China’s draft law on foreign investment: A first step towards full reciprocity?

On December 23, 2018, quite unexpectedly, a new draft law on foreign investment (the “Draft”) was submitted to the bimonthly session of the National People’s Congress Standing Committee (NPCSC).

Once adopted, which technically could happen at the upcoming session of the NPC in March 2019, the new foreign investment law will replace three existing laws on foreign investment, namely the laws on Chinese-foreign equity joint ventures, non-equity joint ventures (or contractual joint ventures), and wholly foreign-owned enterprises. As such the new law is intended to reorganize the basic framework for foreign investment in China. Given that foreign investment has been – and will remain for the foreseeable future- an essential driver of the Chinese economic growth, the importance of this new draft law cannot be underestimated.

The Draft essentially introduces the rather broad list of general principles and guidelines regulating the operations of foreign investors and foreign-invested entities in China going forward. As would be expected, the Draft reaffirms the intention of Chinese government to continuously implement high-standard investment liberalization and facilitation policies, build and improve foreign investment facilitation systems, and create a stable, transparent and predictable environment for foreign investors. More specifically and perhaps more remarkably, the Draft postulates that China is committed to the equal treatment of foreign investors, specifically with respect to compulsory standards, government procurement and government sponsored business development policies. Furthermore, the draft explicitly confirms the Chinese government’s commitment to protecting the intellectual property rights of foreign investors. Even more interestingly, the Draft bans or at least restricts local government interference with respect to technology transactions involving foreign investors. Technology transfers are described as transactions freely agreed upon by the parties to the contract, without involvement from any government administration.

Of course, it cannot be ignored that the Draft is released against the backdrop of the ongoing trade tensions between the United States and China, especially where the Draft deals with the issue of the ‘forced technology transfers.’ This issue forms the essential part of the claims made by the US Department of Commerce to justify the tariffs imposed on Chinese imports earlier in 2018. Such claims have so far been roundly rejected as misleading by China, that is, until now… As such, the Draft could represent the first iteration of a shift in the Chinese government’s approach to the ongoing negotiations with the US.

The Draft, prepared by the Ministry of Commerce, is composed of only 39 articles setting out general guiding principles. For most part, they are in line with current policy principles. We have summarized below the main provisions of the Draft.

Guiding principles for foreign investment under the Draft

To guarantee equal treatment for domestic and foreign-invested enterprises

Article 9 of the Draft stipulates that, except as otherwise stipulated by laws and administrative regulations, all the supportive policies for the development of domestic enterprises shall be equally applied to foreign-invested enterprises.

The normative documents regarding foreign investment formulated by governments and their departments at all levels shall comply with the laws and regulations of the State. None of those documents may illegally reduce the legitimate rights and benefits or increase the obligations of foreign-invested enterprises, nor illegally set any market access and exit conditions, or illegally intervene or influence the normal production and operation activities of foreign-invested enterprises (Article 23).

Furthermore, foreign-invested enterprises shall enjoy an equal participation in government procurement and standardization work. Government procurement shall treat products produced by foreign-invested enterprises in China equally according to law (Article 15 and 16).

To fully implement pre-establishment national treatment and negative list management

Article 4 of the Draft stipulates that, the State shall implement the pre-establishment national treatment and negative list management for foreign investment. If the international treaties or agreements concluded or acceded to by the People’s Republic of China have other provisions on the treatment of foreign investors, the international treaties or agreements shall prevail.

Moreover, it is stipulated in the Draft that foreign-invest enterprises shall not invest in the areas prohibited in the negative list, and shall meet the required conditions for restricted investment listed in the negative lists.  As for the investment in the areas other than those regulated in the negative lists, such investment shall be implemented and managed equally for domestic and foreign-invested enterprises (Article 27).

To enhance the protection of legal rights and benefits of foreign-invested enterprises (a general rule stipulated in Article 5)

The property rights of foreign-invested enterprises, as well as their capital contributions, profits, capital gains and Intellectual Property royalties shall be protected. The Draft stipulates further that foreign investment may not subject to expropriation by the State, except where this is done in need of public interest, and in such case expropriation shall be carried out in accordance with statutory procedures and a fair and reasonable compensation shall be provided in accordance with the law (Article 20 & 21).

Meanwhile, the Draft emphasized the protection of intellectual property rights (IPR) of foreign-invested enterprises. The State protects the intellectual property of foreign investors and foreign-invested enterprises in accordance with the law. The Draft also underlines that technological cooperation by and with foreign investors should be based solely on voluntary commitment and according to “business rules”. The conditions of technological cooperation shall be decided freely by the parties through negotiation. Authorities or government departments shall have no right to use administrative means to force the transfer of technology (Article 22).

In addition, the Draft stipulated that local governments at all level shall rigorously fulfill their policy commitments and all types of contracts legally entered into with foreign-invested enterprises. Where the governmental commitments and contracts have to be changed due to the needs of national and public interest, it shall be carried out strictly according to the statutory authorities and procedures, and compensate the losses of such foreign investors (Article 24).

To further simplify the registration and management of foreign investment

According to the draft, the approval and filing of foreign investment projects shall be carried out in accordance with the relevant provisions of the State. Where a foreign investor invests in an industry or field requiring a license according to law, he shall go through the relevant licensing procedures according to law. Except as otherwise stipulated in laws and administrative regulations, the competent authorities shall examine and verify foreign investors licensing applications in accordance with the conditions and procedures consistent with domestic investment (Article 28 & 29).

Furthermore, the State Council will establish a reporting system for foreign investment information. The content and scope of the information report shall be determined in strictly in accordance with the principle of control and necessity. Foreign-invested enterprises shall submit investment information to the competent authorities through the enterprise registration system and the enterprise credit information publicity system. It is not allowed to require further submission of investment information which can be obtained through department information sharing system. (Article 31)

To improve the mechanism of complaints and rights protection for foreign-invested enterprises

The Draft stipulated that the formulation of laws, regulations and rules related to foreign investment shall be subject to the opinions and suggestions of foreign-invested enterprises. The normative documents and judicial decisions related to foreign investment shall be announced in a timely manner according to law (Article 10).

China will establish a foreign investment service system to provide foreign-invested enterprises with advice and services on laws and regulations, policy measures, and investment project information (Article 11).

China will also establish a complaint mechanism for foreign-invested enterprises, to coordinate and improve major policy measures concerning complaints of foreign-invested enterprises, and to promptly resolve problems reflected by foreign-invested enterprises (Article 25).

  A first step?

Obviously, it remains to be seen how the implementation measures of the new law (if and when it is approved by the NPC) will bring about practical reform to the general PRC policy on foreign investment. Insofar as the Draft reiterates the determination of the Chinese authorities to enhance to its foreign investment policy, which has been undeniably critical in bringing about 40 years of economic growth to China, it should be seen as a positive signal. Under the current circumstances, this in itself is encouraging.

The Draft is also interesting because it is intended to replace the three existing laws that currently provide the backbone for foreign investment in China. Doing away with the structural distinction between foreign invested entities and so-called domestic entities should be seen as an important step towards a more level playing field for all market players. As a matter of fact, we may even be on the way to greater reciprocity if, as some reports have mentioned, the State Council eventually abolishes the specific procedures for filing, examination, and approval which currently apply to any and all foreign investments to China. Applying the same rules for registration of a company, regardless of whether the investor is foreign or Chinese, would be an exemplary application of the principle of pre-establishment national treatment for foreign investment, and would represent a landmark change in PRC foreign investment policy.