How China’s new law may affect foreign business

In March, China passed a new law governing all foreign investments, a move that could create a level playing field for foreign and domestic companies operating in the country. However, the announcement has been generating more questions than answers amongst foreign investors, as many are unsure how the new law will be implemented.

Here are some highlights and recommendations from experts on what businesses can do.

What is in the law?

Comprising 42 articles in six chapters, the Foreign Investment Law formally bans forced technology transfer and assures foreign investors that their intellectual property rights will be protected. It also covers investment promotion, protection, and management, and the legal responsibilities of the Chinese government and foreign entities.

The law will enter into force on 1 January 2020 and will replace three existing laws — the Sino-Foreign Equity Joint Venture Law, the Sino-Foreign Cooperative Joint Venture Law, and the Wholly Foreign-Owned Enterprise Law — enacted in the late 1970s and 1980s when China first opened its doors to foreign capital. It’s a response to long-standing concerns of foreign investors in China and seen as a step toward a more level playing field for foreign investors.

The law will affect businesses with investments in China, whether through a wholly owned foreign company, equity joint venture, or contractual joint venture.

Why a new law now?

The law’s timing is leading China observers to believe that the country’s ongoing trade talks with the US played a huge factor.

“We’re surprised but not surprised at the same time,” said Catherine Zheng, an intellectual property partner at Deacons law firm in Hong Kong, in an interview with FM. “The trade war has really made a difference on this particular field. The complaint by foreign companies had always been that it’s not a level playing field for foreign companies in China.”

The reason China’s decades-old laws governing foreign investments are undergoing reform is to ensure that the country remains an attractive economy to invest in. Last year, China was the second largest recipient of foreign investments, behind the US, at a record $142 billion, according to the UN’s Conference on Trade and Development’s (UNCTAD) Investment Trends Monitor.

Amidst China’s economic slowdown, ensuring a healthy flow of foreign investment into its economy is crucial for the government to maintain economic and social stability.

A report by British law firm Linklaters projects the new Foreign Investment Law will attract $1.5 trillion of inbound investment into China over the next ten years.

“Opening up is China’s fundamental state policy. It has delivered real benefits to Chinese people and the world, so why wouldn’t we go ahead with it? If we make a promise of opening up, we will certainly deliver,” said Chinese Premier Li Keqiang at the closing of the National People’s Congress meeting in March, the South China Morning Post reported.

Concerns with the new law

Foreign investors and business groups, however, have raised concerns as to how the new law will be implemented.

“The main issue is [that] a lot of concerns have been raised about implementing regulations which have not yet been released in draft form,” Lester Ross, a Beijing-based partner at law firm WilmerHale, told FM. “As a result, it’s unclear how much of a positive impact the law will have on foreign investment.”

Ross said that companies are uncertain how they can be legally compliant in both China and their home countries under the new law. An example is in data privacy and security.

“How can [companies] be assured they can govern their [China-based] subsidiaries, if the subsidiary may not be able to transfer data routinely to the home [country] office?” Ross said.

The Chinese government requires all companies operating in China to store data within the country. For instance, last year, Apple transferred its Chinese iCloud operations to a Chinese firm to comply with this.

“How much cost will arise if [companies] have to maintain separate data centres and data operating facilities [in China] or to somehow isolate China from their operations elsewhere?” Ross added.

Another example is in governance. The law does not explain what the role of Communist Party entities within foreign companies will be, Ross said.

A provision in China’s Company Law requires all companies registered in China to set up a Communist Party branch and “provide the necessary conditions” for its activities. As of 2016, 70% of wholly or partly owned foreign companies in China had a Communist Party entity within their companies, the Wall Street Journal reported.

The Chinese government has said that the presence of a party branch is beneficial as it helps companies understand China’s policies and resolve labour disputes, and provides guidance in corporate culture.

However, foreign business groups like the European Union Chamber of Commerce in China have highlighted pressures from Chinese joint-venture partners to allow party branches to expand their roles in business operations and to be involved in investment decisions.

The six months leading up to January 2020 will be crucial as China’s State Council, its executive and administrative body, releases information on the new law’s implementation mechanism.

What can companies do now?

Ross points to three key things to look out for in the coming months: continual legal reforms, implementing regulations for the Foreign Investment Law, and the impact of China’s trade war with the US.

Companies in the meantime can perform internal reviews to determine their best strategy, and an important consideration is whether they will be compliant with the laws in their home countries by complying with China’s new law, Ross advised.

“Decide what to keep in China, including data and the supply chain,” he said.

When it comes to protecting intellectual property, C.F. Wong, ACMA, CGMA, finance head of a company with manufacturing and sales operations in China, said it’s important to have business control procedures in place, whatever the legal environment.

He advised:

• Control access to intellectual property information. In companies’ research and development departments, for example, procedures can be set up to control employees’ access to information on intellectual property. He also recommends companies have a centralised control system to document which employees have access or copies of that information.
• Implement checks when employees leave the company. When a staff member leaves the company, there should be a check to ensure they don’t possess confidential information belonging to the company and its customers. “You can’t be sure that there will not be theft, but you have to put in the appropriate control procedure,” Wong said.
  
• Scan the horizon. Giving the example of the consumer goods sector, Wong advised that a company should perform routine horizon-scanning of what’s being sold in the market, especially in today’s e-commerce marketplace, where copies of original products are made more easily accessible. “You can see what competitors have come up with, and if there’s a carbon copy of your product, you should examine it carefully and take appropriate action to safeguard your intellectual property rights,” he said, adding that this task can be placed under the sales and marketing team’s remit as their roles already include competitor analysis and benchmarking.

Resources: See the law’s official release in English here and an informal English translation of the law here.

— Alexis See Tho (Alexis-SeeTho@aicpa-cima.com) is an FM magazine associate editor.