China’s negative list, which is released annually by the Ministry of Commerce and National Development and Reform Commission, outlines the country’s restricted and prohibited sectors for foreign investment. The 2021 version, effective January 1 2022, has been welcomed by market participants as it relaxes a number of rules in the manufacturing sector and introduces a new section on listing regulations that provides a path to IPOs for businesses in restricted sectors.
What are the biggest changes to the list this year?
The list of industries restricted or prohibited for foreign investments has been shortened year on year with only 33 industries on the national list and 33 on the list for free trade zones included in the 2020 version. The 2021 version removed more industries from the lists, such as restrictions on foreign investors from holding a majority stake in the auto and television manufacturing industries, and from holding stake in two or more car manufacturers.
Foreign investors are now allowed to establish wholly foreign-owned enterprises for whole vehicle manufacturing, including special purpose vehicles, new energy vehicles, commercial vehicles and passenger vehicles. “In the past, the shareholding ratio of Chinese shareholders in a whole vehicle manufacturer had to be at least 50%,” said Ulrike Glueck, managing partner at CMS in China. “Such relaxation may give foreign investors more freedom and dependency in investing in the whole vehicle manufacturing industry.”
Further, there is no restriction on the number of joint ventures to be founded by foreign investors in China to manufacture the same type of vehicles, while in the past, one foreign investor may only establish up to two such joint ventures.
“This would open up the vast China auto market for full competition among domestic and international car makers, and this has been an area which has been getting a lot of attention from the international community,” said Fang Jian, partner at Fangda Partners. “Coupled with the removal of broadcasting equipment manufacturing from the list, it means that China now has effectively allowed full foreign access to the manufacturing industry, and further demonstrates the strong commitment of the Chinese government to open up its market to international investors.”
It is foreseeable that foreign investors will consider investing in television and broadcasting equipment manufacturing. However, Glueck said that since this is a new industry for foreign investment, whether and to which extent the relevant administrative authorities, such as the Ministry of Industry and Information Technology, will impose certain administrative control measures, such as a manufacturing licence, remains to be seen.
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What will be the impact of the new provision on companies in negative lists seeking overseas IPOs?
In addition to removal of manufacturing restrictions, a new section on listing regulations enables domestic companies in businesses prohibited for foreign investments to seek approval to list their shares in Hong Kong SAR or in foreign jurisdictions.
“In the past, some of these companies, such as those in the telecom sector, have successfully listed their shares in Hong Kong SAR or foreign jurisdictions but these decisions were made by the Chinese government as special cases,” said Fang. “With this provision, these companies now have a clear path to seek approvals for their offshore listings assuming that they will meet the relevant foreign equity ratio and management requirements.”
The new provision also offers another avenue for international investors to access these companies in addition to the QFII (qualified foreign institutional investor) and Stock Connect channels.
“The guidance provides a path for companies that operate in sectors on the negative list to go public if foreign investment is below certain thresholds,” said Marcia Ellis, partner at Morrison & Foerster. “This is positive as they were previously not allowed to list.”
Enterprises engaged in businesses where foreign investment is prohibited could previously only take an overseas listing by way of contractual arrangements, and could not pursue an H-share IPO listing. H-shares refer to the shares of companies incorporated in mainland China which are traded on the Hong Kong Stock Exchange. “Under the new rules of the negative list, listing of H-share IPOs will be allowed if exemptions from the negative list are obtained from the China Securities Regulatory Commission,” said Andrew Ling, partner at Jingtian & Gongcheng.
Foreign investors are effectively offered an avenue to access such companies notwithstanding certain parameters such as foreign equity ratios. “At the same time, it is made clear that foreign invested companies in China will be treated the same as foreign investors in the application of the negative lists – this is in line with the guiding principle stated in the Foreign Investment Law and its implementation rules,” said Fang.
If a domestic enterprise engaging in activities in any field prohibited from foreign investment under the negative list wants to go public overseas, it needs to fulfill two additional requirements and needs to obtain the approval by the relevant Chinese authorities.
“No overseas investors are allowed to participate in the operation and management of such domestic enterprise, and the equity ratio of overseas investors in such domestic enterprise shall be governed accordingly by the relevant regulations on the management of domestic securities investments made by overseas investors,” said Glueck.
According to the explanation of the Ministry of Commerce, such equity ratios refer to foreign investors investing in domestic securities market through QFII, RMB qualified foreign institutional investors (RQFII), and stock market transaction interconnection mechanism. The equity ratio of a single foreign investor and its affiliates shall not exceed 10% of the total number of the company share and the total equity ratio of all foreign investors and their affiliates shall not exceed 30% of the total number of the company shares.
What are other key areas where foreign investors are seeking further relaxation on?
With the removal of nearly all restrictions on the manufacturing sector, the service sector would now be the focus of foreign investors. “Currently, there remain restrictions on foreign investments in industries including telecom services, market survey, entertainment and vocational education,” said Fang. Some of these restrictions have been relaxed in free trade zones on a pilot basis and similar relaxation of the rules may follow at the national level.
According to Glueck, compared with other negative lists released by provincial governments, such as the negative list for the Hainan free trade port, other areas that are of interest for foreign investors to be further opened up are restrictions on foreign shareholding ratios in companies investing in value-added communication services which are currently no more than 50%, prohibition for foreign investment in Chinese legal affairs, and restrictions on foreign investment in higher education.
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What are areas that could have further clarity?
It remains to be seen whether the relaxation of the rules will be fully implemented. “In practice, we have seen that in some sectors expressly permitted for full foreign access, there are non-public quota controls for foreign investors,” said Fang. “In some other cases, the relevant authorities or industry associations exercise their discretion to apply criteria which are not fully compliant with the negative lists.”
Glueck added that administrative regulations should further clarify the concrete administrative and licensing requirements for foreign investment in manufacturing of ground receiving facilities and key parts for satellite television broadcasting.
Additionally, whether or not the negative list will have an impact on certain special investment vehicles for overseas IPO is not fully clear for the time being. However, administrative regulations should clarify issues, such as the legal definition of an "indirect overseas IPO by domestic enterprises".
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