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Legal Update
Corporate & Securities
Mainland China
28 January 2015
Draft Foreign Investment Law: Fundamental Changes to Foreign
Investment Regime in China
On 19 January 2015, the Ministry of Commerce of
China (“MOFCOM”) released a draft version of the
Foreign Investment Law (中华人民共和国外国投资法
（草案征求意见稿）) (“Draft Foreign Investment
Law”) for public comments. The deadline to submit
comments is 17 February 2015.
The Draft Foreign Investment Law will replace the
three existing foreign investment laws – Sino-Foreign
Equity Joint Venture Law (“EJV Law”), SinoForeign Cooperative Joint Venture Law (“CJV Law”)
and Wholly Foreign-Owned Enterprises Law
(“WFOE Law”). It will significantly change the
existing regime of foreign investment and become the
basic law regulating all foreign investment activities
in China.
Highlights of Changes
SCOPE OF “FOREIGN INVESTORS” AND “FOREIGN
INVESTMENT”
Foreign Investors
One major reform introduced by the Draft Foreign
Investment Law is that foreign investment will no
longer be differentiated and regulated by the form of
organisation such as Sino-foreign equity joint venture
(“EJV”), Sino-foreign cooperative joint venture
(“CJV”) and wholly foreign-owned enterprises
(“WFOE”), which will cease to exist as a specific
form of business vehicle. Instead, the concept of
“actual control” has been introduced. Under the
Draft Foreign Investment Law, foreign investors
(“Foreign Investors”) not only include non-Chinese
individuals, enterprises incorporated under foreign
laws, foreign government bodies and international
organisations, but also any entity which is under the
actual control by these foreign investors. In other
words, a Chinese subsidiary controlled by a Foreign
Investor (such as what is currently known as a
WFOE) will itself be treated as a foreign investor.
Given this approach of “actual control”, investments
by Chinese companies in industries restricted to
foreign investment by using an offshore structure (for
instance, internet companies listed in the US) will
potentially become legitimate. Equally, going
forward, foreign investment using a Variable Interest
Entity (“VIE”) structure attempting to circumvent
any restriction on foreign shareholding will be
expressly prohibited. Please see further below the
section on “Impact on VIE Structure”.
Foreign Investment
A broad scope of foreign investment activities are
now subject to the regulation of the Draft Foreign
Investment Law (“Foreign Investment”). These do
not only include (i) green-field investment and (ii)
merger and acquisition, but also (iii) provision of
long-term financing (with a term of more than one
year) by a Foreign Investor to its subsidiaries in
China, (iv) obtaining licence to explore natural
resources or operate/construct infrastructure project;
(v) acquisition of real property; (vi) controlling, or
holding interest of, a domestic entity, by way of
contractual or trust arrangements (such as VIE); and
(vii) offshore transaction which results in actual
control of a domestic company being transferred to a
Foreign Investor.
NEGATIVE LIST APPROACH
Another major change introduced by the Draft
Foreign Investment Law is the adoption of a
“negative list” approach in respect of foreign
investment approval, similar to the model adopted by
the China (Shanghai) Pilot Free Trade Zone.
Existing regulations require all foreign investors who
intend to set up or acquire a company in China to
first obtain approval from MOFCOM or its local
branch before business registration can be made with
the relevant Administration of Industry and
Commerce (“AIC”). The Draft Foreign Investment
Law fundamentally changes this requirement by
limiting foreign investment approval to only those
investments listed on a negative list (“Negative List”)
to be released by the State Council. The Negative List
will set out industry sectors in which Foreign
Investment is restricted as well as investment
thresholds for Foreign Investment. Foreign
Investment outside the Negative List will be offered
national treatment and may register with AIC
directly. An information reporting procedure is
required for all Foreign Investment (please refer to
the “Information Reporting System” section below)
but this may be completed after the AIC registration.
Furthermore, any enterprise with foreign investment
must file an annual report to MOFCOM disclosing
various operation information. For an enterprise
with large business scale (total assets, sales income or
revenues exceeding RMB 10 billion per annum in
China, or having more than 10 subsidiaries in China)
which is controlled by foreign shareholders, an
additional obligation to report information on a
quarterly basis is also in place. However, it is not
entirely clear whether the above threshold for
quarterly reporting obligation is calculated on a
group basis.
While the Negative List is yet to be published, it is
generally expected that most foreign investment
projects will no longer require pre-approval by
MOFCOM when the Draft Foreign Investment Law
comes into place. This will reduce the time line
required for foreign investment projects and offer
parties greater flexibility in structuring their
investment as relevant contracts (such as joint
venture contracts and equity transfer agreements)
will no longer require MOFCOM approval.
Compared with the existing regulations, the Draft
Foreign Investment Law expands the scope of
matters that are subject to national security review.
Any Foreign Investment that damages or may
potentially damage national security is subject to a
unified national security review regime, regardless of
industry sector or whether it is controlled by a
Foreign Investor. This is a very broad coverage, and
even though the Draft Foreign Investment Law
highlights a number of areas that are subject to
particular review attention (such as national defence,
key infrastructure and key natural resources), this
expanded regime still raise much uncertainty to
foreign investors. Guidelines on national security
review will be promulgated separately, which
hopefully may provide more detailed clarifications.
INFORMATION REPORTING SYSTEM
Under the Draft Foreign Investment Law, Foreign
Investors and their subsidiaries in China are required
to fulfil a number of reporting obligations via an
online reporting system to be set up by MOFCOM.
An initial information report is required for any
Foreign Investment, which should be completed
either before the implementation of or within 30 days
after the implementation of the transaction (which is
the business registration date if the transaction
requires registration, or the closing date if the
transaction does not require registration).
Information to be disclosed in the report includes,
among others, basic information of the Foreign
Investor (including its actual controlling shareholder)
and its subsidiary, and information on the investment
(including sources of investment). Joint venture
contracts and articles of association are not required
to be submitted for this purpose.
An updated information report must be submitted
within 30 days after any change to the matters stated
in the initial investment report occurs.
NATIONAL SECURITY REVIEW
It is also worth noting that Foreign Investors may not
withdraw their applications of national security
review without MOFCOM’s prior consent, and
administrative reconsideration and administrative
litigation are not available for any decision of
national security review.
IMPACT ON EXISTING FIEs
The Draft Foreign Investment Law will no longer
regulate corporate governance issues for enterprises
with foreign investment; instead, they should follow
the same requirements as domestic enterprises under
the Company Law, the Partnership Law and the Law
on Individual Proprietorship Enterprises etc. The
Draft Foreign Investment Law gives existing EJVs,
CJVs and WFOEs (“FIEs”) a three-year transitional
period to conform with these laws. The following are
some of the potential changes to existing joint
venture contracts and articles of association:
2 Mayer Brown JSM | Draft Foreign Investment Law: Fundamental Changes to Foreign Investment Regime in China
• changing the highest authority of an EJV from the
board of directors to the shareholders’ meeting
according to the Company Law;
• changing the legal status of an unincorporated
CJV to either a limited liability company or
a foreign-invested partnership; the highest
authority of a CJV should no longer be the board
of directors or the joint management committee,
it should either be changed to the shareholders’
meeting according to the Company Law or follow
the provisions in the Partnership Law;
• changing the profit distribution ratio of an EJV
since profit sharing among shareholders is not
required to be proportionate to equity ratio under
the Company Law; and
• amending the pre-emptive right requirement so
that selling shareholders of an EJV or a CJV will
only need to obtain consents from more than half
of the non-selling shareholders (rather than all
the non-selling shareholders according to the EJV
Law or CJV Law). This is particularly favourable
to the selling shareholders of an EJV or a CJV
which has multiple partners.
IMPACT ON VIE STRUCTURE
The Draft Foreign Investment Law expressly makes
VIE structure subject to the same regulatory regime
of Foreign Investment.
At present, VIE structure falls within a “grey” area
and is often used by foreign investors to invest in
Chinese entities that are restricted to foreign
investment. It is a critical question on how to deal
with these existing VIEs. The explanatory note that
accompanies the Draft Foreign Investment Law
(“Explanatory Note”) introduces three options for
public comments:
• Option 1: to grandfather any existing VIE that
files a record with MOFCOM to confirm that
its actual controlling shareholders are Chinese
investors;
• Option 2: to grandfather any existing VIE
that applies to and obtains approval from
MOFCOM confirming that its actual controlling
shareholders are Chinese investors; or
• Option 3: MOFCOM to decide and approve on a
case-by-case basis whether to grandfather any
existing VIE upon its application.
Among these three options, Option 1 should have the
least effect on existing VIE structures since it only
requires a filing with MOFCOM, while Option 3
gives MOFCOM a huge discretion on whether an
existing VIE structure shall be continued. However,
these options are intended to legitimise VIE
structures with Chinese controlling interest and do
not assist “actual” foreign investors who have adopted
the VIE structures to avoid restrictions on foreign
shareholding in Chinese companies.
Questions to be Answered
There is no doubt that the Draft Foreign Investment
Law will, when promulgated, bring fundamental
changes to the foreign investment regulatory regime
in China. While the Draft Foreign Investment Law is
seen as a very positive sign of Chinese government’s
determination to relax restrictions on foreign
investment, some questions remain unanswered and
need to be clarified.
RELATIONSHIP WITH EXISTING INVESTMENT
CATALOGUES
Currently, the Catalogue of Industries for Guiding
Foreign Investment (“Foreign Investment
Catalogue”), jointly published by MOFCOM and
NDRC is the key legal investment guide on industry
sectors to foreign investors. With the adoption of the
Negative List approach by the Draft Foreign
Investment Law, whether foreign investment is
subject to MOFCOM’s approval and at which level
will depend on the industry sectors and thresholds
set out in the Negative List. Logically, the Negative
List should replace the Foreign Investment
Catalogue. The NDRC (and MOFCOM) published a
revised draft of the Foreign Investment Catalogue for
comments in November 2014. It remains to be seen
whether the Negative List will be a mere copy of the
restricted and prohibited sectors in the Foreign
Investment Catalogue or whether it will further relax
the current restrictions. The status of the State
Council’s Catalogue of Investment Projects subject to
Government’s Verification, which also applies to
foreign investment, also needs to be clarified.
TOTAL INVESTMENT AND REGISTERED CAPITAL
The long-existing concepts of total investment and
registered capital are unique mechanism of FIEs. As
the difference between the total investment and
registered capital represents the foreign loan quota of
FIEs, the mandatory ratio between the two restricts
the FIE’s ability to get foreign financing. Whether
such financing quota still applies to enterprises with
3 Mayer Brown JSM | Draft Foreign Investment Law: Fundamental Changes to Foreign Investment Regime in China
foreign investment after the Draft Foreign
Investment Law enters into effect remains
unanswered in the draft law. If it applies, whether
short-term foreign shareholders’ loans (with a term of
one year or less) will be subject to such quota is also
unclear.
quarterly reporting is in place. The burden incurred
by these multiple layers of disclosure obligations is
considerable. Further, the information to be disclosed
to MOFCOM overlaps to a great extent with what is
required by AIC under its annual reporting system. If
the two systems are not on an integrated platform, it
will create extra administrative burden for investors.
INTERACTION WITH OTHER FOREIGN INVESTMENT
REGULATIONS
While the Explanatory Note made it clear that the
Draft Foreign Investment Law will repeal the EJV
Law, CJV Law and WFOE Law, it did not clarify how
the Draft Foreign Investment Law may interact with
other foreign investment regulations, in particular
the Provisions on the Merger and Acquisition of
Domestic Enterprises by Foreign Investors (“M&A
Regulations”) and various regulations by the State
Administration for Foreign Exchange.
For foreign acquisition currently subject to the M&A
Regulations, although the relevant approval regime
will be overhauled by the Draft Foreign Investment
Law, whether other regulatory restrictions in the
M&A Regulations, such as the three-month payment
deadline and MOFCOM’s approval on round-trip
investment, will be retained is a question for the
legislators to clarify.
REPORTING OBLIGATIONS
Contact Us
For inquiries related to this Legal Update, please
contact the following persons or your usual contacts
at our firm.
Betty Tam
Partner
T: +86 21 6032 0277
E: [email protected]
Xiangyang Ge
Partner
T: +86 10 6599 9327
E: [email protected]
Ping Liu
Counsel
T: +86 10 6599 9333
E: [email protected]
The Draft Foreign Investment Law establishes a
comprehensive information disclosure mechanism
for Foreign Investors and their subsidiaries in China,
ranging from the initial report, the updated report to
the annual report, and for large enterprises
controlled by Foreign Investors, an additional
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