China's Negative List: An Explainer for Foreign Investment in China

China's Negative List: An Explainer for Foreign Investment in China

As China has become one of the largest recipients of Foreign Direct Investment (FDI) globally, ranking second only after the United States in 2019, the country has actively sought to develop a legal framework to govern foreign investment over the past years.

The implementation of the
new Foreign Investment Law (FIL) as of January 1st, 2020, by the Chinese authorities characterized a major legislative development that brought a unification of the previously existing and distinctly separate laws on foreign investment into China. A key aspect which is upheld within the updated Chinese legal framework for foreign investment is the notion that approval for foreign investment into China occurs according to the principles of the so-called ‘Negative List’.

The Negative List provides guidance and governs industry sectors in which foreign investment is prohibited or where possible restrictions may apply. In July 2020, China’s Negative List for foreign investment was updated and the number of measures limiting foreign investment into the country were further reduced. The Chinese authorities cited both its long-term commitment to reform and opening up of its foreign investment environment as well as the impact of COVID-19 for the further relaxations in the Negative List. As such, with the end of 2020 in sight and global impact of COVID-19 as backdrop, this article provides an overview of the legal framework surrounding China’s Negative List, highlights the relevant updates in the past year and looks ahead at the expectations for future developments of the Negative List.

Background & Legal Framework
The aforementioned Foreign Investment Law which entered into force earlier this year provided a clear definition of foreign direct investment by foreign individuals, enterprises and other organizations, and aims to promote equal treatment of foreign and domestic enterprises, better protect investors rights and protect against forced technology transfers.

A key aspect within the Foreign Investment Law is National Treatment and implies that except for specific requirements pursuant the Negative List for Foreign Investment into China, the Chinese authorities should treat foreign investors as equal to domestic investors.

The 2020 Foreign Investment Negative List
China’s National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOF) jointly issued the updated Negative List (or
Special Administrative Measures on Access to Foreign Investment (2020)) and the updated Free Trade Zone Negative List (or Free Trade Zone Special Administrative Measures to Foreign Investment (2020)), both of which have come into effect as of July 2020.

As mentioned previously, the Negative List governs industry sectors in which foreign investment is prohibited and provides further guidance for industry sectors which are restricted. In turn this implies that if the industry sector does not fall within the aforementioned categories, foreign investors are entitled to the same treatment as domestic enterprises. In general, foreign investment into China is prohibited in industries if such foreign investment:

 
  • Threatens the country’s national security or military facilities;
  • Harms public interest;
  • Damages the environment;
  • Hinders the protection and development of land resources;
  • Or uses unique technology which is the property of China for manufacturing purposes.
Examples of industry sectors facing restrictions notably include industries such as the creative-, energy-, IT and telecommunications-, automotive-, and compulsory education industries. Industries which face restrictions according to the Negative List may still be accessible, however, they may require foreign investors to engage in a partnership with a Chinese partner (i.e. an equity- or cooperative Joint Venture) in which the Chinese party may or may not be required to hold a controlling interest.

Encouraged Industries for Foreign Investment
Shortly after the release of the Negative List for foreign investment into China, the Chinese authorities released as well the updated Encouraged Catalogue (or
Catalogue of Encouraged Industries for Foreign Investment (2020)). Contrary to the Negative List, the Encourage Catalogue stipulates industry sectors in which China welcomes Foreign Direct Investment and may enjoy favorable policies.

The Encouraged Catalogue stipulates three main areas in which the Chinese authorities welcome FDI, namely:

 
  • High-end manufacturing;
  • The production-oriented service industry;
  • Investment in China’s central, western and northeastern provinces.
Foreign-invested enterprises whom engage in investment in industries or regions as stipulated within the Encourage Catalogue may experience some of the following preferential policies:
 
  • Reductions or exemptions of tariffs on imported goods;
  • Increased accessibility to land used for foreign-invested projects through preferential pricing or fewer regulatory requirements;
  • Potential to enjoy a reduced Corporate Income Tax (CIT) rate

Recent Relaxations to the Negative List & Opportunities for Foreign Investors
The release of the updated Negative List and Free Trade Zone Negative List by the Chinese authorities in July of this year marked the fourth consecutive year in which restrictions to foreign investment in China have been formally reduced. In 2020, the restrictive and prohibitive measures as stipulated by the Negative List have been reduced from 40 to 33, whereas the restrictions as set out by the Free Trade Zone Negative List decreased to 30 compared to 37 the year prior.

The abovementioned changes to the Negative List in 2020 notably included further opening of the Services Sector in China to foreign investment. The current Negative List among others removed certain limitations in the Financial Services industry, including limitations on foreign ownership of companies in the futures-, securities-, securities investment fund management-, and life insurance business. The 2020 changes to the Negative List mean that foreign investors can have full direct ownership over companies in these financial sectors Another example of the latest changes to the Negative List is further opening up of the Manufacturing- and Agriculture Sectors. In line with these changes it becomes possible for foreign investors to obtain a shareholding ratio of up to 51% in Joint Ventures active in the commercial vehicles business in China. Other prohibitions which have been removed include the interdiction of foreign investment in the radioactive materials- and nuclear fuel industries. Furthermore, according to the updated Negative List foreign investors can be engaged in the Agricultural Sector in the selection and breeding of wheat as well as the production of seeds, provided that the Chinese partner maintains a minimum of 34% of shares in the partnership.

As was mentioned previously, we have also seen a reduction in the restrictions and prohibitions as stipulated by the Free Trade Zone Negative List. These changes may be of particular interest to foreign investors since the Free Trade Zones can be regarded as an important pilar through which the Chinese authorities intends to further liberalize its economy and promote foreign investment. The main developments which have been introduced in the updated Free Trade Zone Negative List include reducing restrictions in the Pharmaceutical- and Educational Sector. To be specific, foreign investors will be allowed to invest in ‘traditional Chinese medicine decoction units’ and foreign investment into professional training institutes in Chinese Free Trade Zones will be permitted.

Our Thoughts on China's Negative List for Foreign Investment
The implementation of the Foreign Investment Law has sought to further encourage foreign investment into China and promote equal treatment of foreign- and domestic investors through the principle of National Treatment, except restrictions and prohibitions to foreign investment according to the provisions of the Negative Lists.

With the promulgation of the updated Negative List for foreign investment in July 2020 we observe further liberalization and opening of the Chinese economy to foreign investment, where restrictions and prohibitions as set out by the Negative List have been reduced for the fourth consecutive year. Among others, the changes to the Negative List in 2020 include liberalization of foreign ownership requirements in the financial services sector, removal of the interdiction of foreign investment into the radioactive materials and nuclear fuel cells sector and improved access for foreign investors to the pharmaceutical and educations sectors in China’s Free Trade Zones.

Despite the reduction of restrictions and prohibitions as stipulated by the Negative List it must be noted that challenges remain. Without active guidance from the Chinese central government, implementation of the relaxations to the restrictions of foreign investment at the local level may be hindered. Furthermore, foreign investors may experience difficulties to achieve the new (practical) requirements to obtain key licenses in recently liberalized sectors and will likely experience strong competition from existing domestic competitors. Nevertheless, we recommend foreign investors to review the applicable restrictions within the Negative List for a complete and accurate of investment opportunities in China.

We have successfully supported numerous foreign businesses to establish a Chinese subsidiary throughout all regions of China and provided advice on the most suitable business structure taking into account their business requirements.
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