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 .

Ownership Restrictions

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  

Business Facilitation

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.

Outward Investment

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.

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.

Remittance Policies

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.

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.

Privatization Program

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.

Policies Towards Foreign Direct Investment

Hong Kong is the world’s third-largest recipient of foreign direct investment (FDI) according to the United Nations Conference on Trade and Development’s (UNCTAD) World Investment Report 2018. The HKG’s InvestHK encourages inward investment, offering free advice and services to support companies from the planning stage through to the launch and expansion of their business. U.S. and other foreign firms can participate in government financed and subsidized research and development programs on a national treatment basis. Hong Kong does not discriminate against foreign investors by prohibiting, limiting, or conditioning foreign investment in a sector of the economy.

Capital gains are not taxed, nor are there withholding taxes on dividends and royalties. Profits can be freely converted and remitted. Foreign-owned and Hong Kong-owned company profits are taxed at the same rate – 16.5 percent. The tax rate on the first USD 255,000 profit for all companies is currently 8.25 percent. No preferential or discriminatory export and import policies affect foreign investors. Domestic industries receive no direct subsidies. Foreign investments face no disincentives, such as quotas, bonds, deposits, nor other similar regulations.

According to HKG statistics, 3,955 overseas companies had regional operations registered in Hong Kong in 2018. The United States has the largest number with 724. About 35 percent of start-ups in Hong Kong come from overseas.

Hong Kong’s Business Facilitation Advisory Committee is a platform for the HKG to consult the private sector on regulatory proposals and implementation of new or proposed regulations.

Limits on Foreign Control and Right to Private Ownership and Establishment

Foreign investors can invest in any business and own up to 100 percent of equity. Like domestic private entities, foreign investors have the right to engage in all forms of remunerative activity.

The HKG owns all land in Hong Kong, which the HKG administers by granting long-term leases without transferring title. Expatriates claim that a 15 percent Buyer’s Stamp Duty on all non-permanent-resident and corporate buyers discriminates against them.

The main exceptions to the HKG’s open foreign investment policy are:

Broadcasting – Voting control of free-to-air television stations by non-residents is limited to 49 percent. There are also residency requirements for the directors of broadcasting companies.

Legal Services – Foreign lawyers at foreign law firms may only practice the law of their jurisdiction. Foreign law firms may become “local” firms after satisfying certain residency and other requirements. Localized firms may thereafter hire local attorneys, but must do so on a 1:1 basis with foreign lawyers. Foreign law firms can also form associations with local law firms.

Other Investment Policy Reviews

Hong Kong last conducted the Trade Policy Review in 2018 through the World Trade Organization (WTO). https://www.wto.org/english/tratop_e/tpr_e/g380_e.pdf 

Business Facilitation

The Economic Analysis and Business Facilitation Unit under the Financial Secretary’s Office is responsible for business facilitation initiatives aimed at improving the business regulatory environment of Hong Kong.

The e-Registry (https://www.eregistry.gov.hk/icris-ext/apps/por01a/index ) is a convenient and integrated online platform provided by the Companies Registry and the Inland Revenue Department for applying for company incorporation and business registration. Applicants, for incorporation of local companies or for registration of non-Hong Kong companies, must first register for a free user account, presenting an original identification document or a certified true copy of the identification document. The Companies Registry normally issues the Business Registration Certificate and the Certificate of Incorporation on the same day for applications for company incorporation. For applications for registration of a non-Hong Kong company, it issues the Business Registration Certificate and the Certificate of Registration two weeks after submission.

Outward Investment

As a free market economy, Hong Kong does not promote or incentivize outward investment, nor restricts domestic investors from investing abroad. Mainland China and British Virgin Islands were the top two destinations for Hong Kong’s outward investments in 2017.

Capital Markets and Portfolio Investment

There are no impediments to the free flow of financial resources. Non-interventionist economic policies, complete freedom of capital movement, and a well-understood regulatory and legal environment make Hong Kong a regional and international financial center. It has one of the most active foreign exchange markets in Asia.

Asset and wealth managed in Hong Kong posted a record high of USD 3.1 trillion in 2017 (the latest figure available), with two-thirds of that coming from overseas investors. In order to enhance the competitiveness of Hong Kong’s fund industry, open-ended fund companies as well as onshore and offshore funds are offered a profits tax exemption.

The HKMA’s Infrastructure Financing Facilitation Office (IFFO) provides a platform for pooling the efforts of investors, banks, and the financial sector to offer comprehensive financial services for infrastructure projects in emerging markets. In March 2018, IFFO joined the Global Infrastructure Facility as an advisory partner, contributing to the World Bank Group and international efforts to help make more infrastructure projects bankable.

Under the Insurance Companies Ordinance, insurance companies are authorized by the Insurance Authority to transact business in Hong Kong. As of January 2019, there were 162 authorized insurance companies in Hong Kong, 73 of them foreign or Mainland Chinese companies.

The Hong Kong Stock Exchange’s total market capitalization dropped by 12.0 percent to USD 3.8 trillion in 2018, with 2,315 listed firms at year-end. Hong Kong Exchanges and Clearing Limited, a listed company, operates the stock and futures exchanges. The Securities and Futures Commission, an independent statutory body outside the civil service, has licensing and supervisory powers to ensure the integrity of markets and protection of investors.

No discriminatory legal constraints exist for foreign securities firms establishing operations in Hong Kong via branching, acquisition, or subsidiaries.  Rules governing operations are the same for all firms. No laws or regulations specifically authorize private firms to adopt articles of incorporation or association that limit or prohibit foreign investment, participation, or control.

In 2018, a total of 267 Chinese enterprises had “H” share listings on the stock exchange, with combined market capitalization of USD 761.8 billion. The Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connects allow individual investors to cross trade Hong Kong and Mainland stocks. In December 2018, the ETF Connect, which was planned to allow international and mainland investors to trade in exchange-traded fund products listed in Hong Kong, Shanghai and Shenzhen, was put on hold indefinitely due to “technical issues.”

By the end of 2018, 50 Mainland mutual funds and 17 Hong Kong mutual funds were allowed to be distributed in each other’s markets through the Mainland-Hong Kong Mutual Recognition of Funds scheme. Hong Kong also has mutual recognition of funds programs with Switzerland, France, the United Kingdom, and Luxembourg.

Hong Kong has developed its debt market with the Exchange Fund bills and notes program. Hong Kong Dollar debt stood at USD 236.5 billion by the end of 2018. As of January 2019, RMB 871.2 billion (USD 129.6 billion) of offshore RMB bonds were issued in Hong Kong. Multinational enterprises, including McDonald’s and Caterpillar, have also issued debt. The Bond Connect, a new mutual market access scheme that allows investors from Mainland China and overseas to trade in each other’s respective bond markets, was launched in July 2017.

The HKG requires workers and employers to contribute to retirement funds under the Mandatory Provident Fund (MPF) scheme. Contributions are expected to channel roughly USD five billion annually into various investment vehicles. By the end of 2018, the net asset values of MPF funds amounted to USD 104.2 billion.

Money and Banking System

Hong Kong has a three-tier system of deposit-taking institutions: licensed banks (152), restricted license banks (18), and deposit-taking companies (16). HSBC is Hong Kong’s largest banking group. With its majority-owned subsidiary Hang Seng Bank, HSBC controls more than 40.3 percent of Hong Kong Dollar (HKD) deposits. The Bank of China (Hong Kong) is the second-largest banking group with 13.9 percent of HKD deposits throughout 200 branches. In total, the five largest banks in Hong Kong had more than USD 1.7 trillion in total assets at the end of 2017. Thirty-five U.S. “authorized financial institutions” operate in Hong Kong, and most banks in Hong Kong maintain U.S. correspondent relationships. Full implementation of the Basel III capital, liquidity, and disclosure requirements is expected in 2019.

Credit in Hong Kong is allocated on market terms and is available to foreign investors on a non-discriminatory basis. The private sector has access to the full spectrum of credit instruments as provided by Hong Kong’s banking and financial system. Legal, regulatory, and accounting systems are transparent and consistent with international norms. The HKMA, the de facto central bank, is responsible for maintaining the stability of the banking system and managing the Exchange Fund that backs Hong Kong’s currency. Real Time Gross Settlement helps minimize risks in the payment system and brings Hong Kong in line with international standards.

Banks in Hong Kong have in recent years strengthened anti-money laundering and counter-terrorist financing controls, including the adoption of more stringent customer due diligence (CDD) process for existing and new customers. In September 2016, the HKMA issued a circular stressing that “CDD measures adopted by banks must be proportionate to the risk level and banks are not required to implement overly stringent CDD processes.”

The HKMA welcomes the establishment of virtual banks, which are subject to the same set of supervisory principles and requirements applicable to conventional banks. In May 2018, HKMA issued guidelines on authorization of virtual banks, giving priority to those applicants demonstrating, among other requirements, that they have a credible and viable business plan to provide new customer experience and to promote financial inclusion and fintech development. In March 2019, the HKMA granted three virtual banking licenses, with five more applications under consideration.

In March 2016, the HKMA set up the Fintech Facilitation Office (FFO) to promote Hong Kong as a fintech hub in Asia. Seven banks in Hong Kong have joined an HKMA-led blockchain-based trade finance proof-of-concept to digitize and share trade documents, automate processes and reduce risks and fraud. In 2018, the HKMA signed four fintech co-operation agreements with the regulatory authorities of Switzerland, Poland, Abu Dhabi, and Brazil.

Foreign Exchange and Remittances

Foreign Exchange

Conversion and inward/outward transfers of funds are not restricted. The HKD is a freely convertible currency linked via de facto currency board to the U.S. dollar.  The exchange rate is allowed to fluctuate in a narrow band between HKD 7.75 – HKD 7.85 = USD 1.

Remittance Policies

There are no recent changes to or plans to change investment remittance policies. Hong Kong has no restrictions on the remittance of profits and dividends derived from investment, nor reporting requirements on cross-border remittances. Foreign investors bring capital into Hong Kong and remit it through the open exchange market.

Hong Kong has anti-money laundering (AML) legislation allowing the tracing and confiscation of proceeds derived from drug-trafficking and organized crime. Hong Kong has an anti-terrorism law that allows authorities to freeze funds and financial assets belonging to terrorists. Effective from July 2018, travelers arriving in Hong Kong with currency or bearer negotiable instruments (CBNIs) exceeding HKD 120,000 (USD 15,385) must make a written declaration to the CED. For a large quantity of CBNIs imported or exported in a cargo consignment, an advanced electronic declaration must be made to the CED.

Sovereign Wealth Funds

The Future Fund, Hong Kong’s wealth fund, was established in 2016 with an endowment of USD 28.2 billion. The fund seeks higher returns through long-term investments and adopts a “passive” role as a portfolio investor. About half of the Future Fund has been deployed in alternative assets, mainly global private equity and overseas real estate, over a three-year period. The rest is placed with the Exchange Fund’s Investment Portfolio, which follows the Santiago Principles, for an initial ten-year period. In February 2019, the Financial Secretary announced that an expert team will review the fund’s investment strategies and portfolios to achieve more diversified investments.

Hong Kong has several major HKG-owned enterprises, which are classified as “statutory bodies.” Hong Kong is party to the Government Procurement Agreement (GPA) within the framework of WTO. Annex 3 of the GPA lists as statutory bodies the Housing Authority, Hospital Authority, Airport Authority, Mass Transit Railway Corporation Limited, and the Kowloon-Canton Railway Corporation, which procure in accordance with the agreement.

The HKG provides more than half the population with subsidized housing, along with most hospital and education services from childhood through the university level. The government also owns major business enterprises, including the stock exchange, railway, and airport.

Conflicts occasionally arise between the government’s roles as owner and policy-maker. Industry observers have recommended that the government establish a separate entity to coordinate its ownership of government-held enterprises and initiate a transparent process of nomination to the boards of government-affiliated entities. Other recommendations from the private sector include establishing a clear separation between industrial policy and the government’s ownership function, and minimizing exemptions of government-affiliated enterprises from general laws.

The 2012 Competition Law exempts all but six of the statutory bodies from the law’s purview. While the government’s private sector ownership interests do not materially impede competition in Hong Kong’s most important economic sectors, industry representatives have encouraged the government to adhere more closely to the Guidelines on Corporate Governance of State-owned Enterprises of the Organization for Economic Cooperation and Development (OECD).

Privatization Program

All major utilities in Hong Kong, except water, are owned and operated by private enterprises, usually under an agreement framework by which the HKG regulates each utility’s management.