In the past four decades, China has been slowly opening to foreign direct investment (FDI). More recently, the country increased the range of activities open to sole foreign investment without the need for a local partner. Along the way, China has developed a robust legal and regulatory framework particular to foreign investment.
There are four categories of FDI in China: encouraged, permitted, restricted, and prohibited. Two separate regimes regulate it: the foreign investment regime, valid for all foreign investment activities carried out directly or indirectly by foreigners in China, and the national security review regime, which applies only to foreign investment that raises security concerns.
China’s first Foreign Investment Law (FIL) came into effect on January 1, 2020, and establishes the core principles for the promotion, protection, and market access of foreign investment.
One key aspect of the FIL is that it promises foreign enterprises "national treatment", on a par with domestic enterprises, for permitted investments. However, the FIL does not provide national treatment with respect to market access. FDI is still prohibited and restricted in several of areas, which can be found in the so-called ‘Negative List’.
Chinese authorities use the Negative List to limit and control foreign investment in specific areas, where FDI is completely prohibited or is permitted, but subject to certain restrictions (such as foreign ownership limits).
On the other hand, foreign investment is welcomed in other sectors, listed in the Catalogue of Encouraged Industries for Foreign Investment (the Encouraged Industries Catalogue). This document includes activities that the government wishes to promote (and for which various incentives are offered), with separate categories nationally or in less developed Central-Western areas.
Both the Catalogue and the Negative List are updated once a year by the Ministry of Commerce (MOFCOM) and the National Development and Reform Commission (NDRC). Foreign investments in sectors not listed in either the Negative List or the catalogue are considered permitted.
In addition to the national Negative List, foreign investors should investigate the Negative List particular to the Free Trade Zones (FTZ), with a narrower range of prohibited and restricted activities. Currently, China has 21 FTZ in operation.
The principal organisms governing foreign investment activities in China are MOFCOM, NDRC and the State Administration for Market Regulation (SAMR). Previously, any foreign investment that fell within the restricted sector category needed to be approved by MOFCOM before registering with SAMR or its local branches.
Since the FIL came into effect, the prior approval of MOFCOM is no longer needed. Instead, as part of the corporate registration process, SAMR or its local branches will review the information provided by foreign investors or foreign invested enterprises (FIEs), or both, to verify if the investment does not violate the restrictions of the Negative List.
In addition, foreign investments that involve fixed-asset projects may require the approval of the NDRC or its local branches in certain circumstances.
Besides the restrictions that fall under the Negative List, FDI will also be subject to a national review if it "affects or may affect national security". The rules do not expressly apply to JVs with Chinese partners, although an analogous informal review may take place in those cases.
The national security review regime was introduced by a circular in 2011 and determined that MOFCOM would lead the reviews in coordination with other government agencies. In 2015, the State Council issued another circular regarding reviews of FDI in Pilot Free Trade Zones (the Free Trade Zone Circular), under which a slightly modified security review regime was created for foreign investment in the Shanghai, Guangdong, Tianjin, and Fujian Pilot Free Trade Zones.
In 2020, the Measures on National Security Review of Foreign Investment (the NSR Measures) were issued jointly by the NDRC and MOFCOM. The document amended the 2011 Circular and the Free Trade Zone Circular and provided more detailed rules to implement the national security review regime.
According to the NSR Measures, effective since January 2021, national security reviews are conducted by a working mechanism led by the NDRC and MOFCOM.
Under the existing review system, the security review applies to acquisitions of all or parts of domestic military industrial enterprises and tertiary enterprises, enterprises located near major and sensitive military facilities, and other entities related to national defense or security.
The review mechanism is also triggered by acquisitions in other national security related sectors such as major agricultural products, major energy and resources, infrastructure, transportation services, key technologies and key equipment manufacturing.
If an acquisition by a foreign investor is likely to trigger national security concerns, the foreign investor should notify MOFCOM of the transaction. Upon receiving a notification, if MOFCOM determines that a national security review is required, it will establish an inter-ministerial panel, run by NDRC and MOFCOM, to conduct the review and issue a decision within 100-120 working days.
Depending on the sensitivity of the transaction, the inter-ministerial panel will conduct a ‘general review’ or ‘special review’. If it determines that the transaction is likely to have a major impact on national security, MOFCOM will require the applicant to either terminate or restructure the transaction, including transferring back equity interests or assets if the acquisition has already been closed.
The foreign investment and national security regimes are stand-alone regimes and not part of the merger control regime.
There are further approval procedures and formalities to take into consideration depending on the individual investment.
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DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.