China’s State Council issues Implementation Regulations for Foreign Investment Law, effective January 1, 2020

Publication January 2020


Introduction

On December 31, 2019, the State Council of the People's Republic of China (PRC or China1) released the Regulations on the Implementation of the Foreign Investment Law (Implementation Regulations) which took effect on January 1, 2020. The Implementation Regulations set out detailed rules for the implementation of the Foreign Investment Law (FIL), which came into effect on the same date. In early November 2019, the Ministry of Justice circulated the draft version of the Implementation Regulations (Draft Regulations) for public consultation. For further information on the Draft Regulations, please refer to our recent publication.

The FIL and the Implementation Regulations (together with various other related regulations and rules) herald a new era of the legal regime governing foreign investments into China. Whilst the overall structure of the Draft Regulations is maintained, various provisions in the draft are amended; the Implementation Regulations introduce a number of alterations not appearing in the Draft Regulations. Here is a summary of some noteworthy changes.

Administration of the Negative List

The Implementation Regulations re-emphasize the basic principles that foreign investors must not invest in any industry which is set out in the Negative List as prohibited for foreign investment, and that foreign investors must comply with the restrictive measures (on foreign shareholding and/or senior management personnel, etc.) when investing in any restricted industry set out in the Negative List. The Implementation Regulations add that the relevant authorities will not process regulatory approval or registration if the foreign investment enters an industry falling within the Negative List, but fails to comply with the applicable restrictive measures set out therein. In addition, the competent regulatory authorities are required to strengthen the supervision and inspection of the enforcement of the Negative List. If a foreign investor is found to have invested in a prohibited industry or violated the restrictive measures in the Negative List, Article 36 of the FIL will apply – this means that the competent Chinese regulatory authority may order the investment activity to stop, or require the relevant shares and/or assets (acquired through the foreign investment) to be disposed of or other necessary measures be taken within a specified time limit; it may also confiscate any illicit income.

Upon the FIL taking effect on January 1, 2020, the laws and regulations specifically applicable to Sino-foreign joint ventures and wholly foreign-owned enterprises ceased to be effective. Likewise, the approval and record filing regime enforced by the Ministry of Commerce (MOFCOM) under those laws came to an end.

Under the new legal regime, a foreign investment project will generally be subject to three major regulatory procedures2 including: (i) approval by the industry-specific regulator (e.g. China Banking and Insurance Regulatory Commission) to the extent applicable, (ii) project approval by, or filing with, the National Development and Reform Commission as applicable, and (iii) registration with the State Administration for Market Regulation (SAMR), in each case including their competent local counterparts. These regulatory authorities are expected to review compliance with the aforementioned requirements in the Negative List by a foreign investment project. However, according to the Notice of SAMR on the Implementation of Foreign Investment Law and the Handling of Registration Work for Foreign-invested Enterprises published on December 31, 2019, the SAMR will not review the foreign investment’s compliance with the restrictive measures if the industry-specific regulator has previously approved the investment prior to the SAMR procedure. This will avoid unnecessary overlap.

We also note that the Implementation Regulations have omitted the provisions in the Draft Regulations dealing with the ways in which foreign shareholding restrictions may apply to foreign-invested partnership. This change addresses and avoids the conflict that may otherwise arise with the provisions in the 2019 version of the Negative List, which provide that setting up a foreign-invested partnership in an area that is subject to shareholding requirements is not permitted.

Exceptions to the Application of Restrictive Measures

The Draft Regulations provide that when a foreign investor is wholly-owned by a Chinese natural person or legal entity (excluding foreign-invested enterprises (FIEs)), investments made by such foreign investor in China will not be subject to the restrictive measures in the Negative List, provided that the approval of the State Council is obtained for such investment. This provision attracted great attention in the market as it indicates an intention by the regulator to look at the ultimate ownership of foreign investors and signals a relaxation in the restrictions on “round-tripping” investments back to China although the thresholds are rather high to meet. However, the Implementation Regulations omitted this provision, which suggests that the regulatory authority has decided not to take this step at present. Whilst leaving the ultimate ownership of foreign investors unaddressed, the regulatory position on VIE structure remains opaque (please refer to our comments on VIE structure in our previous publication.

Establishment of the information reporting system

The FIL provides that the State establishes a foreign investment information reporting system. The Implementation Regulations have fine-tuned the Draft Regulations in this regard and provided that the content, scope, frequency and specific procedures in respect of the foreign investment information reporting will be determined according to the principles of necessity, efficiency and convenience. Further, the Implementation Regulations emphasize that the relevant regulatory authorities shall enhance information sharing and shall not require foreign investors or FIEs to submit information which can be shared among the regulatory authorities. Clearly, this is a very positive step toward promoting efficiency in the administration of foreign investment in China.

On December 30, 2019, MOFCOM and SAMR jointly issued the Measures for Foreign Investment Information Reporting (Reporting Measures) which take effect from January 1, 2020. Under the Reporting Measures, foreign investors or FIEs shall report the requisite investment information based on the principles of authenticity, accuracy and completeness and must not make any false or misleading report or make any material omission; otherwise the relevant foreign investor or FIE may be ordered to rectify it within 20 working days and failure to do so will attract fines ranging from RMB100,000 to RMB500,000, depending on the seriousness of non-compliance.

Foreign investment security review regime

The Implementation Regulations included a provision, which was not initially included in the Draft Regulations. It provides that the State establishes a foreign investment security review regime to conduct security review of foreign investment that affects or may affect national security. This provision reflects the wording in the FIL.

China’s national security review regime was introduced in 2011 and primarily applies to foreign investors’ acquisition of domestic enterprises in various strategically important industries where foreign investors gain de facto control3 (with the exception in several free trade zones where security review may also apply to greenfield investments4). We anticipate that as contemplated in the FIL and the Implementation Regulations, the national security review regime will be expanded to cover all types of foreign investment activities as provided in Article 2 of the FIL (including for instance, acquisitions as well as greenfield investments).

Local governments’ commitments and consequences for breach

The Implementation Regulations reinforce the binding effect of local government policy commitments legally made to, or contracts entered into with, foreign investors and FIEs by local governments. Moreover, the Implementation Regulations provide that the local governments and/or the relevant personnel may be held accountable if they fail to perform the policy commitment or contractual obligations, or if the policy commitment is made beyond the authorized powers of the local government, or if the policy commitment is not in compliance with laws or regulations. Foreseeably, local governments would be more cautious in making policy commitments or subjecting themselves to contractual obligations with foreign investors in the future, due to potential personal liabilities that may be imposed on the relevant officials.

Protection of intellectual property rights (IPRs)

The Draft Regulations provide that China will establish a punitive damages system against intellectual property infringements and an IPR assistance regime to strengthen the protection of the IPRs of foreign investors and FIEs. The Implementation Regulations, however, replaced the references to “punitive damages system” and “intellectual property rights assistance regime” with a more high-level provision that “the State will put more efforts in the penalization of IPR infringement and continuously strengthen the IPR law enforcement.”

Although not explicitly reflected in the Implementation Regulations, China has partly established, and is in the course of developing, a punitive damages system in the intellectual property space5. In addition, China has made some progress in the establishment of IPR protection and assistance regime at different levels6.

Transition Period

The FIL implements a five-year transition period (starting from January 1, 2020) for existing FIEs to convert their corporate governance structure in line with the PRC Company Law. The Draft Regulations further require existing FIEs to complete the conversion within six months from January 1, 2025. The Implementation Regulations have now removed the six-month extension period and provide that local authorities will not process applications made by FIEs for any other company registration matters if they fail to convert their corporate form and governance structure by January 1, 2025.

The Implementation Regulations also provide that after an existing FIE has converted its corporate form and governance structure according to the abovementioned requirements, the provisions in the old joint venture contract on transfer of equity interest/right, allocation of profit and allocation of remaining assets may continue to apply to the parties. This provision reflects the basic position of the PRC Company Law which gives shareholders of a company a great degree of freedom and flexibility to negotiate and agree on the rights and obligations between them unless the subject matter falls within the ambit where a statutory requirement/provision applies.

Investment by FIEs

The Implementation Regulations included a provision that the FIL and the Implementation Regulations apply to the FIEs’ investment in China. Therefore, we anticipate that the current regulations7 governing the FIEs’ further investment in China will be abolished or amended soon.

The commencement of the new era of the legal regime governing foreign investment will require great efforts in further tidying up existing legislation which conflicts with the FIL and the Implementation Regulations. Meanwhile, as the Implementation Regulations lack the level of detail required to address specific issues and questions that may arise from the actual practices, more detailed rules will need to be put in place. The regulatory authorities will also need time to prepare themselves as well as the infrastructure (e.g. the online registration/reporting system) to ensure that local practice starts to operate in compliance with the new legal regime. We understand that not all local authorities are now ready to apply the new regime and the practices in different locations may well vary. Getting legal advice and consulting with the relevant local authority concerned may be even more important than it was in the past, when a foreign investor intends to make an investment in China.

It remains to be seen how this new legal regime will be further supplemented, elaborated and implemented.


Footnotes

1

“PRC” or “China”, solely for the purpose hereof, does not include Hong Kong and Macau Special Administrative Regions and Taiwan.

2

The merger control clearance and national security review may also apply.

3

See Notice of the General Office of the State Council on Launching the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (effective on March 5, 2011) and Provisions of the Ministry of Commerce on the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (effective on September 1, 2011).

4

See the Trial Measures for the National Security Review of Foreign Investment in Pilot Free Trade Zones issued by the General Office of the State Council (effective on May 8, 2015).

5

The PRC Trademark Law (amended version effective on November 1, 2019) contains provisions on punitive damages against trademark infringements (see Article 63). The Amendments to the PRC Patent Law (Draft), which were released in 2018, also contemplate punitive damages. The Opinions on Strengthening the Protection of Intellectual Property Rights, jointly issued by the General Office of the CPC Central Committee and the General Office of the State Council on November 24, 2019, explicitly state that China will “accelerate the introduction of punitive damages system to the areas of patent and copyrights.”

6

The National Intellectual Property Administration issued the Guiding Opinions on Conducting Intellectual Property Rights Protection and Assistance Work (Guiding Opinions) on November 7, 2007, which provide for the target, content and procedures of IPR assistance and the establishment, operation and supervision of IPR assistance centers. Thereafter, certain local regulations have been promulgated based on the Guiding Opinions and assistance centers were set up in a few cities by the local intellectual property administrations.

7

For example, the Interim Provisions on Investment Made by Foreign-Invested Enterprises in China (effective on September 1, 2000).



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