PRC inbound and outbound investment regulatory highlights

This note provides a summary and analysis of key inbound and outbound legal and regulatory developments in China.

Background
The third plenum of the 18th Chinese Communist Party Central Committee (CCPCC), held in November 2013, culminated in the release of a high-level strategy paper that laid out the Chinese Communist Party’s (CCP) ambitious pledge to transform the role of government so as to reduce the hand of the state in the economy.
 
From a law-making and regulatory perspective, observers witnessed an energetic 2014, with National People’s Congress legislators and government agencies promulgating a series of pro-business laws and regulations aimed at liberalising the existing regulatory regime and cutting red tape for market participants.
 
1. Draft foreign investment law
If enacted, the draft foreign investment law (FIL), released by MOFCOM on January 19, 2015, will gradually replace the sino-foreign equity joint venture enterprise law, the sino-foreign cooperative joint venture enterprise law and the wholly foreign-invested enterprise law that historically have set the parameters of foreign investment regulation in China. The FIL, once promulgated, will significantly reshape the entire Chinese regulatory landscape for foreign investors.
 
In the 11 chapters (170 articles) of the draft FIL, some select highlights include:
• A control-based definition of foreign investor and foreign investment which will likely cause the FIL to have an extraterritorial effect and capture offshore transactions that will result in the transfer of de facto control of onshore entities to foreign investors.
• Easier market access for foreign investors with a limited entry clearance system for select industries on the ‘negative list’, coupled with an information reporting system that is more in alignment with international practice.
• Elaboration on the treatment of variable interest entities (VIEs) adopted after promulgation of the FIL.
 
While the draft FIL has received significant third party analysis since its release, it should be pointed out that there is still a long way to go before the FIL is finalised and passed into law by the standing committee of the NPC (SCNPC). This process could take a year, perhaps even longer, given the lengthy internal procedures that must be completed before the draft FIL can be submitted to the SCNPC for its formal review and deliberation. It is also highly possible that the final version of the FIL will differ in a number of key areas from the current draft which has not been vetted by other key agencies such as the National Development and Reform Commission and State Administration of Foreign Exchange (SAFE).

In particular, the provisions relating to VIE structures will certainly need further revisions as the current draft intentionally left unaddressed how existing VIE arrangements should be treated. MOFCOM explicitly acknowledged in the draft explanation notes that VIE related provisions will need to be finalised after further analysis and consultation with various stakeholders.

Foreign exchange
There have been a number of material moves on the foreign exchange control front, represented by the issuance of new foreign exchange rules. These are outlined in the SAFE’s Circulars 29, 36 and 37.
• Circular 29 outlines the new rules on the Foreign Exchange Administration of cross-border guarantees promulgated by SAFE in May 2014.
• Issued by SAFE on July 15, 2014, Circular 36 allows foreign invested enterprises (FIEs) located within several dozen pilot zones to convert foreign equity capital (in any amount and at any time) without waiting until the need for payment in renminbi actually arises from genuine underlying transactions. The renminbi that is converted will then be transferred to a designated renminbi account and withdrawal of funds from such renminbi account is still on an as-needed basis. It is expected that measures in Circular 36 may soon be extended to more areas outside of the pilot zones and eventually be implemented nationwide.
• Circular 37 replaces outdated rules regarding offshore special purpose vehicles (SPVs) established by Chinese citizens for fundraising and other specialised investment purposes. Under Circular 37, funding sources for SPVs have been expanded from domestic business to cash held onshore and funds and assets lawfully held offshore by Chinese citizens. A natural inference from such expansion is that ownership of an existing business in China is no longer the prerequisite for a Chinese individual to successfully complete the required SAFE registration of the SPV (though recent practices seem to suggest that this requirement is still being enforced by SAFE).

Investment project approvals
On October 31, 2014, the state council published the 2014 version of the Catalogue of Investment Projects Requiring Government Approval (Catalogue)—the most important legal basis for the government to impose government approval requirements on various investment projects. Compared to the 2013 version and the 2004 version, the latest Catalogue has substantially reduced the number of projects subject to approval, increased the monetary threshold triggering approval requirements and delegated greater approval authority to provincial and municipal governments.

Conclusion
Of all the developments, the draftFIL is the most significant for foreign investors. While other developments are encouraging, they are of a procedural nature and still take place within the existing parameters of the foreign investment regime. The draft FIL, on the other hand, aims to completely redraw the framework of foreign investment into China.

Post enactment of the FIL, foreign investors are expected to have more flexibility in negotiating the terms of their investment. This simplified process is more in line with practices in developed economies and is seen as a major stepping stone to making China more investor friendly.

However, the draft FIL should not be looked at in isolation, but rather should be read in the context of shifting policy cycles and macro-economic promulgations. Creating a more friendly business environment is one of the key pledges made by Premier Li Keqiang, who has stressed that the government will “unswervingly” support and encourage the private sector during the opening meeting of the third session of China’s 12th National People’s Congress. The regulatory developments are testament to the government’s effort to deliver on Premier Li’s pledge.

Moving forward, more reforms can be expected not only targeting foreign investors, but also extending to private investors and entrepreneurs. While it is possible to move capital into or out of the country, the process is still relatively onerous and foreign investors very often found their capital utilisation plan (formulated at the parent level) difficult to implement in China due to various restrictions in relation to foreign exchange. It will undoubtedly be well received by international investors if capital controls could be further relaxed, liberalised and streamlined in a manner closer to international best practice.