Chinese Premier Li Keqiang inspects Waigaoqiao Port in Shanghai before the establishment of the Shanghai Pilot Free Trade Zone. In recent years, China has been reforming its examination and approval system to encourage foreign investment. (PHOTO: XINHUA)

 

Several laws and regulations have laid the foundation for the supervision of foreign direct investment (FDI) in mainland China, but the legacy of the planned economy has lingering effects on legislation and the economic structure. Despite enormous demand for foreign investment, legislators established strict mechanisms for the examination and approval of FDI in the early stages of reform, when China first opened its doors to the establishment of foreign-invested enterprises.

 

Limitations
In the early period of China’s opening up, foreign applications to establish an enterprise were submitted for approval to the department in charge of foreign economic relations and trade under the State Council, an authorized agency or the local people’s government. The procedures were cumbersome and covered a wide variety of issues, from the scope of business in the period of establishment to any change, amendment or dissolution of the enterprises. Only those enterprises examined and approved were entitled to register and do business in China.

This process of individual approval was meant to ensure China’s economic interest and national security, but whether it achieved the intended result is debatable. The red tape involved in gaining official approval has led to the ineffectiveness of the authorities in charge.
 

Furthermore, the guidelines on the process were not made public, diminishing China’s attractiveness to foreign investors. From this perspective, the authorities in charge of foreign investment performed too many functions, acting on issues ranging from market access and national security review to anti-monopoly investigation. This state of affairs meant that they inevitably intervened too much when evaluating a potential foreign investment.
 

Procedures for approving FDI have been constantly amended and adjusted in accordance with China’s rapid development of a market economy. However, jurisdictional conflicts have emerged in cases where several authorities were simultaneously empowered to make laws, statutes or regulations according to the legislative powers granted to each domain. Despite its appropriateness for a certain period of development, the present mechanism of FDI approval, if not reformed, will impede the influx of foreign investment in the long run.

 

Road to reform
Under the guidance of the Party’s Central Committee, the Chinese government is reforming administrative review and approval while transitioning to the role of a service-oriented government. Detailed reforms are also happening in the supervision of foreign investment. The scope of investments that are required to be submitted for review has been narrowed, and regulations on some issues that can be best governed by the free market will be gradually relaxed or removed to strengthen the autonomy of enterprises.
 

In addition, the procedures and the form taken have been optimized through strengthened cooperation among all sectors of the government, which improves the efficiency of the authorities and benefits foreign investors.
 

The Draft Foreign Investment Law issued for public comment by the Ministry of Commerce last year marked a profound change of China’s attitude towards the supervision of FDI. This draft laid out a new mechanism of supervision under which most issues will no longer be subject to the review and approval currently required. The mechanism is now undergoing a transition, and periodic achievements have been made since China conducted pilot projects on selected areas. More improvements both in legislation and practice are needed to fundamentally reform the mechanism.
 

From the perspective of legislation governing the acts of enterprises, three major laws have been amended to fine-tune the FDI approval mechanism, according to the legislative schedule of the Standing Committee of the National People’s Congress. However the present legal mechanism still can be improved to more effectively manage, guide and encourage foreign investment in China.
 

It is not enough to amend or supplement only the administrative laws that govern foreign investments. Other laws concerned, such as the Company Law and the Securities Law, should be also updated to adapt to the reforms, despite the fact that these laws are comparatively more advanced and scientific than other laws pertaining to corporate governance and the securities market.
 

Some of the more detailed actions may be taken. For example, rules may be unified that are generally accepted in all laws concerned. Specific rules about foreign investment should be checked based on the rationality and necessity of their specialties.
 

Rules that are not necessary should be abolished or merged into the existing rules of the Company Law. Rules that are necessary should be divided into two categories according to their specific content: rules concerning the supervision and management of foreign investment may be codified into the Foreign Investment Law in the future, while rules concerning the organizational form of the enterprise may be codified into laws like the Company Law, with an entire section dedicated specifically to such issues.
 

The FDI approval mechanism allows the government to intervene in the establishment and operations of foreign-invested enterprises. And the autonomy of enterprises will be restored, easing the limitations on foreign investment after the amendments made to laws like the Company Law.
 

Proposals regarding legal matters accounted for a significant portion of proposals at the Two Sessions, including proposals for an amendment to the Company Law, which would be a great opportunity for FDI reform.

 

New mechanism
Foreign investment has a non-negligible influence on the market economy in China because of its impact, both positive and sometimes negative, on China’s industrial structure optimization and upgrading, capital market and securities market. Limitations on foreign investment in China are necessary even if some rules of the existing mechanism will be abolished in the future.
 

Enterprises established by foreign investors cannot be seen as domestic enterprises despite the changes made to the mechanism. Therefore, the focus of FDI reform should be the establishment of an effective mechanism of market access combined with anti-monopoly investigation and national security review. Laws on the supervision of foreign investment should be improved while amendments and supplements to laws governing corporations are also needed.
 

In 2011, the State Council released guidelines for security review in cases of mergers and acquisitions, which will play an important role in future FDI reforms. And the mechanism of national security review, which has adopted the negative list model for foreign investment access, has been applied in the Shanghai Pilot Free Trade Zone.

Together with China’s National Security Law, which entered into force in 2015, a preliminary mechanism of national security review on foreign investment has been established. However, this mechanism lacks effective supervision of the review process itself, which is typical in situations where there are conflicting jurisdictions and there is no means of seeking administrative relief when an investor fails to pass the review.
 

The supervision of review agencies should be strengthened in future legislation. The power to supervise and question the review on foreign investment should be endowed to the Standing Committee of the National People’s Congress. A mechanism of review on foreign investment, which is of mutual restriction and mutual supervision, should be established and effectively implemented to both secure the corporate autonomy of foreign investors and encourage the sustained development of foreign investment in China.

 

Ye Xue is from the School of Law at Renmin University of China.