D. Transition period
The Three Foreign Investment Laws will be repealed when the FIL takes effect on January 1, 2020. FIEs established according to the Three Foreign Investment Laws whose original organization forms are inconsistent with the requirements of the Company Law and Partnership Enterprise Law will be allowed five years plus a grace period of an additional six months to conform their structure to the FIL after the FIL takes effect (Miscellany).
While the Draft Implementing Regulations signify progress in addressing the concerns of foreign investors, several issues remain to be clarified:
- The Draft Implementing Regulations largely reiterate important principles at a high level but lack detailed rules on mechanisms to implement these principles. A lack of detailed implementing mechanisms at the central, provincial and local government levels will likely allow government agencies broad discretion in implementation which has been a key challenge faced by foreign investors in China in the past. The specification of more detailed procedures and timelines for action, as in the Draft Procedures for the Implementation of Administrative Licenses posted on October 11 by the China Banking and Insurance Regulatory Commission for the banking and insurance industries, is a positive sign, however.
- Many concepts and principles in the Draft Implementing Regulations are undefined or lack detail. For example, the standards for determining fair and reasonable compensation in cases of government expropriation and the procedure for determining value remains unclear. With respect to IPR protection, no further explanation is provided with respect to the key features of the punitive damages system and the collaborative protection mechanism that the draft rules claim to establish. It is unclear which government agency is to take the lead in establishing and enforcing these mechanisms. It is also unclear what remedies foreign investors or FIEs will have in case of IPR infringement.
- While the Draft Implementing Regulations briefly touch upon the establishment of a foreign investment complaint working mechanism, detailed rules as to how this complaint working mechanism is to work are not provided. No timelines or other procedures are set. Foreign investors and FIEs may hesitate to resort to such procedures for fear of retribution.
- The Draft Implementing Regulations do not specify penalties for violations, potentially reducing the deterrent effect.
- Concern about compliance with the strict information security requirements and government scrutiny under the Cybersecurity Law is not addressed. Many foreign investors are concerned about the effect of the broad applications of these rules and how it will affect normal business operations in China. The Draft Implementing Regulations are, however, entirely silent about this issue. The Draft Implementing Regulations should clearly provide that legitimate business information and trade secrets of foreign investors and FIEs are protected and there will be no restrictions on the flow of data, whether domestically or cross-border, or forced disclosure or scrutiny of such data.
- FIEs should be able to conduct their businesses independently without any undue influence from any third party. The compulsion to establish Party Committee or other political organizations within their organizations may create risks as such entities have a loyalty independent of their shareholders or employees.
II. Regulations on Optimizing the Business Environment
The Business Environment Regulations consist of 72 articles across seven chapters, and are intended to foster a stable, fair, transparent and predictable business environment by cutting red tape, minimizing government interference in the allocation of market resources, and providing equal protection to all market entities regardless of structure or the nature of the shareholder (domestic- and foreign-invested alike). The principal features of the draft are:
A. Protection of market players
- Market entities regardless of type of ownership enjoy equal rights, equal opportunities, and equal legal protection (Art 10).
- Market entities enjoy autonomy to operate their business and to be free from interference from any entity or individual (Art. 11).
- The State protects the equality of market entities to use capital, technology, and natural and public resources. The State’s development policies shall apply equally to all types of market entities (Art. 12).
- Government procurement process shall be fair, transparent and equal without restrictions or exclusions on the basis of unreasonable conditions or product origin (Art. 13).
- A punitive damages system will be established with respect to IPR infringement together with a rapid collaborative protection mechanism to better resolve IPR disputes (Art. 15).
B. Business environment
- The State continues to relax market access for market entities, and implement a unified national market access negative list system. All types of market entities may enter on an equal footing in areas not included on the negative list. No region or industrial sector may formulate a separate negative market access list (Art. 20).
- The government will strengthen anti-monopoly and anti-unfair competition law enforcement to foster a competitive market environment (Art. 21).
- The State will strengthen construction of the social credit system, strictly protect commercial secrets and personal privacy (Art. 30).
- People’s governments at all levels shall honor the policy commitments made to and contracts entered with market entities, unless a change is required for reasons of the state or social and public welfare, in which case, proper compensation shall be provided (Art. 31).
C. Government services
- People’s governments at all levels shall provide convenience and efficiency to the market by cutting red tape, streamlining administrative procedure, not imposing additional registration conditions, reducing approval time and providing one-stop services (Arts. 34-36).
- The government will promote unified online government service platforms (Arts. 37-38).
- The administrative approval system is strictly controlled by the State - unless expressly provided in laws or regulations, no administrative approval procedure may be set up in the form of filing, registration, catalogue, plan, annual inspection, annual report, supervision, certification, or any other form (Art. 39).
- The State shall publish lists of items that require administrative approval, subject to adjustment from time to time. No administrative approval beyond such lists may be implemented by administrative authorities, trade associations or other organizations in other guise (Art. 40).
D. Regulatory enforcement and legal protection
- The State shall improve supervision and administrative enforcement (Arts. 51-60).
- The State shall consider the comments of market entities and chambers of commerce when promulgating laws, regulations and rules concerning business operations, for which the public comment period shall be not less than 30 days (Art. 62).
- A fair competition review and legal review will be carried out before regulations and rules concerning business operations are issued (Art. 63).
- Without the support of laws and regulations, administrative normative documents may not detract from the legitimate rights and interests of market entities or increase their obligations, set market access conditions, or interfere with normal market operations (Art. 64).
- Government officials, public utility organizations and trade associations will be penalized if they illegally interfere with or harm the legitimate rights of interests of market entities (Arts. 69-71).
The Draft Implementing Regulations have long been anticipated and several provisions are likely to be welcomed by foreign investors, especially in areas such as standard setting, IPR protection, negative list implementation and level treatment for FIEs. However, the draft is still quite vague in important areas, including what constitutes fair compensation in the event of expropriation, the availability of remedies when trade secrets are compromised by government officials, and the circumstances under which a policy commitment may be dishonored. Although the Draft Implementing Regulations mark another effort by the Chinese government to protect and promote foreign investment, it remains unclear how effective they will be in practice with respect to leveling the playing field for FIEs, and whether the requirements to comply with local laws and regulations may impose a price on the freedom to engage in business.