China: China's New Foreign Investment Law

Last Updated: 10 April 2019
Article by Alexander Chipman Koty

China has been facing international criticism over its promised market opening and the inconsistent enforcement of laws.

China Briefing discusses the newly introduced Foreign Investment Law and where it stands in terms of international expectations.

Last Friday, China's National People's Congress closed out the Two Sessions meetings by passing a new Foreign Investment Law. It will come into effect on January 1, 2020 and is a new guiding document to govern foreign investment in China.

The new law was passed only three months after being brought back onto the agenda by Chinese policymakers. An earlier version of the draft law was initially introduced in 2015, but was put on the back-burner due to disagreements on its content.

Observers believe the law's sudden rush to the spotlight is an attempt by the Chinese government to respond to international criticism from the US and others about China's openness – or lack thereof – to foreign businesses.

The new Foreign Investment Law seeks to address common complaints from foreign businesses and governments, such as by explicitly banning forced technology transfers.

Critics, however, point out that the law – as it stands – still does not go far enough in addressing their concerns. The law's vague wording means that foreign investors will need to wait and see to determine what it means in practice.

What do we know about the new Foreign Investment Law?

The Foreign Investment Law will govern the activities of all individual foreign investors and foreign-invested enterprises (FIEs), which include both wholly foreign-owned enterprises (WFOEs) and Sino-foreign joint ventures (JVs). It also includes investors originating from Hong Kong, Macau, and Taiwan.

It replaces three previous laws, namely the Wholly Foreign-Owned Enterprises Law (also known as the Foreign-Capital Enterprises Law), the Sino-Foreign Equity Joint Ventures Law, and the Sino-Foreign Contractual Joint Ventures Law.

The new law pledges to "build a market environment of stability, transparency, predictability, and fair competition" for foreign investors.

In the closing press conference of the Two Sessions, Premier Li Keqiang explained that the law is part of China's "fundamental state policy" to open up to the world.

According to Li, "This piece of legislation is designed to better protect and attract foreign investment through legislative means."

Specifically, the Foreign Investment Law contains a number of provisions that pledge to give foreign investors a level playing field with their domestic counterparts.

For example, it explicitly bars Chinese JV partners from stealing IP and commercial secrets from their foreign partners via protections included in Article 22. Further, it not only prohibits government officials from using administrative measures to pursue forced technology transfers (also Article 22), but also makes them criminally liable if they do so (Article 39).

Besides IP considerations, the law says that foreign investors will receive equal treatment when applying for licenses (Article 30) and participating in government procurement (Article 16) – two common complaints from the international business community. According to Article 15, foreign investors will also be given equal opportunity to participate in the formulation of standards.

In terms of managing foreign investment, Article 4 of the law says that the state should use the Negative List to ensure pre-establishment national treatment. It means that foreign investors will be treated at par with domestic investors during the initial stages of setting up.

China's Negative List is a comprehensive list of restrictions on foreign investment determined by the State Council, China's cabinet.

The new law also contains measures (for example, Article 20) to guard foreign investments from arbitrary expropriation. Under special circumstances, however, the law says that the State may expropriate or requisition the investment of foreign investors for the public interest.

In such an event, the law pledges that expropriations and requisitions will be done in accordance with legally prescribed procedures and offer "fair and reasonable compensation". Further, Article 35 states that some investments could be subject to national security reviews, and that decisions made for national security reasons are final and cannot be appealed.

What is missing from the law?

Although the Foreign Investment Law is designed to respond to oft-repeated complaints from the foreign business community, it has been met with a tepid response.

Critics of the law say that it is too general to know how it will work in practice. According to media reports, some of the language was intentionally made vague – or removed altogether – due to ongoing disagreements among policymakers over how certain issues should be treated.

Ines Liu, Assistant Manager, International Business Advisory at Dezan Shira & Associates, said, "Overall, the Chinese government tried to make a positive step for foreign investors."

Liu cautioned, however, that "since the law is drafted in a very general way, it might take a long time until the government releases the implementation rules.

The very critical step would be to see how the Chinese government will steer new avenues to strengthen legal enforcement."

Likewise, Kyle Freeman, International Business Advisory Manager at Dezan Shira & Associates, said, "Though the new law is a step in the right direction to address certain concerns of foreign investors, in its current form, it is fairly light on actual substance and should be read as an overarching framework."

In his press conference, Premier Li said the government is aware of these issues and that they will be remedied with the issuance of subsequent implementation directives. "The government will introduce a series of matching regulations and directives to protect the rights and interests of foreign investors, such as on working mechanisms for handling complaints filed by foreign-invested enterprises."

Li continued, "These will be the important things for the government to do in the following weeks and months to see that this law will be truly operable."

Concerns over negative impact of new provisions

Despite the assurances from Li, many analysts are unsure whether forthcoming guidelines will fully address their concerns. This is partly because Chinese laws tend to be intentionally vague, thereby empowering local officials to interpret rules themselves. While this strategy allows local officials to interpret and adapt laws according to local conditions and needs, it also makes them less consistent and transparent for foreign investors.

Even more fundamentally, critics are skeptical over how the law will end forced technology transfers and IP theft; in practice, the government could turn a blind eye to enforcement.

For example, although the law now formally bans forced technology transfers, government officials have said that such transfers were already illegal, downplayed their prevalence, or said that they did not occur at all.

Last May, Chinese ambassador Zhang Xiangchen said, "There is no forced technology transfer in China" even though a 2018 survey by the American Chamber of Commerce found that one-in-five respondents felt pressured to transfer technology in exchange for market access.

In addition to concerns over the law's vague wording, some observers believe that new provisions could in fact empower the government to target businesses as retaliation in the event of a dispute with a foreign country.

According to Liu, language that foreign investments could be expropriated under "special circumstances" and "for the public interest" and are subject to broad national security reviews give the Chinese government a statutory basis to retaliate against a foreign company in the event of an international dispute.

For the time being, however, most foreign investors will be more concerned with the law's practical day-to-day implications for doing business in China. Freeman suggested that most foreign investors will likely take a wait-and-see approach before assessing the law's impacts: "One of the main concerns of investors that will still persist is that the on-the-ground reality of industry-specific laws, regulations, and local administrative approvals, or 'window guidance' may impede full market access at the implementation level."

Freeman concluded that "most articles within the law lack substantial details and require further clarification. The subsequent provisions of detailed implementation rules, especially their timeliness and interpretive content linking to other laws, will be critical in the successful implementation of the Law."

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.

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