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New Shanghai Foreign Investment Rules — What You Should Know

2020-09-08/ARTICLES/ Elizabeth Lan LanElsie SHI

On August 10, 2020, the Office of the Standing Committee of Shanghai People’s Congress published the draft Shanghai Municipality Rules on Foreign Investments (the “Draft Rules”) and invited the public to provide comments on the Draft Rules (once finalized in the future, the “Rules”). [1] 

This paper will use the Draft Rules to illustrate to international investors on how they should work with Chinese local governments under their local rules, vis-à-vis China’s central government and its national rules.  Our thesis is that even with a very friendly and dynamic local government like Shanghai Municipality, international investors should still be aware of the limitations of a local government’s authorities, given that local governments do not have jurisdictions over certain matters, their rules are subject to the central government’s rules, and their authorities generally stop at the boarders of their respective regions.  However, a pro-investor environment as envisioned by the Draft Rules of Shanghai Municipality speak volumes of what a local government can do for investors in that city, and we believe the Draft Rules are worthy of notice and efforts of international investors to provide comments thereon.  In the second part of this paper, we will suggest two proposals to international investors who can consider putting them forward to the Shanghai Municipality with respect to the Draft Rules, with the sole purpose of further enhancing Shanghai’s status as a destination of international investments.    

1. Why Shanghai?

Shanghai stands out as one of the most sought-after Chinese cities, among international investors, either already investing in China or heading for China.   The Draft Rules reflect the intent and enthusiasm of Shanghai Municipality to continue to lead, among all the provinces and municipalities in China, in attracting international investments and businesses. 
Despite the fact that, for the first time in the past 20 years at least, the Chinese government starts to emphasize its domestic market and calls for “internal circulation” of goods and services, the Chinese government simultaneously continues to intend Shanghai to be a vanguard in China’s new efforts to keep the Chinese market open and attractive to international investors.

2. What are the limitations of local rules and local authorities in China vis-a-vis China’s central government rules and powers?

First, local rules are subject to: the laws enacted by the Chinese national legislature, the National People’s Congress and its Standing Committee; regulations promulgated by the Chinese central government, the State Council; or rules made by China’s national regulatory agencies in the areas over which such national agencies have exclusive jurisdictions, for example, with respect to banking, insurance and securities licensing and regulations.  So being aware of the national laws, regulations and rules, and understanding the limitations of local authority is critical to have the right expectations of what a local government can provide. 

Take Article 8 (Further Opening of the Service Sector) of the Draft Rules as an example.  Article 8 provides:

In accordance with the national (government) plan to open up service industry sectors, this Municipality shall push for implementation of early opening in the financial service areas of banking, securities, insurance, futures, trusts, asset management, credit rating, and shall also orderly push for opening in such areas as telecommunications, internet, medical services, transportation, culture and education, and shall also proactively try to obtain priority trials in Shanghai of opening up in the other service areas.   

Does Article 8 mean if you are domiciled in Shanghai, you can obtain a banking or insurance license from Shanghai government, or a significantly more favorable financial service license, or a significantly earlier approval, than a company domiciled in Beijing?

The answers to the above questions are, generally speaking, all “no”, because generally speaking, it is the national regulatory agencies such as China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission, People’s Bank of China, that have the exclusive authorities to license any financial institutions or financial activities mentioned in Article 8 above, regardless where these institutions are domiciled, or where these activities occurred in China. [2] 

Take Article 22 of the Draft Rules (Financing) as another example.  Article 22 provides:

Foreign invested companies may obtain financing by borrowing loans, issuing equity or debt securities or publicly or privately issuing other financial instruments inside or outside China according to laws.

The key phrase here is “according to laws.”  Since most of the above-mentioned financing activities are subject to the national laws and rules of the national regulatory agencies, what Article 22 of the Draft Rules is really saying is that investors can obtain the financing, not in accordance with these (Shanghai) Rules, but in accordance with the national laws, regulations and rules. 

Second, a local government’s jurisdiction is almost always limited to the borders of the region itself.  This is easier to understand but often forgotten or neglected by investors.   Labor rules of Shanghai, for example, are different from those of Beijing;business incentives, certain tax benefits,[3] also vary province by province.  So if an investor has businesses or business entities both in and outside Shanghai, the investor should be aware that Shanghai rules, including the Rules covered by this paper, will not apply to those businesses or entities beyond Shanghai.

3. What can a local government, especially a friendly and powerful local government like Shanghai Municipality, do for investors?

The short answer is plenty as illustrated by the Draft Rules.

Having tried to manage the expectations of an investor with respect to the powers of a Chinese local government, we must also emphasize that there is a plethora of areas a Chinese local government can do for international investors. 

For example, Articles 25, 30 and several other sections of the Draft Rules provide that an international company should be treated equally with the other companies by the Municipal and District government agencies of Shanghai.  Specifically, international companies should be on a level playing field with domestic companies in Shanghai in terms of accessing government-provided funds, land, tax benefits, and when the government sets up qualification or other standards, invites bidding, purchases services, including in the areas of water, gas, waste treatment, municipal road, highway, public transportation etc..  If Shanghai can truly and fully implement these rules, that will place Shanghai above many other provinces or municipalities in China in terms of providing a friendly investment environment for international investors.   

Another area in which Shanghai Municipality can facilitate international investors is to advocate on behalf of international investors in front of the Chinese central government.  Given that many senior central government officials have come from Shanghai, and that this city holds high expectations of the Chinese government as a testing ground for further attracting foreign investments, Shanghai Municipality leaders often have the ears of the central government.  

The above being said, we have generally found that the willingness of a Chinese local government, including Shanghai Municipality, to lobby on behalf of an international investor, as well as the effectiveness of such lobbying, depends on many factors, including whether the subject matter involved is aligned with the priorities of the central governmental agency who receives the lobbying, whether the individual who actually does the lobbying is effective, and whether those who receive the lobbying are responsive.  So an international investor should proactively push for the Shanghai Municipality to be your advocate while maintaining a reasonable expectation of its success in your particular case.

4. Two proposals international investors can consider putting forward to the Shanghai Municipality with respect to the Draft Rules

By the time this paper is published, the current deadline for public comments for the Draft Rules (September 10, 2020) may very well have expired.  But it does not mean international investors should stop trying to bring to the attention of the Shanghai government proposals, which, if adopted, should further improve Shanghai’s investment environment and investors’ chance of business success in Shanghai and China. 

The first proposal international investors may want to consider putting forward to the Shanghai Municipality is to further increase transparency in the implementation of Chinese laws, regulations, and rules, including these Shanghai Municipal Rules on Foreign Investments

A major issue facing any investor in China, including in Shanghai, is to understand exactly what the government means by a certain requirement.  Written rules always leave space for interpretations, and an investor, especially an international investor who is even less familiar than domestic investors with the ways of governance in China, particularly needs transparency and guidance on the part of the Chinese government. 

One of the many consistent and continuous frustrations of international investors is lacking of access to the Chinese government officials who have the power to interpret and implement government requirements.  Calls for explanations, requests for meetings, often fall on deaf ears unless the investor can access government officials through relationships and contacts.  Opaqueness not only wastes time, resources but also is a major source of corruption as well as a killer of investment incentives.

Many measures could potentially increase the transparency of investment environment in Shanghai; what we have put forward below are based on our long-time experience in representing international clients in front of both local and central government agencies in China; they are not intended to exclude other measures, or even to be literally followed, but we hope such measures could represent some of the many measures Shanghai Municipality could consider and adopt, which we believe will make Shanghai even more attractive to even more international investors. 

First, the Municipality needs to have the political will to face the issue of transparency.  It needs to be aware and acknowledge that the lack of transparency is a major issue, and must enforce mechanisms to bring about transparency throughout the ranks of its working-level officials, especially at the levels of officials who have the power to interpret and implement government requirements of all sorts, including these Rules.    

Second, we believe an investor-focused service line, staffed by well trained, highly respected, constantly rated government officials, should be provided by each District government and some of the key agencies of Shanghai Municipality, such as Shanghai Tax Bureau, Shanghai Industry and Commerce Bureau, etc. which line could be similar to a customer service line of a bank or an airline in China.  The officials answering the calls should understand the relevant rules pertinent to the agency, have the authority to interpret the rules on behalf of the agency, and can truly facilitate resolving difficulties of investors within the framework of relevant laws.   The calls should be recorded, with the callers’ names and questions being kept confidential, but the questions and answers should be collected, with some of the most frequently asked questions and answers promulgated periodically in a centralized place.

The current Shanghai Municipal service line “12345” and the other media mentioned in Articles 45 and 48 of the Draft Rules are good beginnings in the right direction.  We hope they will not remain just conduits of messages, but will become forceful bridges between investors and the Shanghai Municipality.   

The second proposal international investors should consider putting forward to the Shanghai Municipality is to enhance efficiency through public rating of government officials on anonymous basis

Government officials throughout the ranks should be rated by the public constantly on anonymous basis, and the ratings should be publicly available so that the immense powers of officials are monitored by the public.  If public rating of every level of government officials is difficult to implement for now, those working-level officials who directly interface with the public and have the power to interpret government policies and rules and otherwise make decisions, should be the first to be rated. 

Such a rating system should not be substituted by the complaint system provided for under Article 36 of the Draft Rules.   Article 36 allows an investor to bring complaints to the municipal, or district government, if the investor believes its legal rights have been infringed upon.  But when a division chief or a department head refuses to tell you whether your filing has been accepted, or how much longer you have to wait before you can receive the approval, or when no one in the government agency can tell you what a particular government requirement means, it is hard for you to lodge a “legal right” complaint; further, investors are usually very reluctant to bring their regulators to a dispute resolution mechanism out of the reasonable concern for backlashes.  Therefore, a public monitoring system is different from a dispute resolution system.  A meaningful and effective public monitoring system is indispensable for a friendly investment environment.     

5. Conclusion

The Draft Rules represent a genuine effort of the Shanghai Municipality to improve Shanghai investment environment for international investors.  Like many rules in China, the success of rules lies in whether they can be implemented as they are intended; and successful implementation depends on the many individuals who interpret them, apply them, i.e. the working-level government officials. 

If Shanghai Municipality is truly determined to see success in making Shanghai a major international business and financial center, it must create mechanisms under which investors can access the officials, and the officials are under public checks and balances. 

To an international investor, if Shanghai is where you want to be, and now that the Shanghai government genuinely invites, you should submit your proposals, if you can, before the expiration of the current deadline (September 10, 2020) or down the road.  Improvement in the investment environment of Shanghai improves the chance of an investor’s success in China.

[1] The current deadline for comments is September 10, 2020.

[2] Each of these central government agencies has provincial and even lower levels of branches, but they are not, strictly speaking, subject to local government administration.

[3] Tax benefits given out by local governments, in theory, are also subject to the central government’s rules as to how much and what form of tax benefits local governments can give out, although in practice, certain local governments may deviate from the central government rules. 

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