What are the implications of China’s Foreign Investment Law?

The new law is facused on a variety of measures to make investing in China more attractive to foreign enterprises.

China continues to be an important market for foreign investment. According to the 2019 World Investment Report¹ by the United Nations Conference on Trade and Development (UNCTAD), China is the world’s second largest recipient of foreign direct investment (FDI). The Foreign Investment Law² (FIL), which came into force on 1 January 2020, is the government’s latest move to continue opening up the country’s economy and make it more attractive to foreign investors.

A welcome development

Premier Li Keqiang made it clear that the FIL is an important part of China’s stance toward foreign investment: “Opening up is China’s fundamental state policy, it has delivered real benefits to Chinese people and the world… if we make a promise of opening up, we will certainly deliver.”³

The FIL was introduced on the back of China’s reforms in 2018 that lifted restrictions on foreign ownership in sectors such as infrastructure, and it is envisioned to replace the three existing laws governing foreign-invested enterprises: the Law on Sino-Foreign Equity Joint Ventures, the Law on Sino-Foreign Contractual Joint Ventures and the Law on Foreign-Capital Enterprises. These laws, introduced between 1979 and 1999, accompanied the early years of China’s opening up. The FIL has provided an important update on these promulgations.

Seen as a response to the demand among foreign investors for a fairer and more competitive market environment in China, the FIL is attempting to meet such expectation by improving the conditions for investment.

Protecting foreign investors’ rights

The central value of the FIL is the protection of investors’ rights, making China a more attractive target for investment. The highlights of the law in this regard are as follows:

• The FIL abolishes the existing “case-by-case approval” system for foreign investment and establishes a system of national treatment. This means that foreign investors will be treated in a similar way to domestic investors in important areas such as during the initial stages of setting up except in the remaining restricted areas⁴.
• It explicitly protects foreign partners’ intellectual property and commercial secrets, and prohibits government officials from using administrative measures to engage in forced technology transfers⁵. This directly addresses concerns among foreign enterprises about the requirements to disclose excessive numbers of trade secrets to obtain regulatory approvals, thereby risking their secrets being leaked to local competitors.
  
• The FIL allows foreign enterprises, similar to domestic companies, to raise funds via public offering and the issuance of corporate bonds and securities in accordance with applicable laws. Foreign investors may also freely remit profits, capital gains, income from asset sales, and other forms of income – in Renminbi or any foreign currency – into or out of China.
  
• The new law also guards foreign investment from arbitrary expropriation. If it is in the public interest, the government may expropriate the investments of foreign investors. However, the investors will be given “fair and reasonable compensation” in a timely manner.
  

These provisions are a welcome development for foreign enterprises seeking to invest in China. Although the law is vague on some points and will benefit from future clarification, it reinforces China’s basic stance on opening up during a time when the global investment landscape is becoming more restrictive, particularly in developed markets like the US and the EU.

State of FDI in China

Another way to see the potential value of the FIL is to look at the current condition of FDI in China. Since 2011, the growth of China’s FDI has hovered around an average of 3% year-on-year, a far cry from the average 10% year-on-year growth of the previous decade. That is to say, the general trend is stagnation. The FIL could help mitigate this trend by reforming the measures that have generated concerns among foreign investors.

The decreasing share of foreign investment in fixed assets in China might be reversed with the implementation of FIL. In 1996, foreign investment accounted for almost 12% of China’s total fixed asset investment (FAI), dropping to 0.34% in 2017. A reversal could be seen due to the fact that the FIL streamlines the procedures for investment approval and increases the breadth of available investment targets.

The focus of FDI has also changed. In 2007, manufacturing was the primary target of FDI; by 2017, that focus shifted to technology and services of various kinds. While the 2019 “negative lists” reflect a further opening up of previously closed or restricted industries, there are other industries – agriculture, advanced manufacturing, technology, energy conservation, environmental protection, and services⁶ – where foreign investment is being actively encouraged.

The FIL may also play a role in unlocking foreign investments that are currently on hold due to perceived threats around intellectual property rights and fair treatment. Although foreign-invested enterprises (FIEs) have been significantly outpaced by domestic enterprises in sectors like technology, this could change quickly should the investment conditions change. The FIL could be the catalyst for a windfall of new investment in China.

Further implementation details await

The FIL is an important step forward in making China an equitable environment for foreign investment. However, foreign enterprises need to note about the areas that need further clarification.

• The FIL is vague about indirect investment activity such as those dealing with real estate. Although the law indicates the terms for foreign investment apply to both direct and indirect investment activity, it is not clear how the FIL relates to other policies on the matter, such as the Interim Measures regarding Domestic Investment by Foreign-invested Enterprises (Re-investment Measures).
• The law does not comment on variable interest entities (VIEs), which is a situation where a foreign investor retains a controlling interest in a domestic entity (one owned by Chinese shareholders) through a series of contractual agreements. VIEs have been widely used by foreign investors seeking to invest in restricted or prohibited industry sectors, such as telecoms and internet-related businesses. It remains to be seen if any explicit regulations regarding VIE arrangements will be introduced.

The FIL represents a welcome development of the foreign investment landscape in China and a reinforcement of the country’s “fundamental state policy” of opening up. Multinational corporations and other foreign enterprises are hoping to see benefits in the form of equal treatment and intellectual property protection. If these benefits are realized, the FDI landscape in China could see an uptick in dynamism.