Yang Zhou

Zhong Lun Law Firm, Shanghai

zhouyang@zhonglun.com

The development of China’s foreign investment security review regime

China’s foreign investment security review (FISR) regime dates back to 2006, when, for the first time, the Ministry of Commerce (MOFCOM) of China required foreign investment to be reported for national security review in the Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors (‘M&A Rule’). Under this rule, national security review only applies to foreign investment through merger and acquisition. The MOFCOM was the authority in charge of national security review under the M&A Rule.

On 15 March 2019, China promulgated the Foreign Investment Law (FIL) which came into effect on 1 January 2020. The FIL broadened the scope of national security review to cover greenfield foreign direct investment and indirect foreign investment if such investment will impact national security. Under the FIL, the authority in charge of national security review is a joint working mechanism established by the State Council, with its office sitting within the National Development and Reform Commission (NDRC). The NDRC and MOFCOM take joint lead in the daily operation of the office.

On 19 December 2020, the NDRC and the MOFCOM jointly released the Measures for Foreign Investment Security Review (‘FISR Measures’). The FISR Measures provide detailed requirements and procedures for the FISR, which signals the establishment of foreign investment security review system under the FIL.

The sectorial scope of the FISR

The FISR Measures specify two sector category that will be subject to national security review. The first category is investment in sectors related to national defence and security and in areas surrounding military facilities. Foreign investment in these sectors will be subject to national security review regardless of the investment amount or shareholding ratio in the target business. The second category is foreign investment in critical sectors, provided that the foreign investor will take control of the target business.

The definition of ‘critical sectors’ is growing. In 2011, the Circular on the Establishment of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, released by the General Office of the State Council of China, enumerated six sectors, including: (i) critical agricultural products; (ii) critical energy and resources; (iii) critical infrastructure; (iv) critical transportation services; (v) key technology; and (vi) major equipment manufacturing.

In 2015, the Foreign Investment Security Review Trial Measures for Free Trade Zones in China added two more sectors: (vii) critical culture; and (viii) critical information technology products and services. In 2020, the FISR Measures added another two more sectors: (ix) internet services; and (x) financial services. There is also a catch-all provision of ‘other critical sectors’ under the FISR Measures.

The FISR Measures do not provide guidance as to how to determine a sector, which will become an issue when there is an overlap between the sectors. For example, providing industrial Software as a Service (SaaS) to railway companies could come under both ‘critical transportation services’ and ‘internet services’. Both the catch-all provision and the lack of clarity on how to identify a sector leave the authority with great discretion in enforcing the FISR.

How to understand ‘actual control’?

The FISR Measures adopt a broad definition of ‘actual control’. Under the FISR Measures, ‘actual control’ includes situations in which:

• a foreign investor owns more than 50 per cent of the target enterprise’s shares;
• a foreign investor owns less than 50 per cent of the shares but has sufficient voting rights to exert a material influence over the shareholder votes and resolutions of the board of directors; and
• other circumstances that might cause a foreign investor to have a significant impact on the decision-making, personnel, finance and technology of the target business.

Perhaps to reduce ambiguities of the law and ease anxieties of foreign investors, the FISR Measures establish a consultation mechanism to help foreign investors determine in advance whether an investment meets the requirements and is therefore subject to national security review.

Impact on foreign investment in China

It is critical for foreign investors to be aware of the requirements of the FISR in China and plan their investment carefully before entering the Chinese market. Having said that, it should be noted that the FISR Measures were promulgated alongside China’s continued openness for foreign investment. Generally speaking, foreign investors should not be panicked by the FISR but should take the necessary precautions.