On December 27, 2021, the National Development and Reform Commission (“NDRC”) and the Ministry of Commerce jointly issued the Special Administrative Measures (Negative List) for Foreign Investment Access (2021 Edition) (外商投资准入特别管理措施(负面清单)(2021年版)) (the “2021 FDI Negative List”).1 The 2021 FDI Negative List replaced the 2020 edition (promulgated on June 23, 2020) and took effect on January 1, 2022.
Relationship between Different Negative Lists
The Chinese government maintains three distinct negative lists, the Negative List for Market Access (市场准入负面清单)2 (the “Negative List”), the Special Administrative Measures (Negative List) for Foreign Investment Access (外商投资准入特别管理措施(负面清单)) (the “FDI Negative List”), and the Special Administrative Measures for Foreign Investment Access in Free Trade Pilot Zones (自由贸易试验区外商投资准入特别管理措施(负面清单))3 (the “FTZ FDI Negative List”).
The Negative List consists of sectors prohibited or restricted for investment from both Chinese and foreign companies without special regulatory approval. For sectors listed on the Negative List, Chinese and foreign investors will be treated the same with respect to investment restrictions and approval requirements.
The FDI Negative List applies only to foreign investors (including foreign-invested enterprises (“FIEs”) in China), and includes additional sectors that are prohibited or restricted to such investors, beyond those specified on the Negative List. The FDI Negative List applies nationwide.
The FTZ FDI Negative List similarly applies only to foreign investors, but only with respect to their investment activities in free trade zones in China. Compared to other parts of China, free trade zones offer greater investment access to foreign investors.
The negative lists have been updated on an annual basis since 2017. The Negative List, the FDI Negative List, and the FTZ FDI Negative List constitute the cornerstones of China’s negative list regulatory regime. Sectors not included on these lists are open to investment.
Major Changes on the FDI Negative List
Compared to its 2020 edition, the 2021 FDI Negative List reduces the number of sectors restricted or prohibited to foreign investors from 33 to 31. The two sectors removed from the earlier edition are:
- Automobile Manufacturing: The 2020 edition of the FDI Negative List included the restriction that, “[f]or the manufacture of complete automobiles other than special-purpose vehicles, new energy vehicles and commercial vehicles, the Chinese party shall own a controlling stake of not less than 50% and the foreign investor may not establish more than two equity joint ventures for manufacturing of the same line of complete automobiles in China.” The removal of this sector from the FDI Negative List means that, as of January 1, 2022, foreign companies are no longer subject to a 50% investment cap on the manufacture of all complete passenger vehicles, including internal combustion engine vehicles, and they are no longer required to cap the number of joint ventures in China for the same production line at two.
- Satellite Television Broadcast Ground Receiving Facilities: In addition to the automobile manufacturing sector, the 2021 FDI Negative List also deletes the “[m]anufacture of satellite television broadcast ground receiving facilities and critical components.” However, while this sector no longer appears on the FDI Negative List, it remains on the Negative List, and both Chinese and foreign investors are required to receive regulatory approval to invest in this sector.
The 2021 FDI Negative List includes more extensive explanatory notes in the preamble, including:
- Sectors not listed on the 2021 FDI Negative List are administered under the principle of national treatment for domestic and foreign investment. In other words, with the exception of sectors included on the 2021 FDI Negative List, foreign investors will be treated the same as Chinese domestic investors with respect to investment and market access. Investment restrictions and approval requirements specified on the Negative List will apply equally to Chinese and foreign investors.
- FIEs are required to comply with the 2021 FDI Negative List. FIEs refer to companies invested and established by foreign investors in China. They are incorporated as Chinese companies with foreign ownership. Equity investments made by FIEs (even though they are incorporated as Chinese companies) will be treated as foreign investment for purposes of sectors prohibited or restricted to foreign investors under the 2021 FDI Negative List.
- Chinese government pre-approval is required for overseas initial public offerings (“IPOs”) of Chinese companies engaged in business sectors prohibited for foreign investment under the 2021 FDI Negative List. Sectors prohibited for foreign investment primarily include: breeding and production of genetically modified agricultural organisms; fishing for aquatic products; exploration and mining of rare earths and radioactive minerals; Chinese herbal medicines; tobacco and cigarettes; postal services; publishing, news organization and Internet news services; social surveys; human stem cells and genetic diagnostics and treatment technologies; humanities and social science research institutions; geodetic surveying; marine surveying and mapping; compulsory education institutions; and radio and television programs. These sectors are considered critical to China’s national security and/or public interest and overseas IPOs will be subject to a stringent review process.
- Overseas investors purchasing shares in overseas IPOs of Chinese companies in sectors prohibited for foreign investment may not participate in the operation or management of these companies and their ownership percentages must comply with restrictions set forth in relevant regulations governing securities investments in domestic companies by foreign investors. In this regard, for example, the Administrative Measures on Domestic Securities Investment by Qualified Foreign Institution Investors (合格境外机构投资者境内证券投资管理办法) (2012, as amended) provides that qualified foreign institutional investors in aggregate may not hold more than 30% of shares of companies publicly traded in China.
The 2021 Negative List (Draft)
In October 2021, the NDRC promulgated a draft Negative List for Market Access (2021 edition) for public comment. Compared with its 2020 edition, the draft Negative List reduced the number of restricted sectors from 123 to 117 (including six prohibited categories and 111 categories subject to regulatory licensing and approval). However, several new sectors were added to the prohibited or restricted list, including:
- Non-public capital (including both foreign and Chinese private capital) investment is prohibited in the reproduction of news content from foreign media and organizing of news industry summits and awards. This adds to existing prohibitions on non-public capital in the establishment and operation of news outlets, online newsgathering, editing and broadcasting.
- New investment is prohibited in cryptocurrency mining. The Chinese government has recently announced that all cryptocurrency-related transactions are illegal in China and enforcement actions have been initiated.
- To echo the recent “Double Reduction” (双减) policy in China’s education industry, the draft 2021 Negative List provides that all training institutions providing “subject-based” programs targeting K-12 students are prohibited from seeking financial investment through IPOs and that public companies may not invest in “subject-based” training institutions by issuing new shares or making cash payments.
- The draft 2021 Negative List also imposes regulatory reviews on senior executive appointments in specialized financial institutions, such as banking institutions, insurance companies, credit rating companies, and bank clearing institutions.
Draft Overseas Listing Rules and VIE Structures
On December 24, 2021, three days before promulgation of the 2021 FDI Negative List, the State Council and the China Securities Regulatory Commission (“CSRC”) published for public comment the draft Regulations on Administration of Overseas Issuance of Securities and Initial Public Offerings of Chinese Domestic Companies (境内企业境外发行证券和上市管理规定) and the draft Administrative Measures on the Filing of Overseas Issuance of Securities and Initial Public Offerings of Chinese Domestic Companies (境内企业境外发行证券和上市备案管理办法) (collectively the “Overseas Listing Rules” or the “Rules”).
The draft Overseas Listing Rules tighten regulation of Chinese companies listing abroad (which implicitly includes Hong Kong listings), especially those listed through an “indirect listing” where the listing is conducted by an offshore holding company incorporated to hold China-based assets. Many Chinese companies listed this way use a structure widely known as Variable Interest Entities (“VIEs”).
In the past, the CSRC would only examine companies incorporated in China intending to conduct direct overseas listings. The draft Rules for the first time extend the CSRC’s authority to regulate indirect listings of Chinese companies using offshore holding companies as the listing vehicle.
The draft Rules define “indirect listing” as “issuing securities overseas or conducting an IPO on overseas stock markets in the name of a foreign entity which conducts primary business activities in China based on equity interests, assets, income or economic rights in China.” To constitute an indirect listing, the following conditions also must be met under the draft Rules: Chinese domestic assets or revenue must account for 50% or more of total assets or revenue of the overseas issuer; the majority of the issuer’s senior management must reside in China (or be Chinese nationals); and the issuer must conduct its primary business activities in China.
The draft Rules establish a “filing-based” regulatory regime for Chinese companies seeking indirect overseas listings. Under the draft Rules, a company will have to submit materials including its prospectus, legal opinions, opinions from or filings with industry regulators, if applicable, and other materials to the CSRC for review within three business days after it submits an IPO application to the overseas regulator or makes the first public announcement of the relevant transaction.
The CSRC will determine whether a company may proceed with its overseas listing within 20 working days if the application meets the relevant legal requirements.
The CSRC, working with other government agencies, may reject an overseas listing application under any of the following circumstances: (1) if national laws or regulations prohibit the listing; (2) if the listing presents a threat to or endangers national security; (3) if there are major disputes over equity, assets, and core technology; (4) if the domestic company, its controlling shareholder, or ultimate controlling person have been convicted for corruption, bribery, embezzlement, and/or misappropriation of property in the past three years or are under investigation for criminal allegations; (5) if the domestic company’s senior management has been subject to administrative punishment in the past three years or are under investigation for major violations; and (6) the catchall other circumstances as prescribed by the State Council.
The draft Rules also require that foreign investment banks or securities firms that underwrite a Chinese company’s overseas listing be registered with the CSRC. This requires that such institutions establish subsidiaries in China.
The filing requirement applies to all Chinese companies seeking overseas listings, including those using VIE structures. Many Chinese companies engaged in media, Internet, education and other sectors restricted for foreign investment have used VIE structures to circumvent restrictions on foreign ownership and successfully completed overseas IPOs. Now, overseas listings using VIE structures will be subject to CSRC scrutiny under the draft Rules but will have official recognition.
The CSRC and other regulators will focus their review on whether an overseas listing presents national security concerns. Note that data security is clearly part of national security from the Chinese government’s perspective,4 as suggested by the Didi data-breach investigation. Having said this, the CSRC officials in a media interview relating to the promulgation of the draft Rules remarked that while the draft Rules apply to VIE-structured companies, overseas listings of VIE-structured companies will still be allowed as long as they are in compliance with the rules and their IPOs do not present national security, public interest, or data security concerns.