Foreign Investment Law to allow majority shareholders of existing JVs to make decisions
It is no exaggeration to say that China’s Foreign Investment Law, which will come into force on Jan 1, 2020, signals the beginning of a new era for foreign investment in China.
The Foreign Investment Law shows the Chinese government’s resolve to further open up the Chinese market to foreign businesses and addresses the concerns of other countries by creating a level playing field for foreign-invested companies, protecting their intellectual property and allowing them access to public procurement projects.
At a stroke, the new law will replace China’s three existing laws on foreign investment passed between 1979 and 1990. Although passed at an early stage of China’s reform and opening-up, these laid a solid foundation to attract foreign investment.
By the end of 2018 approximately 960,000 foreign-invested enterprises, or FIEs, had been set up in China with actual foreign-invested capital exceeding US$2.1 trillion (some 150 times the investment volume in 1983).
However, the foreign investment laws of the late 1980s are no longer the right framework for China, which has become far richer, more open, more competitive and better connected to the world in recent decades. It is also a far more confident country.
And although heartening to see issues such as market access, intellectual property rights protection, payment of dividends offshore and foreign exchange balancing stated in the law, these reflect changes that have already been underway in China or have been non-issues for many years.
The world’s biggest market still presents challenges, but for most sectors there are limited legal hurdles to overcome. The vast majority of sectors are already very open to foreign investment, with no prohibition or requirement to have a Chinese partner, and indeed most FIEs in China are already wholly foreign-owned enterprises.
China has also placed great emphasis — as much for its internal development as to placate overseas rights holders — on improving and enforcing the rights of intellectual property holders. Problems still exist, but the situation is far better than it was even five years ago, and it has moved swiftly to end forced technology transfers.
The transfer of funds offshore is still restricted but it is important to note that the Chinese authorities have not blocked legitimate repatriation of dividend payments. In recent years measures have been tightened at times, but crucially this has always been a question of timing rather than possibility.
The biggest and most immediate impact of the Foreign Investment Law will be on foreign companies already in the Chinese market.
The coming changes will allow existing joint ventures to be restructured to models that better allow for the majority shareholder to make decisions — subject to some caveats.
The important changes that powerful foreign shareholders will seek to impose upon their joint ventures will be changing unanimous board decisions to two-thirds majority decisions; internally agreeing how management is organized; and more flexible ability to transfer shares.
Naturally, these changes will be opposed by the minority (or 50/50) shareholder.
However, the problem for foreign investors seeking to unshackle themselves from the blocking power of their Chinese partners is that they will need the consent of their Chinese partners to make such changes. Invariably, joint venture contracts turn regulatory restrictions into contractual ones.
Accordingly, foreign investors in joint ventures will need to carefully consider their strategy before engaging with their Chinese partner. China is not going to issue any implementation regulations that require the Chinese partner to make commercial decisions to the benefit of foreign investors.
For this reason, foreign and Chinese investors will need to work matters out by themselves based on their shareholding, role in the joint venture and dependence on the other party. Foreign investors seeking to build a majority in an existing joint venture will likely need to leverage their financial strength, support for the joint venture like the introduction of state-of-the-art products, or other aspects of leverage that will vary from case to case.
China has been on a long journey of foreign investment liberalization. It is likely that over the five-year transition period, China’s Negative List for sectors prohibited or restricted to foreign investment will continue to become shorter.
Recent examples in 2018 included the lifting of foreign ownership restrictions in the auto manufacturing industry and financial industry.
When these restrictions were lifted, Tesla immediately signed a deal to set up a wholly foreign-owned car plant in China, BMW entered into an agreement with its Chinese partner to secure a majority stake in its existing joint venture and UBS doubled its shareholding ratio in a securities joint venture.
Accordingly, foreign shareholders in restricted sectors should continue to monitor the advantages that may arise from China’s further relaxing of the restrictions on foreign investments. Investors new to China in the process of establishment should ensure that the contracts take advantage of the future loosening of restrictions.
The Foreign Investment Law is more than China’s response to a looming trade war coupled with the retreat from globalization.
In a world increasingly erecting barriers, the law is a welcome message from the Chinese government that China is very much open for business. After almost 40 years of reform it signals that China is the (perhaps unlikely) champion of trade and investment liberalization.
The author is international partner of King & Wood Mallesons. The author contributed this article to China Watch, a think tank powered by China Daily.
The views do not necessarily reflect those of China Daily.
HONG KONG NEWS