TRANSPARENCY OF THE REGULATORY SYSTEM
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 IPR (TRIPS), and the control of foreign exchange. Despite mandatory 30-day public comment periods, PRC ministries continue to post only some draft administrative regulations and departmental rules online, often with a public comment period of less than 30 days. As part of the Phase One Agreement, China committed to providing at least 45 days for public comment on all proposed laws, regulations, and other measures implementing the Phase One Agreement. While China has made some progress, 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.
In China’s state-dominated economic system, the relationships between the CCP, the PRC government, PRC business (state- and private-owned), and other PRC stakeholders are blurred. Foreign enterprises perceive that China prioritizes political goals, industrial policies, and a desire to protect social stability at the expense of foreign investors, fairness, and the rule of law. The World Bank Global Indicators of Regulatory Governance gave China a composite score of 1.75 out 5 points, attributing China’s relatively low score to stakeholders not having easily accessible and updated laws and regulations; the lack of impact assessments conducted prior to issuing new laws; and other concerns about transparency.
For accounting standards, PRC companies use the Chinese Accounting Standards for Business Enterprises (ASBE) for all financial reporting within mainland China. Companies listed overseas or in Hong Kong may choose to use ASBE, the International Financial Reporting Standards, or Hong Kong Financial Reporting Standards.
While the PRC government announced several policies in 2021 to support ESG reporting, they remain voluntary, lack verification mechanisms, and are focused on impact, not governance. Only eighteen PRC companies are signatories to the UN Principles for Responsible Investment. The PRC’s green finance taxonomy known as the “Catalogue of Green Bond Supported Projects” and ESG-like principles for overseas development initiatives outlined in the Guiding Opinions on Promoting Green Belt and Road Construction are voluntary and lack verification mechanisms. However, the PBOC and the European Commission launched a sustainable finance taxonomy to create comparable standards on green finance products on November 4, 2021. China’s goal to peak carbon emissions before 2030 and reach carbon neutrality by 2060 may increase reporting on decarbonization plans and could increase alignment with international standards such as those outlined in the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations. A lack of quality data and a shortage of third-party auditors further hinder expansion of ESG reporting.
MEE’s disclosure rules requiring five types of domestic entities to disclose environmental information on an annual basis came into effect February 8, 2022. The rules will apply only to listed companies and bond issuers that were subject to environmental penalties the previous year and other MEE-identified entities, including those that discharged high levels of pollutants. Entities must disclose information on environmental management, pollution generation, carbon emissions, and contingency planning for environmental emergencies. These same companies and bond issuers must also disclose climate change and environmental protection information related to investment and financing transactions.
On June 28, 2021, the CSRC issued final amendments requiring listed companies disclose environmental penalties and encouraging carbon emissions disclosures. It also issued guidelines on the format and content of annual reports and half-year reports of listed companies, requiring them to set up a separate “Section 5 Environmental and Social Responsibility” to encourage carbon emission reduction related disclosure. In May 2021 the Ministry of Ecology and Environment (MEE) issued a plan for strengthening environmental disclosure requirements by 2025. Most contacts assessed foreign investors are the key drivers of increased ESG disclosures.
INTERNATIONAL REGULATORY CONSIDERATIONS
As part of its WTO accession agreement, China agreed to notify the WTO Committee on Technical Barriers to Trade (TBT) of all draft technical regulations. However, China continues to issue draft technical regulations without proper notification to the TBT Committee.
The PRC is also a member of the Regional Comprehensive Economic Partnership (RCEP), which entered into force on January 1, 2022. Although RCEP has some elements of a regional economic bloc, many of its regulatory provisions (for example on data flow) are weakened by national security exemptions.
China’s application to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) remains under consideration by member states. The PRC would face challenges in addressing obligations related to SOEs, labor rights, digital trade, and increased transparency.
LEGAL SYSTEM AND JUDICIAL INDEPENDENCE
China’s legal system borrows heavily from continental European legal systems, but with “Chinese characteristics.” The rules governing commercial activities are found in various laws, regulations, departmental rules, and Supreme People’s Court (SPC) judicial interpretations, among other sources. While China does not have specialized commercial courts, it has created specialized courts and tribunals for the hearing of intellectual property disputes (IP), including in Beijing, Guangzhou, Shanghai, and Hainan, as well as specialized Internet courts for the handling of disputes arising from conduct online. The PRC’s constitution and laws are clear that PRC courts cannot exercise power independent of the Party. Further, in practice, influential businesses, local governments, and regulators routinely influence courts. Outside of the IP space, U.S. companies often hesitate in challenging administrative decisions or bringing commercial disputes before local courts due to perceptions of futility or fear of government retaliation.
LAWS AND REGULATIONS ON FOREIGN DIRECT INVESTMENT
The PRC’s new Foreign Investment Law, the FIL, came into force on January 1, 2020, replacing the previous foreign investment framework. 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 the same domestic laws as PRC companies, such as the Company Law. The FIL standardized the regulatory regimes for foreign investment by including the negative list management system, a foreign investment information reporting system, and a foreign investment security review system all under one document. The FIL also seeks to address foreign investors complaints by potentially banning forced technology transfers, promising better IPR, and the establishment of a complaint mechanism for investors to report administrative abuses. However, foreign investors remain concerned that the FIL and its implementing regulations provide PRC ministries and local officials significant regulatory discretion, including the ability to retaliate against foreign companies.
The December 2020 revised investment screening mechanism under the Measures on Security Reviews on Foreign Investments (briefly discussed above) came into effect January 18, 2021, without any period for public comment or prior consultation with the business community. Foreign investors complained China’s new rules on investment screening were expansive in scope, lacked an investment threshold to trigger a review, and included green field investments – unlike most other countries. Moreover, new guidance on Neutralizing Extra-Territorial Application of Unjustified Foreign Legislation Measures, a measure often compared to “blocking statutes” from other markets, added to foreign investors’ concerns over the legal challenges they would face in trying to abide by both their host-country’s regulations and China’s. Foreign investors complained that market access in China was increasingly undermined by national security-related legislation. While not comprehensive, a list of official PRC laws and regulations is here.
On June 10, 2021, the Standing Committee of the NPC adopted the Law of the People’s Republic of China on Countering Foreign Sanctions (“Anti-Foreign Sanctions Law” or AFSL). The AFSL gives the government explicit authority to impose countermeasures related to visas, deportation, and asset freezing against individuals or organizations that broadly endanger China’s “sovereignty, security, or development interests.” The law also calls for Chinese citizens and organizations harmed by foreign “sanctions” to pursue damages via PRC civil courts.
On October 13, 2021, MOF issued a circular prohibiting discrimination against foreign-invested enterprises (FIEs) in government procurement for products “produced in China.” The circular required that suppliers not be restricted based on ownership, organization, equity structure, investor country, or product brand, to ensure fair competition between domestic and foreign companies. The circular also required the abolition of regulations and practices violating the circular by the end of November, including the establishment of alternative databases and qualification databases. This circular may have been intended to address the issuance of Document No. 551 in May by MOF and the Ministry of Industry and Information Technology (MIIT) (without publishing on official websites), titled “Auditing guidelines for government procurement of imported products,” outlining local content requirements for hundreds of items, many of which are medical devices, including X-ray machines and magnetic resonance imaging equipment. It is unclear whether Document 551 will be rescinded or revised based on this circular. Additionally, the circular applies only to FIEs and does not provide fair treatment for imported products from companies overseas. While the circular does state FIEs should be afforded equal treatment, the circular does not address concerns about localization pressures created by Document 551. Further, the circular provides no guidance on what constitutes a “domestic product” and does not address treatment of products manufactured in China that incorporate content from other jurisdictions, key concerns for a wide range of U.S. firms.
FDI Requirements for Investment Approvals
Foreign investments in industries and economic sectors that are not explicitly restricted on China’s negative lists do not require MOFCOM pre-approval. However, investors complained that in practice, investing in an industry not on the negative list does not guarantee a foreign investor “national treatment,” or treatment no less favorable than treatment accorded to a similarly situated domestic investor. Foreign investors must comply with other steps and approvals such as receiving land rights, business licenses, and other necessary permits. When a foreign investment needs ratification from the NDRC or a local/sub-national NDRC office, that administrative body oversees assessing the project’s compliance with a panoply of PRC laws and regulations. In some cases, NDRC solicits the opinions of relevant industrial regulators and consulting agencies acting on behalf of domestic firms, creating potential conflicts of interest disadvantageous to foreign firms.
COMPETITION AND ANTITRUST LAWS
China’s newly revised Anti-Monopoly Law (AML) came into effect on August 1, 2022. Changes included stepped-up fines for AML violations and specification of the factors to consider in determining whether an undertaking in the internet sector has abused a dominant market position. In February 2021, SAMR published (after public comment) six AML-related department rules, including “Antitrust Guidelines for the Platform Economy” and the “Provisions Prohibiting IP Abuse to Preclude or Restrict Competition”, among others. The Platform Guidelines address monopolistic behaviors of online platforms operating in China, while the IP Abuse Provisions address monopolistic abuse of intellectual property rights. China also included its fair competition review system into the newly revised AML.
In November 2021, the PRC government announced transformation of the Anti-Monopoly Bureau of the SAMR, renaming it the National Anti-Monopoly Administration, reorganizing the existing structure into three new divisions, and adding staff to double in size. The National Anti-Monopoly Administration enforces the AML and oversees competition issues at the central and provincial levels. The bureau reviews mergers and acquisitions, and investigates cartel and other anticompetitive agreements, abuse of a dominant market positions, including those related to IP, and abuse of administrative powers by government agencies. The bureau also oversees the Fair Competition Review System (FCRS), which requires government agencies to conduct a review prior to issuing new and revising administrative regulations, rules, and guidelines to ensure such measures do not restrict competition. SAMR issues implementation guidelines to fill in gaps in the AML, address new trends in China’s market, and help foster transparency in enforcement. Generally, SAMR has sought public comment on proposed measures, although comment periods are sometimes less than 30 days.
Foreign companies have long expressed concern that the government uses AML enforcement in support of China’s industrial policies, such as promoting national champions, particularly for companies operating in strategic sectors. The AML explicitly protects the lawful operations of government authorized monopolies in industries that affect the national economy or national security. U.S. companies expressed concerns that in SAMR’s consultations with other PRC agencies when reviewing M&A transactions, those agencies raise concerns not related to competition concerns to block, delay, or force transacting parties to comply with preconditions – including technology transfer – to receive approval. The amended AML also featured a new provision mandating that “antimonopoly work [must] uphold the leadership of the Communist Party of China”, which is viewed as a further signal to U.S. businesses operating here that China’s competition law enforcement is motivated and guided by factors outside traditional considerations found in jurisdictions adhering to the rule of law.
EXPROPRIATION AND COMPENSATION
China’s law prohibits nationalization of FIEs, except under vaguely specified “special circumstances” where there is a national security or public interest need. PRC law requires fair compensation for an expropriated foreign investment but does not detail the method used to assess the value of the 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 (New York Convention). PRC legislation that provides for enforcement of foreign arbitral awards related to these two Conventions includes the Arbitration Law, the Civil Procedure Law, and other laws with similar provisions that have embraced many of the fundamental principles of the United Nations Commission on International Trade Law’s Model Law on International Commercial Arbitration. However, in some disputes, PRC courts have refused to enforce arbitral awards they deem violate public interest and policy. Further, the process by which PRC courts – and ultimately the Supreme People’s Court – agree or refuse to enforce an arbitral award is opaque, and U.S. companies seeking enforcement of such awards are often left in the dark for years awaiting a determination.
Investor-State Dispute Settlement (ISDS)
As China has become a capital exporter under its “Going Global” initiative and through infrastructure investments under BRI, its views on ISDS have shifted to allow foreign investors with unobstructed access to international arbitration to resolve any investment dispute that cannot be amicably settled within six months. PRC investors did not use investor-state dispute settlement (ISDS) mechanisms until 2007, and the first known ISDS case against China was initiated in 2011 by Malaysian investors. China is a signatory to the International Centre for Settlement of Investment Disputes (ICSID) under the World Bank which provides arbitration under ICSID and United Nations Commission on International Trade Law (UNCITRAL) rules. China submitted a proposal on ISDS reform to the UNCITRAL Working Group III in 2019. Under the proposal, China reaffirmed its commitment to ISDS as an important mechanism for resolving investor-state disputes under public international law. However, it suggested various pathways for ISDS reform, including supporting the study of a permanent appellate body.
International Commercial Arbitration and Foreign Courts
PRC officials typically urge private parties to resolve commercial disputes through informal mediation. If formal mediation is necessary, PRC 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 for foreign-related disputes. Some foreign parties have obtained favorable rulings from CIETAC, while others have questioned CIETAC’s fairness and effectiveness. Besides CIETAC, there are also provincial and municipal arbitration commissions. 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 PRC and foreign arbitration bodies. In these instances, foreign investors may appeal to higher courts. The government of China and its judicial bodies do not maintain a public record of investment disputes. The SPC maintains an annual count of the number of cases involving foreigners but does not provide details about the cases.
In 2021, the CIETAC handled 636 foreign-related cases, of which 136 cases are involved with China’ One Belt and One Road Initiative.
In 2018, the SPC established the China International Commercial Courts (CICC) to adjudicate international commercial cases, especially cases related to BRI. Two SPC’s CICCs are respectively installed in Shenzhen and Xian. Despite its international orientation, CIIC’s 16 judges are all PRC citizens and Mandarin Chinese is the court’s working language. Parties to a dispute before the CICC can only be represented by PRC law-qualified lawyers, as foreign lawyers do not have a right of audience in China’s courts; and unlike other international courts, foreign judges are not permitted to be part of the proceedings. Judgments of the CICC, given it is a part of the SPC, cannot be appealed from, but are subject to possible “retrial” under the Civil Procedure Law.
By the end of 2020, the China International Commercial Court had heard 18 cases and completed 8 cases. The cases involved foreign parties from the United States, the Philippines, Japan, Italy, Thailand, the Philippines, etc. In addition, eight municipalities have also established international commercial local courts within their local courts.
Without distinguishing which courts handled the cases, the President of the Supreme People’s Court reported October 28 to the National People’s Congress Standing Committee that in 2021, PRC courts had handled 27,300 “foreign-related civil and commercial cases” involving over 100 countries.
China has bilateral agreements with 27 countries on the recognition and enforcement of foreign court judgments, but not with the United States. Under PRC law, courts must prioritize the Party’s needs, China’s laws, and other regulatory measures above foreign court judgments.
Comprehensive data on investments disputes over the last ten years involving a U.S. or international person was not available, however, there have been limited instances of PRC courts enforcing U.S. court (or other foreign court) decisions on the basis of reciprocal treatment. But some companies reported that they believed the resolution of their dispute was not consistent with local laws or with international business practices. It is unclear what the trend on enforcement of foreign judgments will be. Businesses also reported that that in 2022, it had become more difficult to access Chinese data from outside of China. For example, trademark filings and court case databases became inaccessible outside of China or require registration with a PRC phone number. China also made legislative changes to address upper-level statutory damages, but there was no data available about whether the courts were issuing higher damages.
The PRC introduced bankruptcy laws in 2007, under the Enterprise Bankruptcy Law (EBL), which applies to all companies incorporated under PRC laws and subject to PRC regulations. In May 2020, the PRC released the Civil Code, contract and property rights rules. The NPC listed amendments to the EBL as a top work priority for 2021 and 2022. According to the NPC website in November 2022, the NPC has worked out an initial amendment draft and is soliciting opinions from delegates, which has not yet been released to the public, and will accelerate the legislative process and submit it to NPC Standing Committee for reading and review as soon as possible. Court-appointed administrators – law firms and accounting firms that help verify claims, organize creditors’ meetings, list, and sell assets online – look to handle more cases and process them faster. As of 2021 official statements cited 5,060 institutional administrators and 703 individual administrators.
On August 18, 2021, the Law Enforcement Inspection Team of the Standing Committee of the NPC submitted its report on the enforcement of enterprise bankruptcy to the 30th meeting of the Standing Committee of the Thirteenth NPC for deliberation. The report is available publicly at the NPC website. The report found that from 2007 to 2020, courts at all levels nationwide accepted 59,604 bankruptcy cases, and concluded 48,045 bankruptcy cases (in 2020 there were 24,438 liquidation and bankruptcy cases). Of the total liquidation and bankruptcy cases recorded in 2020, 90 percent involved private enterprises. The announcement also cited the allocation of additional resources, including the establishment of at least 14 bankruptcy tribunals and 100 Liquidation & Bankruptcy Divisions and specialized collegial panels to handle bankruptcy cases. As of August 2021, bankruptcy cases are handled by 417 bankruptcy judges, 28 high people’s courts, and 284 intermediate people’s courts.
The government added a new court in Haikou and Changzhou in December 2021 and April 2022 respectively. Zhejiang also established new bankruptcy courts in Hangzhou and in Wenzhou.
Official national data is unavailable for 2021 or 2022, but local courts released information covering five-year spans that suggest as of November 30, 2022, Haikou court had accepted 342 liquidation and bankruptcy cases and Changzhou court accepted 762 liquidation and bankruptcy cases in 2022. According to the Jiangsu People’s High Court 2022 report, over the past five years, Jiangsu closed 14,000 bankruptcy cases, which released frozen assets valued at over 1 trillion RMB. Zhejiang People’s High Court 2022 report, covering the 2018-2022 period reported that it closed 16,000 bankruptcy cases, releasing frozen financial assets valued at over 480 billion RMB. Anhui province reported concluding 2,120 bankruptcy cases, which released frozen assets valued over 149.5 billion RMB. Finally, a 2022 Shanghai People’s High Court report disclosed it had reached a judgement on 1,288 bankruptcy cases in 2022, unfreezing assets valued at 65 billion RMB.
Various sub-national reports also confirmed a 99 percent increase in accepted liquidation and bankruptcy cases in Nanjing, the capital city of Jiangsu province from June 2020 to June 2022. While many property developers defaulted on various forms of debt in 2022 – including Evergrande – none were restructured or declared bankrupt by the end of the reporting period. In addition to the real estate sector, the financial sector experienced several high-profile bankruptcy cases in 2022. In July, the China Banking and Insurance Regulatory Commission (CBIRC) approved the entry of the New China Trust Co, Ltd into bankruptcy proceedings, and the Beijing financial court accepted the reorganization of 1an Property Insurance Co, Ltd. The CBIRC approved the start of bankruptcy proceedings for Liaoyang Rural Commercial Bank and Liaoning Taizihe Village Bank in August 2022, and for Zhongwang Group Finance Co, Ltd in September.
While PRC authorities are taking steps to address corporate debt and are gradually allowing some companies to fail, companies generally avoid pursing bankruptcy because of the potential for local government interference and fear of losing control over the outcome. According to the SPC, 2.899 million enterprises closed business in 2020, of which only 0.1 percent or 3,908 closed because of bankruptcy.
In August 2020, Shenzhen released the Personal Bankruptcy Regulations of Shenzhen Special Economic Zone, which took effect on March 1, 2021. This was the PRC’s first regulation on personal bankruptcy. On July 19, 2021, the Shenzhen Intermediate People’s Court of Guangdong Province, China served a ruling on Liang Wenjin approving his personal bankruptcy reorganization plan. This was the first personal bankruptcy case closed by Shenzhen Court since the implementation of the Personal Bankruptcy Regulations of Shenzhen Special Economic Zone and is the first personal bankruptcy reorganization case in China. From its opening in March 2020 through the end of calendar year 2022, the court had received 1308 individual bankruptcy applications total, of which 171 (13%) have been concluded, with bankruptcy proceedings initiated in 80 of the concluded cases (47%).
The Personal Bankruptcy Regulations is China’s first set of rules on personal bankruptcy, which formally establishes the personal bankruptcy system in China for the first time. At present, the Personal Bankruptcy Regulations is only applicable in Shenzhen. Numerous other localities have also begun experimenting with legal remedies for personal insolvency, in part to deter debtors from taking extreme measures to address debt.