A stabilising force amid tumultuous times?

The Foreign Investment Law (FIL) and its Implementing Measures were promulgated in January 2020. Since then, China—alongside the rest of the world—has faced momentous challenges and uncertainties. Its political, social and economic environment has altered and adapted to tackle these obstacles, not to mention shifting geopolitical concerns, climate change and digitalisation.

Given that foreign-invested enterprises (FIEs) account for about a quarter of China’s industrial output, a fifth of its tax revenue, and about 40 per cent of its total imports and exports, stabilising foreign investment and optimising the distribution of foreign capital is indeed a top priority for the Chinese Government, a point recently reaffirmed in President Xi Jinping’s report to the 20^th Party Congress. Reflecting on the aforementioned points, Carlo D’Andrea, vice president of the European Chamber, and Shane Farrelly of D’Andrea & Partners Legal Counsel examine how national policymakers have sought to stabilise foreign investment since the FIL was introduced.

National Security Review mechanism

An oft-contentious aspect for foreign investors within China has been the security review of certain investments. This requirement dates back to 2006, when the Ministry of Commerce (MOFCOM) released the Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors (M&A Rule). Under this rule, national security review (NSR) only applied to foreign investment through merger and acquisition, with the MOFCOM the authority in charge.

However, the FIL has broadened the scope of national security review to cover greenfield foreign direct investment and indirect foreign investment in cases where national security may be affected. The authority in charge of national security review now consists of a joint working mechanism under the National Development and Reform Commission (NDRC).

On 19^th December 2020, the NDRC and the MOFCOM jointly released the Measures for Foreign Investment Security, providing detailed requirements and procedures, and signalling the establishment of the foreign investment security review system under the FIL.

Categories and scope

The first category concerns security of national defense. In practice, this rarely applies as it is quite uncommon to have transactions involving foreign investment into military-related sectors in China, especially following the Trump Administration bans on such investment by United States firms.

However, the second category, in which investments confer at least de facto control upon foreign investors (meaning if the voting rights enjoyed by a foreign investor allow it to exert material influence over the board of directors, shareholders’ meetings or resolutions of shareholders’ meetings; or there are other circumstances that would enable foreign investors to exert material influence over management decision-making, human resources, finance, technology, or other areas) is of more relevance. This category includes investments into a list of industry sectors that are considered to concern national security, including important energy and resources; important equipment manufacturing; important infrastructure; important transport services; important information technology (IT) and internet products and services; and important financial services, to name but a few of the most relevant.

In practice, the Measures do not specify what amounts to ‘important’, leaving the authorities with considerable discretion, and thus a relatively broad interpretation appears likely. In summation, an investor should consider the invested sectors as in-scope if they appear close to the description provided by the Measures.

Big data, IT, artificial intelligence and internet-based technologies have all come under the spotlight due to the rise of the digital economy. Therefore, foreign investors should not underestimate the strategic importance and sensitivity of these sectors when assessing the relevance of Chinese NSR regime to a particular transaction.

Impact

Although the Review Measures provide more detail on the NSR mechanism, the list of sensitive areas that could potentially trigger a NSR remains quite vague and general. While the NDRC has made efforts to assist businesses—for example, setting up a contact point for NSR-related consultancy—it is necessary for additional relevant stakeholders to provide more clarity on this topic.

According to the European Chamber’s Business Confidence Survey 2022, ambiguity in rules and regulations has ranked for six consecutive years as the most significant regulatory obstacle to doing business in China, highlighting the need for regulatory reform as well as improved communication between government and industry.

Complaint mechanism for FIEs

In conjunction with the provisions set out in the FIL, the MOFCOM created a new mechanism for handling complaints lodged by FIEs, codified in the Measures for Processing Complaints of Foreign-invested Companies (Measures), with greater intellectual property (IP) rights protection, equal treatment, and transparency.

These latest complaint rules include several important developments, most notably the creation of a new, high-level system with the authority to coordinate complaints at the central level and guide others at regional levels. When a complaint is filed with one of the complaint-handling agencies in MOFCOM, the complainant will have to provide supportive documents, facts and evidence. The agency will then have to either accept or reject the complaint within seven working days from the day of receiving the complaint. Upon acceptance of a case, the agency should resolve it in 60 days (which can be extended if the matter is relatively complex and involves several departments).

Other notable additions include a ‘no-retaliation’ clause in which foreign companies are guaranteed in writing that punitive retaliatory actions are not to be conducted, as well as a shortened timeframe for processing longer complaints (reduced from two years to one.)

Despite these improvements, the complaint measures are not a remedy for all issues, as it remains unclear if the new scheme will consider IP-related complaints within its administrative scope. Additionally, the word ‘complainant’ is defined narrowly as ‘FIEs’ and ‘foreign investors’. Business organisations had called for expanding the definition of complainant to include industry associations, as this would allow for the anonymising of complaints and their presentation as collective problems, thereby minimising any risks assumed by any individual company.

Conclusion

With the release of the FIL and its subsequent apparatus for effective realisation, meticulously arranged over the past three years, stabilisation of foreign investment has been pursued from a multitude of angles. However, European investment in China has over that time become increasingly consolidated among a few investors, sectors and origin countries. Over 80 per cent of European FDI has come from just 10 investors, 70 per cent of FDI from Europe into China went to just five sectors—automobiles, food processing, pharmaceuticals and biotech, chemicals, and consumer products manufacturing—and just four European countries—Germany, the United Kingdom, France and the Netherlands—accounting for 87 per cent of total FDI in China on average during the aforementioned period.

FDI data into China has also declined since 2020; investment from the EU dropped 11.8 per cent from 2019 levels, and the EU’s share of overall FDI into China fell to 3.8 per cent from a high of 11.1 per cent in 1999.

Although the NDRC recently introduced Several Policy Measures to Stabilise Foreign Investment Stocks and Spur Foreign Investment Quality and Quantity with a Focus on the Manufacturing Sector, which details 15 measures to stabilise and attract foreign investment, various factors indicate that China has become less attractive as an investment destination for European companies since the promulgation of the FIL.

Stalling state-owned enterprise reform and increasingly ad hoc policymaking, disorganised COVID-19 policies, fewer opportunities for in-person knowledge exchange, and shifting supply chain strategies all need to be addressed to assuage investors’ concerns over the opening up of market segments and decoupling with other markets.

​D’Andrea & Partners Legal Counsel (DP Group) was founded in 2013 by Carlo Diego D’Andrea and Matteo Hanbin Zhi, both of whom have extensive backgrounds in Chinese and EU law. Our firm’s services encompass a full range of foreign direct investment/overseas direct investment-related matters, with a special focus on business relationships between Europe and Asia, inclusive of topics such as cross-border mergers and acquisitions; scouting, relocation and negotiation with local and government authorities; dispute resolution and corporate governance; IP protection, litigation and arbitration; and employment and labour law, among others. DP Group currently has four service entities: D’Andrea & Partners Legal Counsel; PHC Tax & Accounting Advisory; EASTANT Communication and Events; and Chance & Better Education Consulting. DP Group has branches around the world, including in several major developing economies.