The New Free Trade Zones Explained, Part II: The Negative List

By Dezan Shira & Associates
Legal Editor: Steven Elsinga

Along with the release of the policy framework for the three new Free Trade Zones (FTZ), the State Council released the Negative List for Foreign Investment on April 20. Effective May 8, 2015, the Negative List provides an outline of the sectors in which foreign investment is restrained and is applicable only to the four current FTZs. For all industries not listed in this document, foreign investors will receive equal treatment to domestic companies. However, foreign investments that have bearing on China’s national security are subject to a Foreign Investment National Security Review.

Restricted Industries – Key Features

While a textual comparison between the new 2015 Restricted List and the 2014 Shanghai FTZ Restricted list will show a great number of changes, in fact this is mostly due to different articles being merged or rephrased. Where the original Shanghai FTZ Negative List was essentially a condensed version of the Guidance Catalogue for Foreign Investment, the 2015 Restricted list includes all the limitations and restrictions on foreign investment from other laws as well, making the 2015 version more comprehensive.

The new list is intended to reflect solely where foreign investors are treated differently from Chinese entities. So while for example ‘weapons and ammunition’ is removed from the list, this does not mean foreign investors may now start manufacturing weaponry in the Free Trade Zone. It is removed because regular Chinese private entities are not allowed to produce these either. 

That said, there are a number of new changes to be aware of, some of which could hold interesting opportunities for foreign investors. Apart from newly lifted restrictions, the application of the new Restricted List of course means that the opportunities that were previously only available in the – now enlarged – Shanghai FTZ, extend to the three new FTZs.

Agriculture and fishery

In the area of agriculture and fishery, crop seeds and animal husbandry remain sensitive. Research in the area of precious plant and animal species therefore continues to be prohibited, as well as genetic modification and the creation of new crops and animal breeds. Also, fishing within the territorial waters of China is subject to approval from the Chinese government.

Mining and the exploitation of natural resources

A number of restrictions on mining have been lifted, with only the rules below remaining.

1. Prospecting for and exploitation of natural resources within China’s Exclusive Economic Zone and on its continental shelf requires approval from the Chinese government.
2. Exploration and development of oil and gas deposits is allowed with a contractual or equity joint venture.
3. Mining of and prospecting for rare earths, radioactive materials, tungsten, molybdenum, tin, antimony and fluorite is prohibited. It is restricted for lithium, precious metals and graphite.

RELATED: With Reboot of Import Tariffs, A Sooty Future Awaits for Foreign Coal in China

Manufacturing

A number of restrictions in the manufacturing industry have been lifted, including those on the processing of rice, corn, edible oils, tea, alcohol, tobacco and chemicals (now fully allowed). In the area of pharmaceuticals and health care, anesthesia and blood products are now allowed.

The manufacturing of motorized vehicles remains sensitive, making up most restrictions in the manufacturing industry. The restriction on construction vehicles, motorcycles and new energy vehicle batteries is however lifted.

1. Aircraft, unmanned aerial vehicles and helicopters: requires Chinese controlling interest
2. Finished cars (maximum 50 percent foreign-owned) – car parts are fully open to foreign investment.
3. Ships, ship engines and marine engineering equipment: requires Chinese controlling interest
4. Rail transport equipment: limited to a contractual or equity joint venture; for urban rail transport, 70 percent of the equipment used must be made in China.
5. Satellites for civilian use: requires Chinese controlling interest
6. Processing and smelting of rare earths, tungsten, molybdenum, tin, antimony: limited to a contractual or equity joint venture.
7. Processing radioactive material: prohibited.
8. Chinese herbal medicine: prohibited
9. Ivory, tiger bones and traditional Chinese handicrafts: prohibited

Utilities and infrastructure

These industries are considered sensitive; the current restrictions remain in place. These include airports; railroads; power grids; water, heat, gas and drainage supply for cities; postal services; telecom and internet. 

Wholesale and retail

A number of important sectors have seen their restrictions lifted. These include: fertilizers, agricultural film (to cover greenhouses), the sale of petrol through petrol stations and the sale of books, newspapers and magazines. Remaining prohibitions include the sale of tobacco, lottery tickets and the auctioning of cultural relics.

Transportation

Limitations on transportation largely remain in place. 

IT and telecom

1. As with the Catalogue of Restricted Industries, value-added telecom services (except e-commerce) are restricted to maximum 50 percent foreign shareholding, and basic telecom services limited to 49 percent.
2. It is prohibited to operate news websites, online publications, online audiovisual programs or other broadcasting of information on the internet, except for music and those sectors that have been liberalized due to China’s membership of the World Trade Organization.
3. It is prohibited to create and publish maps on the internet.
4. If a domestic entity cooperates with a foreign entity to create online news, this activity shall be subject to a National Security Review.

Crucially, with e-commerce excepted from the restricted industries, foreign investors can now set up e-commerce companies in Fujian, Guangdong, Tianjin as well as Shanghai.

RELATED: Further Signs of Liberalization for E-commerce in the Shanghai Free Trade Zone

Finance

The new Negative List has a detailed set of rules for investment in banks:

1. The shareholder(s) in a bank that is either wholly foreign-owned or a Sino-foreign joint venture must itself be a financial institution, and the controlling entity a commercial bank.
2. The investor in a fully Chinese-owned bank or trust company must be a financial institution.
3. Only foreign banks may invest in Chinese rural-commercial banks, rural cooperative banks or rural credit cooperative unions.
4. The investor in a financial leasing company must itself be a financial leasing company.
5. The main capital contributor in a consumer finance company must be a financial institution.
6. The investor in a currency brokerage must itself be a currency brokerage.
7. The investor in a financial asset management company must itself be a financial institution, but may not be involved in the establishment of a new asset management company.
8. The investor in a financial institution will be subject to asset requirements – the Negative List does not specify the amounts.
9. In addition, foreign banks may not conduct the following activities, as defined in the Commercial Banking Law: acting as an agent to issue, honor and underwrite government bonds, issuance of bank cards and the acting as an agent for receipt and payments of funds. Apart from taking time deposits for Chinese nationals of less than 1 million RMB, foreign banks in China may not engage in RMB activities for Chinese nationals.
10. The parent company of a foreign invested bank in China must provide its operational funds free of charge. The foreign invested bank must operate with an eight percent RMB capital reserve. Banks providing RMB services must follow the minimum required business hours. 

The requirements for financial companies other than banks focus mainly on equity restrictions.

1. Futures companies: requires Chinese majority interest.
2. Securities companies: foreign investment may not exceed 49 percent of shares. In addition, for securities companies listed on the stock exchange, a single foreign entity may not hold over 20 percent of shares, and total foreign shareholding may not exceed 25 percent.
3. Fund management: foreign investment may not exceed 49 percent of shares.
4. Foreign entities may not become regular members of futures and securities exchanges, and may not open securities and futures accounts to trade A shares.
5. Life insurance: foreign investment may not exceed 50 percent of shares.
6. Chinese insurance companies must hold at least 75 percent of shares in insurance asset management companies. 

The regulation announces that there will be a separate National Security Review for investments in the financial sector, but these have not been released as of yet.

Professional services

1. Accounting: the main partner must be a Chinese national
2. Legal services: Foreign law firms may only be present in China through a representative office, which is subject to approval. Foreign nationals may not advice on Chinese law or become partners of a Chinese law firm. Representative offices of foreign law firms may not hire Chinese legal professionals, and its support staff may not provide legal advice.
3. Credit rating: restricted
4. Investment in polling and social surveys: prohibited.
5. Market research is restricted to contractual or equity joint ventures, with the surveying of radio and television requiring Chinese controlling interest.
6. The legal representative of a visa agency must have Chinese nationality and domicile.

Education:

1. Foreign entities may not independently establish schools and educational institutions mainly enrolling Chinese nationals (except non-academic vocational training) 
2. Foreign entities may establish and run educational institutions in cooperation with a Chinese party, under the following conditions:
   a. Education must be unrelated to the military, law enforcement, politics or political parties
   b. Foreign entities may not provide religious education
   c. Regular high schools and tertiary education institutions must be led by the Chinese party, i.e. the principal or main administrator must be a Chinese national and be domiciled in China; the board of the school must have a Chinese majority and the education program must be in line with Chinese law

Health care:

Medical institutions can be set up as an equity or contractual joint venture.

RELATED: Investing in China’s Medical Device Industry

 Scientific research:

Most types of mapping are prohibited due to political reasons.

1. Mapping of the oceans, administrative boundaries, political maps, maps for use in education, aerial photography, most other types of maps, and geological research: prohibited
2. For companies engaging in mapping that is allowed: requires Chinese controlling interest.
3. Human stem cell and genetic research: prohibited.
4. Establishing and operating social science research centers: prohibited.

Media, culture and entertainment:

1. The establishment and operation of television and radio station, television channels, broadcast networks, satellite television, TV on-demand and other broadcast media: prohibited
2. The production of television and radio shows: prohibited.
3. Foreign satellite channels are subject to approval.
4. Sino-foreign co-productions of television and film series are subject to a licensing system.
5. The establishment of news and press agencies, publishing companies, newspapers: prohibited
6. Foreign news agencies may set up a representative office in China and employ foreign reporters upon approval of the Chinese government. Foreign press agencies may provide news services in China upon approval of the Chinese government.
7. The production of newspapers, books, audiovisual materials, periodicals, electronic publications, etc.: prohibited
8. Cooperation between Chinese and foreign news agencies must be led by the Chinese side, and is subject to approval of the Chinese government.
9. Provision of financial information is subject to approval of the Chinese government
10. The construction and operation of cinemas: prohibited.
11. The establishment of performing arts groups in China is prohibited, and performance agencies must have Chinese controlling interest. 

RELATED: Market Overview: The Entertainment Industry in China

The new Negative List no longer prohibits construction of villas, nor does it restrict investment in hotels, offices and convention centers.

For a comprehensive list of all newly liberalized industries or a consultation on what the new Free Trade Zones can do for your business, please contact Dezan Shira & Associates’  Tianjin, Shanghai or Guangzhou offices.

Foreign Investment National Security Review

The new Free Trade Zone regulations state that certain foreign investments shall be subject to a National Security Review. The concept of a National Security Review was first introduced when the Chinese government released a draft for the new Foreign Investment Law. The intention behind the National Security Review is to keep national security risks in check while more industries are opened to foreign investment.

The Review is held by the National Development and Reform Commission and the Ministry of Commerce, usually at the suggestion of the registration authority of the Free Trade Zone. There are six factors the Review takes into consideration:

1. Impact on national security, including China’s capacity to provide essential goods and services to that end;
2. Impact on the stability of the economy;
3. Impact on basic social order;
4. Impact on culture and social morality;
5. Impact on internet security; and
6. Impact on sensitive technology for use in national defense.

The Review will be held when an investment is believed to touch upon sensitive agricultural products, key natural resources and energy, strategic infrastructure, transport capabilities, important IT and technology, and investment near military facilities.

Interestingly, the Review does not merely look at the equity a foreign party has in a Chinese company, but extends to the “actual control” over a company. This appears to be a continuation of the government’s recent scrutiny on VIEs.

In the separate regulation that introduces this National Security Review, the term “actual control” is defined for the first time. It refers to one or more foreign investors, and parties affiliated to them:

• holding over 50 percent of a company’s shares;
• having sufficient voting rights to exert significant control over the company’s board of directors or shareholder’s meeting; or
• through other circumstances, being able to exert significant control over the company’s operational decision, staffing, finance or technology.

Also, the regulation does not only apply to foreign entities setting up a company in China or purchasing the shares or assets of Chinese companies. “Foreign investment” is also considered to be obtaining control by agreement (another overt reference to VIEs), holding of assets by an agent for a foreign entity, transactions that take place abroad but affect Chinese entities, leasing and subscription to convertible bonds.

Managing Your Accounting and Bookkeeping in China
In this issue of China Briefing, we discuss the difference between the International Financial Reporting Standards, and the accounting standards mandated by China’s Ministry of Finance. We also pay special attention to the role of foreign currency in accounting, both in remitting funds, and conversion. In an interview with Jenny Liao, Dezan Shira & Associates’ Senior Manager of Corporate Accounting Services in Shanghai, we outline some of the pros and cons of outsourcing one’s accounting function.

China Investment Roadmap: The Medical Device Industry
In this issue of China Briefing, we present a roadmap for investing in China’s medical device industry, from initial market research, to establishing a manufacturing or trading company in China, to obtaining the licenses needed to make or distribute your products. With our specialized knowledge and experience in the medical industry, Dezan Shira & Associates can help you to newly establish or grow your operations in China and beyond.

Revisiting the Shanghai Free Trade Zone: A Year of Reforms
In this issue of China Briefing, we revisit the Shanghai FTZ and its preferential environment for foreign investment. In the first three articles, we highlight the many changes that have been introduced in the Zone’s first year of operations, including the 2014 Revised Negative List, as well as new measures relating to alternative dispute resolution, cash pooling, and logistics. Lastly, we include a case study of a foreign company successfully utilizing the Shanghai FTZ to access the Outbound Tourism Industry.

• Previous Article China to Roll Back Local Tax Incentives for Foreign Investors
• Next Article China Outbound: New Investment Trends in Asia, Moving Your Business from China to Vietnam