In brief, the current reform of China's foreign investment administrative system is significantly good news to foreign investors, especially to those who make investment outside the Negative List.
On 3 September 2016, China's Standing Committee of the National People's Congress approved the Resolution of Amending Four Laws, including the Law of the People's Republic of China on Wholly Foreign-Owned Enterprises, which provides that the establishment and changes of the foreign-invested enterprises ("FIE") that do not fall under special market entry administrative measures shall be subject to record-filing administration, rather than approval administration. On 8 October 2016, Ministry of Commerce and National Development and Reform Commission jointly issued the No. 22 Announcement ("No. 22 Announcement") further clarifying that the scope of special market entry administrative measures for FIEs shall be defined in accordance with the restricted sectors, the prohibited sectors and some industries in the encouraged sectors which have equity requirement or senior manager requirement, as set forth in the Catalogue of Industries for Guiding Foreign Investment (2015 Revision).[1] On the same day, Ministry of Commerce officially issued the Interim Measures on Administration of Record-filing for the Establishment and Change of Foreign-Invested Enterprises ("Interim Measures"), which further details relevant record-filing procedures, requirements, supervisions and legal liabilities. In addition, on 30 September 2016, the State Administration of Industry and Commerce ("SAIC") issued Circular on Effectively Implementing the Registration Procedures After the Implementation of the Record-filing Administration for Foreign-invested Enterprises ("Circular 189") to guide the registration procedures for FIEs and the transition from approval administration to record-filing administration. Therefore, the implementing rules for this legal reform are well in place, and the "Negative List Model" of foreign investment administrative system previously tested in the Pilot Free Trade Zones is now officially applied nationwide. Following is an overview of the key points of these newly released implementing rules.
1. Applicable Scope of Record-filing
No. 22 Announcement states that the scope of special market entry administrative measures for FIEs shall be defined in accordance with the restricted sectors, the prohibited sectors and some industries in the encouraged sectors that have equity requirement or senior manager requirement, as set forth in the Catalogue of Industries for Guiding Foreign Investment (2015 Revision). In other words, the aforesaid industries belong to the negative list for foreign investment administration ("Negative List"). Foreign investment projects falling within the scope of Negative List shall still require approval from the relevant bureau of commerce ("BOC").[2] Foreign investment projects that fall outside the scope of the Negative List shall be subject only to the record-filling requirement set forth in the Interim Measures, and they do not need approval from BOC. However, one point needs to be clarified, which is that the reform of the current foreign investment administrative system refers only to the approval authority of BOC, and it will not affect other approvals that are required by other government authorities, such as the approvals for project setup, environmental impact assessment, zoning, design and construction of the project.
In addition, No. 22 Announcement points out that the establishment and change of FIEs due to M&A need to comply with the existing laws and regulations. In other words, transactions involving foreign investors' acquisition of Chinese domestic enterprises, whether they are conducted through assets acquisition to set up new FIEs or through equity acquisition to transfer the domestic enterprises into FIEs, should still be subject to BOC approval and other governmental approval as set forth in existing regulations, such as the Provisions on Acquisition of Domestic Enterprises by Foreign Investors and the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors, regardless of whether or not the target enterprises or assets fall within the scope of the Negative List. As for the FIEs established through acquisition, if their businesses do not fall within the Negative List, when there are changes of business after the establishment, theoretically speaking, they need only do record-filing for such changes, rather than obtain the BOC approval.[3]
Finally, in a long People's Republic of China legislative tradition, foreign investment as referred to in current legal reform shall apply to investment from Hong Kong, Macao and Taiwan and also to domestic investment made by foreign-invested enterprises with an investment nature (e.g., investment companies and venture capital enterprises).
2. Record-filing Requirements and Procedures
The record-filing mentioned in the Interim Measures is a kind of informative record-filing, which is substantially different from the former approval system of foreign investment. That is, record-filing with BOC is not a pre-condition for FIEs to go through other governmental procedures. However, under the former approval regime, without approval from BOC, it would be impossible to establish an FIE (even a small and simple one) or to make any material changes to its businesses.
According to the new provisions of the Interim Measures, for FIEs that fall outside the Negative List, they can finish the record-filing with BOC through online application, whether the purpose is to establish new enterprises or to make changes to existing enterprises (i.e., the changes of registered capital, equity ratio, scope of business, and merger, division and termination). The record-filing of newly established enterprises can be completed before the issuance of a business license (but after pre-approval of the FIE's name) or can be completed within 30 days after the issuance of a business license. The record-filing of the changes to FIEs needs to be completed within 30 days after the change occurs. The required materials that need to be submitted for record-filing are much more simple and concise; FIEs need to provide only record-filing forms, identification proofs, undertakings for information truthfulness, etc. Compared with former approval regime, FIEs no longer need to submit to BOC the commercial transaction documents, such as joint venture contracts, articles of association and equity transfer agreements. This will significantly increase the autonomy of the transaction parties and substantially eliminate the impact of BOC to relevant commercial arrangements (but it is important to note that foreign-related acquisition still needs to be approved by BOC). BOC will merely review the formality of the submitted documents, mainly to identify whether the industry of the FIE falls within the scope of the Negative List. To the FIEs that passed formality review, BOC will issue a "Record-filing Acknowledgement." The former Approval Certificate of Foreign-Invested Enterprises will no longer apply to the enterprises eligible for record-filing.
3. Supervision of Record-filing and Penalties
BOC will supervise record-filing by conducting random inspection, inspection according to whistle-blower and inspection launched ex officio. To the FIEs that did not perform record-filing obligations as scheduled, or provided false information during record-filing or utilized record-filing to evade approval requirement, BOC will record these enterprises in the enterprise integrity system and disclose them publicly. Concurrently, a fine of up to RMB 30,000 may be imposed on these enterprises.
4. The Link-up Registration by the Administration of Industry and Commerce ("AIC")
AICs are traditionally the competent authority of registration to various enterprises (including FIEs). However, the former registration of FIEs by AIC is subordinate to the approval process by BOC. Actually, the current reform of foreign investment administration is more or less to shift the foreign investment administrative center from BOC to AIC. Circular 189 is a reflection of this trend.
Circular 189 first clarifies the registration jurisdiction of AICs at various levels under the new situation; at the same time, it points out that foreign investors who invest outside the Negative List may apply directly to AIC for entity formation, changes and de-registration. There is no need for them to submit the Record-filing Acknowledgement issued by BOC. Where foreign investors invest within the Negative List, they still need to submit the approvals and approval certificates issued by BOC for AIC registration purposes. It is noteworthy that, unlike the Interim Measures, Circular 189 did not simplify or reduce the requirements or materials for AIC registration. This means that it is possible for AIC to require FIEs to submit commercial transaction documents, such as articles of association and equity transfer agreements, for AIC registration, and they may even require specific modifications to these documents.[4]
In brief, the current reform of China's foreign investment administrative system is significantly good news to foreign investors, especially to those who make investment outside the Negative List. The record-filing system created by this reform substantially reduces or even eliminates BOC's power/discretion to review commercial transaction terms, which will likely provide foreign investors with more space, freedom and discretion to make their own commercial judgment. This reform will significantly benefit China in terms of attracting and retaining foreign investment, and it also sends a signal to the world that China will continue its reform and open-door policy.
For Further Information
If you have any questions about this Alert, please contact Justin J.X. Cai, any of the attorneys in the Duane Morris & Selvam LLP Shanghai office or the attorney in the firm with whom you are regularly in contact.
Notes
[1] However, the establishment and change of foreign-invested enterprises due to M&A still needs to comply with the existing approval system—that is, it still needs to be approved by Bureau of Commerce.
[2] Foreign investors cannot invest industries in prohibited catalogue.
[3] Theoretically, this may provide flexibilities for the design of M&A structure. The parties may consider carving out key business arrangements, which may cause challenges for BOC approval, leaving them to be settled after the acquisition was approved. After BOC approval of the acquisition, the record-filing system may apply to any further changes to the target company (as long as it is not within the Negative List), and this will make it much easier for the parties to arrange commercial terms because the record-filing system does not require BOC approval. However, this interpretation needs to be tested in M&A practices.
[4] Generally speaking, AIC will not propose material changes to commercial transaction documents.
