China has announced a major overhaul of its foreign investment regime, in what will amount to the single largest reform to foreign investment in China since the beginning of the "opening and reform" era over thirty years ago.
The PRC Ministry of Commerce, or Mofcom, on Monday issued a public exposure draft of a new Foreign Investment Law which would scrap numerous decades-old joint venture laws, introduce a national security review process, and for the first time formally regulate the so-called "VIE" structures commonly adopted by Chinese internet companies such as Alibaba.
The new Foreign Investment Law proposes to scrap China’s existing approach that focuses on regulating the permitted "entities" -- in particular, Sino-foreign joint ventures and wholly-foreign owned entities -- through which foreign companies can invest in China. Instead, Mofcom will regulate foreign investment on the basis of the identity of the investor and proposed investment activity.
Foreign investors will also no longer require PRC government approval on a case-by-case basis for each individual investment project, and PRC regulators will no longer review individual joint venture contracts and articles of association. This reform alone promises to cut miles of red tape from the foreign investment process in China.
Instead, the "negative list" approach to regulating foreign investment that is currently being trialled in Shanghai's Free Trade Zone, will be rolled out nationwide. Under the negative list system, foreign investors are permitted to invest in any industry sector provided that it is not listed on the negative list as being prohibited or restricted for foreign investment. Mofcom has said that this new approach to regulating foreign investment will mean that most foreign investment projects in China will no longer require government approval, and ensure "national treatment" for foreign invested companies, putting foreign investors on the same legal footing as domestic Chinese companies.
However, all foreign investors will still be required to submit periodic "information reports" to the PRC government on their investment activities in China, ensuring the PRC government will continue to keep a close eye on foreign businesses in China.
The other key piece of the new draft legislation is the proposal for a new national security review mechanism. The review will consider the effect of particular foreign investment projects on national defence, technology, vital infrastructure, communications and network security, energy and food security, and public interest and public order, among other factors. Mofcom have said that they intend to borrow fully from the national security review policies adopted by other "relevant countries" in formulating their new approach.
In announcing the new draft Foreign Investment law, Mofcom also addressed head-on the dilemma posed by the so called "variable interest entities", or VIEs. VIEs are structures whereby a foreign company enters into contractual control arrangements with a domestic Chinese company to circumvent restrictions on foreign investment directly in particular industries. VIEs are the structures commonly adopted by Chinese internet companies such as Alibaba when listing on overseas stock exchanges.
Mofcom has stated their intention that VIEs will be treated as foreign investors in future, and will be subject to the new Foreign Investment Law, including the restrictions on the "negative" list which presumably will continue to restrict foreign investment in the internet industry, and therefore prevent VIEs from being used to invest in the internet and other restricted industries in future.
For existing VIEs already in place when the law comes into force which are operating in a restricted industry -- including Alibaba and the countless other Chinese internet companies listed overseas -- Mofcom proposes three different possible solutions:
First, where the ultimate controller of the foreign party to a VIE structure is Chinese, they would simply report their Chinese controller to the PRC government and be permitted to continue operations unhindered.
Second, VIEs with Chinese controllers may be required to apply for government approval of their Chinese controlling status, following which they may continue their operations.
Third, and most stringently, VIEs would have to apply to the PRC government for approval in order to continue operations, and the PRC government would consider, among other factors, the nationality of the ultimate controllers when determining whether to permit the VIEs to continue operations.
The focus in all cases seems to be whether or not the offshore portion of the VIE is ultimately Chinese-controlled. Given that Jack Ma, a Chinese citizen, is the ultimate controller of the foreign-listed Alibaba company, it appears that the end result will leave Alibaba and other VIE companies with Chinese controlling shareholders unaffected by the new approach, while VIEs where the ultimate controller is indeed a foreign investor may be forced to cease operating.
Mofcom state that they will further research their approach to VIEs after "broadly listening to social opinions" on the issue, a recognition that regulation of VIEs will be sensitive both domestically and abroad.
The draft law is open for public comment now before it works its way through China's legislative process, which is expected to take up to twelve months.
Antony Dapiran is a Hong Kong-based lawyer and writer. Twitter @antd