The Ministry of Commerce of China issued a draft Foreign Investment Law earlier in a significant move to reduce barriers to foreign investment through streamlining the current regulatory framework and replacing three existing laws, namely the Sino Foreign Equity Joint Venture Law, the Wholly Foreign owned Enterprise Law and the Sino-Foreign Contractual Joint Venture Law.
The principle of national treatment, the narrowed focus on investment actually controlled by non-Chinese persons, the emphasis on openness and transparency, the consolidation of rules relating to foreign investment, and the convergence of organizational and governance arrangements for foreign-invested and domestic enterprises are all positive developments.
When the new law comes into effect, foreign companies will be treated – more or less – in the same legal manner as other domestic companies in the country. However, there are a number of areas in the draft law needing further modifications and clarifications in order to design a thorough and comprehensive modernization of China’s foreign investment regime.
There are many provisions of the draft law that raise important concerns in relation to the rule of law, and there are fundamental uncertainties about the scope of “foreign investment” governed by the new rules, particularly flowing from the broad and vague concept of “control.”
In this regard, the vague and undefined concepts of “material influence” and “decisive influence,” for instance, are particularly troublesome. The definition of “decisive influence” should be clarified explicitly to exclude the kind of “negative controls” or minority investor approval rights, including those relating to financing and fundamental operational matters, that are typically negotiated to protect minority investors (as well as lenders and commercial counterparties) against controlling investors using their power to change the agreed parameters of an investment project.
The provisions regarding national security review covering all foreign investment are also extremely broad and vague, and are based on the very expansive concept of “national security.” There are no standards nor criteria, and no avenues for review, that satisfy the standards for rule of law in application of the national security review, particularly given the comprehensive scope of “national security” as conceived in the draft law.
In addition, it puts unfair requirements and potential liabilities on foreign investors with respect to application for and reporting related to national security review. Given the universal scope of factors that are defined as relevant to “national security,” it would be impossible for foreign investors in many circumstances to know whether application for national security review is required or not.
The draft law is a somewhat radical departure from previous regulation of foreign investment in the PRC, in that it would cause transactions occurring outside of China to trigger approval and reporting requirements in the PRC, with effects for China or international markets that may not have been fully taken into account.
The filing and reporting requirements based on nationality of ultimate owners of offshore enterprises may simply be unworkable for companies traded in fluid global markets where beneficial ownership reporting requirements do not provide the kind of information that would be necessary to ensure compliance with provisions of the draft law.
While it seems to reflect a policy to encourage greater competition, there are aspects of the draft law that are fundamentally anti-competitive because of the possibility of a broad and undefined range of limitations that can be placed on approved foreign investment operations, affording little room for protection against these being used to give competitive advantage to domestic enterprises.
Fair competition requires protection of proprietary information, including not just “trade secrets” and other intellectual property but also proprietary strategic, financial and other information concerning a business enterprise. The reporting requirements do not provide adequate assurances of the confidentiality of such information. More importantly, the national security review provisions can potentially be used without any accountability to protect the interests of competitors.
The draft law, in short, raises many issues regarding certainty and predictability in its current form – issues that can translate into pricing discounts, at best, and capital flight, at worst, in international capital markets. They harm both the ability of Chinese enterprises to raise capital and the ability of Chinese investors to realize the value of what they have created. China’s interests will be best served by giving full consideration to a wide range of experiences and perspectives in refining and improving the draft law.