China: China Amends Foreign Investment Policy: New Foreign Investment Industry Guidance Catalogue

Originally published V&E China Practice Update E-communication, January 13, 2012

On December 24, 2011, China's National Development and Reform Commission (NDRC) and Ministry of Commerce (MOC) jointly issued a new, revised version of its Foreign Investment Industries Guidance Catalogue (the "Catalogue"). The Catalogue will become effective January 30, 2012, and will replace the existing version of the guidance catalogue promulgated in late 2007.

Background

China first published the Catalogue in 1995 in order to regulate the inflow of foreign investment in a manner consistent with the central government's economic development objectives. Over the years, the Catalogue has subsequently been revised several times to conform with China's commitments under its Protocol of Accession to the World Trade Organization (WTO) and to reflect China's continued economic and social development. The latest amendments to the Catalogue reflect China's current emphasis on improving the quality of foreign investment to promote the development of high and new technology, valued-added manufacturing, efficient use of resources, and environmental sustainability.

The Catalogue classifies foreign direct investments in the various Chinese industry sectors as "encouraged," "restricted," "permitted," or "prohibited," and sets out specific industries in which foreign investment is either "encouraged," "restricted," or "prohibited." Activities not listed are, in the absence of other rules to the contrary, considered to be "permitted" for foreign investments. Foreign investment in "encouraged" industries may enjoy certain tax benefits and is often subject to less strict administrative requirements from approval authorities. The "restricted" category includes industries into which foreign investment is subject to a higher level of scrutiny, stricter administrative requirements, and may be denied at the discretion of the approval authorities. Foreign investment is not permitted in industries categorized as "prohibited."

Continued Decentralization of Approval Authority

The Chinese government approvals required for foreign investment in a particular industry will depend on the category into which that industry falls. In general, local government authorities have greater discretion to approve foreign investment in industries that are in the "encouraged" or "permitted" category, while investments in "restricted" industries may require review and approval of central government authorities.

In spring 2011, in anticipation of the new Catalogue, the State Council had issued regulations giving local authorities greater scope to approve foreign investments, by lifting the threshold for requiring central authority approval of investments in the "encouraged" or "permitted" categories from US$100 million to US$300 million.

We set forth in a table below the current foreign investment approval regime:

Please also note that the Catalogue specifies that investments in certain industry sectors need to be structured as joint ventures with Chinese partners (rather than wholly-foreign owned) and in some cases, a Chinese partner is required to hold a majority ownership interest. Therefore, any potential in-bound investor should consult the Catalogue in order to determine in which category the contemplated investment falls and properly structure their investments.

Major Amendments in the New Catalogue

Select major amendments in the new Catalogue are set forth below:

I. Exploration of Select Rare Earth Elements and Radioactive Minerals Prohibited

The Mining sector spans across the "encouraged," "restricted," and "prohibited" categories depending on the type of energy and natural resources in question. The mining and beneficiation (a process whereby extracted ore is separated into mineral and gangue) of iron ore and manganese ore continue to fall under the "encouraged" category. The new Catalogue further explicitly prohibits foreign investments for the exploitation and exploration of high-alumina refractory clay, wollastonite, lithium ore, pyrite ore, and refining of the salt lake brine resources, and a selection of radioactive minerals.

We will further discuss the important changes in the regulation of the oil and gas industry below.

II. Foreign Investors Encouraged to Invest in China's Emerging Shale Gas Industry

The traditional oil and gas industry has largely been unaffected by the revisions in the new Catalogue, which continues to provide that investments in risk exploration, development, and production of petroleum and natural gas, as well as investments relating to new technologies for petroleum, are encouraged in the form of cooperation with Chinese partners (either through equity joint ventures or cooperative joint ventures). The new Catalogue adds that foreign investments to explore and develop unconventional natural gas resources such as shale gas and seabed-level gas hydrates through joint ventures with Chinese partners are encouraged.

According to a 2011 report published by the U.S. Energy Information Administration, China has a tremendous amount of exploitable shale gas, yet the country is in the early stages of developing these natural resources. Relaxation on foreign investments in shale gas introduced in the new Catalogue will open doors for international energy companies that have been seeking opportunities to participate in shale gas development in China. As this client e-communication goes to press, China's Ministry of Land and Resources has officially changed the legal status of shale gas to "independent mining resources," thus allowing for the first time smaller private firms to join in oil and gas exploration in China. We are working on a separate client e-communication covering this topic.

Please note, however, ambiguities remain as to whether a foreign energy company can hold a majority participating interest, and/or act as operator in the exploitation and development of shale gas blocks.

III. More Service Industries Open to Foreign Investors

In addition to the energy and natural resources industry updates mentioned above, changes in the new Catalogue also span across many other industries. For example, nine service industries such as venture capital enterprises, intellectual property services, marine petroleum cleaning technology services, home services, logistics consultancy services, vocational skill training, and motor vehicle charging stations have been promoted to the "encouraged" category in the new Catalogue. In addition, foreign investments in health care, financial leasing companies, and commercial companies engaging in franchise or commission business or business management have been upgraded from the "restricted" category to the "permitted" category. Note, however, that foreign investments in financial companies (except for the financial leasing companies) such as banks, securities companies, and trust companies remain in the "restricted" category.

IV. Environmentally Friendly and High-Tech Manufacturing Encouraged

The changes in the new Catalogue continue to reflect China's goal to encourage foreign investments in environmentally friendly industries and high-technology and value-added industries. For example, the new Catalogue encourages foreign investments in the (i) manufacturing of key components and parts for new energy or fuel-efficient automotives (though foreign investment in energy-powered battery is capped at 50 percent), (ii) manufacturing of high-technology equipment for large construction projects, electricity generation, and waste treatment, and (iii) research and development of automotive components and environmentally protective aerospace materials. Foreign investments in the manufacturing of complete automobiles, however, are downgraded from the "encouraged" category to the "permitted" category (foreign investment remains capped at 50 percent).

V. Prohibition on Luxury Real Estate Projects

The rapid development of the Chinese real estate industry in this decade has led the Chinese government to introduce restrictions in order to "cool down" the real estate market. The new Catalogue continues this policy trend by downgrading foreign investments in the construction of high-end villas from the "restricted" category to the "prohibited" category.

VI. Go West Policy

In addition to the Catalogue, China has promulgated specific catalogues since 2000 steering foreign investment capital to China's less-developed central and western regions by providing more favorable treatment for foreign investments focused on those regions. We understand from the Q&A published in connection with the new Catalogue that the current 2008 Catalogue of Priority Industries for Foreign Investment in the Central and Western Regions will be further revised to redeploy certain foreign capital to the central and western regions. In particular, foreign investments in the environmentally friendly and labor-intensive industries are likely to be encouraged.

Conclusion

The new Catalogue will impact all new foreign investments into China over the next few years. Generally speaking, the notable changes in the new Catalogue are consistent with the principles outlined in China's 12th Five-Year Plan (covering 2011 – 2015) that China will further restrict industries with heavy pollution and consumption of energy resources or running-over capacity, but encourage foreign investments in industries such as high technology, modern services, new energy, energy-saving, and environmental protection.

It is important to note, however, that the Catalogue is drafted with both specific details and many ambiguities (e.g., ownership percentages allowed, the interplay between the central and local government authorities). Further guidance and detailed analysis will be required as a matter of practice.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.