INTERPRETING CHINA’S DRAFT FOREIGN INVESTMENT LAW
Updated: Aug 2, 2019
In late December 2018 China released a new draft of the Foreign Investment Law, which sets out key principles aiming to address the accusations of an uneven playing field for foreign business in China, including intellectual property challenges. But what does the detail tell us about China’s shifting approach?
Recently the Chinese Government has announced fast tracking the legislation. Furthermore, we do not anticipate any substantial changes to the draft. None of this is much of a surprise, given the mounting trade war pressure and the need for China to respond. But looking into the detail, what can this draft law tells us about China’s emerging response specifically in intellectual property?
The nuts and bolts
The current version of the draft, released by the Standing Committee of National People’s Congress has been reduced to 39 articles only, down from 170 in the previous draft issued in early 2015 by the Ministry of Commerce. The sentiments of the two drafts remain aligned. Both adopted the same approach and basic principles, details of which are set out below. However, the current version provides less details on the operation, procedures and timelines of the proposed approach.
Drafting of the draft law
The draft proposes the following principles for market entry and protection of foreign investment:
Protection from expropriation of investments by Chinese governments unless for social and public interests and free repatriation of legitimate revenues including foreign investors’ dividends and intellectual property royalties.
Reaffirming the national treatment with the addition of a Negative-List Approach for investment opportunities for overseas entities in China.
Strict fulfillment of the policy commitments to and contracts with foreign investors and foreign-invested enterprises (FIEs) by local governments.
Treatment for FIEs on a par with domestic enterprises, and equal treatment in government procurement processes for products produced in China by FIEs.
Improving the mechanisms for complaints and protection of the rights of FIEs.
The draft proposes the following principles to address forced technology transfer by administrative means:
Technical cooperation shall be on a voluntary basis and align with commercial norms.
The conditions for technology cooperation shall be negotiated and agreed upon by the investment parties.
The administrative authorities and its personnel shall not force technology transfer through administrative means.
Impact of the proposed new law in practice
As much of the media commentary already states, much will depend on the implementation of the law. It is an outward display from China which demonstrates a willingness to react to the US’s accusations. However, it may not be enough to completely ease concerns around forced tech transfer, as the issues are multiple fold and may not simply be rectified through establishing basic principles.
For example, one of the causes of the forced technology transfer claim is the requirement in certain sectors for Joint Ventures with Chinese partners. Foreign investors often feel that it strengthens the bargaining power of the Chinese partners and increases the pressure on foreign parties to transfer technologies in exchange for market entry. This may be true in some cases and won’t necessarily change based on the principles as stated.
Not only are the principles high level statements, the law will also replace the current three Foreign Investment Enterprise laws: the Sino-foreign Equity Joint Ventures (“EJV Law”), the Sino-foreign Co-operative Joint Ventures (“CJV Law”) and the Wholly Foreign-owned Enterprises (“WFOE Law”). However, there is currently no detail on how the provisions from the previous legislation which will be replaced. These laws influence how foreign businesses can operate in China. Whilst the new approach is not currently clear, there will be a five-year transition period before the new law is implemented, which will allow FIEs to respond.
Reaffirming the National Security Review in the foreign investment process
Although not talked about much in current media coverage, the new draft restates the importance of China’s National Security Review system. The review process which is already in place through administrative rules currently applies when foreign investors acquire ownership, shares or control in Chinese domestic companies or for foreign investors established in the Free Trade Zones.
However, the new draft states that the National Security Review system shall be applicable to all relevant foreign investment activities. If the provisions are adopted in their current form, the Chinese government needs to issue further implementation regulations and clarifications regarding the criteria and detailed procedures, especially for foreign investments falling into the scope of the Negative List.
In addition, the draft formalises the need to undergo national security review for foreign investors acquiring domestic technology companies with key intellectual property rights, which is considered to be a technology export out of China. Although this measure has been adopted since March 2018 in the Interim Measures on Outbound Transfer of Intellectual Property Rights issued by the General Office of the State Council. This mirrors the strengthening of national interest investment committees seen in other countries.
The next stages
The coming year will be of interest to watch how China responds to developing negotiations with the US. This draft law leaves some gaps in controversial areas which were addressed in the old draft and may possibly be held back as bargaining chips. This includes administration of foreign investment via a Variable Interest Entity (VIE), a structure which has previously been popular to enable foreign investment in China’s restricted sectors; and whether PRC law should be applied to all foreign investment (joint venture) contracts.
In addition, one type of legal liability - the administrative fines for foreign investment into negative list area without obtaining approval - has been removed. Therefore, the legal liabilities for non-compliance will be exit of foreign investment and the confiscation of illegal gains, which could be perceived as a potential risk for VIE controlled investments in China.
Watch this space…
China is likely to move quickly in this area and how the principles are interpreted and implemented will be critical to all foreign businesses wishing to operate in China. We’ll track the developments and keep you updated here!