GC Agenda China: October 2015

Practical Law UK Articles 8-619-8519 (Approx. 10 pages)

GC Agenda China: October 2015

by Brad Herrold, Consultant and Practical Law China

State Council initiates negative list approach to market access

On 19 October 2015, the State Council officially released the Opinions on Implementing the Negative List System for Market Access (国务院关于实行市场准入负面清单制度的意见). The opinions will complete the transformation of China’s traditional system in which all companies were required to apply in advance for permission to operate with an approach under which companies only need to obtain prior clearance if they seek to operate in certain blacklisted industrial sectors (the list of these sectors is the “negative list”). The new system will take effect on a trial basis starting 1 December 2015 and ending 31 December 2017 in certain areas that remain to be designated, and will be implemented nationwide from 2018.

The opinions contemplate two blacklists of regulated sectors:

A market access negative list. This will apply to both domestic and foreign investors.
A foreign investment negative list. This is a list of additional industrial sectors which applies only to foreign investors.

The principal change under the new system is to those industries that do not appear on either list. In industries not on the list, all market participants will be subject to the same systems of regulation and corporate law, whether they are owned by foreign companies or individuals, by private Chinese citizens or by the Chinese state. This replaces a system under which market participants were subject to different levels of regulation and required to incorporate under separate types of corporate form based on their ultimate beneficial ownership. For example, all foreign-invested enterprises (FIE) are currently required to obtain approvals from the Ministry of Commerce (MOFCOM) and potentially the National Development and Reform Commission of China (NDRC) to operate, regardless of industry sector, purely by virtue of being foreign.

Industries that do appear on the lists will be subject to a regime that looks very similar to that currently in force. Some will be designated as prohibited, and will be entirely off limits to investment. Others will be designated as restricted. In restricted industries, investment will be permitted subject to restrictive administrative measures such as, for example, investor qualifications, equity ownership caps, and limitations on business scope and business models. For information on the current system of restrictions to market access, see Practice note, Chinese foreign direct investment law: overview: Restrictions on business scope.

The new system will apply to all forms of investment, including greenfield investments, acquisitions and indirect forms of market entry such as the use of variable interest entity (VIE) contractual control structures (for more information on these, see Practice note, Variable interest entity (VIE) structures in China).

MOFCOM and NDRC, in consultation with industry regulators, will draft the negative list and propose the trial regions, subject to State Council and Communist Party of China approval. The opinions require all government agencies to draft new rules to implement the new approach and to amend or repeal conflicting rules already in effect.

The negative list approach is already in force in China’s four pilot free trade zones and was reflected in the draft Foreign Investment Law of the People's Republic of China.

For further information on the negative list approach, see Legal update, Draft Foreign Investment Law open for comment until February 17.

For further information on the pilot free trade zones, see Practice note, China (Shanghai) Pilot Free Trade Zone: overview.

Market reaction

Qing Ren, Partner, Zhong Lun Law Firm, Beijing

"This is an important step in China’s further reform and opening-up. The idea of negative list was introduced in China first in the field of foreign investment, including in the Shanghai FTZs and the draft Foreign Investment Law released in this January, now spreads to the entire administrative system on market accession for all types of investors and investment irrespective of its nationality. T he release of this opinion reconfirms the resolution of the Chinese government to adopt the mode of negative list for the administration of foreign investment. However, foreign investors should be advised that, in addition to this negative list for market access, another negative list specifically for foreign investment will apply for their investment in China, and the latter list will be formulated later. Another important message that foreign investors should take note is that the State Council appears to agree with MOFCOM’s idea to establish a foreign investment information reporting system besides the SAIC’s system applying to all types of enterprises."

Action items

Once the trial regions are selected and the negative list is approved, GC and particularly GC for companies that operate in highly regulated or “sensitive” industries should determine if the new approach initiated by the opinions offer new or improved investment opportunities.

US SEC fines Bristol Myers Squibb US$14 million for FCPA violations in China

On 5 October 2015, the US Securities and Exchange Commission (SEC) announced that Bristol Myers Squibb (BMS) agreed to settle administrative claims that its majority-owned joint venture in China provided cash and other benefits (including meals, travel, entertainment and conference sponsorships), to state-owned hospitals to secure and increase sales between 2009 and 2014. The announcement did not emphasise violations of the anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA), that is the prohibitions against giving value to a public official with intent to obtain or retain business. Instead, the notice focused on the joint venture’s violations of the FCPA’s accounting and internal controls provisions. Specifically, the SEC alleged that the China joint venture:

Inaccurately booked the cost of the improper payments as legitimate business expenses.
Ignored “red flags” that sales personnel provided bribes and other benefits to generate sales.
Failed to properly investigate claims by disgruntled former employees that the joint venture faked purchase orders, invoices and receipts.
Failed to address repeated revelations in internal audits regarding the improper payments.

Without confirming or denying the allegations, BMS agreed to:

Return US$ 11.4 million in illegal profits.
Pay US$ 500,000 in prejudgment interest.
Pay a civil penalty of US$ 2.75 million.

BMS also agreed to report to the SEC on its implementation of anti-corruption compliance measures for a two-year period.

For information on the legal requirements and practical considerations in deciding whether to report allegedly corrupt activities that occurred in China to government agencies in the US, UK, China, or Hong Kong, see Practice note, Bribery and corruption reporting obligations: China.

Market reaction

Timothy Blakely, Partner, Morrison & Foerster, Hong Kong

“The SEC’s harsh criticisms of the failure to respond to red flags, enforce existing controls, or remediate identified controls deficiencies underscore the fact that having a compliance program that identifies risks is not enough to protect against liability. This resolution also serves as yet another reminder that operating through foreign joint ventures does not insulate US issuers from FCPA-scrutiny: the FCPA’s recordkeeping and internal control provisions can provide the government with a powerful tool for holding U.S. issuers responsible for the conduct of its foreign joint venture—even where that conduct does not otherwise have any nexus to the US.”

Action items

GC for companies that operate in China and the United States should ensure that comprehensive anti-corruption compliance policies are put in place, and implement these policies by thoroughly evaluating and addressing red flags, employee allegations, and other potential violations of the anti-corruption regimes in both countries.

Supreme People’s Procuratorate publishes authoritative financial crimes cases list

On 23 September 2015, the Supreme People’s Procuratorate (SPP) held a press conference to discuss the situation involving financial crime in 2014 and published the Typical Cases of Financial Crimes Prosecuted by the Procuratorial Authority in accordance with Law (检察机关依法查处金融犯罪典型案例), which contains summaries of six financial crimes cases prosecuted in 2014. These authoritative cases demonstrate the urgency of addressing various prosecutorial issues involving white collar crime in China, as well as the legal basis for prosecuting such crimes. The six cases include:

Three non-public information or insider trading cases.
An evasion case where the accused fraudulently manipulated China’s recent free trade zone financial reforms.
A case involving the misuse of an innovative financial product to implement a fraudulent loan scheme.
A fraudulent fund raising case where the accused exploited China’s nascent regulatory environment in the internet finance sector.

These authoritative cases illustrate, among other things, the need to:

Implement similar sentences in similar situations, for consistency's sake.
Improve the level of cooperation between companies and regulators.
Encourage financial institutions to develop a sound risk control mechanism when marketing new financial products.
Strengthen the law on new financial products and financial services such as P2P and crowdsourcing.

For further coverage of this development, see Legal update, SPP publishes authoritative financial crime cases list.

Action items

GC for financial companies, stock trading companies and other companies with exposure to “white collar crime” should note the recent uptake in the enforcement of rules that criminalise corrupt and fraudulent behavior and consider raising awareness of these rules, implementing or reviewing internal risk control mechanisms, and building relationships with regulators.

Haidian court rules in China’s first crowdfunding case

On 15 September, Haidian District People’s Court in Beijing upheld the validity of a crowdfunding contract created to finance a limited partnership restaurant. Beijing Nuomiduo Restaurant Management Co., Ltd. (Nuomiduo) entered into a commissioned finance services agreement with Beijing Feidu Network Services Co., Ltd. (Feidu), which agreed to finance the project through its licensed crowdfunding platform. Both parties performed their financial obligations under the contract, but a dispute arose over the style and cost of the business premises selected by Nuomiduo. After settlement talks stalled, Nuomiduo and Feidu each attempted to terminate the contract early and assert claims against the other for damages. The court upheld the validity of the contract for the following reasons:

Feidu did not offer securities to more than 200 specific persons (in violation of Article 10 of the Law of the People’s Republic of China on Securities 2005) through the use of a crowdfunding platform.
Feidu did not violate laws and regulations related to crowdfunding (mainly because there are no such laws or regulations in force at this time).
Feidu operated lawfully, including the use of YeePay to handle online payments, and implemented risk management controls, project supervision and other mechanisms designed to protect against potential abuse of the crowdfunding model.
Most importantly, the contract adhered to the principles set forth in the Guiding Opinions on Promoting the Healthy Development of Internet Finance 2015 (2015 Internet Finance Guidelines).

For further information on the Internet Finance Guidelines, see Legal update: China publishes internet finance guidelines.

Market reaction

Paul McKenzie, Partner, Morrison Foerster, Beijing

“This Beijing case is a promising beginning in the development of Chinese legislation and judicial practice in regard to crowdfunding. The recent guidelines governing crowdfunding and other alternative financing models have signaled policy on the part of regulators towards relevant financing models. The Haidian court has followed their lead. In due course, CSRC can be expected to issue legislation in order to better regulate crowdfunding.”

Action items

GC for small and medium sized companies, or investment funds, should consider the opportunities presented by alternative financing models such as crowdfunding and closely monitor further legislative and judicial developments in this area. It is often possible in China to vet an innovative approach directly with regulators before concluding a potential arrangement.

NDRC abolishes quota approval for long-term foreign debt of Chinese companies

On 14 September 2015, the NDRC issued the Notice on Promoting the Reform of Managing the Foreign Debt Issuance by Enterprises with a Record-filing Registration System (关于推进企业发行外债备案登记制管理改革的通知). The notice abolished the NDRC quota examination and approval requirement and replaced it with a new record filing system for regulating the long-term foreign debts of Chinese companies. The term “long-term foreign debt” refers to a debt instrument borrowed by a Chinese company (including offshore affiliates under the company’s control) from an offshore lender with a term of more than 12 months. In particular, the notice:

Requires a borrower to apply for record-filing with the NDRC before incurring long term foreign debt and submit a debt information form within 10 business days after each debt issuance or borrowing.
Requires the NDRC to render its decision on whether to accept a record filing application within five business days after receipt of the application and to issue a record filing registration certificate within seven business days after the date of the NDRC decision to accept the record filing application.
Permits the borrower to handle the inflow and outflow of foreign debts in accordance with the record filing registration certificate.

Once the total amount of foreign debt reaches the annual quota for the current calendar year, the NDRC will issue a public announcement and stop accepting additional record-filing applications for that year.

For more information on the regulation of foreign debt in China, see Practice note, Foreign exchange control in China: Regulation of foreign debt.

Market reaction

Shirley Wang, Partner, Zhong Lun Law Firm, Beijing

“The new record filing system for regulating the long-term foreign debts of Chinese companies will simplify governmental procedures and accelerate the process of raising foreign debt by Chinese companies. On the other hand, subject to the NDRC’s macro-control of the annual quota for the foreign debt of the state, record-filing applications may not be accepted for those companies that fail to meet the general requirements for raising foreign debt under the notice or where the outstanding foreign debt has exceeded the relevant annual quota.”

Action items

GC for Chinese companies that plan to incur long term foreign debt should become well-versed in the new record-filing rules and make advance preparations in order to ensure that an application for long term foreign debt is accepted before the annual quota for that calendar year is met.

NCA circulates draft revisions to rules on copyright administrative penalties

On 8 September 2015, the National Copyright Administration circulated a draft of its proposed revisions to the Measures for the Implementation of Copyright Administrative Penalties (2009 measures) for public comment. The changes contained in the new draft codify recent practice in copyright administrative enforcement and resolve conflicts between the 2009 measures and revisions made to the Copyright Law of the People’s Republic of China 2010 (2010 Copyright Law) and other related legislation since 2010.

The changes include:

Imposing administrative liability on internet service providers (ISPs) for engaging in acts defined as “illegal conduct” under the 2010 Copyright Law, provided the infringement harms the public interest and the ISP either knows (or should know) of the infringement or fails to take remedial measures after receiving notice of the infringement from the copyright owner.
Expanding the government’s right to confiscate equipment during a copyright infringement investigation to include equipment “used to provide network services”.
Supplementing the circumstances deemed to involve a “serious” copyright infringement to include, for example, dissemination of infringing content online that receives 25,000 or more hits or views or that reaches via a membership arrangement to a group of 500 or more registered members.
Clarifying that “certification” in regard to what constitutes acceptable evidence of copyright infringement includes certificates issued by the copyright owner or its agents as well as government agencies.

For further coverage of this development, see Legal update, NCA releases draft amendments to copyright administrative penalties rules.

Market reaction

Scott Palmer, Partner, Sheppard Mullin, Beijing

“The draft measures are noteworthy as an attempt to bring current practice in line with recent government policy and enforcement priorities focused on rectifying infringements on e-commerce sites, and on addressing longstanding issues of online piracy. There is nothing revolutionary here, but the clarification these measures would provide for administrative enforcement is indeed welcome to industry.”

Action items

GC in most industries should gain a general awareness of the government’s increasing interest in enforcing rules that prohibit copyright infringement through ecommerce platforms. GC for companies dealing directly with online piracy should seek specialist advice to determine the practical implications of the draft measures.

MOFCOM circulates draft standard on pricing information for ecommerce services

On 23 September 2015, MOFCOM circulated for public comment a draft domestic industry standard, General Requirements for Ecommerce Merchant Services Pricing (电子商务商贸服务标价通用要求). The draft standard would apply to businesses and other organisations that provide services over the internet and regulate the content and presentation of pricing information.

The draft standard would cover various types of merchant services, including:

Human resources services, for example, beauty salons, spas, housekeeping, portrait photography, food & beverage and hospitality.
Services related to goods, for example, warehousing, logistics, recycling, printing, dyeing, appliance repair, inspection and pawn brokering.

The draft standard would address two components of pricing information: administrative requirements and labelling requirements.

Administrative requirements include:

Requiring sales of services by online vendors to accord with lawful standard service prices.
Requiring pricing information linked to prompt boxes or service price diagrams to conform to the labelling requirements.
Requiring service providers to indicate service pricing attributes by means of color coding that conforms to SB/T10955-2012.
Requiring online service price diagrams to link to an electronic version of the relevant label.

Labelling requirements include:

Requiring the content of online services to include the applicable main and auxiliary service types, enterprise names and service labelling requirements.
Requiring the content of online service price diagrams to include the abbreviated name of the service, as well as the service ID, class, location, specifications, price, unit measurement and supervisors.

For more information on e-commerce in China, see Article, E-commerce in China.

Market reaction

Robert Lewis, Senior Counsel, Zhong Lun Law Firm, Beijing

“The draft industry standard looks to be a positive step in the direction of establishing a transparent pricing mechanism for the online services market in China, which should help protect online consumer interests. However, it will be difficult to assess the impact of these standards until it can be seen how ‎they are implemented in practice following formal adoption.”

Action items

GC for companies that operate ecommerce platforms or provide online services should pay particular attention to the development and adoption of ecommerce standards. GC for companies that purchase online services also may wish to become familiar with these standards as they emerge.

GC Agenda China: October 2015 | Practical Law