22 January 2015China Unveils Draft New Foreign Investment Law Contents The Draft New Law The Ministry of Commerce (the “MOC”) published a draft law on foreign investment on 19 January 2015 (the “Draft New Law”) for public comment, which aims to make significant changes to the foreign investment regime. The Draft New Law proposes to standardise the market entry requirements and procedures for foreign and domestic investors, replacing the existing requirements for approval of all foreign investments by the MOC or the competent local authority in charge of foreign investment (the “Foreign Investment Authority”), on a case by case basis. The Draft New Law also aims to consolidate and simplify the various regulatory requirements on foreign investment. By abolishing the Sino-foreign Equity Joint Venture Law, the Sino-foreign Cooperative Joint Venture Law and the Law on Wholly Foreign-owned Enterprises, the Draft New Law proposes to remove all differences between the corporate governance requirements that apply to foreign invested and domestic enterprises. At the same time, the Draft New Law proposes to apply foreign investment approval, reporting and national security review requirements to a range of new investments and structures, which is expected to have a profound impact in the planning of future transactions. The Draft New Law ........... 1 Reform of corporate governance ....................... 1 National treatment and removal of MOC approval requirement....................... 2 New scope and requirements of foreign investment review ............. 2 Reporting based supervision........................ 5 National security review .... 5 How the Draft New Law applies to VIE structures ... 6 Reference ......................... 8 In accordance with the normal Chinese law-making process, the Draft New Law is expected to undergo further revisions by MOC following its public consultations. MOC is then expected to provide the draft to the State Council, whose Legal Affairs Bureau will undertake further revision following consultation among various government departments. The revised version of the Draft New Law will then need to be submitted by the State Council to the National People’s Congress where it will need to complete at least three readings before becoming law. Accordingly, there is no definitive timeline for the coming into effect of the Draft New Law, and the current draft may need to undergo significant amendment before the law is finally passed. Reform of corporate governance The Draft New Law proposes to abolish the specific organisational requirements which apply to foreign invested enterprises, leaving only the China Unveils Draft New Foreign Investment Law 1 The list is to be divided into: a prohibited investment list. being a list of sectors in which no direct or indirect foreign investment is permitted. with the exception of the financial sectors where the foreign investment-specific requirements and restrictions under the existing rules continue to apply. where the relevant foreign investment is subject to the applicable conditions set out in the restricted investment list and the prior approval of the Foreign Investment Authority. under the Draft New Law a Sino-foreign joint venture could have the shareholders’ meeting rather than the board of directors as its highest decision-making authority. The negative list is expected to provide certainty by consolidating the various requirements contained in China’s laws. regulations and decisions in relation to foreign investment. and a restricted investment list. Foreign investment: in addition to greenfield establishments and acquisitions of domestic equity and assets which are covered by the China Unveils Draft New Foreign Investment Law 2 . liquidation and amendments to its articles of association would no longer be required. For example. and be applied to all investments (including financing) made in relation to the same project over a two-year period. This is expected to considerably simplify the governance of a foreign invested enterprise. regardless of percentage or nature of the interest held. Of note is that these amounts would include all financing with a term of one year or more. New scope and requirements of foreign investment review The Draft New Law proposes to bring a new range of activities and transaction structures (as set out below) within the scope of the foreign investment review regime (if they fall within the negative list) and these investments may also be subject to national security review and reporting obligations. in addition to equity investment. the negative list (which is yet to be formulated by the State Council) still needs to be reviewed in order to determine the real impact of the Draft New Law. mergers. Whilst the Draft New Law sets national treatment as a general principle.requirements of the PRC Company Law (with which all foreign invested and domestic enterprises must comply). and the unanimous approval of the board of directors to changes in its registered capital. as well as applicable international treaties. which sets out restrictions on foreign investments above a certain amount and in certain sectors. National treatment requirement and removal of MOC approval The Draft New Law proposes a principle of national treatment. in which all investments that do not fall within a negative list will no longer require the approval of the Foreign Investment Authority and will not be subject to restrictions specifically applied to foreign investment. and . . the Draft New Law proposes to regulate additionally: . Foreign investor: in addition to non mainland Chinese enterprises and individuals as is the case under the current regime. While the current regime would not require Foreign Investment Authority approval to such investments. any offshore transaction resulting in the actual control of an onshore entity being transferred to a foreign investor shall be deemed an onshore transaction and be subject to the new foreign investment regime (see further below).the acquisition of real estate. The new proposals emphasise the principle that China's new approach is intended to cover "foreign investment" in the broad sense of the word. Control: a key change introduced by the Draft New Law is the use of the concept of foreign “control” in ascribing foreign investor status.the acquisition of control of.the provision of financing to domestic entities (in relation to which a foreign investor has made an investment) of a term of one year or more. or interests in. remains to be seen. including by way of clarifying the restrictions in the restricted investment list. Furthermore. domestic entities by way of contract or trust. .concessions to prospect for or develop natural resources and to build/operate infrastructure. the Draft New Law leaves open this possibility by characterising all investments within China by such foreign national (whenever made) as foreign investments. expanding the existing foreign investment regime which still characterises certain types of investments within China made by foreign invested enterprises as domestic investments. a "foreign investor" under the Draft New Law also includes a domestic PRC entity controlled by a foreign investor. The Draft New Law proposes to prohibit all investments by foreign investors and any PRC incorporated entities in which a foreign investor has any direct or indirect equity. Whether the Draft New Law will eventually cover investments within China made by non-controlled foreign invested enterprises in areas that are covered by the restricted investment list. The Draft New Law includes all of the following as ”control” by one entity over another: China Unveils Draft New Foreign Investment Law 3 . voting or other interests in areas that are covered by the prohibited investment list.existing foreign investment review regime. Yet another potential extension of the foreign investment regime concerns the status of a Chinese national who acquires foreign nationality after making an investment within China. directly or indirectly. directly or indirectly. If the application is successful. voting or other similar rights.with the right to. (iii) decisive influence over business operations.. Chinese investor treatment: when an ultimately Chinese investorcontrolled foreign investor applies for foreign investment approval of an investment which falls within the restricted investment list. or more of the equity.with the power to procure the appointment. for example. or if only positive control is intended to be covered. the Draft New Law would enable the investor to apply to the Foreign Investment Authority for Chinese investor treatment (note that this does not apply to the prohibited investment list). This potentially brings a wide range of transactions between entities outside China within the scope of the foreign investment approval (to the extent within the negative list). or . However. the implications of being “regulated as a China Unveils Draft New Foreign Investment Law 4 . human resources or technology whether by contract. Extraterritoriality: the Draft New Law proposes that an offshore transaction resulting in a transfer of actual control to a foreign investor will be treated as foreign investment. term limits. it is unclear whether a package of veto rights in the overseas holding vehicle of a domestic entity (as is common in preIPO financing transactions) would be viewed as “control” under this definition. finance. including asset or business disposal.with ability to exert significant influence on the resolutions of the shareholders’ meeting or board of directors or other decision making bodies. assets. (ii) any such direct or indirect holding of less than 50 per cent. or if it is only intended to cover the transfer of actual control from an ultimately Chinese investor-controlled foreign investor. the Draft New Law does not specify if the transfer of actual control to a foreign investor from another foreign controlled investor is intended to fall within the scope of the provision. shareholding restrictions. of half or more of the board members. without being subject to restrictions on the making of the foreign investment. geographical limits or minimum local labour percentages or numbers. Conditions to approval: in granting its approval for foreign investment. . but: . trust arrangements or otherwise. national security and reporting regimes. Further clarification of the definition of control would be welcomed. the Foreign Investment Authority may impose one or more conditions to approval. However.(i) direct or indirect holding of 50 per cent. appoint half or more of the board members. the investment will be regulated as a domestic investment. the Draft New Law proposes to ascribe a more extensive role to the national security review regime in the regulation of foreign investment and has expanded the scope of the existing regime in the following key areas. as well as operational information and details of litigation (which are to be supplied in an annual report). The process by which an investor can ensure that this exempted information is not put on public record. Self assessment: the Draft New Law would require foreign investors to make a self assessment and include a statement in the application documents for foreign investment approval on whether their investments will trigger national security review or antitrust review requirements. All of the above information is to be made publicly available. National security review As a counterpoint to the general relaxation of foreign investment restrictions and MOC approval requirements. The reporting obligations are required to be discharged within 30 days after foreign investment approval is obtained (for investments falling within the restricted investment list). These appear to be more extensive than the current filing requirements of the State Administration for Industry and Commerce with which both domestic and foreign invested entities are required to comply. and at the latest by the 30th day after the investment is implemented (for investments not falling within the negative list).domestic investment” need further clarification in the final version of the Draft New Law and it is at this stage uncertain if this means that the investor will be exempt from all restrictions in the negative list that would otherwise be applicable. China Unveils Draft New Foreign Investment Law 5 . A foreign invested entity whose controlling foreign investor has total assets. Annual filing of prescribed information and post-investment filing of material changes relating to the investment also apply. Reporting based supervision The Draft New Law would impose certain obligations to report to the Foreign Investment Authority on all foreign investors or foreign invested entities in relation to all foreign investments (whether or not in areas within the negative list). remain unclear. sales volume or revenue of more than RMB10 billion or more than 10 subsidiaries is additionally required to submit a quarterly report within 30 days from the end of each quarter. The key additional items include information on the actual controllers of the foreign investor and the invested entities. as well as the national security review process. other than information relating to trade secrets or personal privacy of the foreign investor or the investment. as well as a confirmation that all statements. representations and information in the application documents are true and complete. and the exact scope of this exception. would apply to variable interest entity (“VIE”) structures and a placeholder for the treatment of contractual control arrangements has in fact been reserved in the Draft New Law. such that a VIE investment in the prohibited investment list would not be permitted. national security review will only be initiated in relation to a foreign investor’s acquisition of actual control of domestic enterprises or assets. the Draft New Law would regulate new VIE investments in the same way as other types of foreign investments. veto decisions by the Joint Ministerial Committee will also need to go through the State Council. and greenfield investments that do not involve asset acquisitions are excluded. VIE structures are typically used by foreign investors when there are regulatory restrictions in place in China which prevent or restrict foreign investment. the changes to the Draft New Law would extend the existing foreign investment regime to include foreign-controlled entities. A VIE structure allows a foreign investor to control and derive the economic benefits of a restricted business in China via contractual arrangements rather than direct ownership which would be in breach of Chinese regulations. Veto jurisdiction: under the existing regime. By way of background. On its face. This in turn requires consideration of how the Draft New Law. Conditional clearance: at the same time as veto decisions are made more stringent by the need for State Council approval. regardless of structure and degree of control by the foreign investor. national security review could apply to any foreign investment that endangers or may endanger national security. New VIE investment: applying the wide definitions of “foreign investor” and “control”. discretion is given to the Joint Ministerial Committee to impose conditions in the clearance of a transaction for national security review. Under the Draft New Law. the Joint Ministerial Committee is the authority having discretion to veto a transaction on national security grounds. and a VIE investment in the restricted investment list would be subject to foreign investment approval. where “control” is broadly defined and includes contractual control. though it must however be emphasised that the restricted and prohibited investment lists will only be set out in the negative list which is to be separately issued. when passed in final form. and has successfully applied to the Foreign Investment Authority to be treated as a domestic investor. Treatment as a domestic investment would only be available to a VIE investment in the restricted investment list (but not the prohibited investment list) where the controlling foreign entity is in turn controlled ultimately by a Chinese investor. Under the new law. this appears to be a limited exception given that it does not apply to the prohibited investment list. Broader scope of application: under the existing regime. China Unveils Draft New Foreign Investment Law 6 . How the Draft New Law applies to VIE structures As mentioned above. (ii) verification . China Unveils Draft New Foreign Investment Law 7 . both in the restricted and the prohibited sectors of the negative list that is yet to be issued. real estate and financial sectors) and the number of VIE structures listed on overseas stock exchanges. Important clarifications to the Draft New Law are also awaited on whether any grace period applies within which existing VIE investments must be made compliant. is to be welcomed. the Draft New Law clearly indicates the desire of the Chinese government to regulate and monitor a wide range of investments. MOC proposed and solicited public opinion on at least three possible means of regulating existing VIE investments: (i) reporting – the structure being permitted to continue following notification to MOC of the VIE investment being actually controlled by a domestic investor. it is already apparent that the Draft New Law will have a significant impact on foreign investment regulation in China. media. Though only a first draft for public consultation has been released.the structure being permitted to continue following the approval of MOC. by MOC of the VIE investment being actually controlled by a domestic investor. The general intent of the Draft New Law in standardising market entry requirements and procedures for foreign and domestic investors. and consolidating and simplifying the various regulatory requirements on foreign investment. on the application of the foreign investor. In the notes accompanying the release of the Draft New Law. as well as any special requirements that will apply to foreign-controlled (as opposed to Chinese-controlled) existing VIE investments. education. indicating the wish of the authorities to tread carefully given the widespread use of VIE structures in the Chinese economy (for example. which under the current rules do not specifically fall within its jurisdiction. At the same time. Existing VIE investment: the Draft New Law is silent on the treatment of VIE investments which have completed before its coming into effect.the structure being permitted to continue following confirmation. in the internet. and (iii) approval . com Linklaters LLP Shanghai Office 29th Floor Mirae Asset Tower 166 Lu Jia Zui Ring Road Shanghai 200120 People's Republic of China Telephone +86 21 2891 1888 Facsimile +86 21 2891 1818 Linklaters LLP Beijing Office 25th Floor China World Office 1 No.com Betty Yap Partner (+852) 2842 4896 betty. please let us know by emailing us at marketing. or contact the editors. This information is available to our offices worldwide and to those of our associated firms. © Linklaters LLP. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. 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