China’s New Foreign Investment Law — Less Than Meets the Eye

On October 1, China changed its system for government control over foreign investment. The change was accomplished by revising the statutes concerning wholly foreign owned entities (WFOEs), equity joint ventures and contractual joint ventures and by promulgating a new basic regulation governing registration of foreign invested entities (FIEs).

The big change under China’s new system is that government regulation of foreign invested entities will move from a system that requires MOFCOM (China’s Ministry of Commerce) approval to one that will now just require simple registration with MOFCOM. This change will be implemented through the issuance of a National Negative List. For FIEs that are not restricted or regulated under the National Negative List, MOFCOM requires online registration through a national website employing a standard set of documents. This registration will apply to initial formation of the FIE and to most changes in FIE structure, such as changes in management, ownership and registered capital.

The following essential elements of this new system have already been implemented:

  • Final regulations for management of the new registration system were officially promulgated.
  • The national website for online filing became operational.
  • MOFCOM announced that the 2015 version of the already released Catalogue of Foreign Investment will be treated as the National Negative List. The status of the existing negative lists from the Shanghai and other Free Trade Zones is unclear.

All future Foreign Invested Entities (FIEs) formed in China will now follow the following five-step procedure:

Step 1. Obtain name reservation from the local administration of industry and commerce (AIC).

Step 2. If not restricted by the National Negative List, register online with MOFCOM. Provided the registration is accurate and complete, the regulations require MOFCOM to issue a registration notice within three days. Though the new regulations allow for registration with MOFCOM after issuance of the AIC business license, all of the AIC agencies with which we have spoken have told us that they will require MOFCOM registration prior to issuance of the AIC business license.

Step 3. Register your FIE with the local AIC. Since the local AIC may impose special procedures for FIEs, it is not yet known what impact of the change on this step will have overall. The most likely result at the outset is that each district will impose its own rules. Some districts may impose rules to make things easier. And some districts may impose rules that increase the time and documentation effort required at this stage. Though this result would be contrary to the spirit of the new laws, such a result would be consistent with past local government practice in China.

Step 4. Each local AIC will require compliance with other regulatory requirements such as environmental impact statements, building construction safety reports, neighborhood impact reports, energy usage reports, local employment impact reports, reports required for access to local special benefit programs, land usage and price analysis reports, and similar. The list of required studies and reports can get shockingly long and must be determined on a local AIC to local AIC basis. Dealing with these requirements typically requires a major amount of time and effort and expertise in forming a FIE in China.

Step 5. After receipt of a business license, comply with AIC, tax agency, regulatory agency and banking registration procedures. These requirements may be local, provincial or national, depending on the nature of the FIE business. Compliance with all these requirements is required before the FIE can formally begin business. Such compliance typically adds at least a month to the formation process.

Some China attorneys see the change in China’s FIE laws as a move to “open up” China to increased foreign investment. At this point, and for the following reasons, we do not foresee much change:

  • The basic structure of foreign investment does not change. Foreign invested entities are still essentially confined to the former categories of WFOE and Joint Ventures (JVs). Foreigner persons are still prohibited from directly investing in Chinese owned entities. See The China Stock Option Scam.
  • There is no change in the industries open to foreign investment. Many analysts hoped that China’s  new National Negative List would be simple, short and unrestrictive, but it is identical to the current Catalogue of Foreign Investment, which is complex, long and highly restrictive. The vast areas of the Chinese economy that have been off limits to foreign investment remain off limits. There has been no “opening up” and there is no indication that there will be any opening up. What you see now is what you get.
  • There is no significant reduction in the time required to register a foreign owned entity. The only change in the current registration process is the elimination of MOFCOM approval; registration is still required. This means that the MOFCOM stage of the registration process will, at best, be reduced from one month to three weeks. This is a minimal impact. Under the old system, MOFCOM approval was virtually never a substantial source of WFOE or JV formation delays. The delays nearly always were at steps 4 and 5 described above and the new system has no impact on those two steps. Moreover, under the new system, step 3 (AIC registration) may become an additional source of delay.
  • MOFCOM registration requires the FIE identify the persons who actually control the foreign investor. This is a new requirement. This requirement is intended to force foreign investors to reveal whether or not they are wholly are totally controlled by Chinese nationals. The goal here is to prevent illegal “round trip” investments by Chinese nationals and to regulate the use of VIEs.

So the net effect is China’s new FIE rules do not provide for any major change in the structure of the PRC system of management of foreign investment. There has been no opening up and the time and effort required to form a FIE is not likely to substantially change.

So what has changed for registering WFOEs and Joint Ventures in China? I will discuss that in my next post.