China's investment watch

Financial, Fiscal and Enterprise Affairs Directorate (DAF)

Is China becoming more restrictive towards foreign investment? New rules on foreign mergers and acquisitions issued in 2006 suggest that it might be, even if those rules also include significant improvements.

China received large quantities of foreign direct investment (FDI)–around $70 billion in both 2005 and 2006–as a result of investor-friendly policies that have developed rapidly in recent decades. The OECD has played a part in encouraging an open and non-discriminatory institutional framework to attract more and better FDI. One example is the OECD’s speedily-implemented proposal to set up a one-stop website where investors can find authoritative information on China’s policies, laws and application procedures.However, despite some streamlining in permissions and approval procedures, the legislative and regulatory framework for foreign investment remains complicated and less than wholly transparent. Take the Catalogue for the Guidance of Foreign Investment Industries, which is a classification of foreign investment projects into prohibited, restricted, permitted and encouraged sectors. This was lightened in 2002 in line with China’s WTO accession commitments, but another revision in 2004 produced no further liberalisation overall, so the listings remain restrictive and somewhat unclear.The latest OECD Investment Policy Review of China, published in 2006, focuses on cross-border mergers and acquisitions (M&As). It offers policy options to enable this form of foreign investment to make a greater contribution to China’s development: foreign ownership restrictions could be further relaxed, corporate transparency and disclosure improved, and capital markets fully opened to foreign participation. In August 2006 a group of ministries headed by China’s ministry of commerce (MOFCOM) published a new set of Regulations on the Acquisition of Domestic Enterprises by Foreign Investors, replacing the Interim Provisions on mergers and acquisitions of Chinese domestic enterprises by foreign investors promulgated in 2003. The new regulations came into force on 8 September 2006.The 2006 regulations mark a step forward in several ways. First of all, equity in Chinese enterprises may now be acquired in exchange for equities held by foreign investors. Previously, shares in Chinese enterprises could only be bought with cash, not shares, and this limited mergers and acquisitions activity.The new regulations also increase corporate transparency, since participants in a cross-border merger or acquisition must now notify the authorities if a related party is involved in the transaction. This helps to disclose any interests that might affect the deal.Another welcome development is that the cross-border M&A regulations cover special-purpose entities established by Chinese companies operating abroad to invest back into the country. This will help in the difficult task of identifying “round-tripping”, the practice of using entities set up outside the country as vehicles that qualify for tax breaks and other benefits available to foreign investors. This is illegal, so identification is an essential first step towards stopping it.Despite these advances, the new regulations add an extra layer of screening of cross-border M&A deals. This screening is based on vague, undefined criteria, such as whether or not the sector involved is a “major” industry, or if the merger affects “national economic security”. Another criterion is whether or not the proposed transaction would transfer to a foreign investor property rights relating to a “famous national brand”. The new rules have heightened bureaucratic oversight on inward investment, even where deals are satisfactory to both foreign and Chinese transacting parties and have been approved via existing procedures.What has driven this change? After all, Chinese firms tend to welcome M&A, seeing it as a way of accessing new technologies, management and markets. But the surge of inward M&A activity, particularly since China’s WTO accession in 2001, appears to be causing some concern among the authorities that they may not yet be ready to deal with it. The trouble is, while more selectivity may ostensibly be in pursuit of safeguarding legitimate national interests, decisions to block investments may impede China’s development.To be sure, this new screening also appears to have been adopted in response to a recent wave of sentiment in favour of investment protectionism both in China and among several trading partners, not least in the OECD. Some Chinese commentators have described acquisitions by foreigners as “malicious”, allegedly resulting in monopolies that crowd out Chinese businesses. Others have even blamed foreign investment for the weakness of China’s domestic innovative capacity. Such allegations have been rejected by officials in MOFCOM, the body responsible for developing and implementing policies on international investment. MOFCOM’s own research shows no sector to be monopolised by foreign investment. Moreover, the OECD’s 2003 and 2006 investment reviews point out that China’s relatively open regime has spurred domestic firms to compete and expand in precisely those sectors that were first opened to foreign investors.Short of withdrawing the new screening procedure–the least restrictive, and therefore preferred, option–the Chinese authorities could make the procedure more workable. They could define exactly what they mean by “major industry”, “national economic security” and “impact”, and explain the criteria for identifying “famous” trademarks and “traditional” Chinese brands. They could also issue a complete list (though the shorter, the better) of such trademarks and brands since, though famous in China, these might not yet be that well-known abroad, and may otherwise be subject to dispute within China.In the 2006 review, the OECD had recommended that the merger notification procedures in the 2003 Interim Provisions, which apply only to foreign investors, be removed in subsequent updates, since they are expected to be replaced by generally applicable merger notification procedures in the anti-monopoly law that is now making its way through the National People’s Congress.However, the 2006 regulations retain unchanged the existing discriminatory procedures, along with non-transparent notification criteria. This may well be because the regulations were issued in advance of the anti-monopoly law, so the framers found it easier to leave the 2003 procedures untouched for the time being. These discriminatory merger notification procedures will hopefully be removed when the anti-monopoly law comes into force.More generally, it would be helpful to supply all drafts of laws and regulations likely to affect foreign investors in Chinese and English to appropriate co-operation partners, such as the OECD, with enough time allowed to take their comments into account.The worldwide ripple effect of the dip in the Shanghai stock market in late February underlines China’s interconnectedness with the world economy, as well as its growing economic influence. At a time when many countries are facing pressures to backtrack on hard-won openness, China can make an important contribution to maintaining such openness by further developing a clear and transparent regulatory framework for investment. The OECD looks forward to continuing working with China to help it achieve these goals. References
  • OECD (2006), Investment Policy Review of China: Open Policies towards Mergers and Acquisitions, Paris.
  • See one-stop website on investing in China:
  • For more articles on China, including by the same author, see
OECD Observer N° 260, March 2007

Economic data

GDP growth: +0.6% Q1 2019 year-on-year
Consumer price inflation: 2.3% May 2019 annual
Trade: +0.4% exp, -1.2% imp, Q1 2019
Unemployment: 5.2% July 2019
Last update: 8 July 2019

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