China is trying to show it is still open to and encouraging foreign investment with its proposed draft Foreign Investment Law set for passage on March 15th, released at the end of January. This most recent version follows a four-year gap from the first draft law issued in early 2015. Time is now suddenly of the essence as the law is seen as being pushed through to help with the US-China negotiations on tariff escalations.
The law addresses several issues at a very high level:
- Promotes national treatment – The idea, which remains a core principle of the WTO, that foreign companies should enjoy the same treatment as their domestic competitors regarding taxes, licenses, and other requirements in China. This is of course only for industries not on the Negative List (see below).
- Prohibit exceptional local government requirements – China has agreed to open its markets in many industries in the years following its ascension to the WTO in 2001, but progress remains slow as the specific licensing and other processes can break down at the local government level.
- Government procurement – Allowing foreign companies to bid with transparency on government contracts.
- Prohibits “forced” technology transfers – Technology transfer should be made purely on a negotiated, voluntary basis between the parties to a joint venture or other arrangement.
- Maintains the “Negative List” - Designating areas that are off-limits or restricted for foreign investment.
- Condones the “variable interest entity (VIE) structure” - At least for the near future, allowing foreign registered special purpose vehicles to have contractual control of companies in restricted industries (e.g. local internet operating companies).
- National security – Foreign companies and investors must not endanger China’s national security or harm the public interest.
The proposed law should only be seen as a term sheet or letter of intent, but that is absent real teeth until implementation rules come at a later date. The statement of intent is important and surely welcomed in the foreign business community, but that community has also voiced a concern that this law is being rushed through without effective time to comment, in order to be used as a concession in the trade negotiations with the US. That concern is overstated as there will be several other chances to formally and informally comment as those implementing rules are prepared.
Some rules may not have been completely vetted for how they will be put into practice and some potential unintended consequences. For example, there is no absolute grandfather provision (other than a 5 year adjustment window) for structures already in place which may conflict with the new law. This will have particularly big implications for so called “cooperative” joint ventures. Left unchanged, that will create an opportunity for one side of the JV to aggressively renegotiate the original terms of the arrangement.
Foreign governments and trade associations tried to get certain provisions in to the law such as reducing government subsidies for state-owned enterprises, but major issues like this are not new nor were they haphazardly excluded based on time pressures. They were never going to make it into the law no matter how long the comment process took.
Rather than addressing the timing of the law, the bigger concern coming from the Western business community should be whether this law is implemented in a detailed and enforceable manner. In its current draft form, the core tenets of this law simply remain a statement of ideals even more so than the first draft four years ago.
With impending tariffs threatened by Washington, it’s hard to know if this was a statement of true intent or a statement made with a metaphorical gun to one’s head – one therefore likely to breakdown at a later date. China needs to reach the conclusion on its own of the continuing benefits of an open trade and investment environment. Both for its ability to gain access to foreign markets for its new breed of would-be global champions, like Alibaba, Huawei, Lenovo, and others, as well as to allow full access in certain industries, the financial sector being a prime example, that would probably end up helping strengthen national champions in the long-run through the pressures for real competition.
The provision on national security, another issue the foreign business community has voiced concern over, is simply a restatement of a guiding principle of Chinese law in the last four decades. For example, prominently expressed as a principle for deciding on cases in the Anti-Monopoly Law. That “national security” considerations can be open to ambiguity, misinterpretation, and abuse is true. However, until we see how the pilot program for the revamped version of CFIUS (Committee on Foreign Investment in the US) concludes, the trajectory seems to favor an ever-expanding domain of CFIUS for review of national security to determine foreign investment restrictions in companies now including with “critical and emerging” technologies or sensitive data. So long as issues are framed in terms of national security, regardless of country, everything is open to interpretation in a way favorable to local protectionism.
The issue of “forced” technology transfers has of course always been one open to interpretation as well. The EU claims in its recent WTO complaint that China has more than just pushed the boundaries on its WTO commitments to not impose “performance” requirements by requiring technology transfer as a condition to market entry. But by and large most technology transfers in joint ventures are done as a product of negotiation between the parties. Again, so long as market access is restricted to joint venture form only and this market access rule complies with the WTO, the actual negotiation then left between two potential JV partners is exactly that, a negotiation. Cash contributions on the Chinese side of the venture is no longer a problem as it used to be, and a Chinese partner is right to ask for access to technology and know-how (and pay for that directly or indirectly through capital contributions, royalties, and/or remitted profits) as part of the negotiations in giving local marketing know-how. That is the price most foreign companies have to choose to pay to be in such a massive market.
With imminent passage of the new law coming at the time of intense trade negotiations, only future implementing rules and then the actual administration of those rules will dictate whether the law is a fleeting statement of nice-sounding principles or something that represents major market access reform. Many of the ideas contained in the law are not new and have either already been committed to previously under the WTO or simply sound aspirational but not concrete. At the time of agreeing to the WTO imposed rules almost two decades ago, market reformers used the prestige of entering the WTO and its rules as a hammer to make many changes they had long been seeking internally anyway. Here, China is being directly threatened, it is being asked to make substantial changes to keep trade flowing on existing terms. There is no positive prestige gain in play here, so one has to look carefully at its intent. Still, the draft and impending passage of the law is undoubtedly a good sign that China is not flagrantly turning its back on market reform. That much is most definitely clear now.