China is set for major reforms on the 1st of January 2020, the current regulations the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures, Law of the People’s Republic of China on Sino-foreign Cooperative Joint Ventures and Law of the People’s Republic of China on Foreign Investment Enterprises (the “Three Laws on Foreign Investment”) being superseded by the Foreign Investment Law of the People’s Republic of China.
The Foreign Investment Law (FIL) will greatly simplify the legislative environment with only 42 articles over six chapters, albeit the FIL is being accompanied by (draft) Implementing Regulations (IR) which contain another 45 articles.
Below are the most notable features of the (draft) Implementing Regulations;
A Transition Period for Existing Foreign Invested Enterprises (FIEs)
As the FIL will require the corporate governance structure of existing FIEs to be amended to fulfil the requirements under the PRC Company Law rather than Three Laws on Foreign Investment, Article 42 of the IR provides for the following;
A 5-year transition period (01/01/20 – 31/12/24): in this transition period existing FIEs should undertake their corporate restructuring process and registration with the relevant authorities;
A 6-month grace period (01/01/25 – 30/06/25): FIE which have not yet modified their corporate governance will be obligated to do so; and
Rejection of registration (01/07/25): if a FIE’s corporate governance structure does not satisfy the requirements as established in the PRC Company Law, the FIE will be deregistered.
It is important for FIEs to modify their corporate governance in a timely manner as scheduled, as there will be significant changes to the corporate structure of Sino-foreign joint ventures which will likely include negotiations between all joint venture partners.
FIEs with Individual Chinese Investors
The FIL permits foreign investors to establish FIEs in China and the IR clarify that the “other investors” from the FIL includes Chinese natural persons.
This is a significant development as currently; a Chinese natural person may only become a shareholder of an FIE resulting from the acquisition of a domestic company (where the Chinese natural person is an existing shareholder) by a foreign investor.
Foreign-Invested Enterprises and Round-Trip Investing
Article 35 of the IR provides that if a foreign investor is wholly owned by a Chinese person or legal entity (excluding FIEs), investments made by the foreign investor in China will not be subject the Negative List if approval of the State Council is obtained.
This examination of the ultimate owner of foreign investor signifies the relaxation of restrictions on round trip investments back to China. However, the thresholds quite high as;
the State Council approval is required, and
the foreign investor needs to be wholly Chinese owned.
Uncertainty Regarding Variable Interest Entities (VIE)
It is clear under the FIL whether variable interest entities ("VIE") will be subject to FIL regulations. VIE structures can by virtue of various contractual arrangements, allow foreign investors to gain de facto control over domestically owned business operators holding licenses in the negative list.
From the IR however, we see an indication of the legislative intention to look at the ultimate ownership of foreign investors with regards to round trip investing. Therefore, it is plausible examination of the ultimate owner may occur with VIE structures. It remains uncertain however whether VIEs actually fall under the FIL and the IR does not provide any clarity on this point either. This uncertainty regarding VIEs could allow the regulatory bodies to interpret the regulations and its status on a case by case basis, and deem VIEs to be under the purview of the FIL for certain sensitive industries and will consider the ultimate owner of the VIE. With this in mind, foreign investors should continue to be cautious when considering a VIE structure with any company whose industry is on the Negative List.