China has begun the process of revamping its legal regime for foreign investment. On January 19, 2015, the Ministry of Commerce (“MOFCOM”), the ministry charged with regulating foreign investment in China, issued a new draft Foreign Investment Law (the “Draft Law”), representing China’s attempt to unify the governance of foreign and domestic private investment. Comments on the Draft Law are due back to MOFCOM by February 17th, though we understand from informal conversations with MOFCOM officials that actual promulgation of the law is likely at least two years away. MOFCOM’s early outreach for comments is being viewed positively by the foreign business community in China. 

Here, we present a series of blog posts on the Draft Law. From today into next week, we will post analysis and commentary on a number of its key features (see below for list of topics).

Foreign investment in China has long been closely monitored and controlled by the Chinese government, with all foreign investment required to undergo a government approval process that can often be onerous and opaque. The review of foreign investment is usually more rigorous and time consuming than that required for domestic investment. For example, the documents used to establish a foreign invested enterprise (“FIE”) must undergo substantive review by MOFCOM — a requirement not imposed on most domestic investment projects — with terms agreed by all parties not always given deference by the authorities.

The process is complicated further by the fact that foreign investment is governed by a fragmented and sometimes conflicting set of laws and regulations enacted over a period of decades. Currently, three core foreign investment laws — governing wholly foreign-owned enterprises (“WFOEs”), equity joint ventures, and cooperative joint ventures, respectively — together with China’s Company Law, which applies to all enterprises in the country, govern foreign investment in China. The ad hoc development of China’s foreign investment law has resulted in inconsistencies between regulations governing FIEs and China’s developing body of corporate law, sometimes confusing investors and even local government officials.

In recognition of these difficulties, and also considering global trends in investment liberalization and bilateral negotiations currently underway with both the United States and the EU, China’s leadership proposed a revamp of the current investment regime during the November 2013 Third Plenary Session of the 18th Central Committee of the Communist Party of China (the “Third Plenum”). In particular, it made three key proposals related to China’s foreign investment regime:  

• First, it called for applying the principle of national treatment more broadly to foreign investment. Under the national treatment principle, foreign investment would be treated the same as domestic investment, and exceptions to equal treatment would be carved out and listed in a “negative list.” With national treatment, review by MOFCOM (or another designated body) would become the exception, rather than the rule, for entry into the Chinese market.

• Second, the Third Plenum proposed to unify the domestic and foreign investment regime. Thus, FIEs, which are currently governed by a set of core foreign investment laws as well as the Company Law (and consequently subject to two systems of corporate governance), would fall under the governance of a single body of corporate law.

• Third, the Third Plenum proposed the creation of a National Security Council and the strengthening of national security review in order to address threats to the state, both within and outside of China.

The draft Foreign Investment Law adopts these three proposals from the Third Plenum and sets forth three systems in order to implement them: (1) a market entry review system, applicable to foreign investments captured by the negative list; (2) an information reporting system, applicable to all foreign investments (whether or not captured by the negative list), which ostensibly places additional reporting burdens on FIEs; and (3) a national security review system, applicable to any foreign investment that jeopardizes or threatens to  jeopardize China’s national security. In addition, the Draft Law includes an expansive definition of foreign investment that would be subject to regulation under this new investment regime.

During this series, we will post discussions of the following topics:

(1) Comparison of the Draft Law with the existing investment regime;

(2) Analysis of the Draft Law’s new market entry requirements and penalties;

(3) Review of the expanded definition of foreign investment and additional reporting obligations for foreign investors;

(4) Analysis of the impact of the Draft Law on “VIE” (variable-interest entity) structures, which are commonly used by China’s internet companies that have listed on overseas exchanges; and

(5) Overview of the expansion and solidification of the national security review process.

We look forward to expanding on these topics and hearing your comments.

Material for this post was supplied by Ashwin Kaja and Shirleen Hong of Covington & Burling LLP, with contributions from Mark Chu.