China's Ministry of Commerce (MOFCOM) published on Jan 19 a draft of the proposed new Foreign Investment Law (FIL), which can be a game changer that seeks to bring the treatment of foreign companies in line with that of domestic enterprises, said Kit Kwok, a Shanghai-based partner for one of the world's largest law firms, DLA Piper.

The various deficiencies of the existing FIL in terms of corporate governance, efficiency of the approval and consistency with the country's domestic corporate law have been well known, Kwok told China Daily in an exclusive telephone interview. The new FIL has the promise to reshape the common practice and regulatory regime that have dominated Chinese mainland's inbound and outbound investments for years, he said.

The mainland's outbound direct investment (ODI) is widely expected to exceed inbound investment in the near future, as the world's second-biggest economy is poised to become a net exporter of capital. The mainland's ODI in 2014 surged 14.1 percent to a record $102.9 billion, while FDI rose 1.7 percent to $119.56 billion, according to MOFCOM.

The annual world investment report of the UN economic think tank UNCTAD published in June 2014 predicts that the outflow of capital from the mainland will surpass inflows within two to three years.

"When the mainland initially opened its door, it desperately needed capital and advanced technology from overseas investors to support domestic economic growth. But things are different now," said Kwok. "Flush with capital, mainland enterprises are now scouting around the world to acquire companies with the technological know-how that they need," he said.

But many mainland enterprises have complained that their "go global" efforts, though strongly encouraged by the government, have been frustrated by the many hurdles built into the existing law on capital account flow.

The existing FIL, designed with the purpose of protecting the inexperienced mainland enterprises in their dealings with foreign companies in the early days of economic development has failed to catch up with the fast changing economic landscape, said Kwok.

On the domestic front, Kwok said that it's time to subject foreign invested enterprises on the mainland to observe the same corporate law that applies to domestic enterprises.

Foreign investors should welcome the new law because it is designed to make life easier for them, Kwok said. For example, under the proposed new law, foreign investors will no longer require central government's approval for each and every investment project. According to a provision in the draft law, mainland regulators will no longer be required to go through the time consuming process of reviewing joint venture contracts and the partners' articles of association.

Instead, the "negative list" approach to regulating foreign investment that is currently being tested in the Shanghai Free Trade Zone, is expected to be enshrined in the proposed new law. Under the negative list system, foreign investors are permitted to invest in any industry sector that it is not listed on a negative list.

"In the wake of increasingly mature economy, we have good reasons to ensure foreign investors 'national treatment' and put them on the same legal footing as mainland counterparts," said Kwok.

However, uncertainties still loom over the long-anticipated new draft legislation, said Kwok.

At issue is a proposed new national security review mechanism which seeks to screen out foreign investments that are deemed to pose a threat to national security.

Also, it's not clear whether contracts negotiated under the existing law need to be reviewed and revised when the new law comes into force, Kwok said. Any such revision could be disruptive, he added.

The dilemma posed by the so called "variable interest entities", or VIEs, is also addressed head-on by the new draft legislation, which could be a game-changing reform for the country's burgeoning Internet industry, Kwok noted.

The VIE structure was designed to allow foreign investors access to restricted or prohibited industry sectors on the mainland, such as Internet or e-commerce, and is also used by domestic entities such as Alibaba for offshore listings to gain access to international capital markets. VIE has long sit in a regulatory grey area. The proposed new law contains provisions that is expected to address the issue.

As the concept of actual control was introduced in the new legislation, companies established on the mainland but controlled by foreign investors would be deemed to be foreign-invested enterprises, while foreign entities controlled by mainland investors would be categorized as domestic enterprises.

As such, Alibaba and other VIE companies with mainland controlling shareholders would be unaffected by the new approach and well-positioned to seek overseas financing. Those VIEs controlled foreign investor could be forced to cease operating under the proposed law, said Kwok. The new approach will also be favorable to Jack Ma Yun, who has been seeking ultimate control of Alibaba for a long time, added Kwok.

Having solicited public comments from diversified channels within a long period of time, MOFCOM took a "transparent approach" which differed sharply from the "autocratic approach" of the past, said Kwok. The new legislation is promulgated after listening to the suggestions and recommendations from the corporate sector, said Kwok.

The draft will be submitted to the National People's Congress for ratification in 2016 and is expected to become law in the following year at the earliest, he said. "Yet, if there is no substantial increase in the number of industry sectors that foreign investors are allowed to invest in, a mere simplification of the approval mechanism would make little sense to foreign investors," said Kwok.

sophia@chinadailyhk.com

The "negative list" approach to regulating foreign investment on the Chinese mainland is expected to be enshrined in the proposed new law. Nelson Ching / Bloomberg

(HK Edition 02/13/2015 page8)