McLARTY CHINA UPDATE: New foreign investment law & SOE reform

March 16, 2019

KEY POINTS:

Lawmakers endorsed China’s new foreign investment law as expected, a step forward to reduce discrimination against foreign firms.
We don’t expect forced technology transfer or intellectual property rights violation will be eliminated or significantly reduced in the near term.
Companies should watch for more specific policies and monitor the new law’s implementation.
China’s SOE reform, state subsidies, and industry policy will remain key sticking points in US-China trade negotiations.

China’s annual legislative meeting concluded on Friday. As expected, lawmakers endorsed the foreign investment law after an expedited review process, designed in part to satisfy US demands in the trade talks. We have heard that USTR Robert Lighthizer is likely to visit Beijing in the week of March 18 for further negotiations, after President Trump gave a hint on the prospects of the talks, saying on Thursday: “probably one way or the other we’re going to know over the next three or four weeks.”

The new foreign investment law marks a step forward in Beijing’s efforts to consolidate three older pieces of legislation — including on forced joint ventures — and formally enacts the existing “negative list” approach to foreign investment, which could reduce discrimination against foreign companies. It’s too soon to tell what the actual effect will be on foreign capital. The inclusion of some new clauses is a positive sign, such as terms banning administrative officials from leaking commercial secrets of foreign companies. The new law also requires that negotiations on technology cooperation must be based on the principle of fairness and equality. However, it falls short of giving a clear definition about forced technology transfer and what punitive measures will be taken against violators.

Given the law’s vague provisions, questions remain on how Beijing plans to interpret and implement the law. The expedited review process didn’t allow much time for soliciting feedback from foreign stakeholders. Premier Li Keqiang said at his annual press conference that follow-up policies will be rolled out, such as making the mechanism for foreign investors to lodge complaints “more transparent and effective.”

We don’t expect practices such as forced technology transfer or IP violations to be eliminated or significantly reduced in the near term. We suggest multinationals monitor the law’s implementation and the introduction of more specific policies.

SOE Reform

Without giving a fresh indication about the status of US-China trade talks at his annual press conference, Premier Li said simply that he hopes the two sides can achieve a mutually beneficial outcome. He avoided speaking in detail about trade talks probably because the negotiations are at a sensitive, finalstage, and have reportedly zeroed in on the phasing out of joint-venture requirements, the deal’s enforcement mechanism, and the lifting of tariffs. But his language overall was general and diplomatic as he addressed trade talks and other major issues such as North Korea, Taiwan, and China-EU relations. In truth, the Premier’s role in economic policymaking has largelyshifted to more of a policy implementer than a top decision-maker in President Xi’s cabinet. President Xi, through his “special envoy” Vice Premier Liu He, is directly overseeing the trade negotiations.

Premier Li didn’t address how the government plans to deepen state-owned enterprise (SOE) reform, another key component of the trade talks. At the press conference, Li reiterated the language in his annual government work report that China will treat all enterprises equally based on “the principle of competitive neutrality” and pledged to reduce the negative list of prohibited or restricted sectors for foreign investment.

We expect the treatment of SOEs, industrial policy, and subsidies will remain key sticking points in the trade talks. None of the questions at Li’s press briefing focused on SOE reform. For a once-a-year event like Premier’s NPC press conference — during which domestic and international media are able to directly ask questions in a pre-selected way — skipping over the fate of SOEs indicates the absence of new policies or a lack of consensus within the government regarding the next step for important reforms.

In another clear signal that removing state subsidies for SOEs will be challenging, State-owned Assets Supervision and Administration Commission (SASAC) Chairman Xiao Yaqing explicitly denied the existence of special subsidies for SOEs at a press conference held on the margin of the legislative meeting. He said China has not made any “special systemic arrangements to offer extra subsidies for SOEs,” and concluded with the questionable assertion that SOEs are “independent market entities”responsible for their own operations.