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Foreign Investment Limitations


FOREIGN INVESTMENT CATALOGUE
 
China has a rigid system of Foreign Direct Investment (“FDI”) guidance and restricts certain industries and/or forms of investments.
 
According to the Catalogue of Industries for Guiding Foreign Investment (the "Foreign Investment Catalogue"), the latest version of which was adopted on March 13th, 2015, foreign investment projects are divided into four categories: encouraged, restricted, prohibited and permitted. The first three categories are detailed in the Foreign Investment Catalogue; projects that do not fall under any of those categories are deemed permitted.
 
Such classification impacts the level of approval (national or local) required to establish a company in China, as well as the availability of preferential treatment (if any). In addition, the Foreign Investment Catalogue can impose restrictions on foreign shareholdings in a domestic company, in which case cooperation with a Chinese partner in the form of a joint-venture is mandatory. Depending on the industry, the Chinese partner may be required to hold a controlling interest (i.e. foreign participation is then limited to 49 per cent) or a simple majority shareholding (i.e. the Chinese partner must be the most important shareholder).
 
Since its inception in 1995, the Foreign Investment Catalogue has been revised regularly. The 2015 version is the sixth and one of the most notable revisions in the past two decades, echoing market expectations for further liberation of Chinese industrial sectors. This revision encourages foreign investments in sectors such as advanced manufacturing, modern services, scientific and technological research and development.
 
In addition, there is a separate catalogue for FDI projects carried out in Central and Western China. The Catalogue of Priority Industries for Foreign Investments in the Central-Western Region ("Central-Western Catalogue") intends to draw investments to traditionally less developed areas, and thus it can be more permissive or offer preferential conditions in certain sectors. More specific policies also apply to particular sectors (e.g. automobile, banking or insurance).
 

NATIONAL SECURITY REVIEW
 
Foreign investors willing to acquire Chinese domestic enterprises operating in sensitive sectors may fall under the PRC National Security Review Law (which latest version was adopted on July 1st 2015) (the "National Security Review").
 
As such, foreigners willing to acquire “actual control” of domestic enterprises operating in sensitive industries shall submit the proposed merger and acquisition (“M&A”) transaction to National Security Review. These industries include: military, national defense and security; important agricultural products, important energy and resources, important infrastructure, important transportation services, key technologies and major equipment manufacturing.
 
In terms of procedure, foreign investors who believe the contemplated M&A transaction potentially raises national security concerns shall spontaneously file National Security Review application with MOFCOM. This is in line with the Draft of Foreign Investment Law, which imposes a duty on foreign investors to self-assess whether their proposed investment triggers national security concerns. Upon application for review, the case is appraised by a joint-committee made of representatives of the State Council and the National Development and reform Commission (“NDRC”), who shall assess the transaction based on its impact on national defense and security, national economic stability, social order, and research and development capacity for key technologies related to national security. MOFCOM shall thereafter notify the final decision of the joint-committee to foreign investors.
 
Specific measures (the “Trial Measures”) have however been adopted in Chinese Free Trade Zones (“FTZ”) for National Security Review. The Trial Measures extend the scope of review beyond M&A transactions, to include Greenfield projects and transactions upon which foreign investors acquire control over a domestic company through contractual arrangements. Besides, the Trial Measures list two additional industries as sensitive: cultural development, and IT products and services, and add two more criteria for assessing the impact of a given transaction: cultural security and public morality, and network security of the state. Unlike the self-assessment process adopted nationwide, within the FTZ, local authorities must take the initiative to notify foreign investors if a transaction triggers national security concerns, in which case they shall temporarily suspend the project approval.
 
The wide scope and ambiguous grounds for National Security Review might affect the review process for inbound investments.

 
FOREIGN EXCHANGE CONTROL
 
Foreign exchange (“forex”) control is the administrative system imposed by a government on forex transactions with a view to maintaining the balance of international payments, and promoting the healthy development of its national economy. In China, the Sate Administration of Foreign Exchange (“SAFE”) is responsible for monitoring forex control. Though Chinese forex control regime has been consistently adapted and relaxed over the past few years, SAFE’s approval is still required for many transactions.
 
The forex control framework implemented in China is structured according to the IMF’s classification of current account transactions and capital account transactions related to a country’s balance of payments. Current accounts record the net flow of money from international trade in goods and services, and transfers of payments made from abroad. Capital account records the net flow of money from cross-border purchases and sales of assets such as stocks, bonds or land. Latest regulations have lifted exchange controls on current account items; while capital account items are still restricted.

Foreign investors shall bear in mind SAFE’s approval might be required for numerous transactions, including capital contributions, use of foreign exchange capital, use of foreign debts, and remittance of dividends or sale proceeds to foreign shareholders.

September 2015

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