Welcome to MoFo's inaugural China Clean Tech Bulletin. We have been assisting clients with Clean Tech matters in China for some time, and are pleased to provide this survey as a regular update to cover developments in this rapidly evolving field. Our goal is to get timely reports and analysis on developments into your hands as they happen.
The last year in China has seen a host of new laws and regulations concerning Clean Tech being pushed out by the government, emphasizing the deepening concern among government officials at the impact of pollution, energy consumption, and resource usage. These are further highlighted by the upcoming 2008 Beijing Olympics, which the Chinese government is promoting as the "Green" Olympics. The pursuit of cleaner skies and water, more efficient energy usage, and the protection of human health is being addressed through broad policy levers such as the Foreign Investment Industrial Guidance Catalog and Energy Conservation Law, as well as tightly targeted laws such as China RoHS which are focused on eliminating the use of hazardous chemicals in electronic products.
This new market environment is creating new opportunities for companies operating in Clean Tech industries, and attracting new sources of VC and PE capital into this space. The Clean Tech matters MoFo has handled recently include representing the Joint U.S.-CHINA Cooperation on Clean Energy ("JUCCCE"), a non-profit incubator of market-driven initiatives to accelerate energy productivity, encourage green building, and increase clean energy supply, representing Goldman Sachs in its investment in Suntech Power Holdings Co. Ltd., a leading PRC-based manufacturer of photovoltaic solar cells, and representing DT Capital in its investment in Sierra Solar Power, a provider of thin-film photovoltaic products.
In December the Clean Tech Network hosted the China Clean Tech Forum XV, an industry conference that demonstrated the depth of interest of companies in China with more than 300 attendees. Fraser Mendel from our Beijing office moderated a panel at the Forum on cross-border investments in Clean Tech companies in China, and then in January he spoke at a follow-on webinar organized by the Clean Tech Network on cross-border issues facing foreign companies coming into China.
China's Updated Foreign Investment Industrial Guidance Catalog - Encouraging Clean Tech in the Middle Kingdom
China's National Development and Reform Commission ("NDRC") and Ministry of Commerce ("MOFCOM") jointly promulgated the Catalog for Guidance of Foreign Investment in Industry (2007 Amendment) (the "2007 Catalog"). The 2007 Catalog came into effect on December 1, 2007, replacing the existing Catalog (the "2004 Catalog"). The 2007 Catalog significantly alters the classification of numerous industrial sectors, and is expected to have a marked effect on patterns of foreign investment in China. One area of significance in the 2007 Catalog is the increased scrutiny of polluting industries, as well as a commensurate increase in emphasis on foreign investment in projects that contribute to a cleaner and more sustainable environment.
Amendments in the 2007 Catalog affect foreign investment across numerous industrial sectors, relaxing restrictions in many areas such as finance and many areas of manufacturing, while increasing restrictions on real estate investments. A full discussion of the changes in the 2007 Catalog is beyond the scope of this report, which focuses on the implications of the 2007 Catalog for investors undertaking Clean Tech investments. The 2007 Catalog amendments clearly reflect PRC government policy to promote environmentally friendly manufacturing and energy efficiency.
Classification of Clean Tech
The 2007 Catalog expands and provides greater detail than the 2004 Catalog regarding Clean Tech investments. It encourages foreign investment in clean energy production, renewable energy research and development, industries that protect the environment, development of organic foods, and production of environmentally friendly components for other manufacturers.
The 2007 Catalog retains the classification system of the 2004 Catalog, classifying industrial sectors according to whether they are "encouraged," "restricted" or "prohibited". Industries not specifically identified fall by default under the "permitted" category. If a particular project falls under the "encouraged", "permitted" or "restricted" category, foreign investors can invest into such a project as long as the appropriate level of government approval can be obtained and the investment complies with applicable restrictions on foreign ownership. Direct foreign investment is not allowed in projects classified as "prohibited".
Projects that are classified as "encouraged" for foreign investment are regulated by provincial as opposed to central authorities. Additionally, certain tax benefits may be available, depending on the location of investment. Conversely, a project classified as "restricted" for foreign investment means that the project will be subject to heightened regulatory scrutiny: investment might only be permitted in the form of a joint venture with a Chinese company, and there may be restrictions on the amount of equity the foreign investor can hold in such enterprise.
The approval authority of different levels of government over different categories includes:
- Provincial or equivalent authorities have the authority to approve projects in the "encouraged" or "permitted" categories if total investment is less than US$100 million. For "restricted" category projects, provincial approval is sufficient only if the total investment is less than US$50 million. Projects over these amounts must be approved by MOFCOM and NDRC.
- Provincial authorities may often delegate their approval authority to municipal or other lower level government authorities. However, the authority of provincial authorities to approve a "restricted" category project may not be delegated.
- State Council approval is required for projects in the "restricted industry" if total investment exceeds US$100 million, but is generally required for projects in the "encouraged industry" or "permitted industry" only if total investment exceeds US$500 million.
Set forth below is a sampling of those Clean Tech sectors in which foreign investment is "encouraged":
- Development and application of new technologies for improving the utilization of mine tailings and the comprehensive application of technology for the remediation of mine ecology
- Exploration for and development of seabed methane ice
- Textiles - Processing of special natural fibers that comply with the requirements of comprehensive utilization of the ecology and resources and environment protection
- Chemicals - Manufacture of environmentally-friendly printing ink and aromatic hydro-carbon oil
- Non-metal Mineral Products - Manufacture of chemical construction materials that can replace steel and wood with plastic and that have energy-saving and high-efficiency features
- Metal Products - Manufacture of light-weight, eco-friendly new construction materials for automobiles and motorcycles
Specialized Equipment Manufacturing
- Production of specialized equipment for the manufacture of solar cells
- Development and production of pollution control equipment
- Manufacture of equipment for the disposal of urban waste and for the comprehensive utilization of rural organic waste
- Manufacture of equipment for the recovery, disposal, and recycling of waste plastic, electronic equipment, rubber, and batteries
- Manufacture of equipment for the comprehensive use of waste tires
Power Generation Machinery and Equipment
- Manufacture of complete sets of equipment and key equipment for power generation from new energy sources: photovoltaic power, geothermal power, tidal power, wave power, waste power, and methane power, as well as wind power generation over 1.5MW
- Manufacture of solar-powered air conditioners, heating systems and drying systems
- Manufacture of biomass decomposition systems and biomass gasification systems
Meters, Measuring Equipment and Machinery for Cultural or Office Use
- Manufacture of production safety and environmental protection devices, technology and equipment
- Manufacture of various categories of equipment for the detection and prevention of air and water pollution and for waste treatment and disposal
Production and Supply of Power, Gas, and Water
- Construction and operation of power stations using clean coal-burning technology (included in the 2004 Catalog, remains in the 2007 Catalog; the 2007 Catalog includes new stipulations on the nature of the technology)
- Construction and operation of new energy power plants (solar energy, wind energy, magnetic energy, geothermal energy, tide energy and biomass energy, etc.) (included in the 2004 Catalog; remains in the 2007 Catalog)
- Utilization of sea water (direct use of sea water, and seawater desalination) and commercialization of applications for the recovery of industrial wastewater
Scientific research, technical services, and geological exploration
- Technology for the development of biomass energy
Very few changes were made to the "restricted categories," except that foreign investment is now restricted in biological liquid fuels such as ethanol and diesel. Foreign investment has been prohibited specifically in water conservation and public facilities.
Encouraging Clean Tech
The gathering global focus on Clean Tech is embodied in the emphasis China's government has given to Clean Tech projects in the 2007 Catalog. We anticipate that the government's policy of encouraging Clean Tech projects will result in a rapid growth of investment in these areas in China.
Revised Energy Conservation Law Increases Flexibility for Investors
On October 28, 2007, the Standing Committee of the Tenth National People's Congress of the People's Republic of China amended the Energy Conservation Law of the People's Republic of China (the "Energy Conservation Law"). The newly Amended Law will go into effect on April 1, 2008 (the "Amended Law"), superseding the current version of the Energy Conservation Law promulgated ten years ago (the "Old Law").
The Amended Law reflects China's attempt to address growing tensions between the demands for economic development and limitations on energy and resources. Since the beginning of China's policies on reform and opening, the government has emphasized aggressive economic development, and energy conservation has been ignored in the race to increase incomes and GDP. China's rapid economic growth over the last 28 years has been fueled by intensive energy and resource consumption. Recognizing this problem, the PRC government has made some efforts to counter-balance the emphasis on promoting economic development with the need for energy conservation. The Amended Law identifies energy conservation as a fundamental state policy, clarifies the responsible authorities or entities for implementing the energy conservation policy, and institutes a range of penalties for failing to fulfill energy conservation requirements. Highlights of the Amended Law include:
- Governmental authorities are included in the scope of regulation. The Amended Law requires public organizations, including governmental authorities, institutional organizations and other organizations which are in whole or part supported by state funds, to strictly enforce energy conservation, take the lead using energy-saving products and equipment and improve energy utilization rates. Public organizations are required to set energy conservation goals and make annual implementing plans, and report energy consumption conditions to the relevant governmental authority. In public procurement, public organizations must give priority to procuring products and equipment listed in the Energy-Saving Products and Equipment List, and are prohibited from purchasing energy-intensive products and equipment which are identified in a government-published catalogue of high energy-consuming products, equipment and productive techniques.
- Free energy supply is prohibited. Energy producers are prohibited from providing energy to their employees for free, and all entities are prohibited from providing energy for a fixed price.
- Use of banned energy-intensive equipment and techniques are prohibited. The Amended Law expressly prohibits the production, importation and sale of high energy-intensive products and equipment that have been banned by the government or do not conform to mandatory standards, and the use of banned energy-intensive equipment and techniques are prohibited. Producers of energy-intensive products cannot manufacture equipment that exceeds the per-unit energy consumption limit set by the State.
- Incentives for energy conservation are expanded. The Amended Law provides a number of incentives to encourage energy conservation. The government will use various economic leverages such as subsidies, taxes, prices and favorable lending to improve energy conservation and upgrading industries. For example, favorable tax rates will be available for companies using energy-saving technologies and products that are on the Energy-Saving Technologies and Products Promotion List. Tax incentives will also be used to encourage importation of energy-saving technologies and equipment, and to control the export of energy intensive and highly polluting products.
- Supervision of major energy-consuming entities will be strengthened. Major energy-consuming entities are those entities whose annual energy consumption exceeds 10,000 tonnes of standard coal, or is less than 10,000 tonnes but more than 5,000 tonnes and identified by the local government. Approximately 35% of China's entire energy consumption in 2006 was used by 922 major energy-consuming entities engaging in steel, non-ferrous metal, coal, power, and chemical industries. Supervision of these entities is of special importance to the success of overall energy conservation. The Amended Law requires major energy-consuming entities to submit annual reports to the relevant governmental authorities explaining their energy consumption conditions, energy utilization rate and energy-saving measures. Failing to submit such report or failing to meet the energy conservation requirements can result in fines, mandatory orders for the offending enterprise to improve their energy-saving systems, or orders to take energy-saving measures within a prescribed time frame.
- Special requirements for construction projects. Under the Amended Law, all parties involved in construction projects, including developers, designers, contractors and supervisors, must comply with the construction energy conservation standards. Authorities are not permitted to approve the commencement of a construction project that does not conform to the construction energy conservation standards. Construction projects that have commenced may be suspended or stopped for failing to meet energy conservation standards. Sale and use of construction projects that have been completed but do not meet the energy conservation standards are prohibited. Significantly, the Amended Law authorizes local governments to promulgate construction energy conservation standards that are stricter than national standards or industry standards to reflect local requirements.Real estate developers must disclose information in connection with the energy-saving measures and include such information in house purchase agreements, warranty documents and house handbooks, and be responsible for the authenticity and accuracy of such information. Real estate developers who fail to disclose such information may be fined.
Update on China's RoHS
The Ministry of Information Industries ("MII") organized a conference on December 19, 2007, to update industry on the drafting of the Special Administration Catalog ("Catalog"), which is the key document for implementing Phase 2 of China's reduction of hazardous substances regime ("RoHS"). Once the Catalog is promulgated, manufacturers and distributors of electronic products listed in the Catalog will need to comply with strict manufacturing requirements that prohibit the use of hazardous chemicals.
Senior MII officials presided at the conference. During the conference, representatives from electronic information product ("EIP") manufacturers and testing institutes discussed major technical issues. In addition to the technical discussion, MII officials spoke at length regarding the progress of rolling out the Catalog. The following projects were identified in connection with commencement of Phase 2 of China RoHS:
- Amendment of the Index of Electronic Information Products ("EIP Index"), although the MII has not yet released a time table for publication.
- MII was consulted last year on the drafting of the Administrative Measures for the Prevention and Control of Environmental Pollution by Electronic Waste ("Electronic Waste Measures") which were promulgated by the State Environmental Protection Administration ("SEPA"). MII is now drafting another set of regulations to address the disposal of waste electronic information products that are separate from SEPA's Electronic Waste Measures. The National Development and Reform Commission and the Ministry of Commerce are also drafting regulations to address the disposal of electronic waste.
- MII is drafting a Procedural Guidance for Catalog Drafting ("Catalog Procedure") which will outline the procedural requirements for putting a specific EIP into the Catalog. MII officials indicated that such Catalog Procedure would be promulgated early in 2008.
- MII officials are continuing to review what type of EIPs should be included in the Catalog initially, and we understand there is still some question whether the Catalog should contain finished products, such as mobile phones and PCs, major assemblies, or components.
- Officials have proposed that the existing China Compulsory Certification ("CCC") model does not fully meet the requirements of RoHS, and the MII is considering implementing a new certification model to accommodate the needs of China RoHS.
- It was clear at the conference that MII officials had not yet decided how rigorously they should implement Phase 2 of China RoHS, due to concerns that they could hamper weak domestic electronics manufacturers.
While there remain many open issues, the MII officials at the conference were confident that the Catalog would be promulgated by the end of 2008.
China Energy Law Draft Released For Public Comment
On December 3, 2007, the much anticipated Energy Law draft (the "Draft") was released by the Energy Law Drafting Committee under the People's Republic of China ("PRC") State Council (the "Drafting Committee") to solicit public comments through February 1, 2008. The Drafting Committee has stated that it intends to submit the revised draft to the PRC National People's Congress ("NPC") for further review in mid-2008, and the Energy Law could be promulgated in 2009.
According to the Drafting Committee, the Draft is positioned neither to be a piece of comprehensive energy legislation like the U.S. Energy Policy Act of 2005, nor to target specific energy sub-sectors or issues like the existing PRC Electricity Law, PRC Coal Law, PRC Energy Conservation Law or PRC Renewable Energy Law. Instead, the Draft provides an overall policy framework for China's energy industry while leaving detailed guidelines to be spelled out in relevant implementing rules.
The following identifies potential implications of the Draft for foreign investors:
- Change to Regulatory Landscape: The energy industry in China is currently subject to the jurisdiction of multiple governmental authorities, including the NDRC, the Ministry of Land and Resources, the State Electricity Supervisory Committee, and MOFCOM. The Draft introduces a unified overseeing entity under the State Council for the energy industry in China (the "Energy Department"), whose role and responsibilities will be specified by the State Council. It is still too early to tell the exact impact of such change on foreign investors. On one hand, it could reduce bureaucratic delays since the number of approvals for foreign-invested energy projects could be reduced. On the other hand, the newly introduced Energy Department could raise the standard of scrutiny during the approval process and thus make the regulatory environment more challenging.
- New Market Access Policies: The Draft identifies a core policy for China's energy industry to implement called "diversified ownership", foreshadowing a more permissive environment for both private investment and foreign investment. However, in sub-sectors of the energy industry that "affect the national security or the lifeline of national economy", the Draft provides that (i) the state must hold a controlling equity interest; and (ii) restructuring or mergers and acquisitions activities shall be subject to Energy Department approval. Despite increased control over sensitive sub-sectors, the Draft includes specific provisions to encourage foreign investment in areas relating to clean energy and clean energy technologies, which may create new business opportunities for foreign investors. Such areas may cover mining projects, renewable energy projects, energy processing/conversion projects and energy supply business. Details of the market access policies are to be provided in relevant implementing rules to be made by the Energy Department in consultation with relevant governmental authorities.
- Potential Increase of Business Costs: The Draft requires energy firms to build their own reserves at their own cost to supplement a government-owned strategic inventory. Such reserves will cover energy products including oil, natural gas, and natural uranium. The Draft specifically requires national strategic reserves to be set aside by petroleum companies that are engaged in the (i) import, processing and distributing of crude oil, or (ii) importing and distributing refined oil. This is a move that could increase the business costs of energy firms and consequently affect their profits. Implementation of this requirement would be subject to the State Council promulgating further regulations.
This version of the Draft is still early in the legislation process, and it is not expected to be promulgated until 2009 at the earliest. Therefore, the Draft may be subject to considerable revision incorporating public comments, and revisions made by the Drafting Committee, as well as the NPC. Consequently, the actual impact of the Draft on foreign investment in China's energy sector is still difficult to gauge, and should be monitored closely by companies active in the energy business.
Clean Tech Forum XV - Beijing
On December 3rd and 4th in Beijing, the Clean Tech Network hosted Clean Tech Forum XV, the inaugural Clean Tech Forum in Beijing, to bring together investors, innovators and companies in the Clean Tech industries to build relationships and identify opportunities for profitably integrating China into the world Clean Tech economy. Fraser Mendel of MoFo's Beijing office moderated a panel on Cross-Border Investment Cooperation: Building Successful Management Teams, Syndicates and Investment Strategies with John Rockwell of DFJ Element, Pierre DuPont of Two-Sigma, and Vincent Chan of Spring Capital as panelists. More information can be found at the Clean Tech website at cleantechnetwork.com.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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