From Approval to Filing: A New Era for Foreign Investment in China

On 3 September 2016, China's Standing Committee of the National People's Congress passed a new resolution (the “2016 NPC Resolution”), which abolished the country’s three-decade-long approval regime for the establishment of foreign-invested enterprises (the “FIEs”) and adopted a much simplified record-filing system.  Since then, the Chinese authorities, notably the Ministry of Commerce (the “MOFCOM”), the National Development and Reform Commission (the “NDRC”) and the State Administration of Industry and Commerce (the “SAIC”), have promulgated a number of rules and regulations to implement the new record-filing system.  This article gives a brief overview of the new system and its implications for foreign investment in China.

Development of FIE Investment Administration in China

In the decades since the beginning of the opening-up policy in 1979, China has developed a comprehensive set of laws and regulations to regulate foreign investment.  At the center of this regulatory framework are the three laws to govern how to set up and operate FIEs in China, namely the Sino-Foreign Equity Joint Venture Law, the Sino-Foreign Cooperative Joint Venture Law and the Wholly Foreign-Owned Enterprise Law (the “Three FIE Laws”).  In addition to them, there are also hundreds of departmental regulations regulating various foreign investment related issues, such as mergers and dissolutions of FIEs, foreign exchange, and beneficial tax treatment for FIEs.  Under this foreign investment regulatory regime, the Chinese government approves foreign investment on a case-by-case basis through reviews by multiple government agencies.  An FIE, regardless of its investment scale, industry and term, is generally required to obtain approvals, primarily from the MOFCOM or its local branches, for its establishment, equity transfer, capital increase or decrease, termination and liquidation.  

Since November 2013, the Chinese government has issued a series of policy initiatives, which are aimed at relaxing its regulatory framework for foreign investment.  Among other things, these policies encourage broader foreign investment access in China, and propose to adopt a “negative list” approach to identify exceptional areas.  Under this approach, foreign investment in all sectors in China is generally permitted except for those explicitly reserved in a “negative list” jointly issued by the MOFCOM and NDRC (the “Negative List”).

In January 2015, the MOFCOM issued China’s first draft of the Foreign Investment Law for public comment.  The law, once promulgated, will supersede the Three FIE Laws.  It aims to abolish the case-by-case review and approval approach to regulating foreign investment, and adopt a fundamentally new system that would offer equal treatment to both foreign and domestic investment, except for those sectors detailed in the Negative List.

A New Regime Based on the Provisional Measures

In order to implement the 2016 NPC Resolution, the MOFCOM promulgated the Provisional Measures for the Record-filing Administration on the Establishment and Alteration of Foreign Investment Enterprises (the “Provisional Measures”) on 8 October 2016, which went into effect on the same date.  The Provisional Measures consist of five chapters and mainly regulate the following aspects of the establishment and alteration of an FIE: record-filing for entity establishment, supervision and administration by government agencies, and legal liabilities for violations.  The Provisional Measures kick-start a new regulatory regime for foreign investment.  Below are some of its key provisions.

Applicability of the Provisional Measures

According to Art. 6 of the Provisional Measures, the following activities of an FIE shall fall within the legislation’s jurisdiction:

  • the establishment of the FIE; and
  • any subsequent changes of the FIE, including:
    • change of the FIE's basic information, such as its name, registered address, term of operation, registered capital and total investment amount, legal representative, and ultimate controller of the FIE;
    • change of the investor's basic information, such as its name, nationality, address, and source of capital ;
    • change of the FIE’s shareholding structure;
    • merger, division or termination of the FIE;
    • mortgage, pledge or assignment of the property rights of a wholly foreign-owned enterprise;
    • an accelerated recovery of investment by a foreign investor of a Sino-foreign cooperative joint venture; and
    • an appointment of a third party to manage and operate a Sino-foreign cooperative joint venture.

According to an interpretation released by the MOFCOM on the same date as the Provisional Measures (the “Interpretation”), the new record-filing system will not apply to the following types of foreign investment:

  • investment into a sector specifically reserved in the Negative List;
  • an acquisition of a PRC domestic enterprise by a foreign investor; and
  • strategic investment in a company listed in the PRC by a foreign investor.

As such, these three types of investment are still subject to the MOFCOM approval-based administrative system.

Procedures and Timeline of FIEs’ Record-filing Administration

Under the Provisional Measures, if a foreign investor intends to establish an FIE in a sector not mentioned in the Negative List, it shall follow the following four steps:

  • Step 1: Reserve its intended business name at the SAIC.
  • Step 2: Conduct a record-filing with the MOFCOM at http://wzzxbs.mofcom.gov.cn/.  This step should be carried out either before the issuance of the SAIC business license to the FIE, or within 30 days after its issuance. 
  • Step 3: If the MOFCOM decided that the information filed at Step 2 is incomplete or inaccurate under a prima facie review on format, it will notify the applicant and request it to provide supplemental information within 15 business days.    
  • Step 4: If the information filed at Step 2 is determined to be accurate and complete, the Provisional Measures requires the MOFCOM to complete the record-filing in three business days and release the result through its online platform.  The MOFCOM will also issue a confirmation receipt to the successful applicant, who may decide whether to pick up the receipt. 

In the Interpretation, the MOFCOM states that its record-filing is not a precondition for an FIE to obtain its business license.  Additionally, the MOFCOM will not review the substance of the information submitted, and its review is strictly limited to information’s formality.  That is to say, an applicant shall be solely responsible for the authenticity, accuracy and completeness of the information it submitted. 

It is noteworthy that the Provisional Measures requires disclosure of the ultimate controlling person of both the FIE and its investors.  The MOFCOM defines the ultimate controlling person of an FIE as any natural person, enterprise, governmental body or international organisation, directly or indirectly, controlling the FIE through equity, agreement, trust or any other types of relationship.  The ultimate controlling person of an FIE’s investor is similarly defined.  Compared with the approval-based system previously used, such disclosure requirement is a new obligation imposed by the Provisional Measures.  This requirement is presumably intended to force foreign investors to disclose whether or not they are wholly controlled by Chinese nationals.  This arguably can help the Chinese government to prevent illegal “round trip” investments by Chinese nationals under the disguise of foreign investment.

Supervision and Administration by Government Agencies

Under the new regulatory system prescribed by the Provisional Measures, administration and supervision of foreign investment will mainly be at the post-establishment stage.  The MOFCOM will conduct random inspections, as well as inspections based on informer reporting or recommendations by other government agencies about FIEs or their investors.  Such inspections will be primarily focused on whether:

  • the record filing procedures were carried out in accordance with the Provisional Measures;
  • the information submitted by the FIE or its investors is true, accurate and complete;
  • the FIE carries on business in a sector categorized as “prohibited” in the Negative List;
  • without any MOFCOM approval, the FIE carries on business in a sector categorised as “restricted” in the Negative List;
  • the investment triggers a national security review;
  • the FIE or its investors forged, altered or transferred a record-filing confirmation receipt; or
  • the FIE or its investors acted according to punishment decisions made by the MOFCOM.

The Provisional Measures also promises to strengthen the collaboration, particularly information sharing, between the MOFCOM and other government authorities responsible for public security, state-owned assets, customs, tax and foreign exchange.  Also, the MOFCOM will set up a credit record system to track and assess the status of good standing of FIEs and their investors, and share said information with other government authorities.

Where an FIE or its investor fails to duly perform its record-filing obligations pursuant to the Provisional Measures, or refuses the MOFCOM's supervision, administrative liabilities will be imposed on the offender.  For a less serious offence, the offender will be ordered to rectify the breach within a specified period.  For those who have committed a serious offence, or failed to rectify the breach within a specified period, a fine of no more than RMB30,000 will be imposed.

Conclusions

The implementation of the new record-filing system for FIEs has greatly simplified the administrative procedures for foreign investment into China.  According to the Chinese Prime Minister Li Keqiang, more than 95 percent approvals for setting up or altering an FIE will no longer be required under the new regime.  With time and costs for setting up an FIE being significantly reduced, the record-filing system will make China more attractive to foreign investment.

On the other hand, there is still a long way to go to perfect the new system.  Guidelines and detailed implementation rules are yet to be released with respect to some key issues, such as the scope of areas that will trigger a national security review.  The new concepts and procedures introduced by the record-filing system also raised new challenges to foreign investors and their FIEs.  In light of this, it is necessary for them to understand the new system, the Provisional Measures and other relevant legislations, and to observe future new rules timely and adjust business operation accordingly.

Jurisdictions: 

Partner, Zhong Lun

Mr. Xu is a partner of Zhong Lun’s Shenzhen Office.  He focuses on advising clients in cross-border mergers and acquisitions, joint ventures and other forms of investment. He has advised a number of high profile direct investment, M&A and restructuring transactions, some of which received awards and recognition from business publications and organizations such as Financial Times and Asia Transformation & Turnaround Association (ATTA).