A new draft law released by China’s Ministry of Commerce (MOFCOM) is expected to facilitate foreign private equity investment in Chinese companies. The new law proposes removing the existing case-by-case approval process for every transaction conducted by a foreign investor. The relief would put foreign private equity firms on more equal footing with their domestic PRC competitors.
“The draft law, if passed, will have far-reaching effects on private equity industry,” said Peng Yu, a Hong-Kong-based lawyer for Ropes & Gray in an email to pfm.
The draft regulation removes the lengthy approval process for each investment and replaces it with a “negative list” of restricted industries. Foreign investments in sectors that are not identified on the “negative list” will be able to proceed with corporate registration in the same way as domestic PRC investors would. The list has not yet been published, but restricted or prohibited industries are likely to include internet, healthcare, education, infrastructure/energy, and financial institutions, according to Yu.
While the overhaul removes the upfront approval requirements for each single foreign investment, investors will have more comprehensive reporting requirements. Those include reporting on deal closings and after certain changes within an investment, as well as periodic reporting for investors whose operations in China exceed defined thresholds.
“Generally speaking, we do not expect this to be a major deterrent when foreign private equity funds formulate their investment strategy in China,” Yu noted.
While the existing regime determines whether an investor is foreign based on the place of incorporation of the investing vehicle, the new regulation introduces the concept of “control.” If the investment is ultimately controlled by PRC nationals, it will not be regarded as a foreign investment and not subject to foreign investment restrictions.
Thus, investors may not need the controversial “variable interest entity” (a structure used to facilitate the offshore financing of PRC companies doing business in regulated sectors) in investments where PRC nationals maintain control, and foreign private equity investors will be able to hold equity in businesses rather than relying on contractual protection through VIE agreements.
Currently, there is no definite timetable for the draft law. As the law was issued by MOFCOM, a number of other PRC governmental agencies also involved in regulating foreign investments will still need to weigh in.
“After the agencies are able to form consensus views, the draft law will need to be reviewed at the State Council level and then submitted to National People’s Congress for formal process. We do not expect this process to have an immediate result,” added Yu.