China releases 2015 foreign investment catalogue

Practical Law UK Legal Update 1-604-7265 (Approx. 10 pages)

China releases 2015 foreign investment catalogue

by Practical Law China

2015 Catalogue is the sixth revision (and may be the last)

Since 1995, the NDRC has issued Foreign Investment Catalogues, generally updating them every three to four years. The regulatory framework governing foreign investment into China changes over time because it is driven by the government’s industrial policy. That is, the government uses the catalogue to direct foreign capital into industrial sectors that the government decides need encouraging because China requires foreign funding and technology, while restricting or prohibiting foreign investment in other sectors. For more information on the overall framework governing foreign direct investment in China, see Practice note, Chinese foreign direct investment law: overview.

Where foreign investment in sectors is restricted, it is because China has overcapacity or overinvestment in that sector, or because the sector is strategically important or politically sensitive and requires close government scrutiny. Restrictions are typically structured either as caps on the economic interest that the foreign shareholder can hold (that is, creating a Sino-foreign equity joint venture company (EJV) or Sino-foreign co-operative joint venture company (CJV) or limitations on the number or amount of investments that can be made by each single foreign investor. Some industries are entirely closed to foreign investment, because the government considers that they are critical to national security, cause pollution, or are natural government monopolies.

On 13 March 2015, the NDRC and MOFCOM jointly released the 2015 Catalogue, which is the sixth revision. The full text of the 2015 Catalogue can be accessed on NDRC's website: Catalogue of Industries for Guiding Foreign Investment 2015 (Chinese language only).

The 2015 Catalogue will come into force on 10 April 2015. The last Foreign Investment Catalogue was adopted in 2011. Prior to the official release of the 2015 Catalogue, a draft version was circulated on 4 November 2014 for public comment. For more information on the changes once proposed in the 2014 draft, see Legal update, Foreign Investment Catalogue November 2014 revised draft opened for comments. Compared with the 2014 draft version, the 2015 final version contains a number of limited changes focused on the culture and entertainment sector (see Changes from the November 2014 draft catalogue).

The Chinese government is negotiating bilateral investment treaties with the United States and the European Union which will eventually require China to open its market further. However, an agreement between China and its major trading powers on how open the China market will take some time. To prepare for this, China has started to reform its foreign investment structure, with a view to eventually adopting a negative list that would replace the catalogue (the first draft of a universal foreign investment law, which would incorporate a negative list approach, was released by MOFCOM on 19 January 2015 for public comment). For more information on the implications of the draft foreign investment law, see Legal update, Draft Foreign Investment Law open for comment until February 17. Alongside this, since 2013, China has been applying a negative list approach in the Shanghai FTZ. For more information on the key reforms applied inside the Shanghai FTZ, see Practice note, China (Shanghai) Pilot Free Trade Zone: overview.

Features of the 2015 Catalogue

The principal changes in the 2015 Catalogue against the 2011 Foreign Investment Catalogue are:

Reducing the number of industrial sectors restricted to foreign investors from 79 to 38.
Cutting the number of industries limited to EJVs or CJVs from 43 to 15.
Rolling back the industries that require foreign investment projects to have a Chinese majority shareholder from 44 to 35.

The 2015 Catalogue greatly reduces the regulation of foreign investment in the manufacturing industry, in particular for the transportation equipment manufacturing segment. For example, it removes the joint venture requirement for the manufacturing of:

Wheeled and crawler cranes of 400 tons or above.
Automobile embedded electronic integrated systems.
Civil helicopters of less than three tons.
Equipment for air traffic control systems.
Airborne equipment for civil aviation.
Aircraft engines and engine parts and components, and aircraft auxiliary power systems.
Cabin machinery of vessels.
Yachts.

The 2015 Catalogue also removes the joint venture requirement or the minimum domestic shareholding requirement in a number of service sectors. Key industries include:

Operating e-commerce platforms.
Large scale chain operations of vegetable oil, sugar, crude oil, agricultural chemicals, agricultural plastic film and fertilizers.
Construction and operation of branch and intercity railway lines and related bridges, tunnels, ferries and station facilities.
Construction and operation of urban subway, light railway and other track transport.
Scheduled or unscheduled international marine transportation services.
Operation of performance sites.

In addition, the 2015 Catalogue makes clear for the first time that only formal laws and regulations have the power to affect market entry restrictions and prohibitions for foreign investment; special regulations of the State Council and industrial policy documents do not have the force of law. It will be interesting to see how this is implemented in practice as the current regime for regulating foreign investment incorporates a large number of special regulations and industry policies, which set detailed rules and implementation requirements for the participation of foreign capital.

The practical impact of these changes is less than the number of the changes would suggest, as many are not actual changes in law but merely codify existing provisions found in industry-specific regulations and policies, or clarify wording that in the 2011 Foreign Investment Catalogue was vague.

Sector-by-sector, the principal changes since the 2011 Foreign Investment Catalogue are:

Automobiles

Foreign investment in the complete automobile, special purpose vehicle and motorcycle industries has been reclassified as a restricted sector. This industry was classified as ‘encouraged’ in the 2007 Foreign Investment Catalogue and subsequently moved to the ‘permitted’ category in the 2011 Foreign Investment Catalogue.

The 2015 Catalogue codifies the NDRC’s policy on development of the automobile industry, which requires a foreign investor in any of these industries to involve a Chinese partner who holds at least 50% of the equity interest, and prevents any individual foreign investor from investing in more than two joint ventures that manufacture the same category of auto vehicles (Policy on Development of Auto Industry 2004). The restriction will not apply if the foreign investor acquires or merges other automobile manufacturers in China together with its Chinese joint venture partner. These policies are directed at consolidating the industry, and promoting the growth of domestic auto makers and their brands.

Life sciences and health care

This sector presents a mixed picture.

On the one hand, the manufacturing of certain medical and pharmaceutical products such as oral calcium preparations and blood products (which were thought in 2011 to have been suffering from over-capacity), has been shifted from the restricted into the permitted category.

On the other hand, foreign investment in medical institutions has been shifted back from the permitted category to the "restricted"’ category, alongside a requirement that projects in this industry must be established as an EJV or a CJV. This joint venture requirement is consistent with the existing foreign investment policy on medical institutions adopted since 2000 under the Interim Measures for the Administration of Sino-Foreign Equity/Cooperative Joint Venture Medical Institutions 2000 (2000 Measures on Joint Venture Medical Institutions). However, unlike the 2000 Measures on Joint Venture Medical Institutions, the 2015 Catalogue does not require the Chinese investor to hold at least 30% of the shares of a joint venture medical institution. It is therefore likely that the 2000 Measures on Joint Venture Medical Institutions will be amended to remove the minimum domestic Chinese shareholding requirement.

The broader trend is that China is gradually opening its domestic medical services market to foreign investment. For example,

Since 2013, foreign investors have been allowed to set up wholly foreign-owned medical institutions in the Shanghai FTZ (Article 2, Provisional Measures on the Administration of Wholly Foreign-invested Medical Institutions in the China (Shanghai) Pilot Free Trade Zone 2013 (中国（上海）自由贸易试验区外商独资医疗机构管理暂行办法 )).
Since 2014, foreign investors have been allowed to set up wholly foreign-owned medical institutions in seven pilot provinces or cities (including, Beijing, Tianjin, Shanghai, Jiangsu, Fujian, Guangdong and Hainan) on a trial basis (Article 1, Notice of the National Health and Family Planning Commission and the Ministry of Commerce on the Pilot Scheme of Establishing Wholly Foreign-owned Hospitals 2014).

For more information on foreign investment policies on medical institutions applied nationwide and in the Shanghai FTZ, see Checklist, Comparison of policy in the China (Shanghai) Pilot Free Trade Zone and the rest of China.

Services

The services sector provides a mixed picture.

Restrictions on accounting and auditing services are being relaxed by allowing foreign investment through wholly-owned foreign enterprises (WFOE), subject to a new requirement that the managing partner must be a Chinese citizen. However, this relaxation is unlikely to be that significant in practice. The Big Four typically conduct their auditing practices in China using limited liability partnerships in which around 65% of partners are locally licenced and the remainder are not, but conduct their consulting practices (including tax) through WFOEs. It is unlikely that the Big Four will move their auditing practices to WFOEs, because a partner in a CPA firm must be licensed as a CPA in China and that requirement is likely to apply to the shareholders of a WFOE.

The other eye catching change is to the treatment of legal services. The 2011 Foreign Investment Catalogue lists legal advice (法律咨询) as restricted. In the 2015 Catalogue, the sector description is revised to Chinese legal advice (中国法律事务咨询) and moved to the "prohibited" category but with a carve-out for the provision of information relating to Chinese legal environment influence. Foreign law firms are already prohibited from advising on Chinese law, so this would appear to be a harmonisation of the 2015 Catalogue with existing policy rather than a new restriction.

Education

The 2015 Catalogue codifies government educational policy set out elsewhere.

Higher education, ordinary senior high schools and pre-school education (that is nurseries and kindergartens) are now all classified under the "restricted" category and are limited to CJVs led by the Chinese party (which means that the principal or chief executive officer of the school must be a Chinese citizen and at least half of the board of governors, board of directors or joint management committee of the school must be appointed by the Chinese party). This is not a new development as the restrictions already applied under the Regulations of the People's Republic of China on Sino-Foreign Cooperative Operation of Educational Institutions 2003 and the Implementing Measures for the "Regulations of the People's Republic of China on Sino-Foreign Cooperative Operation of Educational Institutions" 2004 (2004 Measures on CJV Educational Institutions).

However, 2015 Catalogue does not clarify whether these educational institutions can be operated for profit-making purpose. The existing industry rule forbids foreign investors to establish for-profit educational institutions (Article 28, 2004 Measures on CJV Educational Institutions).

Real estate and infrastructure

The 2015 Catalogue lifts the restriction on foreign investment in subways and real property projects.

Going further, the construction and operation of rail transit such as city metro and light rail are now encouraged and no longer require a Chinese majority shareholder. However, given that all infrastructure projects are initiated by local governments through their corporate arms, it is unlikely that these will be operated as anything other than joint ventures in practice.

Although the 2015 Catalogue has shifted foreign investment in high grade hotels, office buildings and international exhibition centres from the restricted category into the permitted category, the Chinese government has imposed significant domestic law restrictions in the area of foreign investment in real estate, and a mere shift to the permitted category does nothing to unwind these. It is yet to be watched how those policy restrictions on foreign investment in real estate sector will be affected following the coming into force of the 2015 Catalogue.

Technology

The Chinese government has opened up investment in some aspects of the Internet, while keeping tight control of related sensitive sectors. Online publishing and online audio-visual program services are prohibited, while the development and applications of technologies for the Internet of Things (that is, the connection of household objects such as appliances to the Internet) is encouraged. This new addition is in line with the Chinese government's continuing efforts to obtain a leading advantage in technologies related to Internet of Things in the era of mobile Internet.

The definition of technologies for the Internet of Things is subject to the authorities’ further clarification. Examples that may potentially fall into the category are Internet vehicle technology, smart grid technology and mobile wearable devices. These are likely to qualify for preferential policies (including for example tax relief).

E-commerce

Although value-added telecoms services are still within the restricted category and subject to a foreign shareholding cap of 50%, the operations of e-commerce is now expressly carved out and foreign investors are able to set up WFOEs to run e-commerce platforms in China. This follows the recent relaxation of e-commerce policy in the Shanghai FTZ in January 2015. For a detailed overview of e-commerce in China and in the Shanghai FTZ, see Article, E-commerce in China.

Financial

The financial sector (including banks, insurance companies and securities companies and fund management companies) remains within the restricted category but the 2015 Catalogue further clarifies that:

For banks,
- a single foreign financial institution and the affiliated parties under its control or joint control may invest in up to 20% of the shares of a single Chinese-funded commercial bank as promoters or strategic investors;
- multiple foreign financial institutions and the affiliated parties under their control or joint control may invest in up to 25% of the shares of a single Chinese-funded commercial bank as promoters or strategic investors; and
- overseas financial institutions investing in rural commercial banks must be banking financial institutions.
For insurance companies, the foreign shareholding ratio of life insurance companies is capped at 50%.
For securities companies and fund management companies, the foreign shareholding ratio is capped at 49%.

Changes from the November 2014 draft catalogue

It appears that a great deal of lobbying has been done by Chinese industries concerned about their market position and the impact of foreign competition. The changes in the 2015 final version compared with the draft version released in November 2014 are a good illustration of this lobbying in action. Most of the changes relate to the culture and entertainment sector, including:

Items that were shifted from the restricted category to the permitted category in the 2014 draft catalogue but put back into the restricted category in the 2015 Catalogue. These include:
- printing of publications (only permitted so long as Chinese parties are the controlling shareholders);
- construction and operation of large theme parks;
- construction and operation of movie theatres (only permitted so long as Chinese parties are the controlling shareholders); and
- performance brokerage agencies (only permitted so long as Chinese parties are the controlling shareholders).
Items shifted from the prohibited category to the restricted category in the 2014 draft catalogue but put back into the prohibited category in the 2015 Catalogue. These include the highly culturally sensitive industries of the production of audio-video products and electronic publications.
Items shifted from the prohibited category to the permitted category in the 2014 draft catalogue but put back into the prohibited category in the 2015 Catalogue. These include theatre companies.

China releases 2015 foreign investment catalogue | Practical Law