China’s FDI obstacle course

The requirement that investments from China over $248 million be referred to the Foreign Investment Review Board for approval is reportedly a sticking point for Australia-China Free Trade Agreement negotiations. Beijing wants the review-free threshold raised to $1 billion in line with concessions offered to American and New Zealand investors, arguing that the review system is discriminatory against China.

Those such as Barnaby Joyce would argue that the investment review regime is far more onerous and obstructive for foreigners in China and that Beijing should not complain about the rules from our side. Putting aside whether we are actually well served by a tit-for-tat approach (i.e., whether a more open attitude to Chinese FDI irrespective of restrictions in China’s investment regime will aid or harm our national and economic interests) there has been little written about how China’s approval and review process actually works.

As you can see from the details below, the labyrinthine process that foreigners have to go through, and China’s investment regime overall, is even more restrictive and politically motivated than many Australians realise.

The approval process for budding foreign investors in China can involve up to eight steps. The article will outline the most significant hoops that foreign investors must jump through, and where the obstacles really lie.

The first is the Pre-Establishment Approval process which is issued by the Ministry of Commerce and the National Development and Reform Commission which reports to the State Council, the country’s peak legislative body. These organisations issue a Foreign Investment Catalogue detailing industries for foreign investors that are ‘encouraged’, ‘restricted’ and ‘prohibited’. Industries that are ‘encouraged’ will attract a far lower level of scrutiny than those that are ‘restricted’. Any other industries not listed are generally permitted.

The classification for various industries is largely based on China’s industrial policies encapsulated in documents such as the Five Year Plan. For example, ‘national champions’ are encouraged in so-called ‘strategic industries’ such as bio-technology, alternative energy, high-end equipment manufacturing, energy conservation, clean-energy vehicles, new materials and information technology. Other designated ‘important’ industries such as fossil fuel energy, heavy industry, chemicals, banking and finance, insurance, construction and property generally fall into the ‘restricted’ categories.

Importantly, newly announced industrial policy by various ministries can override the Foreign Investment Catalogue guidance at any time, without notification, and with no recourse to appeal. In particular, the NDRC has a record of continually changing the goalposts through announcing policy to enhance domestic ownership (especially by state-owned-enterprises or SOEs) at short notice. Ongoing policy also consistently removes industries from the ‘encouraged’ classification to the ‘restricted’ or ‘prohibited’ classification, making it harder or impossible for foreign firms to enter or thrive in these sectors.

The next stage is to formally obtain government approval. To do so requires negotiating past a two-step review process. First, under China’s Anti-Monopoly Law, the Ministry of Commerce will review any merger or acquisition of assets by a foreign company when the joint turnover of the foreign and domestic entity (in the case of a joint venture) or the foreign entity (in the case of a wholly owned foreign enterprise) in China exceeds RMB 400 million or about $US65 million. The Ministry simply access whether the transaction has the capacity to ‘eliminate or restrict competition’, with little consistent guidance as to how it reaches that assessment.

Second, government approval is subject to a ‘National Security Review’ if the foreign enterprise will gain ‘formal’ or ‘actual’ control of the local asset. A panel of representatives from the Ministry, NDRC and other unspecified departments and agencies will assess whether the acquisition involves entry into the ‘Military and military support’ space, is located in the vicinity of key and/or sensitive military facilities, is an enterprise associated with ‘National Defence and Security’, or is an enterprise engaged in sectors that ‘relate to national security.’

This latter specification covers a broad range of sectors and includes key technologies, major equipment manufacturing, agricultural products, energy and resources, infrastructure and transportation services. Once again, the definition of sectors that ‘relate to national security’ changes according to industrial policy, not just national security policy.

If this obstacle is negotiated, there are then a number of formalities, ranging from getting corporate name approval to approval for site registration. There are also some fairly normal administrative hoops to jump through including getting project and environmental approval for the business activity which are not unique to the Chinese system.

The fifth step is to gain approval from the Ministry of Commerce. This is another opportunity to knock back FDI based on wide-ranking criteria which includes ‘Damage to China’s sovereignty or the social public interest’, risk to ‘state security’ and failure to ‘comply with the requirements of the development of China’s national economy.’ Note that a common complaint is that the criteria for approval during this step are somewhat at odds with aspects of China’s World Trade Organisation commitments.             

The final steps are not prima facie controversial and involve various administration tasks such as registration and offering documentary proof of stated business intention and activity etc. However, the final licensing requirements required at the local levels are often used by local officials to protect their turf for SOEs or else line their pockets through demand for bribes.

It is clear that foreign companies are increasingly complaining about China’s FDI regime for the following broad reasons: that the categories of restricted and prohibited industries are increasingly widening based on an increasingly protective and mercantilist national mentality in the name of national development; that the process and review of decisions is opaque, arbitrary and even highly corrupt; and that local officials impose arbitrary licensing restrictions and demands on foreign entities.

None of this is itself an economic argument that we should have a more restricted regime against Chinese FDI. The position that we will need an increasing amount of Chinese capital to further develop key sectors of our economy is compelling.

But understanding the reality of the process and implementation of China’s own FDI regime will provide an effective counter against Chinese accusations of Australian xenophobia. As our trade negotiators should point out, our regime is far more welcoming of Chinese and other foreign capital than China is of FDI – with the majority of it still destined for the export manufacturing sectors.  

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China is not prepared to allow foreigners to take over their country purely for profit they can hide. Australia seems happy to lose their control, and the new government appears to be even worse. Foreign investment is increasingly based on taking over resources that can be exported at false prices that grossly undervalue the resources and cheat the people of the country out of a fair income. "Third country invoicing" used to be the name for the system.

China has for centuries been the dream market for gold diggers and of course the lessons of the past are now being implemented to make the gold flow in the other direction! However let there be no doubt that foreign investment is welcome in China for so long as it suits the other parties involved in the investment be it, business partners, local government or SOE's. Once their purpose is served then all bets are off as many have found out to their cost.
As for Chinese investment in Australia one would have thought that the
Government would require that the investment be made by or through an entity incorporated under the laws of Australia with at least two independent directors of repute and with one of the Big Four as internal auditors. That would take care of quite a few of the problems associated with such investments. Money is money and business is business and no one is doing anyone a favour either in China or Australia. Take it or leave it.