China is one of the top global foreign direct investment destinations due to its large consumer base and integrated supply chains. China remains, however, a relatively restrictive investment environment for foreign investors due to restrictions in key economic sectors. Obstacles to investment include ownership caps and requirements to form joint venture partnerships with local Chinese firms, as well as the requirement often imposed on U.S. firms to transfer technology as a prerequisite to gaining market access. While China made modest openings in some sectors in 2018, such as financial services, insurance, new energy vehicles, and shipbuilding, China’s investment environment continues to be far more restrictive than those of its main trading partners, including the United States.
China relies on the Special Administrative Measures for Foreign Investment Access (known as the “nationwide negative list”) to categorize market access restrictions for foreign investors in defined economic sectors. While China in 2018 reduced some restrictions, foreign participation in many industries important to U.S. investors remain restricted, including financial services, culture, media, telecommunications, vehicles, and transportation equipment.
Even in sectors “open” to foreign investment, foreign investors often face difficulty establishing an investment due to stringent and non-transparent approval processes to gain licenses and other needed approvals. These restrictions shield inefficient and monopolistic Chinese enterprises in many industries – especially state-owned enterprises (SOEs) and other enterprises deemed “national champions” – from competition against private and foreign companies. In addition, lack of transparency in the investment process and lack of rule of law in China’s regulatory and legal systems leave foreign investors vulnerable to discriminatory practices such as selective enforcement of regulations and interference by the Chinese Communist Party (CCP) in judicial proceedings. Moreover, industrial policies such as Made in China 2025 (MIC 2025), insufficient protection and enforcement of intellectual property rights (IPR), requirements to transfer technology, and a systemic lack of rule of law are further impediments to successful foreign investments in China.
During the CCP 19th Party Congress held in October 2017, CCP leadership underscored Party Chairman Xi Jinping’s primacy by adding “Xi Jinping Thought on Socialism with Chinese Characteristics for the New Era” to the Party Charter. In addition to significant personnel changes, the Party announced large-scale government and Party restructuring plans in early 2018 that further strengthened Xi’s leadership and expanded the role of the Party in all facets of Chinese life: cultural, social, military, and economic. An increasingly assertive CCP has caused concern among the foreign business community about the ability of future foreign investors to make decisions based on commercial and profit considerations, rather than political dictates from the Party.
Although market access reform has been slow, the Chinese government has pledged greater market access and national treatment for foreign investors and has pointed to key announcements and new developments, which include:
- On June 28, 2018 the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM) jointly announced the release of Special Administrative Measures for Foreign Investment Access (i.e., “nationwide negative list”), which replaced the Foreign Investment Catalogue. The negative list was reformatted to remove “encouraged” economic sectors and divided restrictions and prohibitions by industry. Some of the liberalizations were previously announced, like financial services and insurance (November 2017) and automobile manufacturing and shipbuilding (April 2018). A new version of the negative list is expected to be released in 2019.
- On June 30, 2018 NDRC and MOFCOM jointly released the Special Administrative Measures for Foreign Investment Access in the Pilot Free Trade Zones (i.e., the Free Trade Zone, or FTZ, negative list). The FTZ negative list matched the nationwide negative list with a few exceptions, including: foreign equity caps of 66 percent in the development of new varieties corn and wheat (the nationwide cap is 49 percent), removal of joint venture requirements on oil and gas exploration, and removal of the prohibition on radioactive mineral smelting and processing, including nuclear fuel production.
- On December 25, 2018 the NDRC and MOFCOM jointly released The Market Access Negative List. This negative list, unlike the nationwide negative list that applies only to foreign investors, defines prohibitions and restrictions to investment for all investors, both foreign and domestic. This negative list attempted to unify guidance on allowable investments previously found in piecemeal laws and regulations that were often industry-specific. This list also highlighted what economic sectors are only open to state-owned investors.
- On March 17, 2019 the National People’s Congress passed a Foreign Investment Law (FIL) that effectively replaced existing law governing foreign investment (i.e., the China-Foreign Joint Venture Law, the Contract Joint Venture Law, and the Wholly Foreign-Owned Enterprises Law). As drafted, the FIL would address longstanding concerns of U.S. investors, including forced technology transfer and national treatment; however, due to lack of details and implementation guidelines, it is not clear how foreign investor rights would be protected.
While Chinese pronouncements of greater market access and fair treatment of foreign investment is welcome, details are needed on how these policies will address longstanding problems foreign investors have faced in the Chinese market, including being subject to inconsistent regulations, licensing and registration problems, insufficient IPR protections, and various forms of Chinese protectionism that have created an unpredictable and discriminatory business climate.
Table 1: Key Metrics and Rankings
|Transparency International’s Corruption Perceptions Index||2018||87 of 180||http://www.transparency.org/research/cpi/overview|
|World Bank’s Doing Business Report||2018||46 of 190||http://www.doingbusiness.org/en/rankings|
|Global Innovation Index||2018||17 of 126||https://www.globalinnovationindex.org/analysis-indicator|
|U.S. FDI in partner country ($M USD, stock positions)||2017||$107,556||http://www.bea.gov/international/factsheet/|
|World Bank GNI per capita||2018||$8,690||http://data.worldbank.org/indicator/NY.GNP.PCAP.CD|
1. Openness To, and Restrictions Upon, Foreign Investment
Policies Towards Foreign Direct Investment
China continues to be one of the largest recipients of global FDI due to a relatively high economic growth rate, growing middle class, and an expanding consumer base that demands diverse, high quality products. FDI has historically played an essential role in China’s economic development. In recent years, due to stagnant FDI growth and gaps in China’s domestic technology and labor capabilities, Chinese government officials have prioritized promoting relatively friendly FDI policies promising market access expansion and national treatment for foreign enterprises through general improvements to the business environment. They also have made efforts to strengthen China’s legal and regulatory framework to enhance broader market-based competition. Despite these efforts, the on-the-ground reality for foreign investors in China is that the operating environment still remains closed to many foreign investments across a wide range of industries.
In 2018, China issued the nationwide negative list that opened up a few new sectors to foreign investment and promised future improvements to the investment climate, such as leveling the playing field and providing equal treatment to foreign enterprises. However, despite these reforms, FDI to China has remained relatively stagnant in the past few years. According to MOFCOM, total FDI flows to China slightly increased from about USD126 billion in 2017 to just over USD135 billion in 2018, signaling that modest market openings have been insufficient to generate significant foreign investor interest in the market. Rather, foreign investors have continued to perceive that the playing field is tilted towards domestic companies. Foreign investors have continued to express frustration that China, despite continued promises of providing national treatment for foreign investors, has continued to selectively apply administrative approvals and licenses and broadly employ industrial policies to protect domestic firms through subsidies, preferential financing, and selective legal and regulatory enforcement. They also have continued to express frustration over China’s weak protection and enforcement of IPR; corruption; discriminatory and non-transparent anti-monopoly enforcement that forces foreign companies to license technology at below-market prices; excessive cybersecurity and personal data-related requirements; increased emphasis on requirements to include CCP cells in foreign enterprises; and an unreliable legal system lacking in both transparency and rule of law.
China seeks to support inbound FDI through the MOFCOM “Invest in China” website (www.fdi.gov.cn ). MOFCOM publishes on this site laws and regulations, economic statistics, investment projects, news articles, and other relevant information about investing in China. In addition, each province has a provincial-level investment promotion agency that operates under the guidance of local-level commerce departments.
- American Chamber of Commerce China 2019 American Business in China White Paper: https://www.amchamchina.org/policy-advocacy/white-paper/
- American Chamber of Commerce China 2019 Business Climate Survey: https://www.amchamchina.org/policy-advocacy/business-climate-survey/
- U.S.-China Business Council’s 2018 China Business Environment Member Survey: https://www.uschina.org/reports/uscbc-2018-member-survey
- EU Chamber’s 2018 Business Confidence Survey: http://www.europeanchamber.com.cn/en/publications-business-confidence-survey .
- MOFCOM’s Investment Promotion Website: http://www.fdi.gov.cn/1800000121_10000161_8.html
Limits on Foreign Control and Right to Private Ownership and Establishment
In June 2018, the Chinese government issued the nationwide negative list for foreign investment that replaced the Foreign Investment Catalogue. The negative list identifies industries and economic sectors restricted or prohibited to foreign investment. Unlike the previous catalogue that used a “positive list” approach for foreign investment, the negative list removed “encouraged” investment categories and restructured the document to group restrictions and prohibitions by industry and economic sector. Foreign investors wanting to invest in industries not on the negative list are no longer required to obtain pre-approval from MOFCOM and only need to register their investment.
The 2018 foreign investment negative list made minor modifications to some industries, reducing the number of restrictions and prohibitions from 63 to 48 sectors. Changes included: some openings in automobile manufacturing and financial services; removal of restrictions on seed production (except for wheat and corn) and wholesale merchandizing of rice, wheat, and corn; removal of Chinese control requirements for power grids, building rail trunk lines, and operating passenger rail services; removal of joint venture requirements for rare earth processing and international shipping; removal of control requirements for international shipping agencies and surveying firms; and removal of the prohibition on internet cafés. While market openings are always welcomed by U.S. businesses, many foreign investors remain underwhelmed and disappointed by Chinese government’s lack of ambition and refusal to provide more significant liberalization. Foreign investors continue to point out these openings should have happened years ago and now have occurred mainly in industries that domestic Chinese companies already dominate.
The Chinese language version of the 2018 Nationwide Negative List: http://www.ndrc.gov.cn/zcfb/zcfbl/201806/W020180628640822720353.pdf .
The foreign investment negative list restricts investments in certain industries by requiring foreign companies enter into joint ventures with a Chinese partner, imposing control requirements to ensure control is maintained by a Chinese national, and applying specific equity caps. Below are just a few examples of these investment restrictions:
Examples of foreign investments that require an equity joint venture or cooperative joint venture for foreign investment include:
- Exploration and development of oil and natural gas;
- Printing publications;
- Foreign invested automobile companies are limited to two or fewer JVs for the same type of vehicle;
- Market research;
- Preschool, general high school, and higher education institutes (which are also required to be led by a Chinese partner);
- General Aviation;
- Companies for forestry, agriculture, and fisheries;
- Establishment of medical institutions; and
- Commercial and passenger vehicle manufacturing.
Examples of foreign investments requiring Chinese control include:
- Selective breeding and seed production for new varieties of wheat and corn;
- Construction and operation of nuclear power plants;
- The construction and operation of the city gas, heat, and water supply and drainage pipe networks in cities with a population of more than 500,000;
- Water transport companies (domestic);
- Domestic shipping agencies;
- General aviation companies;
- The construction and operation of civilian airports;
- The establishment and operation of cinemas;
- Basic telecommunication services;
- Radio and television listenership and viewership market research; and
- Performance agencies.
Examples of foreign investment equity caps include:
- 50 percent in automobile manufacturing (except special and new energy vehicles);
- 50 percent in value-added telecom services (excepting e-commerce);
- 51 percent in life insurance firms;
- 51 percent in securities companies;
- 51 percent futures companies;
- 51 percent in security investment fund management companies; and
- 50 percent in manufacturing of commercial and passenger vehicles.
Investment restrictions that require Chinese control or force a U.S. company to form a joint venture partnership with a Chinese counterpart are often used as a pretext to compel foreign investors to transfer technology against the threat of forfeiting the opportunity to participate in China’s market. Foreign companies have reported these dictates and decisions often are not made in writing but rather behind closed doors and are thus difficult to attribute as official Chinese government policy. Establishing a foreign investment requires passing through an extensive and non-transparent approval process to gain licensing and other necessary approvals, which gives broad discretion to Chinese authorities to impose deal-specific conditions beyond written legal requirements in a blatant effort to support industrial policy goals that bolster the technological capabilities of local competitors. Foreign investors are also often deterred from publicly raising instances of technology coercion for fear of retaliation by the Chinese government.
Other Investment Policy Reviews
Organization for Economic Cooperation and Development (OECD)
China is not a member of the OECD. The OECD Council decided to establish a country program of dialogue and co-operation with China in October 1995. The most recent OECD Investment Policy Review for China was completed in 2008 and a new review is currently underway.
OECD 2008 report: http://www.oecd.org/daf/inv/investment-policy/oecdinvestmentpolicyreviews-china2008encouragingresponsiblebusinessconduct.htm .
In 2013, the OECD published a working paper entitled “China Investment Policy: An Update,” which provided updates on China’s investment policy since the publication of the 2008 Investment Policy Review.
- OECD 2013 Update: http://www.oecd.org/china/WP-2013_1.pdf
- OECD Regulatory Restrictiveness Survey: http://www.oecd.org/investment/fdiindex.htm
World Trade Organization (WTO)
China became a member of the WTO in 2001. WTO membership boosted China’s economic growth and advanced its legal and governmental reforms. The sixth and most recent WTO Investment Trade Review for China was completed in 2018. The report highlighted that China continues to be one of the largest destinations for FDI with inflows mainly in manufacturing, real-estate, leasing and business services, and wholesale and retail trade. The report noted changes to China’s foreign investment regime that now relies on the nationwide negative list and also noted that pilot FTZs use a less restrictive negative list as a testbed for reform and opening.
- WTO Investment Trade Review for China: https://www.wto.org/english/tratop_e/tpr_e/tp475_e.htm
- International Monetary Fund (IMF) information on China: http://www.imf.org/external/country/Chn/
- FDI Statistics from MOFCOM: http://www.fdi.gov.cn/1800000121_10000177_8.html
China made progress in the World Bank’s Ease of Doing Business Survey by moving from 78th in 2017 up to 46th place in 2018 out of 190 economies. This was accomplished through regulatory reforms that helped streamline some business processes including improvements related to cross-border trading, setting up electricity, electronic tax payments, and land registration. This ranking, while highlighting business registration improvements that benefit both domestic and foreign companies, does not account for major challenges U.S. businesses face in China like IPR protection and forced technology transfer.
- World Bank Ease of Doing Business: http://www.doingbusiness.org/rankings
- World Bank Investing Across Borders: http://iab.worldbank.org/data/exploreeconomies/china
The Government Enterprise Registration (GER), an initiative of the United Nations Conference on Trade and Development (UNCTAD), gave China a low score of 1.5 out of 10 on its website for registering and obtaining a business license. In previous years, the State Administration for Industry and Commerce (SAIC) was responsible for business license approval. In March 2018, the Chinese government announced a major restructuring of government agencies and created the State Administration for Market Regulation (SAMR) that is now responsible for business registration processes. According to GER, SAMR’s Chinese website lacks even basic information, such as what registrations are required and how they are to be conducted.
- UNCTAD GER: https://ger.co/
- SAMR Business Registration Information: http://www.saic.gov.cn/
The State Council, which is China’s chief administrative authority, in recent years has reduced red tape by eliminating hundreds of administrative licenses and delegating administrative approval power across a range of sectors. The number of investment projects subject to central government approval has reportedly dropped significantly. The State Council also has set up a website in English, which is more user-friendly than SAMR’s website, to help foreign investors looking to do business in China.
The State Council Information on Doing Business in China: http://english.gov.cn/services/doingbusiness
The Department of Foreign Investment Administration within MOFCOM is responsible for foreign investment promotion in China, including promotion activities, coordinating with investment promotion agencies at the provincial and municipal levels, engaging with international economic organizations and business associations, and conducting research related to FDI into China. MOFCOM also maintains the “Invest in China” website.
MOFCOM “Invest in China” Information: http://www.fdi.gov.cn/1800000121_10000041_8.html
Despite recent efforts by the Chinese government to streamline business registration procedures, foreign companies still complain about the challenges they face when setting up a business. In addition, U.S. companies complain they are treated differently from domestic companies when setting up an investment, which is an added market access barrier for U.S. companies. Numerous companies offer consulting, legal, and accounting services for establishing wholly foreign-owned enterprises, partnership enterprises, joint ventures, and representative offices in China. The differences among these corporate entities are significant, and investors should review their options carefully with an experienced advisor before choosing a particular Chinese corporate entity or investment vehicle.
Since 2001, China has initiated a “going-out” investment policy that has evolved over the past two decades. At first, the Chinese government mainly encouraged SOEs to go abroad and acquire primarily energy investments to facilitate greater market access for Chinese exports in certain foreign markets. As Chinese investors gained experience, and as China’s economy grew and diversified, China’s investments also have diversified with both state and private enterprise investments in all industries and economic sectors. While China’s outbound investment levels in 2018 were significantly less than the record-setting investments levels in 2016, China was still one of the largest global outbound investors in the world. According to MOFCOM outbound investment data, 2018 total outbound direct investment (ODI) increased less than one percent compared to 2017 figures. There was a significant drop in Chinese outbound investment to the United States and other North American countries that traditionally have accounted for a significant portion of China’s ODI. In some European countries, especially the United Kingdom, ODI generally increased. In One Belt, One Road (OBOR) countries, there has been a general increase in investment activity; however, OBOR investment deals were generally relatively small dollar amounts and constituted only a small percentage of overall Chinese ODI.
In August 2017, in reaction to concerns about capital outflows and exchange rate volatility, the Chinese government issued guidance to curb what it deemed to be “irrational” outbound investments and created “encouraged,” “restricted,” and “prohibited” outbound investment categories to guide Chinese investors. The guidelines restricted Chinese outbound investment in sectors like property, hotels, cinemas, entertainment, sports teams, and “financial investments that create funds that are not tied to specific investment projects.” The guidance encouraged outbound investment in sectors that supported Chinese industrial policy, such as Strategic Emerging Industries (SEI) and MIC 2025, by acquiring advanced manufacturing and high-technology assets. MIC 2025’s main aim is to transform China into an innovation-based economy that can better compete against – and eventually outperform – advanced economies in 10 key high-tech sectors, including: new energy vehicles, next-generation IT, biotechnology, new materials, aerospace, oceans engineering and ships, railway, robotics, power equipment, and agriculture machinery. Chinese firms in MIC 2025 industries often receive preferential treatment in the form of preferred financing, subsidies, and access to an opaque network of investors to promote and provide incentives for outbound investment in key sectors. The outbound investment guidance also encourages investments that promote China’s OBOR development strategy, which seeks to create connectivity and cooperation agreements between China and countries along the Chinese-designated “Silk Road Economic Belt and the 21st-century Maritime Silk Road” through an expansion of infrastructure investment, construction materials, real estate, power grids, etc.
2. Bilateral Investment Agreements and Taxation Treaties
China has 109 Bilateral Investment Treaties (BITs) in force and multiple Free Trade Agreements (FTAs) with investment chapters. Generally speaking, these agreements cover topics like expropriation, most-favored-nation treatment, repatriation of investment proceeds, and arbitration mechanisms. Relative to U.S.-negotiated BITs and FTA investment chapters, Chinese agreements are generally considered to be weaker and offer less protections to foreign investors.
A list of China’s signed BITs:
- http://investmentpolicyhub.unctad.org/IIA/IiasByCountry#iiaInnerMenu .
The United States and China last held BIT negotiations in January 2017. China has been in active bilateral investment agreement negotiations with the EU since 2013. The two sides have exchanged market access offers and have expressed an intent to conclude talks by 2020. China also has negotiated 17 FTAs with trade and investment partners, is currently negotiating 14 FTAs and FTA-upgrades, and is considering eight further potential FTA and FTA-upgrade negotiations. China’s existing FTA partners are Maldives, Georgia, ASEAN, Republic of Korea, Pakistan, Australia, Singapore, Pakistan, New Zealand, Chile, Peru, Costa Rica, Iceland, Switzerland, Hong Kong, Macao, and Taiwan. China concluded its FTAs with Maldives and Georgia in 2017.
China’s signed FTAs:
The United States and China concluded a bilateral taxation treaty in 1984.
3. Legal Regime
Transparency of the Regulatory System
In assessing China’s regulatory governance effectiveness, the World Bank Global Indicators of Regulatory Governance gave China a composite score of 1.75 out 5 points. The World Bank attributed China’s relatively low score to the futility of foreign companies appealing administrative authorities’ decisions, given partial courts; not having laws and regulations in one accessible place that is updated regularly; the lack of impact assessments conducted prior to issuing new laws; and other concerns about public comments and transparency.
World Bank Rule Making Information: http://rulemaking.worldbank.org/en/data/explorecountries/china
In various business climate surveys, U.S. businesses operating in China consistently cite arbitrary legal enforcement and the lack of regulatory transparency among the top challenges of doing business in China. These challenges stem from a complex legal and regulatory system that provides government regulators and authorities broad discretion to selectively enforce regulations, rules, and other guidelines in an inconsistent and impartial manner, often to the detriment of foreign investor interests. Moreover, regulators are often allowed to hinder fair competition by allowing authorities to ignore Chinese legal transgressors while at the same time strictly enforcing regulations selectively against foreign companies.
Another compounding problem is that Chinese government agencies rely on rules and enforcement guidelines that often are not published or even part of the formal legal and regulatory system. “Normative Documents” (opinions, circulars, notices, etc.), or quasi-legal measures used to address situations where there is no explicit law or administrative regulation, are often not made available for public comment or even published, yet are binding in practice upon parties active in the Chinese market. As a result, foreign investors are often confronted with a regulatory system rife with inconsistencies that hinders business confidence and generates confusion for U.S. businesses operating in China.
One of China’s WTO accession commitments was to establish an official journal dedicated to the publication of laws, regulations, and other measures pertaining to or affecting trade in goods, services, Trade Related Aspects of Intellectual Property Rights (TRIPS), or the control of foreign exchange. The State Council’s Legislative Affairs Office (SCLAO) issued two regulations instructing Chinese agencies to comply with this WTO obligation and also issued Interim Measures on Public Comment Solicitation of Laws and Regulations and the Circular on Public Comment Solicitation of Department Rules, which required government agencies to post draft regulations and departmental rules on the official SCLAO website for a 30-day public comment period. Despite the fact this requirement has been mandated by Chinese law and was part of the China’s WTO accession commitments, Chinese ministries under the State Council continue to post only some draft administrative regulations and departmental rules on the SCLAO website. When drafts are posted for public comment, the comment period often is less than the required 30 days.
China’s proposed draft regulations are often drafted without using scientific studies or quantitative analysis to assess the regulation’s impact. When Chinese officials claim an assessment was made, the methodology of the study and the results are not made available to the public. When draft regulations are available for public comment, it is unclear what impact third-party comments have on the final regulation. Many U.S. stakeholders have complained of the futility of the public comment process in China, often concluding that the lack of transparency in regulation drafting is purposeful and driven primarily by industrial policy goals and other anti-competitive factors that are often inconsistent with market-based principles. In addition, foreign parties are often restricted from full participation in Chinese standardization activities, potentially providing Chinese competitors opportunity to develop standards inconsistent with international norms and detrimental to foreign investor interests.
In China’s state-dominated economic system, it is impossible to assess the motivating factors behind state action. The relationships are often blurred between the CCP, the Chinese government, Chinese business (state and private owned), and other Chinese stakeholders that make up the domestic economy. Foreign invested enterprises perceive that China prioritizes political goals, industrial policies, and a desire to protect social stability at the expense of foreign investors, fairness, and overall rule of law. These blurred lines are on full display in some industries that have Chinese Self-Regulatory Organizations (SROs) that make licensing decisions. For instance, a Chinese financial institution who is a direct competitor to a foreign enterprise applying for a license may be a voting member of the governing SRO and can either influence other SRO members or even directly adjudicate the application of the foreign license. To protect market share and competitive position, this company likely has an incentive to disapprove the license application, further hindering fair competition in the industry or economic sector.
For accounting standards, Chinese companies use the Chinese Accounting Standards for Business Enterprises (ASBE) for all financial reporting within mainland China. Companies listed overseas (including in Hong Kong) may choose to use ASBE, the International Financial Reporting Standards, or Hong Kong Financial Reporting Standards.
International Regulatory Considerations
China has been a member of the WTO since 2001. As part of its accession agreement, China agreed to notify the WTO Committee on Technical Barriers to Trade (TBT Committee) of all draft technical regulations. Compliance with this WTO commitment is something Chinese officials have promised in previous dialogues with U.S. government officials. The United States remains concerned that China continues to issue draft technical regulations without proper notification to the TBT Committee
Legal System and Judicial Independence
The Chinese legal system is based on a civil law model that borrowed heavily from the legal systems of Germany and France but retains Chinese legal characteristics. The rules governing commercial activities are found in various laws, regulations, and judicial interpretations, including China’s civil law, contract law, partnership enterprises law, security law, insurance law, enterprises bankruptcy law, labor law, and several interpretations and regulations issued by the Supreme People’s Court (SPC). While China does not have specialized commercial courts, it has created specialized courts and tribunals for the hearing of intellectual property disputes. In 2014, China launched three intellectual property (IP) courts in Beijing, Guangzhou, and Shanghai. In October 2018, the National People’s Congress approved the establishment of an national-level appellate tribunal within the SPC to hear civil and administrative appeals of technically complex IP cases .
China’s Constitution and various laws provide contradictory statements about court independence and the right of judges to exercise adjudicative power free from interference by administrative organs, public organizations, and/or powerful individuals. However in practice, courts are heavily influenced by Chinese regulators. Moreover, the Chinese Constitution established that the “leadership of the Communist Party” is supreme, which in practices makes judges susceptible to party pressure on commercial decisions impacting foreign investors. This trend of central party influence in all areas, not just in the legal system, has only been strengthened by President Xi Jinping’s efforts to consolidate political power and promote the role of the party in all economic activities. Other reasons for judicial interference may include:
- Courts fall under the jurisdiction of local governments;
- Court budgets are appropriated by local administrative authorities;
- Judges in China have administrative ranks and are managed as administrative officials;
- The CCP is in charge of the appointment, dismissal, transfer, and promotion of administrative officials;
- China’s Constitution stipulates that local legislatures appoint and supervise the courts; and
- Corruption may also influence local court decisions.
While in limited cases U.S. companies have received favorable outcomes from China’s courts, the U.S. business community consistently reports that Chinese courts, particularly at lower levels, are susceptible to outside political influence (particularly from local governments), lack the sophistication and educational background needed to understand complex commercial disputes, and operate without transparency. U.S. companies often avoid challenging administrative decisions or bringing commercial disputes before a local court because of perceptions that these efforts would be futile and for fear of future retaliation by government officials.
Reports of business disputes involving violence, death threats, hostage-taking, and travel bans involving Americans continue to be prevalent. However, American citizens and foreigners in general do not appear to be more likely than Chinese nationals to be subject to this kind of coercive treatment. Police are often reluctant to intervene in what they consider internal contract disputes.
Laws and Regulations on Foreign Direct Investment
The legal and regulatory framework in China controlling foreign direct investment activities is more restrictive and less transparent across-the-board compared to the investment frameworks of developed countries, including the United States. China has made efforts to unify its foreign investment laws and clarify prohibited and restricted industries in the negative list.
On March 17, 2019 China’s National People’s Congress passed the Foreign Investment Law (FIL) that intends to replace existing foreign investment laws. This law will go into effect on January 1, 2020 and will replace the previous foreign investment framework based on three foreign-invested entity laws: the China-Foreign Equity Joint Venture Enterprise Law, the China-Foreign Cooperative Joint Venture Enterprise Law, and the Foreign-Invested Enterprise (FIE) Law. The FIL provides a five-year transition period for foreign enterprises established under previous foreign investment laws, after which all foreign enterprises will be subject to similar laws as domestic companies, like the company law, the enterprise law, etc.
In addition to these foreign investment laws, multiple implementation guidelines and other administrative regulations issued by the State Council that are directly derived from the law also affect foreign investment. Under the three current foreign investment laws, such implementation guidelines include:
- Implementation Regulations of the China-Foreign Equity Joint Venture Enterprises Law;
- Implementation Regulations of the China-Foreign Cooperative Joint Venture Enterprise Law;
- Implementation Regulations of the FIE Law;
- State Council Provisions on Encouraging Foreign Investment;
- Provisions on Guiding the Direction of Foreign Investment; and
- Administrative Provisions on Foreign Investment to Telecom Enterprises.
In addition to the three central-level laws mentioned above, there are also over 1,000 rules and regulatory documents related to foreign investment in China, issued by government ministries, including:
- the Foreign Investment Negative List;
- Provisions on Mergers and Acquisition (M&A) of Domestic Enterprises by Foreign Investors;
- Administrative Provisions on Foreign Investment in Road Transportation Industry;
- Interim Provisions on Foreign Investment in Cinemas;
- Administrative Measures on Foreign Investment in Commercial Areas;
- Administrative Measures on Ratification of Foreign Invested Projects;
- Administrative Measures on Foreign Investment in Distribution Enterprises of Books, Newspapers, and Periodicals;
- Provision on the Establishment of Investment Companies by Foreign Investors; and
- Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors.
The State Council has yet to provide a timeframe for new implementation guidelines for the Foreign Investment Law that will replace the implementation guidelines under the previous foreign investment system. While the FIL reiterates existing Chinese commitments in regards to certain elements of the business environment, including IP protection for foreign-invested enterprises, details on implementation and the enforcement mechanisms available to foreign investors have yet to be provided.
In addition to central-level laws and implementation guidelines, local regulators and governments also enact their own regulations, rules, and guidelines that directly impact foreign investment in their geographical area. Examples include the Wuhan Administration Regulation on Foreign-Invested Enterprises and Shanghai’s Municipal Administration Measures on Land Usage of Foreign-Invested Enterprises.
A Chinese language list of Chinese laws and regulations, at both the central and local levels: http://www.gov.cn/zhengce/ .
FDI Laws on Investment Approvals
Foreign investments in industries and economic sectors that are not explicitly restricted or prohibited on the foreign investment negative list are not subject to MOFCOM pre-approval, but notification is required on proposed foreign investments. In practice, investing in an industry not on the negative list does not guarantee a foreign investor national treatment in establishing an foreign investment as investors must comply with other steps and approvals like receiving land rights, business licenses, and other necessary permits. In some industries, such as telecommunications, foreign investors will also need to receive approval from regulators or relevant ministries like the Ministry of Industry and Information Technology (MIIT).
The Market Access Negative List issued December 2018 incorporated the previously issued State Council catalogue for investment projects called the Decision on Investment Regime Reform and the Catalogue of Investment Projects subject to Government Ratification (Ratification Catalogue). Both foreign enterprises and domestic firms are subject to this negative list and both are required to receive government ratification of investment projects listed in the catalogue. The Ratification Catalogue was first issued in 2004 and has since undergone various reiterations that have shortened the number of investment projects needed for ratification and removed previous requirements that made foreign investors file for record all investment activities. The most recent version was last issued in 2016. Projects still needing ratification by NDRC and/or local DRCs include investments surpassing a specific dollar threshold, in industries experiencing overcapacity issues, or in industries that promote outdated technologies that may cause environmental hazards. For foreign investments over USD300 million, NDRC must ratify the investment. For industries in specific sectors, the local Development and Reform Commission (DRC) is in charge of the ratification.
Ratification Catalogue: http://www.gov.cn/zhengce/content/2016-12/20/content_5150587.htm
When a foreign investment needs ratification from the NDRC or a local DRC, that administrative body is in charge of assessing the project’s compliance with China’s laws and regulations; the proposed investment’s compliance with the foreign investment and market access negative lists and various industrial policy documents; its national security, environmental safety, and public interest implications; its use of resources and energy; and its economic development ramifications. In some cases, NDRC also solicits the opinions of relevant Chinese industrial regulators and “consulting agencies,” which may include industry associations that represent Chinese domestic firms. This presents potential conflicts of interest that can disadvantage foreign investors seeking to receive project approval. The State Council may also weigh in on high-value projects in “restricted” sectors.
If a foreign investor has established an investment not on the foreign investment negative list and has received NDRC approval for the investment project if needed, the investor then can apply for a business license with a new ministry announced in March 2018, the State Administration for Market Regulation (SAMR). Once a license is obtained, the investor registers with China’s tax and foreign exchange agencies. Greenfield investment projects must also seek approval from China’s Ministry of Ecology and Environment and the Ministry of Natural Resources. In several sectors, subsequent industry regulatory permits are required. The specific approvals process may vary from case to case, depending on the details of a particular investment proposal and local rules and practices.
For investments made via merger or acquisition with a Chinese domestic enterprise, an anti-monopoly review and national security review may be required by SAMR if there are competition concerns about the foreign transaction. The anti-monopoly review is detailed in a later section of this report, on competition policy.
Article 12 of MOFCOM’s Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investment stipulates that parties are required to report a transaction to SAMR if:
- Foreign investors obtain actual control, via merger or acquisition, of a domestic enterprise in a key industry;
- The merger or acquisition affects or may affect “national economic security”; or
- The merger or acquisition would cause the transfer of actual control of a domestic enterprise with a famous trademark or a Chinese time-honored brand.
If SAMR determines the parties did not report a merger or acquisition that affects or could affect national economic security, it may, together with other government agencies, require the parties to terminate the transaction or adopt other measures to eliminate the impact on national economic security. They may also assess fines.
In February 2011, China released the State Council Notice Regarding the Establishment of a Security Review Mechanism for Foreign Investors Acquiring Domestic Enterprises. The notice established an interagency Joint Conference, led by NDRC and MOFCOM, with authority to block foreign M&As of domestic firms that it believes may impact national security. The Joint Conference is instructed to consider not just national security, but also “national economic security” and “social order” when reviewing transactions. China has not disclosed any instances in which it invoked this formal review mechanism. A national security review process for foreign investments was written into China’s new Foreign Investment Law, but with very few details on how the process would be implemented.
Chinese local commerce departments are responsible for flagging transactions that require a national security review when they review them in an early stage of China’s foreign investment approval process. Some provincial and municipal departments of commerce have published online a Security Review Industry Table listing non-defense industries where transactions may trigger a national security review, but MOFCOM has declined to confirm whether these lists reflect official policy. In addition, third parties such as other governmental agencies, industry associations, and companies in the same industry can seek MOFCOM’s review of transactions, which can pose conflicts of interest that disadvantage foreign investors. Investors may also voluntarily file for a national security review.
U.S. Chamber of Commerce report on Approval Process for Inbound Foreign Direct Investment: http://www.uschamber.com/sites/default/files/reports/020021_China_InvestmentPaper_hires.pdf .
Foreign Investment Law
On March 15, 2019 the National People’s Congress passed the Foreign Investment Law (FIL) that replaced all existing foreign investment laws, including the China-Foreign Joint Venture Law, the Contract Joint Venture Law, and the Wholly Foreign-Owned Enterprises Law. The FIL is significantly shorter than the 2015 draft version issued for public comment and the text is vague and provides loopholes through which regulators could potentially discriminate against foreign investors. While the law made policy declarations on important issues to U.S. and other foreign investors (e.g., equal protection of intellectual property, prohibitions again certain kinds of forced technology transer, and greater market access,), specifics on implementation and enforcement were lacking. The law goes into effect on January 1, 2020. Many high-level Chinese officials have stated that the implementation guidelines and other corresponding legal changes will be developed prior to the law going into effect. The content of these guidelines and future corresponding changes to other laws to become consistent with the FIL will largely determine the impact it will have on the investment climate.
Free Trade Zone Foreign Investment Laws
China issued in 2015 the Interim Measures on the National Security Review of Foreign Investment in Free Trade Zones. The definition of “national security” is broad, covering investments in military, national defense, agriculture, energy, infrastructure, transportation, culture, information technology products and services, key technology, and manufacturing.
In addition, MOFCOM issued the Administrative Measures for the Record-Filing of Foreign Investment in Free Trade Zones, outlining a more streamlined process that foreign investors need to follow to register investments in the FTZs.
Competition and Anti-Trust Laws
China uses a complex system of laws, regulations, and agency specific guidelines at both the central and provincial levels that impacts an economic sector’s makeup, sometimes as a monopoly, near-monopoly, or authorized oligopoly. These measures are particularly common in resource-intensive sectors such as electricity and transportation, as well as in industries seeking unified national coverage like telecommunication and postal services. The measures also target sectors the government deems vital to national security and economic stability, including defense, energy, and banking. Examples of such laws and regulations include the Law on Electricity (1996), Civil Aviation Law (1995), Regulations on Telecommunication (2000), Postal Law (amended in 2009), Railroad Law (1991), and Commercial Bank Law (amended in 2003), among others.
China’s Anti-Monopoly Law (AML) went into effect on August 1, 2008. The National People Congress in March 2018 announced that AML enforcement authorities previously held by three government ministries would be consolidated into a new ministry called the State Administration for Market Regulation (SAMR). This new agency would still be responsible for AML enforcement and cover issues like concentrations review (M&As), cartel agreements, abuse of dominant market position, and abuse of administrative powers. To fill in some of the gaps from the original AML and to address new commercial trends in China’s market, SAMR has started the process of issuing draft implementation guidelines to clarify enforcement on issues like merger penalties, implementation of abuse of market dominant position, etc. By unifying antitrust enforcement under one agency, the Chinese government hopes to consolidate guidelines from the three previous agencies and provide greater clarity for businesses operating in China. Generally, the AML enforcement agencies have sought public comment on proposed measures and guidelines, although comment periods can be less than 30 days.
In addition to the AML, the State Council in June 2016 issued guidelines for the Fair Competition Review Mechanism that targets administrative monopolies created by government agents, primarily at the local level. The mechanism not only requires government agencies to conduct a fair competition review prior to issuing new laws, regulations, and guidelines, to certify that proposed measures do not inhibit competition, but also requires government agencies to conduct a review of all existing rules, regulations, and guidelines, to eliminate existing laws and regulations that are competition inhibiting. In October 2017, the State Council, State Council Legislative Affairs Office, Ministry of Finance, and three AML agencies issued implementation rules for the fair competition review system to strengthen review procedures, provide review criteria, enhance coordination among government entities, and improve overall competition-based supervision in new laws and regulations. While local government bodies have reported a completed review of over 100,000 different administrative documents, it is unclear what changes have been made and what impact it has had on actually improving the competitive landscape in China.
While procedural developments such as those outlined above are seen as generally positive, the actual enforcement of competition laws and regulations is uneven. Inconsistent central and provincial enforcement of antitrust law often exacerbates local protectionism by restricting inter-provincial trade, limiting market access for certain imported products, using measures that raise production costs, and limiting opportunities for foreign investment. Government authorities at all levels in China may also restrict competition to insulate favored firms from competition through various forms of regulations and industrial policies. While at times the ultimate benefactor of such policies is unclear, foreign companies have expressed concern that the central government’s use of AML enforcement is often selectively used to target foreign companies, becoming an extension of other industrial policies that favor SOEs and Chinese companies deemed potential “national champions.”
Since the AML went into effect, the number of M&A transactions reviewed each year by Chinese officials has continued to grow. U.S. companies and other observers have expressed concerns that SAMR is required to consult with other Chinese agencies when reviewing a potential transaction and that other agencies can raise concerns that are often not related to competition to either block, delay, or force one or more of the parties to comply with a condition in order to receive approval. There is also suspicion that Chinese regulators rarely approve “on condition” any transactions involving two Chinese companies, thus signaling an inherent AML bias against foreign enterprises.
Under NDRC’s previous enforcement of price-related monopolies, some procedural progress in AML enforcement was made, as they started to release aggregate data on investigations and publicize case decisions. However, many U.S. companies complained that NDRC discouraged companies from having legal representation during informal discussions or even during formal investigations. In addition, the investigative process reportedly lacked basic transparency or specific best practice guidance on procedures like evidence gathering. Observers continue to raise concern over the use of “dawn raids” that can be used at any time as a means of intimidation or to prop up a local Chinese company against a competing foreign company in an effort to push forward specific industrial policy goals. Observers also remain concerned that Chinese officials during an investigation will fail to protect commercial secrets and have access to secret and proprietary information that could be given to Chinese competitors.
In prior bilateral dialogues, China committed to strengthening IP protection and enforcement. However, concerns remain on how China views the intersection of IP protection and antitrust. Previous AML guidelines issued by antitrust regulators for public comment disproportionately impacted foreign firms (generally IP rights holders) by requiring an IP rights holder to license technology at a “fair price” so as not to allow abuse of the company’s “dominant market position.” Foreign companies have long complained that China’s enforcement of AML serves industrial policy goals of, among other things, forcing technology transfer to local competitors. In other more developed antitrust jurisdictions, companies are free to exclude competitors and set prices, and the right to do so is recognized as the foundation of the incentive to innovate.
Another consistent area of concern expressed by foreign companies deals with the degree to which the AML applies – or fails to apply – to SOEs and other government monopolies, which are permitted in some industries. While SAMR has said AML enforcement applies to SOEs the same as domestic or foreign firms, the reality is that only a few minor punitive actions have been taken against provincial level SOEs. In addition, the AML explicitly protects the lawful operations of SOEs and government monopolies in industries deemed nationally important. While SOEs have not been entirely immune from AML investigations, the number of investigations is not commensurate with the significant role SOEs play in China’s economy. The CCP’s proactive orchestration of mergers and consolidation of SOEs in industries like rail, marine shipping, metals, and other strategic sectors, which in most instances only further insulates SOEs from both private and foreign competition, signaling that enforcement against SOEs will likely remain limited despite potential negative impacts on consumer welfare.
Expropriation and Compensation
Chinese law prohibits nationalization of foreign-invested enterprises, except under “special circumstances.” Chinese laws, such as the Foreign Investment Law, states there are circumstances for expropriation of foreign assets that may include national security or a public interest needs, such as large civil engineering projects. However, the law does not specify circumstances that would lead to the nationalization of a foreign investment. Chinese law requires fair compensation for an expropriated foreign investment but does not provide details on the method or formula used to calculate the value of the foreign investment. The Department of State is not aware of any cases since 1979 in which China has expropriated a U.S. investment, although the Department has notified Congress through the annual 527 Investment Dispute Report of several cases of concern.
ICSID Convention and New York Convention
China is a contracting state to the Convention on the Settlement of Investment Disputes (ICSID Convention) and has ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). The domestic legislation that provides for enforcement of foreign arbitral awards related to these two Conventions includes the Arbitration Law adopted in 1994, the Civil Procedure Law adopted in 1991 (later amended in 2012), the Law on Chinese-Foreign Equity Joint Ventures adopted in 1979 (amended most recently in 2001), and a number of other laws with similar provisions. China’s Arbitration Law has embraced many of the fundamental principles of The United Nations Commission on International Trade Law’s Model Law on International Commercial Arbitration.
Investor-State Dispute Settlement
Chinese officials typically urge private parties to resolve commercial disputes through informal conciliation. If formal mediation is necessary, Chinese parties and the authorities typically prefer arbitration to litigation. Many contract disputes require arbitration by the Beijing-based China International Economic and Trade Arbitration Commission (CIETAC). Established by the State Council in 1956 under the auspices of the China Council for the Promotion of International Trade (CCPIT), CIETAC is China’s most widely-utilized arbitral body in China for foreign-related disputes. Some foreign parties have obtained favorable rulings from CIETAC, while others have questioned CIETAC’s fairness and effectiveness.
CIETAC also had four sub-commissions located in Shanghai, Shenzhen, Tianjin, and Chongqing. CCPIT, under the authority of the State Council, issued new arbitration rules in 2012 that granted CIETAC headquarters greater authority to hear cases than the sub-commissions. As a result, CIETAC Shanghai and CIETAC Shenzhen declared independence from the Beijing authority, issued new rules, and changed their names. This split led to CIETAC disqualifying the former Shanghai and Shenzhen affiliates from administering arbitration disputes, raising serious concerns among the U.S. business and legal communities over the validity of arbitration agreements arrived at under different arbitration procedures and the enforceability of arbitral awards issued by the sub-commissions. In 2013, the Supreme People’s Court issued a notice clarifying that any lower court that hears a case arising out of the CIETAC split must report the case to the court before making a decision. However, this notice is brief and lacks detail like the timeframe for the lower court to refer and the timeframe for the Supreme People’s Court to issue an opinion.
Beside the central-level arbitration commission, there are also provincial and municipal arbitration commissions that have emerged as serious domestic competitors to CIETAC. A foreign party may also seek arbitration in some instances from an offshore commission. Foreign companies often encounter challenges in enforcing arbitration decisions issued by Chinese and foreign arbitration bodies. In these instances, foreign investors may appeal to higher courts.
The Chinese government and judicial bodies do not maintain a public record of investment disputes. The Supreme People’s Court maintains an annual count of the number of cases involving foreigners but does not provide details about the cases, identify civil or commercial disputes, or note foreign investment disputes. Rulings in some cases are open to the public.
International Commercial Arbitration and Foreign Courts
Articles 281 and 282 of China’s Civil Procedural Law governs the enforcement of judgments issued by foreign courts. The law states that Chinese courts should consider factors like China’s treaty obligations, reciprocity principles, basic Chinese law, Chinese sovereignty, Chinese social and public interests, and national security before determining if the foreign court judgment should be recognized. As a result of this broad criteria, there are few examples of Chinese courts recognizing and enforcing a foreign court judgment. China has bilateral agreements with 27 countries on the recognition and enforcement of foreign court judgments, but not with the United States.
Article 270 of China’s Civil Procedure Law also states that time limits in civil cases do not apply to cases involving foreign investment. According to the 2012 CIETAC Arbitration Rules, in an ordinary procedure case, the arbitral tribunal shall render an arbitral award within six months (in foreign-related cases) from the date on which the arbitral tribunal is formed. In a summary procedure case, the arbitral tribunal shall make an award within three months from the date on which the arbitral tribunal is formed.
China’s Enterprise Bankruptcy Law took effect on June 1, 2007 and applies to all companies incorporated under Chinese laws and subject to Chinese regulations. This includes private companies, public companies, SOEs, foreign invested enterprises (FIEs), and financial institutions. China’s primary bankruptcy legislation generally is commensurate with developed countries’ bankruptcy laws and provides for reorganization or restructuring, rather than liquidation. However, due to the lack of implementation guidelines and the limited number of previous cases that could provide legal precedent, the law has never been fully enforced. Most corporate debt disputes are settled through negotiations led by local governments. In addition, companies are disincentivized from pursing bankruptcy because of the potential for local government interference and fear of losing control over the bankruptcy outcome. According to experts, Chinese courts not only lack the resources and capacity to handle bankruptcy cases, but bankruptcy administrators, clerks, and judges all lack relevant experience.
In the October 2016 State Council Guiding Opinion on Reducing Enterprises’ Leverage Ratio, bankruptcy was identified as a tool to manage China’s corporate debt problems. This was consistent with increased government rhetoric throughout the year in support of bankruptcy. For example, in June 2016, the Supreme People’s Court issued a notice to establish bankruptcy divisions at intermediate courts and to increase the number of judges and support staff to handle liquidation and bankruptcy issues. On August 1, 2016, the court also launched a new bankruptcy and reorganization electronic information platform: http://pccz.court.gov.cn/pcajxxw/index/xxwsy .
The number of bankruptcy cases has continued to grow rapidly since 2015. According to a National People’s Congress (NPC) official, in 2018, 18,823 liquidation and bankruptcy cases were accepted by Chinese courts, an increase of over 95 percent from last year. 11,669 of those cases were closed, an increase of 86.5 percent from the year before. The Supreme People’s Court (SPC) reported that in 2017, 9,542 bankruptcy cases were accepted by the Chinese courts, representing a 68.4 percent year-on-year increase from 2016, and 6,257 cases were closed, representing a 73.7 percent year-on-year increase from 2016. The SPC has continued to issue clarifications and new implementing measures to improve bankruptcy procedures.
4. Industrial Policies
To attract foreign investment, different provinces and municipalities offer preferential packages like a temporary reduction in taxes, resources and land use benefits, reduction in import and/or export duties, special treatment in obtaining basic infrastructure services, streamlined government approvals, research and development subsidies, and funding for initial startups. Often, these packages stipulate that foreign investors must meet certain benchmarks for exports, local content, technology transfer, and other requirements. Preferential treatment often occurs in specific sectors that the government has identified for policy support, like technology and advanced manufacturing, and will be specific to a geographic location like a special economic zone (like FTZs), development zone, or a science park. The Chinese government has also prioritized foreign investment in inland China by providing incentives to invest in seven new FTZs located in inland regions (2017) and offering more liberalizations to foreign investment through its Catalogue of Priority Industries for Foreign Investment in Central and Western China that provides greater market access to foreign investors willing to invest in less developed areas in Central and Western China.
While state subsidies has long been an area that foreign investors have criticized for distorting competition in certain industries, Chinese officials have publicly pledged that foreign investors willing to manufacture products in China can equally participate in the research and development programs financed by the Chinese government. The Chinese government has also said foreign investors have equal access to preferential policies under initiatives like Made in China 2025 and Strategic Emerging Industries that seek to transform China’s economy into an innovation-based economy that becomes a global leader in future growth sectors. In these high-tech and advanced manufacturing sectors, China needs foreign investment because it lacks the capacity, expertise, and technological know-how to conduct advanced research or manufacture advanced technology on par with other developed economies. Announced in 2015, China’s MIC 2025 roadmap has prioritized the following industries: new-generation information technology, advanced numerical-control machine tools and robotics, aerospace equipment, maritime engineering equipment and vessels, advanced rail, new-energy vehicles, energy equipment, agricultural equipment, new materials, and biopharmaceuticals and medical equipment. While mentions of MIC 2025 have all but disappeared from public discourse, a raft of policy announcements at the national and sub-national level indicate China’s continued commitment to developing these sectors. Foreign investment plays an important role in helping China move up the manufacturing value chain. However, there are a large number of economic sectors that China deems sensitive due to broadly defined national security concerns, including “economic security,” which can effectively close off foreign investment to those sectors.
Foreign Trade Zones/Free Ports/Trade Facilitation
China has customs-bonded areas in Shanghai, Tianjin, Shantou, Guangzhou, Dalian, Xiamen, Ningbo, Zhuhai, Fuzhou, and parts of Shenzhen. In addition to these official duty-free zones identified by China’s State Council, there are also numerous economic development zones and “open cities” that offer preferential treatment and benefits to investors, including foreign investors.
In September 2013, the State Council in conjunction with the Shanghai municipal government, announced the Shanghai Pilot Free Trade Zone that consolidated the geographical area of four previous bonded areas into a single FTZ. In April 2015, the State Council expanded the pilot to include new FTZs in Tianjin, Guangdong, and Fujian. In March 2017, the State Council approved seven new FTZs in Chongqing, Henan, Hubei, Liaoning, Shaanxi, Sichuan, and Zhejiang, with the stated purpose to integrate these areas more closely with the OBOR initiative – the Chinese government’s plan to enhance global economic interconnectivity through joint infrastructure and investment projects that connect China’s inland and border regions to the rest of the world. In October 2018, the Chinese government rolled out plans to convert the entire island province of Hainan into an FTZ that will take effect in 2020. This FTZ aims to provide a more open and high-standard trade and investment hub focused on improved rule of law and financial services. In addition to encourage tourism development, the Hainan FTZ will also seek to develop high-tech industries while preserving the ecology of the island. The goal of all China’s FTZs is to provide a trial ground for trade and investment liberalization measures and to introduce service sector reforms, especially in financial services, that China expects eventually to introduce in other parts of the domestic economy.
The FTZs should offer foreign investors “national treatment” for the market access phase of an investment in industries and sectors not listed on the FTZ “negative list,” or on the list of industries and economic sectors restricted or prohibited for foreign investment. The State Council published an updated FTZ negative list in June 2018 that reduced the number of restrictions and prohibitions on foreign investment from 95 items down to 45. The most recent negative list did not remove many commercially significant restrictions or prohibitions compared to the nationwide negative list also released in June 2018.
Although the FTZ negative list in theory provides greater market access for foreign investment in the FTZs, many foreign firms have reported that in practice, the degree of liberalization in the FTZs is comparable to other opportunities in other parts of China. According to Chinese officials, over 18,000 entities have registered in the FTZs. The municipal and central governments have released a number of administrative and sector-specific regulations and circulars that outline the procedures and regulations in the zones.
Performance and Data Localization Requirements
As part of China’s WTO accession agreement, China promised to revise its foreign investment laws to eliminate sections that imposed export performance, local content, balanced foreign exchange through trade, technology transfer, and create research and development center requirements on foreign investors as a prerequisite to enter China’s market. As part of these revisions, China committed to only enforce technology transfer requirements that do not violate WTO standards on IP and trade-related investment measures. In practice, however, China has not completely lived up to these promises with some U.S. businesses reporting that local officials and regulators sometimes only accept investments with “voluntary” performance requirements or technology transfer that helps develop certain domestic industries and support the local job market. Provincial and municipal governments will sometimes restrict access to local markets, government procurement, and public works projects even for foreign firms that have already invested in the province or municipality. In addition, Chinese regulators have reportedly pressured foreign firms in some sectors to disclose IP content or provide IP licenses to Chinese firms, often at below market rates. These practices not only run contrary to WTO principles but hurt the competitive position of foreign investors.
China also called to restrict the ability of both domestic and foreign operators of “critical information infrastructure” to transfer personal data and important information outside of China while also requiring those same operators to only store data physically in China. These potential restrictions have prompted many firms to review how their networks manage data. Foreign firms also fear that calls for use of “secure and controllable,” “secure and trustworthy,” etc. technologies will curtail sales opportunities for foreign firms or that foreign companies may be pressured to disclose source code and other proprietary information, putting IP at risk. In addition, prescriptive technology adoption requirements, often in the form of domestic standards that diverge from global norms, in effect gives preference to domestic firms and their technology. These requirements not only hinder operational effectiveness but also potentially puts in jeopardy IP protection and overall competitiveness of foreign firms operating in China.
5. Protection of Property Rights
Foreign companies have long complained that the Chinese legal system, responsible for mediating acquisition and disposition of property, has inconsistently protected the legal real property rights of foreigners.
Urban land is entirely owned by the State. The State can issue long-term land leases to individuals and companies, including foreigners, subject to many restrictions. China’s Property Law stipulates that residential property rights will renew automatically, while commercial and industrial grants shall be renewed if the renewal does not conflict with other public interest claims. A number of foreign investors have reported that their land use rights were revoked and given to developers to build neighborhoods designated for building projects by government officials. Investors often complain that compensation in these cases has been nominal.
In rural China, collectively-owned land use rights are more complicated. The registration system chronically suffers from unclear ownership lines and disputed border claims, often at the expense of local farmers who are excluded from the process by village leaders making “handshake deals” with commercial interests. The central government announced in 2016, and reiterated in 2017 and 2018, plans to reform the rural land registration system so as to put more control in the hands of farmers, but some experts remain skeptical that changes will be properly implemented and enforced.
China’s Securities Law defines debtor and guarantor rights, including rights to mortgage certain types of property and other tangible assets, including long-term leases. Chinese law does not prohibit foreigners from buying non-performing debt, which can only be acquired through state-owned asset management firms. However, in practice, Chinese official often use bureaucratic hurdles that limit foreigners’ ability to liquidate assets, further discouraging foreign purchase of non-performing debt.
Intellectual Property Rights
Following WTO accession, China updated many laws and regulations to comply with the WTO Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) and other international agreements. However, despite the changes to China’s legal and regulatory regime, some aspects of China’s IP protection regime fall short of international best practices. In addition, enforcement ineffectiveness of Chinese laws and regulations remains a significant challenge for foreign investors trying to protect their IPR.
Major impediments to effective IP enforcement include the unavailability of deterrent-level penalties for infringement, a lack of transparency, unclear standards for establishing criminal investigations, the absence of evidence production methods to compel evidence from infringers, and local protectionism, among others. Chinese government officials tout the success of China’s specialized IP courts – including the establishment of a new appellate tribunal within the SPC – as evidence of its commitment to IP protection; however, while this shows a growing awareness of IPR in China’s legal system, civil litigation against IP infringement will remain an option with limited effect until there is an increase in the amount of damages an infringer pays for IP violations.
Chinese-based companies remain the largest IP infringers of U.S. products. Goods shipped from China (including those transshipped through Hong Kong) accounted for an estimated 87 percent of IPR-infringing goods seized at U.S. borders. (Note: This U.S. Customs statistic does not specify where the fake goods were made.) China imposes requirements that U.S. firms develop their IP in China or transfer their IP to Chinese entities as a condition to accessing the Chinese market, or to obtain tax and other preferential benefits available to domestic companies. Chinese policies can effectively require U.S. firms to localize research and development activities, practices documented in the March 2018 Section 301 Report released by the Office of the U.S. Trade Representative (USTR). China remained on the Priority Watch List in the 2019 USTR Special 301 Report, and several Chinese physical and online markets were included in the 2018 USTR Notorious Markets Report. For detailed information on China’s environment for IPR protection and enforcement, please see the following reports:
- USTR Section 301 Report on China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation: https://ustr.gov/sites/default/files/Section percent20301 percent20FINAL.PDF
- USTR Update Concerning China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation: https://ustr.gov/sites/default/files/enforcement/301Investigations/301 percent20Report percent20Update.pdf
- USTR 2019 Special 301 Report (see section on China): https://ustr.gov/about-us/policy-offices/press-office/reports-and-publications/2019/2019-special-301-report
- USTR’s 2018 National Trade Estimate Report on Foreign Trade Barriers in China (see section on China): https://ustr.gov/sites/default/files/files/Press/Reports/2018 percent20National percent20Trade percent20Estimate percent20Report.pdf
- USTR’s 2018 Report to Congress on China’s WTO Compliance: https://ustr.gov/sites/default/files/2018-USTR-Report-to-Congress-on-China percent27s-WTO-Compliance.pdf
- USTR’s 2018 Notorious Market Report (see China): https://ustr.gov/sites/default/files/2018_Notorious_Markets_List.pdf
For additional information about national laws and points of contact at local intellectual property offices, please see the World Intellectual Property Organization’s country profiles at http://www.wipo.int/directory/en
6. Financial Sector
Capital Markets and Portfolio Investment
China’s leadership has stated that it seeks to build a modern, highly developed, and multi-tiered capital market. Bank loans continue to provide the majority of credit options (reportedly around 81.4 percent in 2018) for Chinese companies, although other sources of capital, such as corporate bonds, equity financing, and private equity are quickly expanding their scope, reach, and sophistication in China. In the past three years, Chinese regulators have taken measures to rein in the rapid growth of China’s “shadow banking” sector, which includes vehicles such as wealth management and trust products. The measures have achieved positive results. The share of trust loans, entrust loans and undiscounted bankers’ acceptances dropped a total of 15.2 percent in total social financing (TSF) – a broad measure of available credit in China, most of which was comprised of corporate bonds. TSF’s share of corporate bonds jumped from a negative 2.31 percent in 2017 to 12.9 percent in 2018. Chinese regulators regularly use administrative methods to control credit growth, although market-based tools such as interest rate policy and adjusting the reserve requirement ratio (RRR) play an increasingly important role.
The People’s Bank of China (PBOC), China’s central bank, has gradually increased flexibility for banks in setting interest rates, formally removing the floor on the lending rate in 2013 and the deposit rate cap in 2015 – but is understood to still influence bank’s interest rates through “window guidance.” Favored borrowers, particularly SOEs, benefit from greater access to capital and lower financing costs, as they can use political influence to secure bank loans, and lenders perceive these entities to have an implicit government guarantee. Small- and medium-sized enterprises, by contrast, have the most difficulty obtaining financing, often forced to rely on retained earnings or informal investment channels.
In 2018, Chinese regulators have taken measures to improve financing for the private sector, particularly small, medium and micro-sized enterprises (SMEs). On November 1, 2018, Xi Jinping held an unprecedented meeting with private companies on how to support the development of private enterprises. Xi emphasized to the importance of resolving difficult and expensive financing problems for private firms and pledged to create a fair and competitive business environment. He encouraged banks to lend more to private firms, as well as urged local governments to provide more financial support for credit-worthy private companies. Provincial and municipal governments could raise funds to bailout private enterprises if needed. The PBOC increased the relending and rediscount quota of RMB 300 billion for SMEs and private enterprises at the end of 2018. The government also introduced bond financing supportive instruments for private enterprises, and the PBOC began promoting qualified PE funds, securities firms, and financial asset management companies to provide financing for private companies. The China Banking and Insurance Regulatory Commission’s (CBIRC) Chairman said in an interview that one-third of new corporate loans issued by big banks and two-thirds of new corporate loans issued by small and medium-sized banks should be granted to private enterprises, and that 50 percent of new corporate loans shall be issued to private enterprises in the next three years. At the end of 2018, loans issued to SMEs accounted for 24.6 percent of total RMB loan issuance. The share dropped 1 percent from 25.6 percent in 2017. Interest rates on loans issued by the six big state-owned banks – Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC), Agriculture Bank of China (ABC), Bank of Communications and China Postal Savings Bank – to SMEs averaged 4.8 percent, in the fourth quarter of 2018, down from 6 percent in the first quarter of 2018.
Direct financing has expanded over the last few years, including through public listings on stock exchanges, both inside and outside of China, and issuing more corporate and local government bonds. The majority of foreign portfolio investment in Chinese companies occurs on foreign exchanges, primarily in the United States and Hong Kong. In addition, China has significantly expanded quotas for certain foreign institutional investors to invest in domestic stock markets; opened up direct access for foreign investors into China’s interbank bond market; and approved a two-way, cross-border equity direct investment scheme between Shanghai and Hong Kong and Shenzhen and Hong Kong that allows Chinese investors to trade designated Hong Kong-listed stocks through the Shanghai and Shenzhen Exchanges, and vice versa. Direct investment by private equity and venture capital firms is also rising, although from a small base, and has faced setbacks due to China’s capital controls that complicate the repatriation of returns
Money and Banking System
After several years of rapid credit growth, China’s banking sector faces asset quality concerns. For 2018, the China Banking Regulatory Commission reported a non-performing loans (NPL) ratio of 1.83 percent, higher than the 1.74 percent of NPL ratio reported the last quarter of 2017. The outstanding balance of commercial bank NPLs in 2018 reached 2.03 trillion RMB (approximately USD295.1 billion). China’s total banking assets surpassed 268 trillion RMB (approximately USD39.1 trillion) in December 2018, a 6.27 percent year-on-year increase. Experts estimate Chinese banking assets account for over 20 percent of global banking assets. In 2018, China’s credit and broad money supply slowed to 8.1 percent growth, the lowest published rate since the PBOC first started publishing M2 money supply data in 1986.
Foreign Exchange and Remittances
Foreign Exchange Policies
While the central bank’s official position is that companies with proper documentation should be able to freely conduct business, in practice, companies have reported challenges and delays in getting foreign currency transactions approved by sub-national regulatory branches. In 2017, several foreign companies complained about administrative delays in remitting large sums of money from China, even after completing all of the documentation requirements. Such incidents come amid announcements that the State Administration of Foreign Exchange (SAFE) had issued guidance to tighten scrutiny of foreign currency outflows due to China’s rapidly decreasing foreign currency exchange. China has since announced that it will gradually reduce those controls, but market analysts expect they would be re-imposed if capital outflows accelerate again.
Under Chinese law, FIEs do not need pre-approval to open foreign exchange accounts and are allowed to retain income as foreign exchange or to convert it into RMB without quota requirements. Foreign exchange transactions related to China’s capital account activities do not require review by SAFE, but designated foreign exchange banks review and directly conduct foreign exchange settlements. Chinese officials register all commercial foreign debt and will limit foreign firms’ accumulated medium- and long-term debt from abroad to the difference between total investment and registered capital. China issued guidelines in February 2015 that allow, on a pilot basis, a more flexible approach to foreign debt within several specific geographic areas, including the Shanghai Pilot FTZ. The main change under this new approach is to allow FIEs to expand their foreign debt above the difference between total investment and registered capital, so long as they have sufficient net assets.
Chinese foreign exchange rules cap the maximum amount of RMB individuals are allowed to convert into other currencies at approximately USD50,000 each year and restrict them from directly transferring RMB abroad without prior approval from SAFE. In 2017, authorities further restricted overseas currency withdrawals by banning sales of life insurance products and capping credit card withdrawals at USD5,000 per transaction. SAFE has not reduced this quota, but during periods of higher than normal capital outflows, banks are reportedly instructed by SAFE to increase scrutiny over individuals’ requests for foreign currency and to require additional paperwork clarifying the intended use of the funds, with the express intent of slowing capital outflows.
China’s exchange rate regime is managed within a band that allows the currency to rise or fall by 2 percent per day from the “reference rate” set each morning. In August 2015, China announced that the reference rate would more closely reflect the previous day’s closing spot rate. Since that change, daily volatility of the RMB has at times been higher than in recent years, but for the most part, remains below what is typical for other currencies. In 2017, the PBOC took additional measures to reduce volatility, introducing a “countercyclical factor” into its daily RMB exchange rate calculation. Although the PBOC reportedly suspended the countercyclical factor in January 2018, the tool remains available to policymakers if volatility re-emerges.
The remittance of profits and dividends by FIEs is not subject to time limitations, but FIEs need to submit a series of documents to designated banks for review and approval. The review period is not fixed, and is frequently completed within one or two working days of the submission of complete documents. In the past year, this period has lengthened during periods of higher than normal capital outflows, when the government strengthens capital controls.
Remittance policies have not changed substantially since SAFE simplified some regulations in January 2014, devolving many review and approval procedures to banks. Firms that remit profits at or below USD50,000 dollars can do so without submitting documents to the banks for review.
For remittances above USD50,000, the firm must submit tax documents, as well as the formal decision by its management to distribute profits.
For remittance of interest and principle on private foreign debt, firms must submit an application form, a foreign debt agreement, and the notice on repayment of the principle and interest. Banks will then check if the repayment volume is within the repayable principle.
The remittance of financial lease payments falls under foreign debt management rules. There are no specific rules on the remittance of royalties and management fees. In August 2018, SAFE raised the reserve requirement for foreign currency transactions from zero to 20 percent, significantly increasing the cost of foreign currency transactions. The reserve ratio was introduced in October 2015 at 20 percent, which was lowered to zero in September 2017.
The Financial Action Task Force has identified China as a country of primary concern. Global Financial Integrity (GFI) estimates that over S1 trillion of illicit money left China between 2003 and 2012, making China the world leader in illicit capital flows. In 2013, GFI estimated that another USD260 billion left the country.
Sovereign Wealth Funds
China officially has only one sovereign wealth fund (SWF), the China Investment Corporation (CIC). Established in 2007, CIC manages over USD941.4 billion in assets (as of 2017) and invests on a 10-year time horizon. China’s sovereign wealth is also invested by a subsidiary of SAFE, the government agency that manages China’s foreign currency reserves, and reports directly to the PBOC. The SAFE Administrator also serves concurrently as a PBOC Deputy Governor.
CIC publishes an annual report containing information on its structure, investments, and returns. CIC invests in diverse sectors like financial, consumer products, information technology, high-end manufacturing, healthcare, energy, telecommunication services, and utilities.
China also operates other funds that function in part like sovereign wealth funds, including: China’s National Social Security Fund, with an estimate USD341.4 billion in assets; the China-Africa Development Fund (solely funded by the China Development Bank), with an estimated USD5 billion; the SAFE Investment Company, with an estimated USD439.8 billion; and China’s state-owned Silk Road Fund, established in December 2014 with USD40 billion to foster investment in OBOR partner countries. Chinese SWFs do not report the percentage of their assets that are invested domestically.
Chinese SWFs follow the voluntary code of good practices known as the Santiago Principles and participate in the IMF-hosted International Working Group on SWFs. The Chinese government does not have any formal policies specifying that CIC invest funds consistent with industrial policies or in government-designated projects, although CIC is expected to pursue government objectives. The SWF generally adopts a “passive” role as a portfolio investor.
7. State-Owned Enterprises
China has approximately 150,000 SOEs which are wholly owned by the state. Around 50,000 (33 percent) are owned by the central government and the remainder by local governments. The central government directly controls and manages 96 strategic SOEs through the State-owned Assets Supervision and Administration Commission (SASAC), of which around 60 are listed on stock exchanges domestically and/or internationally. SOEs, both central and local, account for 30 to 40 percent of total GDP and about 20 percent of China’s total employment. SOEs can be found in all sectors of the economy, from tourism to heavy industries.
SASAC regulated SOEs: http://www.sasac.gov.cn/n2588035/n2641579/n2641645/c4451749/content.html .
China’s leading SOEs benefit from preferential government policies aimed at developing bigger and stronger “national champions.” SOEs enjoy favored access to essential economic inputs (land, hydrocarbons, finance, telecoms, and electricity) and exercise considerable power in markets like steel and minerals. SOEs have long enjoyed preferential access to credit and the ability to issue publicly traded equity and debt.
During the November 2013 Third Plenum of the 18th Party Congress – a hallmark session that announced economic reforms, including calling for the market to play a more decisive role in the allocation of resources – President Xi Jinping called for broad SOE reforms. Cautioning that SOEs still will remain a key part of China’s economic system, Xi emphasized improved SOE operational transparency and legal reforms that would subject SOEs to greater competition by opening up more industry sectors to domestic and foreign competitors and by reducing provincial and central government preferential treatment of SOEs. The Third Plenum also called for “mixed ownership” economic structures, providing greater economic balance between private and state-owned businesses in certain industries, including equal access to factors of production, competition on a level playing field, and equal legal protection.
At the 2018 Central Economic Work Conference, Chinese leaders said in 2019 they will promote a greater role for the market, as well as renewed efforts on reforming SOEs – to include mixed ownership reform. In delivering the 2019 Government Work Report, Premier Li Keqiang pledged to improve corporate governance, including allowing SOE company boards, rather than SASAC, to appoint senior leadership.
OECD Guidelines on Corporate Governance
SASAC participates in the OECD Working Party on State Ownership and Privatization Practices (WPSOPP). Chinese officials have indicated China intends to utilize OECD SOE guidelines to improve the professionalism and independence of SOEs, including relying on Boards of Directors that are independent from political influence. However, despite China’s Third Plenum commitments in 2013 (i.e., to foster “market-oriented” reforms in China’s state sectors), Chinese officials and SASAC have made minimal progress in fundamentally changing the regulation and business conduct of SOEs. China has also committed to implement the G-20/OECD Principles of Corporate Governance, which apply to all publicly-listed companies, including listed SOEs.
Chinese law lacks unified guidelines or a governance code for SOEs, especially among provincial or locally-controlled SOEs. Among central SOEs managed by SASAC, senior management positions are mainly filled by senior CCP members who report directly to the CCP, and double as the company’s Party secretary
The lack of management independence and the controlling ownership interest of the State make SOEs de facto arms of the government, subject to government direction and interference. SOEs are rarely the defendant in legal disputes, and when they are, they almost always prevail, presumably due to the close relationship with the CCP. U.S. companies often complain about the lack of transparency and objectivity in commercial disputes with SOEs. In addition, SOEs enjoy preferential access to a disproportionate share of available capital, whether in the form of loans or equity.
In its September 2015 Guiding Opinions on Deepening the Reform of State-Owned Enterprises, the State Council instituted a system for classifying SOEs as “public service” or “commercial enterprises.” Some commercial enterprise SOEs were further sub-classified into “strategic” or “critically important” sectors (i.e., with strong national economic or security importance). SASAC has said the new classification system would allow the government to reduce support for commercial enterprises competing with private firms and instead channel resources toward public service SOEs.
Other recent reforms have included salary caps, limits on employee benefits, and attempts to create stock incentive programs for managers that have produced mixed results. However, analysts believe minor reforms will be ineffective as long as SOE administration and government policy are intertwined.
A major stumbling block to SOE reform is that SOE regulators are outranked in the CCP party structure by SOE executives, which minimizes SASAC and other government regulators’ effectiveness at implementing reforms. In addition, SOE executives are often promoted to high-ranking positions in the CCP or local government, further complicating the work of regulators.
During the Third Plenum of the CCP’s 18th Central Committee, in 2013, the CCP leadership announced that the market would play a “decisive role” in economic decision making and emphasized that SOEs needed to focus resources in areas that “serve state strategic objectives.” However, experts point out that despite these new SOE distinctions, SOEs continue to hold dominant shares in their respective industries, regardless of whether they are strategic, which may further restrain private investment in the economy. Moreover, the application of China’s Anti-Monopoly Law, together with other industrial policies and practices that are selectively enforced by the authorities, protects SOEs from private sector competition.
China is not a party to the Government Procurement Agreement (GPA) within the framework of the WTO, although Hong Kong is listed. During China’s WTO accession negotiations, Beijing signaled its intention to join GPA. And, in April 2018, President Xi announced his intent to join GPA, but no timeline has been given for accession.
Investment Restrictions in “Vital Industries and Key Fields”
The intended purpose of China’s State Assets Law is to safeguard and protect China’s economic system, promoting “socialist market economy” principles that fortify and develop a strong, state-owned economy. A key component of the State Assets Law is enabling SOEs to play the leading role in China’s economic development, especially in “vital industries and key fields.” To accomplish this, the law encourages Chinese regulators to adopt policies that consolidate SOE concentrations to ensure dominance in industries deemed vital to “national security” and “national economic security.” This principle is further reinforced by the December 2006 State Council announcement of the Guiding Opinions Concerning the Advancement of Adjustments of State Capital and the Restructuring of State-Owned Enterprises, which called for more SOE consolidation to advance the development of the state-owned economy, including enhancing and expanding the role of the State in controlling and influencing “vital industries and key fields relating to national security and national economic lifelines.” These guidelines defined “vital industries and key fields” as “industries concerning national security, major infrastructure and important mineral resources, industries that provide essential public goods and services, and key enterprises in pillar industries and high-tech industries.”
Around the time the guidelines were published, the SASAC Chairman also listed industries where the State should maintain “absolute control” (e.g., aviation, coal, defense, electric power and the state grid, oil and petrochemicals, shipping, and telecommunications) and “relative control” (e.g., automotive, chemical, construction, exploration and design, electronic information, equipment manufacturing, iron and steel, nonferrous metal, and science and technology). China has said these lists do not reflect its official policy on SOEs. In fact, in some cases, regulators have allowed for more than 50 percent private ownership in some of the listed industries on a case-by-case basis, especially in industries where Chinese firms lack expertise and capabilities in a given technology Chinese officials deemed important at the time.
Parts of the agricultural sector have traditionally been dominated by SOEs. Current agriculture trade rules, regulations, and limitations placed on foreign investment severely restrict the contributions of U.S. agricultural companies, depriving China’s consumers of the many potential benefits additional foreign investment could provide. These investment restrictions in the agricultural sectors are at odds with China’s objective of shifting more resources to agriculture and food production in order to improve Chinese lives, food security, and food safety.
At the November 2013 Third Plenum, the Chinese government announced reforms to SOEs that included selling shares of SOEs to outside investors. This approach is an effort to improve SOE management structures, emphasize the use of financial benchmarks, and gradually take steps that will bring private capital into some sectors traditionally monopolized by SOEs like energy, telecommunications, and finance. In practice, these reforms have been gradual, as the Chinese government has struggled to implement its SOE reform vision and often opted to utilize a preferred SOE consolidation approach. In the past few years, the Chinese government has listed several large SOEs and their assets on the Hong Kong stock exchange, subjecting SOEs to greater transparency requirements and heightened regulatory scrutiny. This approach is a possible mechanism to improve SOE corporate governance and transparency. Starting in 2017, the government began pushing the mixed ownership model, in which private companies invest in SOEs and outside managers are hired, as a possible solution, although analysts note that ultimately the government (and therefore the CCP) remains in full control regardless of the private share percentage. Over the last year, President Xi and other senior leaders have increasingly focused reform efforts on strengthening the role of the State as an investor or owner of capital, instead of the old SOE model in which the state was more directly involved in managing operations.
8. Responsible Business Conduct
General awareness of Responsible Business Conduct (RBC) standards (including environmental, social, and governance issues) is a relatively new concept to most Chinese companies, especially companies that exclusively operate in China’s domestic market. Chinese laws that regulate business conduct use voluntary compliance, are often limited in scope and are frequently cast aside when RBC priorities are superseded by other economic priorities. In addition, China lacks mature and independent NGOs, investment funds, worker unions, worker organizations, and other business associations that promote RBC, further contributing to the general lack of awareness in Chinese business practices.
The Foreign NGO Law remains a concern for U.S. organizations due to the restrictions on many NGO activities, including promotion of RBC and corporate social responsibility (CSR) best practices. For U.S. investors looking to partner with a Chinese company or to expand operations by bringing in Chinese suppliers, finding partners that meet internationally recognized standards in areas like labor, environmental protection, worker safety, and manufacturing best practices can be a challenge. However, the Chinese government has placed greater emphasis on protecting the environment and elevating sustainability as a key priority, resulting in more Chinese companies adding environmental concerns to their CSR initiatives.
In 2014, China signed a memorandum of understanding (MOU) with the OECD to cooperate on RBC initiatives. This MOU, however, does not require or necessarily mean that Chinese companies will adhere to the OECD Guidelines for Multinational Enterprises. Industry leaders have pushed for China to comply with OECD guidelines and establish a national contact point or RBC center. As a result, MOFCOM in 2016 launched the RBC Platform, which serves as the national contact point on RBC issues and supplies information to companies about RBC best practices in China.
In 2014, China participated in the OECD’s RBC Global Forum, including hosting a workshop in Beijing in May 2015. Policy developments from the workshops included incorporation of human rights into social responsibility guidelines for the electronics industry; referencing the United Nations Guiding Principles on Business and Human Rights; mandating social impact assessments for large footprint projects; and agreeing to draft a new law on public participation in environmental protection and impact assessments.
The MOFCOM-affiliated Chinese Chamber of Commerce of Metals, Minerals, and Chemical Importers and Exporters (CCCMC) also signed a separate MOU with the OECD in October 2014, to help Chinese companies implement RBC policies in global mineral supply chains. In December 2015, CCCMC released Due Diligence Guidelines for Responsible Mineral Supply Chains, which draw heavily from the OECD Due Diligence Guidelines. China is currently drafting legislation to regulate the sourcing of minerals, including tin, tungsten, tantalum, and gold, from conflict areas. China is not a member of the Extractive Industries Transparency Initiative (EITI), but Chinese investors participate in EITI schemes where these are mandated by the host country.
Corruption remains endemic in China. The lack of an independent press, along with the lack of independence of corruption investigators, who answer to and are managed by the CCP, all hamper the transparent and consistent application of anti-corruption efforts.
Chinese anti-corruption laws have strict penalties for bribes, including accepting a bribe, which is a criminal offense punishable up to life imprisonment or death in “especially serious” circumstances. Offering a bribe carries a maximum punishment of up to five years in prison, except in cases with “especially serious” circumstances, when punishment can extend up to life in prison.
In August 2015, the NPC amended several corruption-related parts of China’s Criminal Law. For instance, bribing civil servants’ relatives or other close relationships is a crime with monetary fines imposed on both the bribe-givers and the bribe-takers; bribe-givers, mainly in minor cases, who aid authorities can be given more lenient punishments; and instead of basing punishments solely on the specific amount of money involved in a bribe, authorities now have more discretion to impose punishments based on other factors.
In February 2011, an amendment was made to the Criminal Law, criminalizing the bribing of foreign officials or officials of international organizations. However, to date, there have not been any known cases in which someone was successfully prosecuted for offering this type of bribe.
In March 2018, the NPC approved the creation of the National Supervisory Commission (NSC), a new government anti-corruption agency that resulted from the merger of the Ministry of Supervision and the CCP’s Central Commission for Discipline Inspection (CCDI). The NSC absorbed the anti-corruption units of the Supreme People’s Procuratorate, and those of the National Bureau of Corruption Prevention. In addition to China’s 89 million CCP members, the new commission has jurisdiction over all civil servants and employees of state enterprises, as well as managers in public schools, hospitals, research institutes, and other public service institutions. Lower-level supervisory commissions have been set up in all provinces, autonomous regions, municipalities, and the Xinjiang Production and Construction Corps. The NPC also passed the State Supervision Law, which provides the NSC with its legal authorities to investigate, detain, and punish public servants.
The CCDI remains the primary body for enforcing ethics guidelines and party discipline, and refers criminal corruption cases to the NSC for further investigation.
President Xi Jinping’s Anti-Corruption Efforts
Since President Xi’s rise to power in 2012, China has undergone an intensive and large-scale anti-corruption campaign, with investigations reaching into all sectors of the government, military, and economy. President Xi labeled endemic corruption as an “existential threat” to the very survival of the CCP that must be addressed. Since then, each CCP annual plenum has touched on judicial, administrative, and CCP discipline reforms needed to thoroughly root out corruption. Judicial reforms are viewed as necessary to institutionalize the fight against corruption and reduce the arbitrary power of CCP investigators, but concrete measures have emerged slowly. To enhance regional anti-corruption cooperation, the 26th Asia-Pacific Economic Cooperation (APEC) Ministers Meeting adopted the Beijing Declaration on Fighting Corruption in November 2014.
According to official statistics, from 2012 to 2018 the CCDI investigated 2.17 million cases – more than the total of the preceding ten years. In 2018 alone, the CCP disciplined around 621,000 individuals, up almost 95,000 from 2017. However, the majority of officials only ended up receiving internal CCP discipline and were not passed forward for formal prosecution and trial. A total of 195,000 corruption and bribery cases involving 263,000 people were heard in courts between 2013 and 2017, according to the Supreme People’s Court. Of these, 101 were officials at or above the rank of minister or head of province. In 2018, a large uptick of 51 officials at or above the provincial/ministerial level were disciplined by the NSC. One group heavily disciplined in recent years has been the discipline inspectors themselves, with the CCP punishing more than 7,900 inspectors since late-2012. This led to new regulations being implemented in 2016 by CCDI that increased overall supervision of its investigators.
China’s overseas fugitive-hunting campaign, called “Operation Skynet,” has led to the capture of more than 5,000 fugitives suspected of corruption. In 2018 alone, CCDI reported that 1,335 fugitives suspected of official crimes were apprehended, including 307 corrupt officials mainly suspected for graft. Anecdotal information suggests the Chinese government’s anti-corruption crackdown oftentimes is inconsistently and discretionarily applied, raising concerns among foreign companies in China. For example, to fight rampant commercial corruption in the medical/pharmaceutical sector, China’s health authority issued “black lists” of firms and agents involved in commercial bribery. Several blacklisted firms were foreign companies. Additionally, anecdotal information suggests many Chinese government officials responsible for approving foreign investment projects, as well as some routine business transactions, are slowing approvals to not arouse corruption suspicions, making it increasingly difficult to conduct normal commercial activity.
While central government leadership has welcomed increased public participation in reporting suspected corruption at lower levels, direct criticism of central government leadership or policies remains off-limits and is seen as an existential threat to China’s political and social stability. Some citizens who have called for officials to provide transparency and public accountability by disclosing public and personal assets, or who have campaigned against officials’ misuse of public resources, have been subject to criminal prosecution.
United Nations Anti-Corruption Convention, OECD Convention on Combating Bribery
China ratified the United Nations Convention against Corruption in 2005 and participates in APEC and OECD anti-corruption initiatives. China has not signed the OECD Convention on Combating Bribery, although Chinese officials have expressed interest in participating in the OECD Working Group on Bribery meetings as an observer.
Resources to Report Corruption
The following government organization receives public reports of corruption:
Anti-Corruption Reporting Center of the CCP Central Commission for Discipline Inspection and the Ministry of Supervision, Telephone Number: +86 10 12388.
10. Political and Security Environment
The risk of political violence directed at foreign companies operating in China remains low. Each year, government watchdog organizations report tens of thousands of protests throughout China. The government is adept at handling protests without violence, but given the volume of protests annually, the potential for violent flare-ups is real. Violent protests, while rare, have generally involved ethnic tensions, local residents protesting corrupt officials, environmental and food safety concerns, confiscated property, and disputes over unpaid wages.
In recent years, the growing number of protests over corporate M&A transactions has increased, often because disenfranchised workers and mid-level managers feel they were not included in the decision process. China’s non-transparent legal and regulatory system allows the CCP to pressure or punish foreign companies for the actions of their governments. The government has also encouraged protests or boycotts of products from certain countries, like Korea, Japan, Norway, Canada, and the Philippines, in retaliation for unrelated policy decisions. Examples of politically motivated economic retaliation against foreign firms include boycott campaigns against Korean retailer Lotte in 2016 and 2017 in retaliation for the decision to deploy the Thermal High Altitude Area Defense (THAAD) to the Korean Peninsula, which led to Lotte closing and selling its China operations; and high-profile cases of gross mistreatment of Japanese firms and brands in 2011 and 2012 following disputes over islands in the East China Sea. Recently, some reports suggest China has retaliated against some Canadian companies and products as a result of a domestic Canadian legal issue that impacted a large Chinese enterprise.
There have also been some cases of foreign businesspeople that were refused permission to leave China over pending commercial contract disputes. Chinese authorities have broad authority to prohibit travelers from leaving China (known as an “exit ban”) and have imposed exit bans to compel U.S. citizens to resolve business disputes, force settlement of court orders, or facilitate government investigations. Individuals not directly involved in legal proceedings or suspected of wrongdoing have also been subject to lengthy exit bans in order to compel family members or colleagues to cooperate with Chinese courts or investigations. Exit bans are often issued without notification to the foreign citizen or without a clear legal recourse to appeal the exit ban decision.
In the past few years, Chinese authorities have detained or arrested several foreign nationals, including American citizens, and have refused to notify the U.S. Embassy or allow access to the American citizens detained for consular officers to visit. These trends are in direct contravention of recognized international agreements and conventions.
11. Labor Policies and Practices
For U.S. companies operating in China, finding adequate human resources remains a major challenge. Finding, developing, and retaining domestic talent, particularly at the management and highly-skilled technical staff levels, remain difficult challenges often cited by foreign firms. In addition, labor costs continue to be a concern, as salaries along with other inputs of production have continued to rise. Foreign companies also continue to cite air pollution concerns as a major hurdle in attracting and retaining qualified foreign talent to relocate to China. These labor concerns contribute to a small, but growing, number of foreign companies relocating from China to the United States, Canada, Mexico, or other parts of Asia.
Chinese labor law does not protect rights such as freedom of association and the right of workers to strike. China to date has not ratified the United Nations International Labor Organization conventions on freedom of association, collective bargaining, and forced labor, but it has ratified conventions prohibiting child labor and employment discrimination. Foreign companies often complain of difficulty navigating China’s ever-evolving labor laws, social insurance laws, and different agencies’ implementation guidelines on labor issues. Compounding the complexity, local characteristics and the application by different localities of national labor laws often vary.
Although required by national law, labor contracts are often not used by domestic employers with local employees. Without written contracts, employees struggle to prove employment, thus losing basic labor rights like claiming severance and unemployment compensation if terminated, as well as access to publicly-provided labor dispute settlement mechanisms. Similarly, regulations on agencies that provide temporary labor (referred to as “labor dispatch” in China) have tightened, and some domestic employers have switched to hiring independent service provider contractors in order to skirt the protective intent of these regulations. These loopholes incentivize employers to skirt the law because compliance leads to substantially higher labor costs. This is one of many factors contributing to an uneven playing field for foreign firms that compete against domestic firms that circumvent local labor laws.
Establishing independent trade unions is illegal in China. The law allows for worker “collective bargaining”; however, in practice, collective bargaining focuses solely on collective wage negotiations – and even this practice is uncommon. The Trade Union Law gives the All-China Federation of Trade Unions (ACFTU), a CCP organ chaired by a member of the Politburo, control over all union organizations and activities, including enterprise-level unions. The ACFTU’s priority task is to “uphold the leadership of the Communist Party,” not to protect workers’ rights or improve their welfare. The ACFTU and its provincial and local branches aggressively organize new constituent unions and add new members, especially in large multinational enterprises, but in general, these enterprise-level unions do not actively participate in employee-employer relations. The absence of independent unions that advocate on behalf of workers has resulted in an increased number of strikes and walkouts in recent years.
ACFTU enterprise unions issue a mandatory employer-borne cost of 2 percent of payroll for membership. While labor laws do not protect the right to strike, “spontaneous” worker protests and work stoppages occur with increasing regularity, especially in labor intensive and “sunset” industries (i.e., old and declining industries such as low-end manufacturing). Official forums for mediation, arbitration, and other similar mechanisms of alternative dispute resolution have generally been ineffective in resolving labor disputes in China. Some localities actively discourage acceptance of labor disputes for arbitration or legal resolution. Even when an arbitration award or legal judgment is obtained, getting local authorities to enforce judgments is problematic.
12. OPIC and Other Investment Insurance Programs
In the aftermath of the Chinese crackdown on Tiananmen Square demonstrations in June 1989, the United States suspended Overseas Private Investment Corporation (OPIC) programs in China. OPIC honors outstanding political risk insurance contracts. The Multilateral Investment Guarantee Agency, an organization affiliated with the World Bank, provides political risk insurance for investors in China. Some foreign commercial insurance companies also offer political risk insurance, as does the People’s Insurance Company of China.
13. Foreign Direct Investment and Foreign Portfolio Investment Statistics
Table 2: Key Macroeconomic Data, U.S. FDI in Host Country/Economy
|Host Country Statistical Source*||USG or International Statistical Source||USG or International Source of Data:
BEA; IMF; Eurostat; UNCTAD, Other
|Host Country Gross Domestic Product (GDP) ($M USD)||2018 (*)||$13,239,840||2017||$12,238,000||www.worldbank.org/en/country|
|Foreign Direct Investment||Host Country Statistical Source*||USG or International Statistical Source||USG or International Source of Data:
BEA; IMF; Eurostat; UNCTAD, Other
|U.S. FDI in partner country ($M USD, stock positions)||2017 (**)||$82,500||2017||$107,556||BEA data available at https://www.bea.gov/international/direct-investment-and-multinational-enterprises-comprehensive-data|
|Host country’s FDI in the United States ($M USD, stock positions)||2017 (**)||$67,400||2017||$39,518||BEA data available at https://www.bea.gov/international/direct-investment-and-multinational-enterprises-comprehensive-data|
|Total inbound stock of FDI as % host GDP||2017 (**)||%16.4||2017||12.6%||UNCTAD data available at https://unctad.org/en/Pages/DIAE/World%20Investment%20Report/Country-Fact-Sheets.aspx|
*China’s National Bureau of Statistics (90.031 trillion RMB converted at 6.8 RMB/USD estimate)
** Statistics gathered from China’s Ministry of Commerce official data
Table 3: Sources and Destination of FDI
|Direct Investment from/in Counterpart Economy Data|
|From Top Five Sources/To Top Five Destinations (US Dollars, Millions)|
|Inward Direct Investment||Outward Direct Investment|
|Total Inward||$2,688,470||100%||Total Outward||N/A||100%|
|China, PR: Hong Kong||$1,242,441||46.21%||N/A||N/A||N/A|
|Brit Virgin Islands||$285,932||10.64%||N/A||N/A||N/A|
|“0” reflects amounts rounded to +/- USD 500,000.|
Source: IMF Coordinated Direct Investment Survey (CDIS)
Table 4: Sources of Portfolio Investment
Data not available.
14. Contact for More Information
Investment Officer – U.S. Embassy Beijing Economic Section
55 Anjialou Road, Chaoyang District, Beijing, P.R. China
+86 10 8531 3000
Other Useful Online Resources
- Chinese Embassy in Washington, D.C.: http://www.china-embassy.org/eng ;
- Ministry of Commerce: http://english.mofcom.gov.cn
- Invest in China: http://www.fdi.gov.cn/pub/FDI_EN/default.htm
- National Development and Reform Commission: http://en.ndrc.gov.cn
- State Administration of Foreign Exchange: http://www.safe.gov.cn
- State Administration of Taxation: http://www.chinatax.gov.cn/2013/n2925
United States Government
- U.S. Embassy in Beijing (Doing Business in China) http://beijing.usembassy-china.org.cn/business.html
- U.S. Department of State travel information: http://travel.state.gov
- U.S. Trade Representative: http://www.ustr.gov
- U.S. Department of Commerce: http://www.export.gov
- U.S. Department of the Treasury: http://www.treasury.gov
- Export Import Bank: http://www.exim.gov
- Overseas Private Investment Corporation (OPIC): http://www.opic.gov
- U.S. Trade and Development Agency: http://www.ustda.gov