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Focus: China unveils Shanghai free trade zone

13 November 2013

In brief: Recently, as part of a broader process of trade liberalisation, the Chinese Government launched its first pilot free trade zone in Shanghai. Some commentators see the move as one of the most potentially significant economic developments in China during the past three decades. Partner Kate Axup (view CV) and Senior Associate Wayne Wang look at the legal changes associated with the launch of the new zone that are relevant to foreign investors.

How does it affect you?

  • Foreign investment approval and registration requirements have been simplified, making the Shanghai free trade zone (the FTZ) an attractive investment destination for foreign investors wanting to enter the Chinese market.
  • Foreign investment in the FTZ in a wide range of sectors is exempt from regulatory approval requirements. Investment in industries included on the 'Negative List' still requires approval.
  • Investment is now permitted in sectors that previously were not open to foreign investment. While the investment vehicle must be established in the FTZ, generally business operations may take place outside the geographic limits of the FTZ.

Background

In the face of China's changing economy, the establishment of the FTZ represents a significant step in the implementation of the Government's 'reform and opening up' strategy. According to the PRC Government, the FTZ is intended to function as a laboratory for further economic and financial reforms, which may ultimately be implemented nationally.

On 18 September 2013, the State Council released the Master Plan for China (Shanghai) Pilot Free Trade Zone. Other legislative and administrative authorities, including the Standing Committee of the National People's Congress, the China Securities Regulatory Commission, the China Insurance Regulatory Commission, the China Banking Regulatory Commission, the Ministry of Culture, the State Administration of Industry and Commerce (the SAIC), the Ministry of Transport, and the Shanghai Municipal Government, released various regulations or policies in relation to the FTZ during the period August – October 2013 (collectively, the FTZ Laws).

The FTZ was officially launched on 29 September 2013 and covers an area of 28.78 square kilometres, comprising areas of the Waigaoqiao bonded area and logistics park, the Yangshan bonded port, and the Pudong airport bonded area of Shanghai.

Simplified approval and registration procedures

Under the FTZ Laws, foreign investment approval and registration procedures have been greatly simplified and streamlined, particularly in relation to setting up foreign invested enterprises (FIEs) in industries other than those included on the Negative List (defined below). For example:

  • Government approval of a foreign investment project in the FTZ is not required (although filing and registration with the government is still necessary), unless the investment is in an industry included on the Negative List or is an investment in respect of which domestic investors must obtain approval.
  • Foreign investors are generally not required to actually pay up the registered capital of their FIEs in the FTZ.1
  • FIEs in the FTZ are generally not required to have a minimum amount of registered capital.2
  • An enterprise set up in the FTZ is not required to pass an annual inspection.3 It is only required to file an annual return with the SAIC. Records of the annual return, however, will be open to the public.
  • A foreign investor can lodge an online application to the FTZ government for the incorporation of a FIE in an industry not included on the Negative List. The FTZ government is required to complete the regulatory filing process within one working day.4
  • The FTZ government will set up a 'foreign investment one stop acceptance platform' for foreign investment in industries not included on the Negative List.5

The Negative List

The FTZ Laws include the Special Administrative Measures on Foreign Investment into China (Shanghai) Pilot Free Trade Zone (Negative List) 2013, released by the Shanghai Government on 29 September 2013 (the Negative List).

Foreign investment in an industry included on the Negative List is restricted (ie subject to regulatory approvals and other restrictions in many cases) or even prohibited. These restrictions include requirements that:

  • the PRC party must hold a controlling interest;
  • the foreign investment must be in the form of a sino-foreign equity or cooperative joint venture;
  • the foreign shareholding must not exceed a certain percentage; and
  • the FIE must have a certain amount of registered capital.

To some extent, the Negative List is a reproduction of many of the restricted and prohibited industries under the Foreign Investment Industries Guiding Catalogue released by the Ministry of Commerce and the National Development and Reform Commission on 24 December 2011.

Industries on the Negative List include:

  • exploration and mining of special and rare types of coal;
  • exploration and production of coal-bed methane;
  • exploration and production of oil and gas (both conventional and unconventional);
  • exploration and mining of precious metals (such as gold, silver and platinum) and important non-metal minerals such as diamonds, high-alumina refractory clay, grammite and graphite;
  • refining of non-ferrous metals such as electrolytic aluminum, copper, lead and zinc;
  • financial institutions such as banks, insurance companies and securities companies;
  • educational institutions; and
  • medical institutions.

Newly opened up sectors

Under the FTZ Laws, a number of sectors have now been opened up to foreign investment (previously, foreign investors were effectively prohibited from investing in such sectors). For instance, foreign investment is now permitted in the following industries/entities in the FTZ:

  • private healthcare insurance;
  • production and distribution of gaming and recreational equipment;
  • engineering design companies (restricted to providing services in Shanghai) whose investors are without a track record at the time of first application for qualification in China;
  • wholly foreign owned entertainment performance brokers (restricted to providing services within Shanghai);
  • wholly foreign owned entertainment resorts (restricted to providing services within the FTZ);
  • sino-foreign cooperative educational and training or professional skills training providers; and
  • wholly foreign-funded medical service providers.

Note that some of the newly opened up sectors are included on the Negative List, which means that the investment is subject to regulatory approvals and may be subject to other restrictions as well.

In general, a FIE set up in the FTZ is not constrained by the geographical limitations of the FTZ and may engage in business outside the FTZ.

As part of its reform agenda, the Shanghai Municipal Government is contemplating more sensitive financial reform measures, including relaxation of foreign exchange controls, liberalisation of interest rates and cross-border use of the RMB by entities set up in the FTZ. However, the FTZ Laws do not contain any timetable or details for the implementation of such reforms. In addition, the enterprise income tax rate in the FTZ remains unchanged.

The way forward

It may be too early to judge whether the launch of the FTZ will become the trigger that ultimately changes the fundamental regulatory and economic landscape of China, in a similar way that the coastal special economic zones set up in the early 1980s drove China's high-speed economic growth over the past 30 years.

The FTZ Laws certainly represent notable changes in the PRC's general corporate laws and foreign investment regulations. These are, of course, positive steps towards a more liberalised economy. Interestingly, some changes implemented in the FTZ have already been identified for nation-wide rollout. For example, the State Council recently decided to overhaul China's business registration regime to remove minimum registered capital requirements, statutory obligations relating to the payment of registered capital, and annual inspection procedures.

However, it remains to be seen when and how the PRC Government will implement the more significant financial reforms in the FTZ.

Footnotes
  1. Previously, foreign investors in the PRC were required by law to pay up their subscribed registered capital in a lump sum or by instalments within a certain period.
  2. Previously, a FIE which was set up as a limited liability company in the PRC was required to have a registered capital of at least RMB 30,000 or 100,0000 (if the FIE had only one equity holder).
  3. Previously, a FIE in the PRC was required to pass annual inspection during March – June. The FIE was required to submit a number of materials, such as copies of its various operational licences and permits and audited financial statements. Failure to attend the annual inspection could result in fines or even revocation of the business licence.
  4. Previously, the Ministry of Commerce approval process for setting up a FIE could take up to 90 calendar days.
  5. Previously, foreign investors needed to submit documents to various authorities for setting up FIEs.

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