New pilot free trade zones launched in China and first regulations announced

China’s three new pilot Free Trade Zones (“FTZ”s) in Tianjin, Guangdong and Fujian were officially launched on 21 April 2015. This comes 18 months after the launch of China’s first FTZ in the financial hub of Shanghai, which has since expanded to more than four times its original size.

The launch coincided with the release of various policies for investment within the FTZs by China’s State Council and Ministry of Commerce. These include the Special Administrative Measures (Negative List) for Foreign Investment Access to Pilot Free Trade Zones (“2015 Negative List”), Measures for the Record-filing of Foreign Investment in Pilot Free Trade Zones (“Record-filing Measures”) and Measures for National Security Review of Foreign Investment (“National Security Measures”). As expected, these generally follow the model of the Shanghai FTZ, but with certain changes.

Negative list for foreign investment

The State Council released the 2015 Negative List in April and it became effective on 8 May 2015. The 2015 Negative List provides an outline of the sectors in which foreign investment is restrained, and will replace the previous negative list (“2014 Negative List”) which applied to the Shanghai FTZ, so will apply to all four existing FTZs in China. For all industries not listed in this document, foreign investors will receive treatment more similar to domestic companies with regard to the establishment and approval requirements and process. This means that they do not require government approval and instead benefit from a simplified filing procedure, whereby the company can be registered by a mere filing process with the competent approval authority (in addition to the usual incorporation process required with the Administration for Industry and Commerce). Under the 2014 Negative List procedure this filing had to be completed before a company’s incorporation, but under the new Record-filing Measures this procedure only needs to be completed within 30 days of the company’s incorporation, or within 30 days of the alternation and filing of contracts and articles of association of the foreign-funded enterprise. This filing is still a step more than is required of domestic companies, but the more flexible procedure should make the incorporation of a foreign company more straightforward.

The 2015 Negative List details 122 prohibited or restricted areas, reduced from 139 in the 2014 Negative List. Much of the 2015 Negative List mirrors the changes made by the 2015 Foreign Investment Catalogue released earlier this year, including reducing the number of sectors that are restricted or prohibited to foreign investors and reducing the number of industries where foreign investors can only participate through a joint venture with a Chinese company or need a minimum amount of Chinese equity participation. This includes removing restrictions in the mining, medical and pharmaceutical product manufacturing and telecoms industries.

However, it is more comprehensive and goes further in removing other limitations and restrictions on foreign investment, including removing certain restrictions in:

• The exploration and mining of special and rare types of coal;
• The processing of certain edible oils and fats, rice and flour;
• International marine transportation services; and
• The construction and operation of water control projects.

There have also been certain items removed from the ‘prohibited’ category, for example the manufacturing of weapons and ammunition. However, this is perhaps misleading, as it does not mean that foreign investors may now manufacture weaponry within the FTZs. The Negative List 2015 only serves to identity where foreign investors are treated differently to domestic Chinese companies. Weapons and ammunition are not allowed to be produced by regular Chinese entities either, hence their removal from the list. The Negative List 2015 therefore needs to be looked at in the context of other laws and regulations.

Additionally, this negative list approach does not apply in certain circumstances, and normal approval procedures still apply. This includes where a foreign investor acquires a domestic Chinese company, strategically invests in a listed company in China or makes a capital contribution using equity held in Chinese companies.

National security review for foreign investment

Alongside the Negative List 2015, the State Council also released the Circular of the State Council on Distributing the Trial Measures on National Security Review of Foreign Investment in the Pilot Free Trade Zones, which was also effective from 8 May 2015. This intention of these measures is to ensure control over potential national security risks as restrictions are relaxed for foreign investors.

The measures are broader than the existing national regime, which only applies to certain types of foreign M&A transactions. Under the FTZ measures, a review will be held of foreign investors in sensitive industries such as military-related fields, key agricultural products, energy, infrastructure, transportation, culture, information technology and equipment manufacturing that concern national security. This applies not only to foreign M&A but to all other types of foreign investment including offshore transactions, re-investment by FIEs and arrangements using share nominees.

The government body in charge of security review is a joint council (the “Joint Council”) composed of officials from the Development and Reform Commission, the Ministry of Commerce and other governmental departments.

The local governments of FTZs are required to inform foreign investors when a review is required, and halt their business application procedures until further notice from the Joint Council. According to the circular, a review will consider the impact of the foreign investment on various factors including national security, economic stability, social order, national cultural security and public morality, cyber security and the ability to research and develop key technologies relating to national security. There are no details in the circular of exactly how these factors can be defined or will be applied, so it remains to be seen how much of a barrier these reviews will be on foreign investors in any of the more sensitive sectors mentioned.

Local characteristics

As we discussed in our previous Law-Now on this subject, the locations of the new FTZs each bring particular advantages.

The Tianjin municipal government confirmed that the Tianjin FTZ will work towards the integration of the Beijing-Tianjin-Hebei region. The Tianjin FTZ will focus on financial leasing, but may also be in a good position to accommodate high-end manufacturing businesses.

Zhu Xiaodan, governor of Guangdong Province, said at the launch ceremony for the Guangdong FTZ that it will become a demonstration zone for Guangdong firms to cooperate with enterprises in Hong Kong and Macao. The focus of Guangdong FTZ is likely to be customs clearance and the finance industry due to its geographic proximity with these regions. Overseas enterprises, particularly those from Hong Kong and Macao, will be welcomed to invest in the Guangdong FTZ, according to a press release by the Guangdong provincial government.

Su Shulin, governor of Fujian Province, said at the launch ceremony for the Fujian FTZ that it will take advantage of its strategic geographic position by playing a key role in cross-Straits economic cooperation with Taiwan. It is likely to focus on producer and high-end services.

Conclusion

The opening of the new FTZs is another sign of China increasingly opening up to foreign investors and affording them more equal opportunities to domestic companies. Companies in sectors including finance, education and healthcare may be able to benefit significantly from the preferential policies in these areas. Some have also speculated that existing companies may move their businesses into the FTZs from outside, to take advantage of the more relaxed policies.

Despite the clear potential for opportunities, there is still significant uncertainty surrounding the implementation of these latest measures, in particular in terms of the potential scope of the industry categories of the 2015 Negative List, which may go further than investors were expecting. There are also concerns that the National Security Measures are another way of imposing restrictions on foreign companies and, if strictly applied, could mean that in practice it is still a difficult and long process for foreign companies to operate in the FTZs. Further local policies for each FTZ are due to be released soon and may help to give a better idea of what foreign investors can expect.

Co-contributed by Ciara Simmons (ciara.simmons@cms-cmck.com)