On March 15, 2019, the long-awaited Foreign Investment Law of China was passed, turning a new chapter of regulatory and legal regime for foreign direct investment in the second largest economy in the world. The legislative process started from 2015 and the Chinese authorities have issued two versions of the draft for public consultation in 2015 and 2018. The law will come into force on January 1, 2020 with a view toward unifying and streamlining the foreign investment framework into China. Arguably, this is a landmark legislation that is believed to provide stronger protection and a better business environment for overseas investors.

Beijing rushed the legislation through the country’s largely ceremonial legislature in an effort to fend off complaints from the United States and Europe about unfair trade practices. The new law was first introduced as a draft in 2015, but its progress picked up markedly from the middle of last year to address issues identified by Washington as part of the US-China trade war. The law attempts to address outstanding concerns from foreign investors, such as unfair treatment in terms of market access and government procurement, forced technology transfer to Chinese partners, which will demonstrate China's determination to provide an ever-more open and transparent environment for foreign investment. The law has been widely promoted as a framework that will emphasize equal national treatment of foreign investment, putting foreign investors on equal footing with domestic investors in the Chinese market and giving them equal protections.

Consisting of some 40 articles in 6 different parts, the law provides legal basis for various aspects of foreign investments from classification to management. Overall the law offers foreign investors equal treatment, greater access, and better legal protection. In other words, China will treat foreign investment no less favorably than domestic investment during the “investment access stage”. The law aims to improve the transparency of foreign investment policies and ensure that foreign-invested enterprises participate in market competition on an equal basis. In response to the concerns over market entry barriers raised by international investors, the new law establishes a nationwide "pre-establishment national treatment and negative list" management system. Foreign investors are barred from investing in prohibited industries on the negative list and must comply with the specified requirements when investing in restricted industries on that list. When a license is required to enter a certain industry, they must apply for one, and the government must treat the application the same as one by a domestic enterprise, except where laws or regulations provide otherwise.

The negative list regime for market entry by foreign investors is not a new concept and has been gradually established in China since 2015, initially in the Free Trade Zones and later nationwide through the rest of China. The most recent version of the negative list issued in 2018 has been greatly shortened compared with the previous versions, demonstrating a step forward to reduce market access restrictions for foreign investment. The Negative List 2018 is a list of industries into which foreign investment is either prohibited or restricted, and contains restrictions or prohibitions on foreign investment in 34 sectors. Aside from steering clear of industries on the Negative List, foreign investors will also need to ensure that their investments do not trigger concerns under the National Security Review laws which have already been in effect for almost eight years.

Incidentally, the law does not specifically mention investment from Hong Kong, Taiwan and Macau, but it will apply to and will not change the legal status of investments from Hong Kong, Macau and Taiwan – specifically, that they would still be considered “foreign” investments.

The new law formally does away with the prior systems that required approval by the Ministry of Commerce and registration with the Administration of Industry and Commerce before a foreign investment would be permitted into China. Other than for investments under the restricted industries in the Negative List, foreign investors are now only required to register their investments with the relevant agencies. This simplified system of foreign investment registration rather than approval has evolved over the past couple of years, and therefore is not a new proposal. Foreign investors will also be required to disclose certain of their information on a periodic basis to the Ministry of Commerce and State Administration of Market Regulation.

The Foreign Investment Law also contains principles designed to encourage foreign investors into China. Foreign investors will now have equal access to national policies supporting the development of certain industries, be allowed to comment during the legislative process, participate in standards-making and participate in government procurement processes. One of the most prominent changes demonstrated in the 2018 Draft is that it substantially expands the protections offered to international investors and their investments in China. This is apparently intended to address the concerns voiced by US and European companies in the past years.

China and the US are currently embroiled in a conflict over trade, resulting in both sides imposing tariffs on each other's goods worth billions of dollars. The tit-for-tat tariffs and rising protectionist tendencies have hurt business sentiment worldwide and stoked uncertainty. Chinese and American officials are currently negotiating a deal to end the dispute. Overall, the new law is a move widely interpreted as extending an olive branch to the United States in the ongoing trade dispute. The speed at which this process was concluded is clearly a response to Beijing's ongoing trade dispute with Washington, a clear signal from China to the US and Europe that Beijing is taking further steps toward market opening. With the new law, China will be able to better protect foreign investors' legitimate rights and interests, and create a law-based business environment that is internationalized and enabling. Yet, European and American business groups appear not entirely satisfied with the law's provisions, where the vague wording adds to the legal uncertainty that the law creates for foreign companies.

In practice, there are still many open questions that will ultimately decide how and to what extent the new rules will actually lead to a tangible improvement in investment conditions for foreign companies in China. In fact, the law is unusually "slim" and consists of a lot of vaguely formulated general clauses. Accordingly, the extent to which the protective rights of foreign investors will be strengthened in a way that can be put into practice will crucially depend on the implementing provisions still to be adopted.

China remains one of the most attractive destinations for foreign direct investment in the world. The issuance of the new law is an important legislative step which will have significant implications for all existing and future foreign investors, in all industries and sectors. Compared with China’s current foreign investment regime, the Foreign Investment Law contains a number of important provisions with a view to offering a better protection to international investors and building a more transparent and investor-friendly business environment. This obviously demonstrates a major step in addressing the concerns raised by international business community and building a level playing field for foreign investments.

On the other hand, it is noted that the Foreign Investment Law is an important legislative piece, with some significant grey areas to be clarified. For example, key issues such as what the detailed national security review requirements will be, and how the investment sanction reciprocity will work are all to be clarified. Chinese governmental authorities are largely expected to issue further rules or regulations.

"One China" policy

On April 25, 2019, the Civil Aviation Administration of China ordered a number of international airlines, including several from the US, to change how Taiwan is described on their websites and promotional material.

The agency also said it "will consider taking appropriate action if necessary in response to unfair Chinese actions."

But this is not the first time China has tried to exert its influence over foreign companies. Earlier this year, the hotel chain Marriott was forced to shut down the Chinese version of its website for a week. The fast-fashion retailer, Zara, was ordered to complete a "self-inspection" and turn in a rectification report for listing certain areas as countries. China's territorial claims to Taiwan have gradually become a confusing and diplomatically-fraught issue for foreign companies, and now air carriers.

In January this year, Delta Air Lines was censured by China's Civil Aviation Administration for listing both Taiwan and Tibet as countries on its website. The agency demanded an "immediate and public apology."

Social credit system imposed on foreign investors

Most recently China has imposed a social credit system on foreign companies in a move to which European business is fully unprepared. Chinese regulators from tax officials to customs agents are increasingly rating companies according to compliance with regulations, and sharing “blacklists” of corporations found to have violated rules. Beijing plans to combine those ratings into a single database that could be operational by 2020.

Beijing has encouraged regulators to jointly sanction companies as it attempts to improve enforcement. For example, a company blacklisted by China’s drug regulator could see an application to operate a securities company rejected by financial officials. Government documents show that a variety of Chinese regulators are compiling ratings of companies against up to 300 specific rules.  Sanctions that can be imposed by regulators depending on compliance include fines, targeted audits, restricted issuance of government approvals and exclusion from preferential policies and public procurement contracts. 

What does this mean for a foreign investor? Companies should first strengthen their compliance regimes as the threat of being blacklisted increases the compliance cost for multinationals in China. However, as some analysts predict, the social credit system is still in its infancy and is unlikely to develop into the fully functional, unified, centrally run system many envision by 2020.