China’s proposed law on foreign investment

In line with the state’s efforts to sustain economic growth, Beijing’s newly proposed foreign investment law has a chance of delivering promising results, Deborah Healey and Lu Wang write.

China‘s new foreign investment law is likely to be approved during the annual meeting of the National People’s Congress (NPC) this week. If enacted, the law will greatly simplify current rules and will address important issues raised in trade disputes between China and the US. However, analysis suggests that the true outcome will only be clear once detailed regulations are released and will also depend on how authorities apply the law in practice.

Foreign investment has become a significant driving force in the rapid development of the Chinese economy. Until October 2018, almost 950,000 foreign-invested companies with more than US $2.1 trillion foreign capital were registered to operate in China. As the second largest economy in the world, China received record foreign direct investment (FDI) in 2017, ranked just behind the US.

However, existing laws governing foreign investment dated back to 1979. Justice Minister Fu Zhenghua said that the existing laws “…could hardly [keep] up with changing requirements in building a new system of open economy”.

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In response, the current draft foreign investment law, based on an original version proposed by the Ministry of Commerce in 2015, was issued last December for “further expanding opening up and better using foreign investment”, in line with recent policies adopted within the jurisdiction. The NPC Standing Committee reviewed an updated draft law on 29 January 2019. The draft foreign investment law makes a positive step towards improving the legal system in China.

The draft law streamlines the current foreign investment law regime by replacing three existing laws for Chinese-foreign joint ventures and wholly foreign-owned companies with a five-year transition period. Amongst other changes, it proposes equal treatment for domestic and foreign business and also prohibits forced technology transfer to protect foreign intellectual property.

More importantly, it fully implements pre-establishment national treatment for foreign investments plus a “negative list”, expanding market access for foreign investors whilst increasing the predictability and transparency of foreign investment administration. The draft law includes rules on investment promotion, protection, and management.

Altogether, these features address some key issues in the current trade dispute with the US, but the extent to which they improve the trade relationship between China and the US, bringing benefits to China and foreign investors, is unclear.

The draft law greatly simplifies the existing foreign investment regime and adds substantial clarity. Some provisions have been criticised on the ground that they are too vague and broad and may trigger additional problems, but the new law will serve as a basic law and will be supplemented by further enforcement regulations and detailed rules.

The nature of the enforcement regulations and detailed rules is key to the practical effect of the draft law. If China maintains the clear approach of the draft law and applies it in that way, the changes should be very advantageous to foreign investors. The overall impact will also depend upon the way the law, rules, and regulations are enforced.

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While some have doubted whether the draft law meets US demands and will be sufficient to address the concerns of foreign investors, there is no doubt that the trade war has accelerated its progress. It remains to be seen what agreement the US and China will reach in the coming face-to-face discussions, but recent policies adopted by China suggest that it is willing to take measures to tackle long-standing complaints.

The draft law should also ultimately work to China’s interests. Liberalising and facilitating foreign investment should increase confidence in China’s investment environment and attract more high-quality investment, especially in areas of high-tech and innovation which will contribute to China’s overarching policy objectives set out in the 13th Five Year Plan and Made in China 2025.

Abandoning forced technology transfer should also create a better environment for foreign high-tech investment. The improved protection and enforcement of intellectual property rights serves China’s interests in its pursuit of an innovation-based economy.

While the draft law focuses on foreign investment, Chinese companies, especially private companies, will also benefit from a “stable, transparent and predictable investment environment” and a more level playing field in conjunction with the implementation of other policies for investment liberalisation and facilitation.

The legislation will make a substantive contribution to institutional reform in China by adopting the negative list approach for foreign investment as a prevailing international practice, in response to new developments in economic globalisation and changes in international rules for investment.

As China is both a major FDI recipient and rising global investor, the new legal framework for foreign investment must help strike a proper balance between protecting and promoting foreign investment and regulating foreign investment to safeguard national security interests. How successful China will be in this will become more obvious in the upcoming NPC meeting. Failure to adopt the law will strand the investment environment in the past, compromising efficient investment processes and certainty for investors and their targets.