China: China Law Bulletin - November 2004

The State Council issued the Decision on Reform of Investment System (the "Decision" hereinafter) on July 25, 2004. The core of the reform is to reduce the government’s direct intervention in enterprises’ activities, enable the market to better distribute resources, optimize investment structure, raise investment efficiency, and promote the sustained, fast, coordinated, and healthy development of the national economy and all-round social progress.

Key features of the Decision are as follows:

1. Approval procedures streamlined

The Decision changes investment approval into three forms, "Approval" (shen-pi), "Authorization" or confirmation (he-zhun), and "Filing" or registration (bei-an).

The Decision confines governmental investment (including loans backed by governmental credit) into areas that relate to national security, public infrastructure, environmental protection, advancement of less-developed regions, and technological development and industrialization. Approval will be required for such projects using governmental investment; a feasibility study will be required to address a project’s financial and social effects.

For important projects and restricted areas of investment, "Authorization" or confirmation will be required. As an attachment to the Decision, the State Council published a catalogue of projects which require governmental authorization for the year 2004 (apparently, such catalogue will be updated annually); the projects are in the fields of agriculture, energy and power, transportation, information industry, raw materials, machinery manufacturing, light industry and cigarette manufacture, high and new technologies, urban construction, social causes (i.e., theme parks), finance, foreign investment, and investment abroad. No feasibility study will be required for governmental authorization; instead, developers shall submit a "project application report" which addresses the social effects of the project, i.e., whether the project conforms to environmental regulations, land use policies, city planning, and antitrust law. It was reported that the National Development and Reform Commission ("NDRC") authorized five investment projects under this new regime in early September.

For other projects which do not fall into the investment authorization catalogue or have no governmental investment, only filing or registration with local government is required.

However, it is not clear from the Decision what the difference is between the Approval (shen-pi) system and the "Authorization" or confirmation (he-zhun) system. The Decision only says a project that is subject to the Authorization system needs only the project application report. The project proposal, feasibility study report, and project opening report are no longer required. Under the Authorization (he-zhun) system, the government will only examine the project from the social effect perspective.

2. Chinese provincial governments gain more powers in approving foreign investment projects announced in the investment authorization catalogue, for foreign investment projects encouraged or permitted according to the Foreign-Invested Industry Guidance Catalogue, the provincial governments will have the right to authorize any project with a total investment amount less than 100 million US dollars, while the highest benchmark in the past was 30 million US dollars. In addition, for foreign investment projects in the restricted category under the Foreign-Invested Industry Guidance Catalogue, the benchmark of the provincial governments’ power of approval has been raised from less than 30 million US dollars to less than 50 million US dollars.

3. The Decision encourages non-governmental capital to enter unrestricted infrastructure, public welfare, and other fields. The Decision also makes it clear that corporate investment, government investment, and investment intermediaries will be put under the watch of a comprehensive supervision system.

On September 15, 2004, the National Development and Reform Commission promulgated the Provisional Measures on Verification and Approval of Projects Invested in by Enterprises (the "Measures") so as to further implement the Decision on Reform of Investment System issued by the State Council on July 25, 2004, and to standardize the authorization system for investment by enterprises. The Measures are applicable to various investment projects in China other than foreign, invested projects and overseas investment projects.

The Ministry of Commerce issued the Provisions on Verification and Approval of Setting up Overseas Enterprises (the "Provisions") on October 1, 2004, to promote overseas investment by domestic enterprises.

Domestic enterprises are encouraged to set up enterprises overseas or gain ownership or managerial power over an existing enterprise outside China by way of setting up new enterprises, merger and acquisition, purchasing stocks in existing enterprises, contributing capital funds, or share swap, etc.

The Ministry of Commerce delegates verification and approval authority to its provincial-level agencies for approving domestic enterprise s’ overseas investment (other than the central enterprises, i.e., large-scale state-owned enterprises which are under the direct governance of the Central Government) in the countries listed in the attachment to the Provisions. Overseas investment made by the central enterprises will be subject to the verification and approval of the Ministry of Commerce.

The Provisions clearly state that the verification and approval authority will not examine and inspect whether the project is economically and technically feasible.

The Provisions stipulate that the verification and approval authority shall decide whether to approve within 15 working days after its acceptance of application documents from the enterprises.

Trade and Commerce

The Standardization Administration of China and the General Administration of Quality Supervision, Inspection and Quarantine jointly issued the new national standards on Classification of Retail Industries (GB/T18106-2004) (the "Standards"), which took effect as of October 1, 2004.

Based on the location, primary type of customer (for example, community residents, floating customers, or youth), business scope, minimum and maximum store area, and length of business hours of each retail business type, the Standards define 17 types of retail businesses, such as convenience stores, large-scale supermarkets, members-only warehouses, shopping malls, television shopping, vending machines, and mail order.

The Standards aim to help investors identify the right business types, to help local governments develop plans for the distribution of local retail networks, and to avoid overlapping investment in the retail sector.

The issuance of the Standards is of significance for China’s further opening up of its retail business sector to fulfill its WTO commitments.

However, the local plans for retail industry development emphasized by the Ministry of Commerce in its Notice on Implementing the New Standards on Classification of Retail Industries (August 13, 2004) could create new local market barriers for foreign retail investors.

Following the new formulation of China’s Foreign Trade Law (April 6, 2004), the Ministry of Commerce promulgated on April 16, 2004, the Regulations on Management of Foreign Investment in the Commercial Sector (the "Regulations") to further open up its commercial sector to foreign investment.

The issuance of the amended Foreign Trade Law and the Regulations on Management of Foreign Investment in the Commercial Sector represents issuance not only the implementation of China’s existing WTO commitments, but also a significant and symbolic step towards granting full PRC market access to foreign-invested enterprises.

The key features of the Regulations are as follows:

• Limitations on foreign ownership are abolished: starting from December 11, 2004, wholly foreign-owned commercial enterprises will be permitted;

• Entry thresholds are lowered: starting from December 11, 2004, the Regulations beginning eliminate all turnover and assets requirements and reduce the minimum registered capital requirements to RMB300,000 (retail) and RMB500,000 (wholesale);

• Business scope of foreign-invested retail, wholesale, and franchising enterprises is expanded;

• Geographic restrictions will be abolished (for retail, until December 11, 2004).

While the Regulations undoubtedly allow foreign companies much greater access to the PRC domestic market, certain restrictions still exist, such as the restrictions on foreign-invested commercial enterprises engaging in sales via television, telephone, post, the Internet, or vending machines.

The Closer Economic Partnership Agreement ("CEPA") was initially signed by the Hong Kong Special Administrative Region and the Mainland on September 29, 2003, and came into effect on January 1, 2004.

On August 27, 2004, the Mainland and Hong Kong reached an agreement to provide further liberalization measures on trade in goods and services under the second phase of CEPA (CEPA II), which will take effect on January 1, 2005.

Under CEPA II, the Mainland will apply zero tariffs to 713 goods, in addition to the 374 products that have been enjoying zero import tariff status since January 1, 2004.

For trade in services, the Mainland has agreed to grant preferential treatment in eight new areas, and to broaden the liberalization to 11 of the 18 service sectors to which preferential treatment has already been provided under CEPA. The 11 sectors are legal services; construction services; distribution services; transport services (including road passenger transportation and maritime transport); freight forwarding agency services; medical services; audio visual services; accounting services; banking services; securities and futures services; and individually owned stores.

The China Securities Regulatory Commission ("CSRC") released a draft of the new IPO pricing regulations (the "Draft") on August 30, 2004, aiming to provide better protection to investors’ interests, and make IPO prices better reflect the real value of the listing firms and market demand.

According to the Draft, companies launching IPOs will have to make inquiries regarding share prices among institutional investors like fund managers, qualified foreign institutional investors, and securities firms. Stock issuers and sponsors shall provide relevant reports on the evaluation of the prices to these institutions. The final IPO price ranges will be decided on the basis of the inquiries.

The new rules will also amend the traditional way of calculating earnings per share and are expected to more factual figures to investors.

To ensure fairness, according to the CSRC, no new IPOs will be approved until the new rules are formally enacted.

The PRC Company Law and the PRC Securities Law were amended before hand on August 28, 2004, to delete the provisions that the issue price of IPOs shall be ratified by the CSRC.

The Notice of Several Issues Concerning Regulating Overseas Initial Public Offerings of the Subsidiaries of Domestic Listed Companies (the "Notice") was promulgated on August, 10, 2004, by the China Securities Regulatory Commission. It sets the criteria, process and obligations for domestic listed companies if their subsidiaries issue IPOs overseas.

The listed company has to satisfy certain conditions before its subsidiary is allowed to issue an IPO overseas, such as the listed company must have made a profit in the last three years, must not transfer money to the subsidiary for it to qualify for an IPO overseas, and shall not receive more than 50% of the net profits mentioned in the consolidated reports; the assets transferred from the subsidiary to the holding company should not be more than 30% of the assets reported in the consolidated report; and both the listed company and the subsidiary should not be engaged in the same business. The board of directors is required to check whether the subsidiary satisfies all the conditions of the Notice. The shareholders meeting needs to discuss and vote on the plan of IPO prepared by the board of directors.

The Notice, however, does not apply to listed companies which issue shares domestically and overseas simultaneously.

The Implementation Rules of Regulations on the Administration of Foreign-funded Financial Institutions (the "Implementation Rules") were issued on August 3, 2004, by the China Banking Regulatory Commission, and took effect on September 1, 2004, to replace the old Implementation Rules (the "Old Rules") issued on January 25, 2002, by the People’s Bank of China.

Compared with the Old Rules, the Implementation Rules reduce the operating capital required to expend the business by foreign-funded financial institutions, and simplify the procedure for approval of foreign-funded financial institutions to access the market in large degree. They also remove the requirement of a one-year waiting period to open additional branches. In addition, the new Implementation Rules strengthen the supervision of risk management and due diligence of foreign-funded financial institutions.

The Ministry of Culture issued the "Explanation of the Strategy and Legal Basis for Administration of Internet Culture" on October 12, 2004, to further clarify that online access is under the Ministry of Culture’s administration, i.e., the establishment of an operational Internet cultural unit and the content of the imported Internet cultural products shall be subject to the approval and inspection of the Ministry of Culture.

The Regulations on Management of Foreign Investment in the International Maritime Transport Industry (the "Regulations") were jointly promulgated by the Ministry of Communications and the Ministry of Commerce on February 25, 2004, and took effect on June 1, 2004.

The Regulations stipulate that a foreign investor may establish a sino-foreign equity joint venture or a sino-foreign contractual joint venture to engage in international shipping services, international shipping agency services, international ship management services, loading and unloading of international shipments, and international maritime container freight station and container yard services with a maximum foreign investment of 49 percent of the total registered capital of the joint venture. The enterprise’s board of directors and general manager must also be appointed by the Chinese side.

Foreign investors are permitted to set up a wholly foreign-owned enterprise to engage in international maritime cargo warehousing services, or to offer routine services for the vessels owned or operated by the investor.

The Law on Electronic Signature (the "Electronic Signature Law") was issued by the Standing Committee of the National People’s Congress and will take effect on April 1, 2005.

This is the first time China has legalized the increasing electronic deals. The Electronic Signature Law grants electronic signatures the same legal effect as handwritten signatures and seals in business transactions, with the exception only of the unilateral electronic notice to the public canceling services like water, electricity, and gas. The Electronic Signature Law aims to set up market access system for online certification providers to ensure the security of e-commerce.

According to the Electronic Signature Law, the providers of online signature certification should be approved and supervised by governments, while both of them should be responsible for their faults. It also details the responsibilities of supervision departments and certification providers. The officials and managers who are found at fault also should be punished.

Provisions for Verification and Approval of Matters Concerning Domestic Enterprises Investing in and Opening up Enterprises in the Hong Kong and Macao Special Administrative Regions

The Provisions for Verification and Approval of Matters Concerning Domestic Enterprises Investing in and Opening up Enterprises in the Hong Kong and Macao Special Administrative Regions (the "Provisions") were jointly issued by the Ministry of Commerce and the Hong Kong and Macao Affairs Office of the State Council and took effect on August 31, 2004. The Provisions clarify criteria, processes and obligations for mainland enterprises to invest in HK and Macao. The whole process has been greatly reduced to 15 days only (it used takes 6 months). In addition, the Provisions state clearly the respective responsibilities of the Ministry of Commerce and its local agencies for different types of applications.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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