Understanding the Implications of China’s New Foreign Investment Law
Over the decades, China has had a regime of multiple legal structures regulating foreign direct investment (FDI) through the so-called “three Foreign Invested Enterprises (FIE) Laws.” These laws covered many aspects of international companies doing business in China, providing guidelines for establishing and managing foreign-invested enterprises. On January 1, 2020, China indeed takes a laudable step into the future- the new Foreign Investment Law supersedes the old FIE laws with a more modern and streamlined legal infrastructure. Though the law is well-designed to promote transparency and provide an equitable playing field and more closely aligned with international standards, it comes with a myriad of changes that foreign business operators in China must know to remain compliant.
Major Changes Under the New Foreign Investment Law
Perhaps the most eye-catching development under the new foreign investment law is the installation of “national treatment” regarding foreign-invested enterprises. That is to say, foreign companies will now receive domestic treatment concerning their foreign-invested enterprises in most industries. “This is a great step on China’s part toward being more open and welcoming to foreign investment, and at the same time aligns its policies with global best practices,” also notes the Ministry of Foreign Trade and Economic Cooperation.
On the other hand, national treatment also carries responsibilities. Now foreign-invested enterprises are subject to the same rules and regulations that domestic companies are governed by, such as China’s Company Law, which may greatly differ from the governance frameworks previously afforded to foreign businesses. This implies that foreign businesses operating in China will not enjoy the flexibility they used to have in their corporate structures. In particular, joint ventures will now have to have governance structures based on the model of a foreign company and will no longer be able to operate under the model of a limited company. Thus, it will no longer become possible to operate as a joint venture and still retain the flexibility in terms of the governance model that served as the essential principle and purpose of joint venturing itself.
For instance, under the old FIE regime, foreign-invested joint ventures were given much higher autonomy with respect to governance, often creating more bespoke arrangements. The new law now requires all FIEs to proceed towards governance models complying with China’s broad corporate laws, potentially necessitating very significant changes in business operations and management.
The Compliance Transition Period for the New Law
In order for foreign companies to adapt to this change, the law grants five years for transition to comply starting from January 1, 2020. This period gives ample time to adjust to the new regulations especially for complex corporate governance structures such as joint ventures. Though the timeframe might be generous, foreign companies should truly start amending early enough to avoid disruption of their operations.
The biggest change that foreign businesses will have to adopt is the reconstituting of their boards of directors in terms of its composition and term limits. Under the previous laws regarding FIEs, a foreign-invested joint venture could appoint a board of directors that would have a term of up to 4-years with renewal facilities. However, as per China’s Company Law, for a general domestic company, the maximum term of the board of directors is only three years-with a renewal option-; this may seem like a small change but will prove effective on thousands of joint ventures that are FDI based and established mainly by countries like the USA, Canada, Europe, and rest of the world. Hence these companies will be required to change their governance structures to adapt to the new regulations.
Consequences for Foreign Business Establishments
Notably important for businesses, the emergence of national treatment principle and the more rapid streamline of foreign investment also offers several advantages; it opens new gates and levels the playing field for domestic and foreign businesses, which probably help international companies extend their footprint in China’s vast market. But it comes at a price: increased and tougher compliance obligations.
Being foreign, the companies have to comply with a number of laws and regulations in the country such as the Anti-Monopoly Law, Environmental Law, and Employment Law, among others. While earlier some sectors were guided by regulations that were only peculiar to foreign companies, the new law clarifies an equal application to international companies as it does for local companies. Opening previously restricted industries to foreign investors may have positive benefits, but it also means that compliance needs to be proactive as legal contestation may become inevitable.
Furthermore, the new law also provides for a mechanism of investment review, which rims in investments in some sensitive industries, particularly national defense-oriented-one such as technology, a portion of the telecommunications category, and defense himself. The foreign investment review has not been entirely new but now has a more structured and formalized procedure that must be followed by companies when applying for investments in such industries. Such companies will have to comply with the new process of vetting for their relevant investments to comply with the national security mandate in areas they work in or intend to enter.
Changes in Corporate Governance
Corporate governance is likely to be one of the most affected areas for foreign enterprises in China. The new Foreign Investment Law now requires foreign-invested enterprises, particularly joint ventures, to revisit their corporate governance structures, including shareholder agreements, management practices, and voting mechanisms. These must comply with the more rigid provisions of China’s Company Law.
One of them is in the area of frequency and structure of shareholder meetings. Under the new law, companies will have to provide for shareholders to hold regular meetings and decisionmaking processes clear enough as to who should decide what. In addition, the previous division of powers between management and shareholders would require review along the lines of much stricter provisions regarding what can or cannot be decided at board level or shareholder votes. Surely, these changes look like routine administrative work. Still, it could mean a significant upheaval since these companies may need to adapt their governance mechanisms to remain “in compliance”.” It could dramatically reorder everyday business.
Strategic Planning for the Future
The status that any new Foreign Investment Law may confer brings both new opportunities and challenges on foreign business. Therefore, existing businesses in China and those seeking to penetrate this market should be proactive in addressing the changes in the law to enable a gradual transition. And while the five years offered by the transitional provisions might be time enough, it is never too soon to start reviewing the corporate governance frameworks, legal structures, and compliance protocols.
For companies with joint ventures or complex corporate structures, taking legal advice from someone familiar with the Chinese corporate arena should be highly advised. The business will be ahead of the problems created by legislation or policy change.
Thus, this new Foreign Investment Law creates a turning point for foreign companies’ regulatory environment. But while the law brings more opportunities and better playing fees to international business, it also brings stricter compliance cuts. Foreign businesses must now mobilize to realign with the provisions of the new law and be ready for doing business in the changing Chinese market. That way, they will ensure that their businesses will future well in the second-largest economy in the world.