How to Read Through China's Foreign Investment Law
Updated: May 7, 2019
On March 15, China’s Second Session of 13thNational People’s Congress passed the Foreign Investment Law of PRC (“FIL”). While welcoming this new law, people have been concerned about its enforcement because the FIL looks too concise (only 42 articles) compared with its predecessor draft for public opinions in 2015. On China side, the government highly praised the new law for its purpose to further encourage foreign investment and offer more confidence in foreign investment protections including IP protection as well as elimination of practice of “forced technology transfer”. All opinions sound reasonable from different perspectives as the FIL was passed “quickly” during US-China trade war when foreign investors were starting to lose confidence on China’s investment policies.
This article is not going to comment those opinions, but to focus on understanding the FIL from practical perspective. In our opinion, the FIL is a significant law in term of China’s legislative efforts on defining China’s foreign investment policies in general.
FIL means a new era for China’s foreign investment policies
f look at policy making timeline, China’s foreign investment policies have experienced 3 major phrases since China adopted an opening up policy for foreign investment since 1979.
In Phrase I (1979 – 2001), it features “3 Foreign Enterprise laws” including Sino-Foreign Joint Venture Law (since July 1979), Foreign Invested Enterprise Law (since April 1986) and Sino-Foreign Cooperative Joint Venture Law (since April 1988) to “announce” China’s welcome to foreign investment in different investment formats. During this phrase, China’s foreign investment policies were more in experiment than knowing exactly what to do. So, the policy making, and enforcement was mixed together with administrative measures, orders (“Red Header Documents”) and even negotiations with local government which gave people impression that everything about investment in China had to go through “negotiation” process with Chinese government. Certainly, China also had issued some industrial guidance (first Industrial Guidance for Foreign Investment was published in 1995) for the foreign investment, which, however, was not as systematic and comprehensive as those in the Phrase II.
In Phrase II (2002-2020 or earlier), from China’s entry into WTO, China was committed to open up its service sectors based on the committed schedule and was required to be more transparent in policy making and governmental practice. To meet the obligations, in addition to amending 3 Foreign Enterprise Laws, China had frequently updated its foreign investment policies and industrial guidance due to adjustments made to the scheduled commitments and the fact that China’s obligations under the international treaties does not automatically become law to be enforceable domestically. Although China’s investment policies were more supported with detailed regulations and rules for enforcement, Phrase II features of constant updates, amendments which sometimes made people feel very confused and difficult to understand. Sometimes, the new rules were way behind what China committed to do based on the schedule for opening up a specific industry. However, Phrase II did force China to become more transparent in policy making and governmental practice. During this phrase, China had become aware and more conscious of what rule of law means in term of foreign investment. With the improvement in governmental and judicial practice, better qualify in policy making, more competitive industries, Phrase II has paved the way to the production of the FIL.
Now, we are at the edge of Phrase III (as of 2020 or even earlier). The FIL is the threshold for the new era of China’s opening up policies, which features with comprehensive IP and investment protection, national treatment for all businesses and elimination of parallel system separating foreign and domestic invested businesses. The FIL is significant because it is the first law in systematically addressing China’s foreign investment policies. More formally, China announces that except those listed in the negative list, foreign and domestic companies shall follow the same standard in market entry and shall compete with each other at the same starting line. In Phrase III, 3 Foreign Enterprise Laws have completed its missions and will be finally put in the history.
FIL is not a law for incorporation/organization
Not like 3 Foreign Enterprise Laws, the FIL is not a law for incorporation/organization. It does not address ways and means how to incorporate a foreign invested company. As the language in Article 31 of the FIL says it does not provide rules how foreign invested businesses are incorporated and how the corporate activities are conducted. Incorporation and other specific matters in corporate activities will be left to corporate, partnership and other business laws to define. When the FIL becomes effective on January 1, 2020, rules embedded in 3 Foreign Enterprise Laws will not be applicable except certain matters during the grace period for transition.
China’s Foreign Investment Law as a policy framework
Unlike its predecessor draft in 2015, the FIL does not have detailed rules for enforcing specific policies, instead, it is more a policy framework providing principles for encouraging and protecting foreign investment in China. There are several benefits to adopt such an approach. First, simplifying law making process and avoiding redundancies. For example, for the incorporation, under national treatment, domestic and foreign invested companies will use the same rules for incorporation and other corporate matters. And, as a matter of fact, a set of comprehensive business laws have already been in place, so there is no need to prescribe redundant rules to repeat what 3 Foreign Enterprise Laws have done. National treatment to eliminate a parallel legal system between foreign and domestic companies has made everything simpler and easier. Second, not to mess up laws of different subject matters. For example, national security issues, as it is a very different subject matter and a national security law has already existed, there is no need to have detailed rules in the FIL for national security matter. If a detailed rule is needed to address national security issues in the investment area, it could be done by amending or prescribing a special regulation to enforce it as a subject of national security law. Finally, for encouraging and protecting foreign investment, many laws and policies have already covered these areas, for example, industrial guidance for foreign investment, IP laws, unfair competition law, tax laws, criminal law, etc. Therefore, providing a policy framework could be a better approach to define China’s foreign investment policies while offering flexibilities for future legislative efforts.
The FIL is a step up from previous legislative efforts on China’s foreign investment policies. In future we should expect no more frequent changes to laws and regulations (like in Phrase II) for specific industries that are out of the negative list. Instead, they will be addressed through general rules that are applicable to both foreign and domestic companies.
Several specific policies under FIL
There are several important policies in the FIL that foreign investors should pay attention.
National treatment plus negative list. This policy says except those listed in the negative list national treatment shall be applied to all other industries equally between foreign and domestic companies. More specific, (a) all regulations will equally be applied to foreign and domestic invested companies as long as those investments are out of the negative list; (b) except the market entry requirements different for those listed in negative list, regulations in other areas should be applicable to the foreign invested companies equally, for example, incorporation, taxation, etc. The purpose of the FIL is to get rid of parallel system treating foreign invested companies from domestic invested companies so there is no differential treatment between two; (c) we expect some specific rules for those listed in negative list particularly in approval, licensing issues (some rules might have already been in place), however these issues would eventually be eliminated when China market has been completely opened up except those still under restriction or prohibition.
Principle of reciprocity. This means when maintaining an open policy for foreign investment, it is conditioned based on principle of reciprocity. If a country does not have favorable investment policy to Chinese investors, China may impose similar treatment to the foreign investment from specific country. This principle allows China to have a flexible stance in maintaining its foreign policies, which is particularly important in today’s complex geopolitical environment.
National security and public interest. Mostly, the negative list will continue to list some industries that are not open to foreign investors due to concerns of national security or public interest. Some of those are equally prohibited or restricted for domestic investors (negative list for domestic investors). In addition to the negative list, foreign investors should not be surprised by China to use national security or public interest as a reason to adjust its industrial policies often in future as the practice of applying national security or public interest to limit market entry has become an international phenomenon when two countries are in technology competition or having trade disputes. However, so far, China has not used this practice widely as China on many occasions committed to maintain a more open policy to welcome foreign investment.
IP protection and China’s governmental practice. As indicated in the FIL, China commits to provide better IP protection and to make governmental practice more transparent and predicable. We read this message a more progressive process than the immediate effect of changes to be made by China. China has significantly been improving its judicial and governmental practice over the past 40 years, however, due to its history, culture, tradition, political system and regional imbalance in social development, China has adopted different approach in addressing same issues because western ways are not completely fit to that market.
Enforcement of the FIL
Many are concerned about the enforcement of the FIL because it is too concise to enforce. In our view, those concerns are not very necessary since the FIL actually will eliminate the parallel system between the foreign invested companies and domestic invested companies. This results in a relay of many existing laws and regulations applicable to the foreign invested businesses, for example, the corporate law (amended 6 times), the partnership law (amended twice). The elimination of 3 Foreign Enterprise Laws will not bring much impact to existing foreign invested companies. As a matter of fact, China has already started the transition in different areas since 2008. Moreover, China’s response to the needs of new laws and regulations is quite agile due to its unique political system. Quick response to legislative needs, continuing efforts in judicial reform, and newly developed case law practice in China have been all contributing to more consistency of law enforcement in China. In our opinion, the enforcement of the FIL is more on judicial or governmental practice, which will need consistent and long-term efforts to get improved.
To address the gap between the FIL and other regulations, we feel rules relating to requirements on market entry for those in the negative list might be needed, particularly when 3 Foreign Enterprise Laws will be gone and thereafter no general rules exist to address how restricted industries to be approved and licensed. However, Phrase II experience and existing practice may offer clues how China will achieve that result.
Compared with initial stage when China just opened its door for foreign investment, today, China’s foreign investment policies should be much better and much easier. Within short 40 years, people have already witnessed huge changes made in China, not only in economic development, but changes in other areas. To ignore that fact is not fair for China’s effort on opening up its market to the world. The fact that people still feel difficult might contribute to other factors, for example, not understanding Chinese language, history, culture, tradition, political system, etc. For many people, China is still a strange place. However, mind opening is always a key, which might lead to a different path to understand China phenomenon.
The purpose of this article is to offer a big picture for understanding China’s foreign investment policies. If you have any specific question, please contact us.