HomeReportsBureau of Economic and Business Affairs2017 Investment Climate Statements...China

# 					2017 Investment Climate Statements: China			

 In this section										/

													Executive Summary											

                -  Executive Summary 
                -  1. Openness To, and Restrictions Upon, Foreign Investment   
                -  2. Bilateral Investment Agreements and Taxation Treaties   
                -  3. Legal Regime   
                -  4. Industrial Policies   
                -  5. Protection of Property Rights   
                -  6. Financial Sector   
                -  7. State-Owned Enterprises   
                -  8. Responsible Business Conduct   
                -  9. Corruption   
                -  10. Political and Security Environment   
                -  11. Labor Policies and Practices   
                -  12. OPIC and Other Investment Insurance Programs   
                -  13. Foreign Direct Investment and Foreign Portfolio Investment Statistics   

## Executive Summary

China has a more restrictive foreign investment climate than its major trading partners, including the United States. While China remains a top destination for foreign direct investment, many sectors of its economy are closed to foreign investors. China continues to rely on an investment catalogue to encourage foreign investment in some sectors of the economy while restricting or prohibiting investment in many others. China’s investment approval regime shields from competition inefficient and monopolistic Chinese enterprises – especially state-owned enterprises (SOEs) and other national champions. Foreign investors are hampered by discriminatory practices, selective regulatory enforcement, licensing barriers, and the lack of an independent judiciary. Other challenges include poor intellectual property rights (IPR) enforcement, forced technology transfer, and a systemic lack of rule of law. Moreover, many of China’s industrial policy goals, including the 13th Five Year Plan and Made in China 2025, inherently discriminate against foreign companies and brands by favoring local products in key high-tech and advanced manufacturing sectors.

U.S. companies and industry associations are increasingly vocal in their criticism of China’s discriminatory investment regime. A 2017 business climate survey by the American Chamber of Commerce in China found over 60 percent of U.S. businesses surveyed felt China would be unlikely in the next three years to carry out needed reforms to provide greater market access to foreign companies; 81 percent felt China’s business climate had deteriorated and become less friendly to U.S. investors in the last year.

In 2016, the Chinese leadership pledged to gradually improve the investment climate through:

- Intensification of U.S.-China Bilateral Investment Treaty (BIT) negotiations covering “pre-establishment” market access and using a “negative list” approach, with the aim of a high-standard agreement reflecting non-discrimination, transparency, and open and liberalized investment regimes on both sides.
- Implementation of staggered “negative lists” to govern investment throughout the country, including: a pilot market access negative list applicable to both domestic and foreign investors; an updated draft Catalogue for the Guidance of Foreign Investment in Industries, which proposes new liberalization in 20 investment sectors; and the announced expansion of the Free Trade Zone (FTZ) pilot foreign investment negative list to include seven new FTZs (for a total of eleven) that will go into effect in 2017.

Although Chinese officials continue to promise economic reforms that will provide greater market access and protection to foreign investors, announcements are met with skepticism due to lack of details and timelines. Investors also cite inconsistent regulations, growing labor costs, licensing and registration problems, shortages of qualified employees, insufficient intellectual property protections, and other forms of Chinese protectionism as contributing to China’s deteriorating business climate.

*Table 1*

							1. Openness To, and Restrictions Upon, Foreign Investment					

**Policies Toward Foreign Direct Investment**

China has long relied on foreign investment to develop key sectors of its economy. Although many industries and economic sectors remain restricted or prohibited to foreign investment, government officials recognize the important role that Foreign Direct Investment (FDI) has historically played in China’s economic development. They have therefore continued to promise economic reforms to further open up China’s economy to provide greater market access for foreign investment. According to the Ministry of Commerce (MOFCOM), 2016 saw China’s total inward FDI flows rise 4.1 percent from the year prior, to 813.22 billion renminbi (RMB) (U.S. $126 billion). China’s sustained high economic growth rate, growing middle class, and the expansion of diverse product demand all contribute to China’s attractiveness as an FDI destination.

Foreign investors, however, often temper their optimism regarding potential investment returns with uncertainty about China’s willingness to offer a level playing field vis-à-vis Chinese competitors. Foreign investors report a range of challenges related to China’s current investment climate, including: broad use of industrial policies to protect and promote state-owned and other domestic firms through employing subsidies, preferential financing, and selective enforcement of laws and regulations; restrictions on controlling ownership of foreign entities through equity caps, limited voting rights, limits to foreign participation on companies’ board of directors, etc.; weak protection and enforcement of IPR; corruption; discriminatory and non-transparent anti-monopoly enforcement; excessive national or cyber security requirements; and an unreliable legal system lacking transparency and rule of law. The 2015 Anti-Terrorism Law, the Foreign Non-Governmental Organization (NGO) Law, the Cyber Security Law, and other measures impede local Chinese firms (especially banks) from purchasing foreign technology, raising concerns that China has back-tracked on reforms to further open up to foreign investment.

China promotes inward investment through MOFCOM’s “Invest in China” website, found at www.fdi.gov.cn . MOFCOM publishes laws and regulations related to foreign investment, economic statistics, lists of investment projects, relevant news articles, and other relevant information about investing in China. In addition, each region has a provincial-level investment promotion agency through local MOFCOM departments.

American Chamber of Commerce China 2016 American Business in China White Paper: http://www.amchamchina.org/whitepaper 

American Chamber of Commerce China 2017 Business Climate Survey:http://www.amchamchina.org/policy-advocacy/business-climate-survey 

U.S.-China Business Council’s China October 2016 Economic Reform Scorecard:https://www.uschina.org/reports/uscbc-china-economic-reform-scorecard-october-2016 

MOFCOM’s Investment Promotion Website:http://www.fdi.gov.cn/1800000121_10000161_8.html 

**Limits on Foreign Control and Right to Private Ownership and Establishment**

The Catalogue for the Guidance of Foreign Investment in Industries, or Foreign Investment Catalogue (FIC), governs the “pre-establishment,” or market access, phase of investment and establishes whether foreign investment in a particular economic sector or industry is “encouraged,” “restricted,” or “prohibited.” In both the encouraged and restricted categories, the FIC clearly outlines industry sectors that are completely liberalized and those that are open to foreign investment but subject to equity caps, joint ventures requirements, and Chinese national leadership requirements. Encouraged sectors are industries China believes would benefit from foreign investment and technology transfer, often in line with industrial policy goals. Restricted and prohibited sectors are those seen as sensitive, possibly touching on national security concerns, or at odds with the industrial goals of China’s economic development plans.

In December 2016, MOFCOM and the National Development and Reform Commission (NDRC) jointly issued for public comment an updated draft of the FIC that proposed reforms to further liberalize 20 sectors of the economy. Of note, the proposed draft FIC changed the header of the restricted and prohibited section to the “nationwide negative list.” Foreign investors interested in industries not on the negative list will no longer require pre-approval from MOFCOM, but rather, need only register their investment with MOFCOM.

The proposed revisions in the draft FIC may improve market access in some sectors, but are relatively minor, and revisions affecting investments in industries that have traditionally faced heavy restrictions, such as banking, telecommunications, and cultural industries, fall short of the reform expectations of the U.S. business community. In addition, it is unclear how the updated FIC will be prioritized vis-à-vis other, contradictory industry-based regulations or whether other industrial policies will supersede the version of the FIC that is ultimately published. This uncertainty undermines confidence in the stability and predictability of China’s investment climate and impedes foreign investors’ future business planning.

The Chinese language version of the 2015 FIC: http://www.mofcom.gov.cn/article/b/f/201503/20150300911747.shtml 

The Chinese language version of the 2016 draft FIC: http://www.ndrc.gov.cn/yjzx/yjzx_add.jsp?SiteId=122 

*Ownership Restrictions*

In both the “encouraged” and “restricted” categories of the FIC, certain industries require joint ventures and/or requirements that a company be controlled by Chinese nationals.

For example:

- In the oil and natural gas exploration and development industry, foreign investment is required to take the form of equity joint ventures and cooperative joint ventures.
- In the accounting and auditing sectors, the Chief Partner of a firm must be a Chinese national.
- In higher education and pre-school, foreign investment is only permitted in the form of cooperative joint ventures led by a Chinese partner.
- In some sectors, the Chinese partners individually or as a group must maintain control of the enterprise. Examples include: construction and operation of civilian airports, construction and operation of nuclear power plants, establishment and operation of cinemas, and the design and manufacture of civil-use satellites.

In some sectors, the foreign shareholder’s proportion of the investment may not exceed a certain percentage. For example, foreign equity ownership is limited to:

- 50 percent in value-added telecom services (excepting e-commerce);
- 49 percent in basic telecom enterprises;
- 50 percent in life insurance firms; and
- 49 percent in security investment fund management companies.

Mandatory joint venture structures and equity caps give Chinese partner firms significant control, often allowing them to benefit from technology transfer. In addition, the relative opacity of the approval process and the broad discretion granted to authorities foster an environment where the Chinese government can impose deal-specific conditions beyond written legal requirements, often with the intent to force technology transfer as a condition of market access or to support industrial policies and the interests of local competitors.

**Other Investment Policy Reviews**

*Organization for Economic Cooperation and Development (OECD)*

China is not a member of the OECD. The OECD Council decided to establish a country program of dialogue and co-operation with China in October 1995. The most recent OECD Investment Policy Review for China was completed in 2008. The OECD Investment Policy Review noted that policy changes in China between 2006 and 2008 tightened restrictions on inward direct investment, including cross-border mergers and acquisitions.

OECD 2008 report:  http://www.oecd.org/daf/inv/investment-policy/oecdinvestmentpolicyreviews-china2008encouragingresponsiblebusinessconduct.htm 

In 2013, OECD published a working paper entitled “China Investment Policy: An Update,” which provided an update on China’s investment policy since the publication of the 2008 Investment Policy Review. The paper noted that while China’s economic strength buoys foreign investor confidence, fears of investment protectionism are growing.

OECD 2013 Update:  http://www.oecd.org/china/WP-2013_1.pdf 

*World Trade Organization (WTO)*

China became a member of the World Trade Organization (WTO) in 2001. WTO membership boosted China’s economic growth and advanced its legal and governmental reforms. The most recent WTO Investment Trade Review for China was completed in 2016. The report highlighted key changes between the 2011 and 2015 FIC. In addition, it noted that the foreign investment pilot negative list expanded from the Shanghai FTZ to the FTZs of Tianjin, Fujian, and Guangdong. The trade review also said that China encourages inward FDI, as well as joint ventures between Chinese and foreign companies, particularly in research and development. The report also mentioned that technology transfer, while not a requirement for investment approval, is a practice widely encouraged by Chinese authorities.

WTO Investment Trade Review for China: https://www.wto.org/english/tratop_e/tpr_e/tp400_e.htm International Monetary Fund (IMF) information on China: http://www.imf.org/external/country/Chn/ FDI Statistics from MOFCOM: http://www.fdi.gov.cn/1800000121_10000177_8.html 

**Business Facilitation**

Basic business registration procedures in China are difficult. The World Bank ranked China 78th out of 190 economies in terms of ease of doing business and 127th for starting a business. In Shanghai and Beijing, at least 11 procedures are reportedly required to establish a business, with an average timeline of more than 30 days to complete the registration process. Steps to register a business include pre-approval for a company name, a business license approved by the State Administration for Industry and Commerce (SAIC), an organization code certificate with the Quality and Technology Supervision Bureau, registration with the provincial and local tax bureaus, a company seal issued by the police department, registration with the local statistics bureau, a local bank account, the authorization to print or purchase invoices and receipts, and registration with the Ministry of Human Resources and Social Security, as well as with the Social Welfare Insurance Center.

The Government Enterprise Registration (GER), an initiative of the United Nations Conference on Trade and Development (UNCTAD), gave China a score of 1.5 out of 10 on its website for registering and obtaining a business license. SAIC is the main government body that approves business licenses, and according to GER, SAIC’s website lacks even basic information, such as what to do and how to do it.

SAIC’s online business registration information can be found at http://www.saic.gov.cn/. 

Recently, the State Council **–**China’s cabinet**–**has tried to reduce red tape by eliminating hundreds of administrative licenses and delegating administrative approval power across a range of sectors. The number of investment projects subject to central government approval has reportedly dropped more than 75 percent. The State Council also has set up a website in English, which is more user-friendly than SAIC’s website, to help foreign investors looking to do business in China: (http://english.gov.cn/services/doingbusiness ).

MOFCOM’s Department of Foreign Investment Administration is responsible for foreign investment promotion in China.

Despite efforts to streamline business registration procedures, foreign companies still continue to complain about the many challenges of setting up a business, including the process of registration and obtaining administrative licenses. Numerous companies offer consulting, legal, and accounting services for establishing wholly foreign-owned enterprises, partnership enterprises, joint ventures, and representative offices. The differences among these corporate entities are significant, and investors should review their options carefully with an experienced advisor before choosing a particular corporate entity or investment vehicle.

**Outward Investment**

In 2001, China initiated a “going-out” investment strategy for SOEs to go abroad to acquire foreign assets and gain greater access to foreign markets. Over time, this policy has evolved to include both state and private Chinese companies in a diversified number of economic sectors. Today, China is one of the largest outbound direct investors in the world and invested over U.S. $200 billion globally in 2016 alone, according to the Rhodium Group, a leading private sector analyst of U.S.-China bilateral investment. China’s preferred investment location is the United States, where China invested over U.S. $45 billion in 2016, almost triple 2015 investment, according to Rhodium reports.

Chinese officials support foreign investment opportunities that help China move up the manufacturing value chain by acquiring advanced manufacturing and high-technology capabilities that can be transferred back to China. This emphasis is stressed in both the 13th Five Year Plan and the Made in China 2025 policy that aims to transform China’s economy to better compete against advanced economies in 10 key high-tech sectors, including: new energy vehicles, next-generation IT, biotechnology, new materials, aerospace, oceans engineering and ships, railway, robotics, power equipment, and agriculture machinery. Chinese government officials provide preferred financing, subsidies, and access to an opaque network of investors to promote and provide incentives for outbound investment in key sectors.

While China continues to push for value-added outbound acquisitions, in November 2016, Chinese officials at the State Administration for Foreign Exchange (SAFE) issued guidelines that regulate foreign currency outflow for investments considered financial in nature or investments deemed “illogical” because the investment falls outside the core business of the acquiring company. In other words, investments made strictly for the purpose of financial returns, like commercial real estate, or investments where a company enters a completely different economic sector than it currently operates, will receive greater scrutiny from Chinese regulators. These guidelines were intended to slow the momentum of China’s shrinking foreign currency reserves, in part brought about by a surge in outbound investment that, starting in Q3 2015, has exceeded capital inflows from foreign direct investment. Experts attribute China’s shrinking foreign currency reserves to two factors. First, as China’s GDP has slowed down, the quality of investment opportunities in China that yield a high return have diminished, making foreign investors less likely to invest in China and causing Chinese investors to look overseas to other markets with better return potential. Second, Chinese investors expect the RMB will continue to depreciate over time, which makes holding RMB-denominated investments less attractive than investments made in U.S. dollars and other foreign currencies. In an attempt to diversify assets into different currencies, Chinese household and company investments have fled to quality destinations like the United States and Europe.

							2. Bilateral Investment Agreements and Taxation Treaties					

China has bilateral investment agreements with over 100 countries and economies, including: Austria, the Belgium-Luxembourg Economic Union, Canada, France, Germany, Italy, Japan, South Korea, Spain, Thailand, and the United Kingdom. China’s bilateral investment agreements cover expropriation, arbitration, most-favored-nation treatment, and repatriation of investment proceeds. They are generally regarded as weaker than the investment treaties the United States seeks to negotiate.

A list of China’s signed BITs: http://tfs.mofcom.gov.cn/article/Nocategory/201111/20111107819474.shtml 

The United States and China were actively engaged in BIT negotiations from October 2012 until January 2017.

In addition to bilateral investment agreements, China also has 14 Free Trade Agreements (FTAs) with its trade and investment partners. It is negotiating an additional nine FTAs and researching six more potential FTAs. China’s FTA partners are ASEAN, Singapore, Pakistan, New Zealand, Chile, Peru, Costa Rica, Iceland, Switzerland, Hong Kong, Macao, and Taiwan. China has also recently signed FTAs with Korea and Australia, both of which include a chapter on investment.

China’s signed FTAs: http://fta.mofcom.gov.cn/index.shtml 

The United States and China concluded a bilateral taxation treaty in 1984.

							3. Legal Regime					

**Transparency of the Regulatory System**

In China’s complex legal and regulatory system, regulators and other government authorities inconsistently enforce regulations, rules, and other regulatory guidelines. Foreign investors rank inconsistent and arbitrary regulatory enforcement, along with the lack of transparency, among the major problems they face doing business in China. Government-controlled trade organizations and regulatory bodies set standards that often ignore Chinese transgressors while strictly enforcing regulations against targeted foreign companies. In China’s regulatory system, different agencies at both the central and local levels issue rules and regulations that impact foreign businesses in certain geographical areas and in certain industries. Some of these rules are only guidelines that are not necessarily considered part of the legal code. Because all of these regulations and guidelines could potential impact foreign investors, foreign companies often feel overburdened by a complex regulatory system rife with contradictions and inconsistencies. Knowing how to apply central versus local rules, for example, is a common complaint of U.S. businesses that are both confused and lack confidence in the regulatory system.

In accordance with China’s WTO accession commitments, the State Council’s Legislative Affairs Office (SCLAO) issued instructions to Chinese agencies to publish all foreign trade and investment-related laws, regulations, rules, and policy measures in the MOFCOM Gazette. Chinese agencies rarely meet these commitments. In addition, the State Council has issued Interim Measures on Public Comment Solicitation of Laws and Regulations and a Circular on Public Comment Solicitation of Department Rules, which require government agencies to post proposed trade and economic-related administrative regulations and departmental rules on the official SCLAO website for 30-day public comment period. Officials have publicly confirmed that these documents are legally binding. However, despite these efforts, ministries under the State Council continue to post only some of the draft administrative regulations and departmental rules on the SCLAO website. When drafts are published, they often are available for comment for less than the required 30 days.

While not provided for in China’s Law on Legislation, the State Council and ministries under the State Council also issue “normative documents” (opinions, circulars, notices, etc.), which are a form of quasi-regulation to implement applicable law, regulations, and rules when further specificity is necessary, or when there is no governing law. The U.S. business community reports that Chinese ministries often impose new requirements on companies through the issuance of a normative document, which, unlike the formal rulemaking process, does not necessitate a public comment period.

Proposed regulations are often drafted without using scientific studies or quantitative analysis to assess the regulation’s impact. When an assessment is made, the results and methodology of the study are not made available to the public. Third parties are asked to comment on draft regulations, but it is unclear what impact the comments have on the final regulation. This lack of transparency adds to foreign investor perceptions that industrial policy goals and other anticompetitive factors are driving forces behind China’s regulatory regime.

Chinese state actions are strongly motivated by the perceived need to protect social stability and/or achieve other political goals, many times at the detriment of foreign investors. The opaque relationship between the Chinese government, Chinese companies, and the Communist Party often makes it impossible to know where decisions originate. An example of these blurred lines is the existence of Self-Regulatory Organizations (SROs) that are responsible for certain licensing decisions. In the financial sector, Chinese financial institutions that are members of these same SROs can decide on the license applications of foreign firms. If a license decision might threaten a Chinese firm’s competitive position in the domestic market, there may be incentives to disapprove the license. For this reason, foreign firms are concerned that decisions may be made based on non-transparent and discriminatory licensing procedures.

Access to foreign online resources — including news, cloud-based business services, and virtual private networks (VPNs) – are increasingly restricted without official acknowledgement or explanation. Foreign-invested companies have also reported threats of retaliation by government regulators for actions taken by the United States and other foreign governments at the WTO or other legal forums.

For accounting standards, Chinese companies must use the Chinese Accounting Standards for Business Enterprises (ASBE) for all financial reporting within mainland China. Companies listed overseas (including in Hong Kong) may choose to use ASBE, the International Financial Reporting Standards (IFRS), or Hong Kong Financial Reporting Standards (HKFRS).

**International Regulatory Considerations**

China has been a member of the WTO since 2001. As part of its ascension agreement, China agreed to notify the WTO Committee on Technical Trade of all draft technical regulations. Compliance with this WTO commitment is something Chinese officials continue to promise in different dialogues with U.S. government officials.

**Legal System and Judicial Independence**

The Chinese court system is based on a civil law model that borrowed from the legal systems of Germany and France. Modified to account for local characteristics in China, the rules governing commercial activities are present in various laws, regulations, and judicial interpretations, including China’s civil law, contractual law, partnership enterprises law, security law, insurance law, enterprises bankruptcy law, labor law, and Supreme People’s Court (SPC) *Interpretation on Several Issues Regarding the Application of the Contract Law*. China does not have specialized commercial courts, but in 2014, began a three-year pilot program to establish three IPR courts in Beijing, Guangzhou, and Shanghai; in addition, courts throughout China often have specialized IPR “tribunals” to hear disputes.

China’s Constitution provides a legal basis for courts to independently exercise adjudicative power, and several laws have provisions stating courts are not subject to interference by administrative organs, public organizations, and/or individuals. However, the Constitution also emphasizes the “leadership of the Communist Party.” In practice, China’s court system is not independent of government agencies or the Chinese Communist Party (CCP), which often intervene in disputes. Interference takes place for many reasons, including:

- Courts fall under the jurisdiction of local governments;
- Court budgets are appropriated by local administrative authorities;
- Judges in China have administrative ranks and are managed as administrative officials;
- The CCP is in charge of the appointment, dismissal, transfer, and promotion of administrative officials;
- China’s Constitution stipulates local legislatures appoint and supervise the courts; and
- Corruption may also influence local court decisions.

The U.S. business community consistently reports that Chinese courts, particularly at lower levels, are susceptible to outside political influence (particularly from local governments), lack the sophistication to understand complex commercial disputes, and operate without transparency. U.S. companies often avoid challenging administrative decisions or bringing commercial disputes before a local court for fear of future retaliation.

Reports of business disputes involving violence, death threats, hostage-taking, and travel bans involving Americans continue to be prevalent, although American citizens and foreigners in general do not appear to be more likely than Chinese nationals to be subject to this treatment. Police are often reluctant to intervene in what they consider internal contract disputes.

**Laws and Regulations on Foreign Direct Investment**

China’s legal and regulatory framework provides discretion to promote investment in specific industries and geographic regions and to restrict foreign investment not considered in China’s national interests. Laws and regulations with undefined key terms and standards allow for inconsistent application by different agencies and localities. As a result, China has in place investment restrictions that are broader than developed countries, including the United States.

Despite repeated calls by Chinese leadership to strengthen the rule of law in China, foreign investors often point out that weaknesses in the legal system allow regulators to inconsistently apply and interpret laws and regulations. This diminishes the predictability of China’s business environment and has created a feeling among U.S. investors that the Chinese legal system discriminates against them.

China’s current foreign investment regime is based on three central laws: the China-Foreign Equity Joint Venture Enterprise Law, the China-Foreign Cooperative Joint Venture Enterprise Law, and the Foreign-Invested Enterprise (FIE) Law. Multiple administrative regulations and regulatory documents issued by the State Council are derived from these three laws, including:

- Implementation Regulations of the China-Foreign Equity Joint Venture Enterprises Law;
- Implementation Regulations of the China-Foreign Cooperative Joint Venture Enterprise Law;
- Implementation Regulations of the FIE Law;
- State Council Provisions on Encouraging Foreign Investment;
- Provisions on Guiding the Direction of Foreign Investment; and
- Administrative Provisions on Foreign Investment to Telecom Enterprises.

There are also over 1,000 rules and regulatory documents related to foreign investment in China and issued by government ministries, including:

- the FIC;
- Provisions on Mergers & Acquisition of Domestic Enterprises by Foreign Investors;
- Administrative Provisions on Foreign Investment in Road Transportation Industry;
- Interim Provisions on Foreign Investment in Cinemas;
- Administrative Measures on Foreign Investment in Commercial Areas;
- Administrative Measures on Ratification of Foreign Invested Projects;
- Administrative Measures on Foreign Investment in Distribution Enterprises of Books, Newspapers and Periodicals;
- Provision on the Establishment of Investment Companies by Foreign Investors; and
- Administrative Measures on Strategic Investment in Listed Companies by Foreign Investors.

Local legislatures and governments also enact their own regulations, rules, and guidelines that directly impact foreign investment in their geographical area. Examples of local regulations include the Wuhan Administration Regulation on Foreign-Invested Enterprises and Shanghai’s Municipal Administration Measures on Land Usage of Foreign-Invested Enterprises.

A list of Chinese laws and regulations, at both the central and local levels: http://www.gov.cn/zhengce/ 

*FDI Laws on Investment Approvals*

China approves foreign investments on a case-by-case basis. China claims to provide foreign investors with “national treatment,” or treatment no less favorable than the treatment it gives to domestic investors, after an investment has been established. The process varies based on industry and investment type, with overall low transparency.

Foreign investors are required to obtain approvals for establishing an enterprise and undertaking an investment project. MOFCOM pre-approval is not required for an investment not listed in the “restricted” or “prohibited” sections of the FIC, but foreign investors still need to register the investment with MOFCOM. That being said, the mere fact that an investment category is not on the FIC negative list does not guarantee approval, as other steps and approvals may be required. In some industries, such as telecommunications, foreign investors are also required to get approval from industry regulators like the Ministry of Industry and Information Technology.

In July 2004, the State Council issued the Decision on Investment Regime Reform and the Catalogue of Investment Projects subject to Government Ratification (Ratification Catalogue). According to the Ratification Catalogue, all proposed foreign investment projects in China must be submitted for “review and ratification” by the NDRC, or provincial or local Development and Reform Commissions, depending on the sector and value of the investment. In 2013, however, the government issued a new catalogue to narrow the scope of foreign investment projects subject to NDRC ratification. An “encouraged” investment under the FIC that does not require a Chinese controlling interest, and is in a sector not listed on the Ratification Catalogue, only needs to be “filed for record” with the local NDRC office. This policy shift marked a positive step toward easing bureaucratic barriers to foreign investment.

In November 2014, China released an updated edition of the Ratification Catalogue, which eliminated NDRC ratification requirements for 15 new sectors and delegated ratification authority to local governments in 23 additional sectors. In several new sectors, the new Ratification Catalogue also raised the threshold of foreign ownership that would trigger the requirement for NDRC approval. When announcing the reforms, NDRC stated the goal of the latest revision to the Ratification Catalogue was to limit ratification to projects relating to “national and ecological security, geographic and resource development,” and the “public interest.” NDRC estimates that revisions made to the Ratification Catalogue over the past several years would reduce the number of projects requiring ratification from central government authorities by 76 percent.

Ratification Catalogue: http://www.gov.cn/zhengce/content/2014-11/18/content_9219.htm 

The NDRC approval process for foreign investment projects also includes assessing the project’s compliance with China’s laws and regulations; its compliance with the FIC and industrial policy; its national security, environmental safety, and public interest implications; its use of resources and energy; and its economic development ramifications. In some cases, NDRC also solicits the opinions of relevant Chinese industrial regulators and “consulting agencies,” which may include industry associations that represent Chinese domestic firms. This presents potential conflicts of interest that can disadvantage foreign investors seeking to receive project approval. The State Council may also weigh in on high-value projects in “restricted” sectors.

After receiving NDRC approval for the investment project and either notifying or applying for approval for an investment from MOFCOM, investors next apply for a business license with the SAIC. Once a license is obtained, the investor registers with China’s tax and foreign exchange agencies. Greenfield investment projects must also seek approval from China’s Environmental Protection Ministry and its Ministry of Land Resources. The specific approvals process may vary from case to case, depending on the details of a particular investment proposal and local rules and practices.

U.S. Chamber of Commerce report on Approval Process for Inbound Foreign Direct Investment: http://www.uschamber.com/sites/default/files/reports/020021_China_InvestmentPaper_hires.pdf 

*Antitrust Review*

For investments made via merger or acquisition with a Chinese domestic enterprise, an antimonopoly review and national security review may be required by MOFCOM if there are concerns about the foreign transaction. The anti-monopoly review is detailed in a later section on competition policy.

Article 12 of MOFCOM’s Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investment stipulates that parties are required to report a transaction to MOFCOM if:

Foreign investors obtain actual control, via merger or acquisition, of a domestic enterprise in a key industry;

- The merger or acquisition affects or may affect “national economic security”; or
- The merger or acquisition would cause the transfer of actual control of a domestic enterprise with a famous trademark or a Chinese time-honored brand.

If MOFCOM determines that the parties did not report a merger or acquisition that affects or could affect national economic security, it may, together with other government agencies, require the parties to terminate the transaction or adopt other measures to eliminate the impact on national economic security.

*National Security Review*

In February 2011, China released the State Council Notice Regarding the Establishment of a Security Review Mechanism for Foreign Investors Acquiring Domestic Enterprises. The notice established an interagency Joint Conference, led by NDRC and MOFCOM, with the authority to block foreign mergers and acquisitions of domestic firms that it believes may impact national security. The Joint Conference is instructed to consider not just national security, but also “national economic security” and “social order” when reviewing transactions. China has not disclosed any instances in which it invoked this formal review mechanism.

Local commerce departments are responsible for flagging transactions that require a national security review when they review them in an early stage of China’s foreign investment approval process. Some provincial and municipal departments of commerce have published online a *Security Review Industry Table* listing non-defense industries where transactions may trigger a national security review, but MOFCOM has declined to confirm whether these lists reflect official policy. In addition, third parties such as other governmental agencies, industry associations, and companies in the same industry can seek MOFCOM’s review of transactions, which can pose conflicts of interest that disadvantage foreign investors. Investors may also voluntarily file for a national security review.

*Foreign Investment Law*

In January 2015, MOFCOM proposed for public comment a new Foreign Investment Law. This law, if enacted, would unify and supersede the three governing foreign investment laws established by the State Council. It also would abolish the case-by-case approval system for foreign investment and replace it with a system that treats foreign investment the same as domestic investments, except in the limited number of industries enumerated on the “negative list.” The draft law calls for streamlining the approval process for foreign investment in some sectors, but contains a number of troubling provisions – e.g., broadening the definition of foreign investor, expanding the role of the national security review mechanism, increasing reporting requirements, and threatening the structure of variable interest entities (VIEs) – that could facilitate discriminatory treatment against foreign investment. To date, there have been no new announcements about a future release of the Foreign Investment Law or a timeline for its implementation.

In addition to transforming the current foreign investment regime, the aforementioned MOFCOM draft Foreign Investment Law would also establish a broad and potentially intrusive national security review mechanism. As it is currently envisaged, the national security review could be used to hinder market access and increase the financial burden of foreign investment in China.

**Free Trade Zones – Negative List Approach**

In April 2015, the State Council issued a General Plan for the FTZs in Tianjin, Guangdong, and Fujian that offers national treatment for the “pre-establishment,” or market access, phase of investment, except as otherwise provided under a negative list. The State Council-issued negative list for these FTZs contains 85 measures restricting foreign investment and 37 measures forbidding foreign investment. Together, this negative list has 17 fewer measures than the negative list adopted in the Shanghai FTZ in 2014 and 68 fewer measures than Shanghai FTZ’s 2013 negative list. Nevertheless, while the number of discriminatory measures declined, the most recent negative list includes no commercially significant openings for foreign investment.

China also issued in 2015 the Interim Measures on the National Security Review of Foreign Investment in Free Trade Zones. The definition of “national security” is broad, implicating investments in military, national defense, agriculture, energy, infrastructure, transportation, culture, information technology products and services, key technology, and manufacturing.

In addition, MOFCOM issued the Administrative Measures for the Record-Filing of Foreign Investment in Free Trade Zones, outlining the streamlined process that foreign investors need to follow to register investments in the FTZs.

**Competition and Anti-Trust Laws**

China uses a complex system of laws, regulations, and agency specific guidelines at both the central and provincial level that impacts an economic sector’s makeup, sometimes as a monopoly, near-monopoly, or authorized oligopoly. These measures are particularly common in resource-intensive sectors such as electricity and transportation, as well as in industries seeking unified national coverage like fixed-line telephony and postal services. The measures also target sectors the government deems vital to national security and economic stability, including defense, energy, and banking. Examples of such laws and regulations include the Law on Electricity (1996), Civil Aviation Law (1995), Regulations on Telecommunication (2000), Postal Law (1986), Railroad Law (1991), and Commercial Bank Law (amended in 2003), among others.

*Anti-Monopoly Law*

China’s Anti-Monopoly Law (AML) went into effect on August 1, 2008. The AML delegates antitrust enforcement to three agencies: MOFCOM to review concentrations (mergers and acquisitions); the NDRC to review cartel agreements, abuse of dominant position, and abuse of administrative powers centered on product pricing; and the SAIC to review the same types of activities as NDRC when those activities are not directly price-related. In addition, the AML established the Anti-Monopoly Commission to provide oversight, expertise, and coordination among different stakeholders and enforcement agencies. After the AML was enacted, the need to clarify parts of the law became apparent, leading MOFCOM, NDRC, SAIC, and other Chinese government ministries and agencies to formulate implementing guidelines, departmental rules, and other measures. Generally, the AML enforcement agencies have sought public comment on proposed measures and guidelines, although comment periods can be less than 30 days.

In 2015, the CCP Central Committee and State Council declared that all future economic policies would reflect China’s competition policy. In 2016, the three AML enforcement agencies drafted guidelines on six enforcement areas: anti-monopoly guidelines for the automobile industry, guidelines on determining illegal incomes and fines, guidelines on the “leniency” system in horizontal monopoly agreements, guidelines on AML settlement cases, guidelines for intellectual property abuse, and guidelines on monopolistic agreement exemptions. In addition, the State Council in June 2016 introduced guidelines on the Fair Competition Review Mechanism that targets administrative monopolies at the local level and requires agencies to first conduct a fair competition review to certify that new measures do not inhibit competition, prior to issuing new policies, laws, and guidelines. While it is too early to tell the extent to which the Fair Competition Review Mechanism will break down China’s pervasive administrative monopolies, Chinese academics in particular are optimistic that this development signals a more prominent role for competition in future economic decisions.

While China’s antitrust law developments are seen as generally positive, China’s actual enforcement of competition laws and regulations is uneven. Inconsistent central and provincial enforcement often will exacerbate local protectionism by restricting inter-provincial trade, limiting market access for certain imported products, using measures that raise production costs, and limiting opportunities for foreign investment. Government authorities at all levels in China may also restrict competition to insulate favored firms from competition through various forms of regulations and industrial policies. The ultimate benefactor of such policies is often unclear; however, foreign companies have expressed concern that the central government’s use of AML enforcement is often selectively used to target foreign companies, becoming an extension of other industrial policies that favor SOEs and Chinese companies deemed potential “national champions.”

Since the AML went into effect, the number of merger and acquisition transactions MOFCOM has reviewed each year has continued to grow. According to MOFCOM statistics, in 2016 alone, MOFCOM completed an AML review for 395 cases (a 19 percent year-on-year increase), with the majority of cases coming from manufacturing industries like semi-conductors, telecommunications, and other high-end manufacturing. Of these reviewed cases, 82 percent were finished in the initial 30-day review period. Since AML’s inception, the vast majority (over 80 percent) of cases “conditionally” approved have involved offshore transactions between foreign parties. The other “conditional” cases involved foreign companies merging with Chinese enterprises. Observers have expressed concerns about the speed and inconsistent application of the review process, along with suspicions that Chinese regulators rarely approve “on condition” transactions involving two Chinese companies, thus signaling an inherent AML bias against foreign enterprises. MOFCOM has stated it will enforce the requirement that Chinese firms, in addition to foreign firms, notify regulators of proposed mergers and acquisitions for review.

In 2016, foreign companies expressed fewer complaints than in previous years about NDRC’s AML investigations. Some experts said leadership changes at NDRC improved enforcement practices, including introduction of a more balanced approach to investigations, which looks into Chinese companies more often than foreign enterprises. NDRC has also made progress in AML enforcement transparency by releasing aggregate data on investigations and publicizing case decisions. That said, many foreign companies still worry about future “dawn raids” and express concerns that NDRC regulators, along with SAIC and MOFCOM, can at any time use competition law to promote China’s industrial policy goals by targeting foreign firms to limit competition.

In bilateral dialogues, China continues to express its commitment to protect and enforce IPR across a range of industry sectors. Chinese officials are also in the process of clarifying AML guidelines that address areas where IPR and AML intersect, such as forcing foreign companies to license IPR technology to local companies at a “fair” price that does not violate a company’s “dominant market position.” Chinese officials also reiterated the need for AML agencies to be free from intervention from other government agencies. Lastly, Chinese officials committed to protecting commercial secrets obtained during AML proceedings. Despite the dialogues, U.S. companies remain concerned about IPR protections, along with the lack of independence of AML agencies from outside influences.

How the AML applies to SOEs and government monopolies in certain industries also is unclear. While language in the AML protects the lawful operations of SOEs and government monopolies in industries deemed nationally important, all three AML enforcement agencies have publicly stated the law does apply to SOEs. All three additionally claim to have pursued some enforcement action, albeit small, against SOEs. Given the prominent role of SOEs in China’s economic structure, along with the CCP’s proactive orchestration of mergers in key industries like rail, marine shipping, metals, and other strategic sectors, concerns persist that enforcement against SOEs will remain limited. These mergers in key industries have been criticized for further insulating SOEs from both domestic and foreign competition, leading to higher prices for Chinese consumers and more concentrated market power post-merger.

**Expropriation and Compensation**

Chinese law prohibits nationalization of FIEs, except under “special” circumstances. Chinese officials have said these circumstances include national security and when an investment presents an obstacle to achieving a large civil engineering project, but the law does not define these special circumstances. Chinese law requires compensation of expropriated foreign investments, but does not explain what method to use or the formula to calculate the value of the foreign investment. The Department of State is not aware of any cases since 1979 in which China has expropriated a U.S. investment, although the Department has notified Congress through the annual 527 Investment Dispute Report of several cases of concern.

**Dispute Settlement**

*ICSID Convention and New York Convention*

China is a member of the International Center for the Settlement of Investment Disputes (ICSID) and has ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). The domestic legislation that provides for enforcement of foreign arbitral awards related to these two Conventions include the Arbitration Law adopted in 1994, the Civil Procedure Law adopted in 1991 (later amended in 2012), the Law on Chinese-Foreign Equity Joint Ventures adopted in 1979 (amended most recently in 2001), and a number of other laws with similar provisions. China’s Arbitration Law has embraced many of the fundamental principles of The United Nations Commission on International Trade Law’s Model Law on International Commercial Arbitration.

*Investment and Commercial Disputes in the Chinese Legal System*

Chinese officials typically urge firms to resolve disputes through informal conciliation. If formal mediation is necessary, Chinese parties and the authorities typically promote arbitration over litigation. Many contract disputes require arbitration by the China International Economic and Trade Arbitration Commission (CIETAC). Established by the State Council in 1956 under the auspices of the China Council for the Promotion of International Trade (CCPIT), CIETAC is China’s most widely-utilized arbitral body for foreign-related disputes. Some foreign parties have obtained favorable rulings from CIETAC, while others question CIETAC’s fairness and effectiveness.

CIETAC is based in Beijing and has four sub-commissions in Shanghai, Shenzhen, Tianjin, and Chongqing. In 2012, CCPIT, under the authority of the State Council, issued new arbitration rules that granted CIETAC headquarters significantly more authority to hear cases than the sub-commissions. Expecting a loss in revenue, CIETAC Shanghai and CIETAC Shenzhen declared their independence, issued their own rules, and changed their names. As a result, CIETAC disqualified its former Shanghai and Shenzhen affiliates from administering arbitration disputes.

This jurisdictional dispute between CIETAC in Beijing and the former sub-commissions raised serious concerns among the U.S. business and legal communities, particularly regarding the validity of arbitration agreements specifying particular arbitration procedures and the enforceability of arbitral awards issued by the sub-commissions. In 2013, the SPC issued a notice clarifying that any lower court that hears a case arising out of the CIETAC split must report the case to the SPC before making a decision. However, the SPC notice is brief and lacks detail on certain issues, including the timeframe for the lower court’s decision to reach the SPC and for the SPC to issue its opinion.

Other arbitration commissions exist and are usually affiliated with the government at the provincial or municipal level. The Beijing Arbitration Commission and the Shanghai Arbitration Commission have emerged as serious domestic competitors to CIETAC. For contracts involving at least one foreign party, offshore arbitration may be adopted. Foreign companies often encounter challenges in enforcing arbitration decisions issued by Chinese and foreign arbitration bodies. Investors may appeal to higher courts in such cases.

The Chinese government and judicial bodies do not maintain a public record of investment disputes. The SPC maintains a count of the annual number of cases involving foreigners tried throughout China, but does not specify the types of cases, identify civil or commercial disputes, or note foreign investment disputes. Rulings in some cases are open to the public.

Although it has not concluded a BIT with the United States, China has bilateral investment agreements with over 100 countries and economies. The majority of these agreements set mediation, domestic remedies, and international arbitration as the means to settle disputes. However, investor-state disputes leading to arbitration are rare in China.

*International Commercial Arbitration and Foreign Courts*

There are few precedents where Chinese courts have recognized and enforced foreign court judgments. Articles 281 and 282 of China’s Civil Procedure Law cover the recognition and enforcement of the effective judgments of foreign courts by the court system in China. According to these laws, if the Chinese courts determine validity of a claim, after reviewing the foreign courts’ judgments, China’s treaty obligations, reciprocity principles, basic principles of Chinese laws, China’s sovereignty, security, and social public interests, the Chinese courts shall issue verdicts to recognize the effectiveness of foreign court judgments and issue enforcement orders if enforcement is needed. China has concluded 27 bilateral agreements on the recognition and enforcement of foreign court judgments, but none with the United States. China’s recognition of judgments by U.S. courts can be inconsistent, according to anecdotal reports.

Article 270 of China’s Civil Procedure Law states that time limits in civil cases do not apply to cases involving foreign investment. According to the 2012 CIETAC Arbitration Rules, in an ordinary procedure case, the arbitral tribunal shall render an arbitral award within six months (in foreign-related cases) from the date on which the arbitral tribunal is formed. In a summary procedure case, the arbitral tribunal shall make an award within three months from the date on which the arbitral tribunal is formed.

**Bankruptcy Regulations**

China’s primary bankruptcy legislation is the Enterprise Bankruptcy Law, which was promulgated on August 27, 2006 and took effect on June 1, 2007. The 2007 law applies to all companies incorporated under Chinese laws and regulations, including private companies, public companies, SOEs, FIEs, and financial institutions. It is commensurate with developed countries’ bankruptcies laws and provides for potential reorganization or restructuring rather than liquidation. Due to uncertainty about authorities and procedures, lack of implementation guidelines, and the limited number of cases providing precedent, the law has never been fully enforced, and most corporate debt disputes are settled through negotiations led by local governments. The potential for local government interference, along with corporate fears of losing control, disincentivize companies from pursuing bankruptcy proceedings. Chinese courts lack capacity to handle bankruptcy cases, and bankruptcy administrators, clerks, and judges all lack experience.

In the October 2016 State Council Guiding Opinion on Reducing Enterprises’ Leverage Ratio, bankruptcy was identified as a tool to manage China’s corporate debt problems. This was consistent with increased government rhetoric throughout the year in support of bankruptcy. For example, in June 2016, the SPC issued a notice to establish bankruptcy divisions at intermediate courts and to increase the number of judges and support staff to handle liquidation and bankruptcy issues. On August 1, the SPC also launched a new bankruptcy and reorganization electronic information platform: http://pccz.court.gov.cn/pcajxxw/index/xxwsy .

Although still relatively small, the number of bankruptcy cases began to pick up starting in 2015, with the government announcing in 2016 several high-profile SOE bankruptcies. The SPC reported that in 2016, 5,665 bankruptcy cases were accepted by the Chinese courts and 3,602 cases were closed, representing a 53.8 percent year-on-year increase from 2015, when only 3568 cases were accepted. Most bankruptcy cases are still resolved through liquidation due to long delays, but 1,041 cases were resolved through reorganization, an 85 percent increase from 2015. Since the fall of 2016, 73 new specialized bankruptcy tribunals were founded, along with the SPC issuing several implementing measures to improve bankruptcy procedures.

							4. Industrial Policies					

**Investment Incentives**

Different localities court foreign investors by providing preferential packages like reduced income taxes, resources and land use benefits, reduced import/export duties, special treatment in obtaining basic infrastructure services, streamlined government approvals, and funding for initial startup. These packages may stipulate export, local content, technology transfer, and other requirements as part of the preferred investment package. These localities offer preferential treatment in special economic zones (like Shanghai, Tianjin, Fujian, and Guangdong), development zones, and science parks. China in 2016 announced seven additional FTZs (Chongqing, Zhejiang, Hubei, Henan, Sichuan, Shaanxi, and Liaoning), to begin operating in 2017. These new economic zones are a shift from prior FTZs because they target inland areas in need of economic development and areas that are consistent with Chinese officials’ call for greater foreign investment in Central and Western China. China also uses the Catalogue of Priority Industries for Foreign Investment in Central and Western China to provide greater market access to foreign investors in inland areas of mainland China, so as to spur investment.

There are no expressed prohibitions against foreign firms participating in research and development programs financed by the Chinese government. In fact, for certain sectors where China lacks the capacity and expertise to conduct advanced research or supply advanced technology in a given field, foreign participation is generally encouraged and solicited. This is part of China’s stated goal of moving up the manufacturing value chain and transforming China’s economy to a model driven by innovative growth. However, there are a large number of sectors that China deems sensitive due to broadly defined national security concerns, including “economic security,” which can effectively close off foreign investment to those sectors.

**Foreign Trade Zones/Free Ports/Trade Facilitation**

China’s principal customs-bonded areas include Shanghai, Tianjin, Shantou, three districts within Shenzhen (Futian, Yantian, and Shatoujiao), Guangzhou, Dalian, Xiamen, Ningbo, Zhuhai, and Fuzhou. Besides these official duty-free zones identified by China’s State Council, numerous economic development zones and open cities offer similar privileges and benefits to foreign investors.

In September 2013, the Shanghai Municipal government and the State Council announced the establishment of the Shanghai Pilot FTZ, which condensed four previously existing bonded areas into a single FTZ. In April 2015, the State Council expanded the number of FTZs to include Tianjin, Guangdong, and Fujian, although the Shanghai FTZ remains the largest of the four. The goal of the FTZs is to provide a trial ground for trade and investment liberalization measures and to introduce service sector reforms, especially in financial services, that China expects to eventually introduce in other parts of the domestic economy.

In particular, Chinese officials tout the use of a “negative list” – that is, a list expressly identifying sectors where national treatment does not apply – as a key reform introduced in the FTZs. On April 20, 2015, the State Council published a revised negative list to supersede the 2014 list. The 2015 list  regulates trade and investment in all four FTZs, reducing the number of excluded items to 122 (down from a high of 190 items when the list was first rolled out in 2013). Major sectors in which restrictions have been lifted include manufacturing, construction, wholesale and retail, information technology services, financial services, real estate, and business services.

In 2016, the State Council announced the establishment of seven additional FTZs in Chongqing, Zhejiang, Hubei, Henan, Sichuan, Shaanxi, and Liaoning. The foreign investment negative list used in the existing four FTZs will also apply to the seven new FTZs. The stated purpose of the new FTZs is to integrate more closely with the “One Belt, One Road” plan – the Chinese government’s initiative to enhance global economic interconnectivity through joint infrastructure and investment projects that connect China’s inland and border regions to countries in Southeast Asia, Central Asia, Africa, and Europe. These new FTZs will be operational beginning in 2017.

Although the FTZ negative list in theory provides greater market access for foreign investment in the FTZs, many foreign firms have reported that in practice, the degree of liberalization in the FTZs is comparable to other opportunities in other parts of China. According to Chinese officials, over 18,000 entities have registered in the FTZs. The municipal and central governments have released a number of administrative and sector-specific regulations and circulars that outline the procedures and regulations in the zones.

**Performance and Data Localization Requirements**

Shortly after China’s WTO ascension, China revised its FDI laws regarding export performance requirements, requirements to include local content, requirements to balance foreign exchange through trade, technology transfer requirements, and requirements to create research and development centers. As part of these revisions, China committed to only enforce technology transfer requirements that do not violate WTO standards on intellectual property and trade-related investment measures. In practice, however, some local officials and regulators prefer investments with “voluntary” performance requirements that develop favored industries and support the local job market. Provincial and municipal governments will sometimes restrict access to local markets, government procurement, and public works projects even for firms that have already invested in the province or municipality. In addition, Chinese regulators have reportedly pressured foreign firms in some sectors to disclose intellectual property content or provide intellectual property licenses to Chinese firms, often at below market rates.

Regulatory restrictions, including in the Cyber Security Law, limits the ability of domestic and foreign operators of “critical information infrastructure” to transfer business and personal data outside of China, while requiring those same operators to store such data in China. Restrictions on cross-border data flows and unclear requirements on the use of domestic encryption algorithms have prompted many firms to review how their China systems interact with their global corporate networks. In order to comply with emerging requirements that technology used by business be “secure and controllable,” foreign firms are facing pressure to disclose source code and other intellectual property disclosures during testing and certification related to government procurement; adhere to prescriptive technology adoption requirements, often in the form of domestic standards that diverge from global standards, which give preference to domestic firms; and to comply with operational restrictions such as privacy measures, data center location, and cross-border data flow restrictions.

							5. Protection of Property Rights					

*Real Property*

The Chinese legal system mediates acquisition and disposition of property. Foreign companies have complained that Chinese courts have inconsistently protected the legal real property rights of foreigners.

Land is entirely owned by the State. The State can issue long-term land leases to individuals and companies, including foreigners, subject to many restrictions. China’s Property Law stipulates that residential property rights will renew automatically, while commercial and industrial grants shall be renewed if the renewal does not conflict with other public interest claims. A number of foreign investors have reported that their land use rights were revoked and given to developers to build neighborhoods slated for building by government officials. Investors often complain that compensation in these cases has been nominal.

In rural China, land use rights are more complicated. The registration system chronically suffers from unclear ownership lines and disputed border claims, often at the expense of local farmers who are excluded from the process by village leaders making “handshake deals” with commercial interests. In 2016, the central government announced plans to reform the rural land registration system so as to put more control in the hands of farmers, but some experts remain skeptical that changes will be properly implemented and enforced.

China’s Securities Law defines debtor and guarantor rights, including rights to mortgage certain types of property and other tangible assets, including long-term leases. Chinese law does not prohibit foreigners from buying non-performing debt, which can only be acquired through state-owned asset management firms. However, in practice, Chinese official often use bureaucratic hurdles that limit foreigners’ ability to liquidate assets, further discouraging foreign purchase of non-performing debt.

*Intellectual Property Rights*

Following WTO accession, China updated many of its laws and regulations to comply with the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) and other international agreements. However, there are still aspects of China’s IPR legal and regulatory regime that the U.S. government believes fall short of international best practices and, if improved, would provide greater protection to IPR. Furthermore, effective enforcement of China’s IPR laws and regulations remains a significant challenge.

Generally speaking, criminal penalties imposed by Chinese courts for IPR infringement are not applied on a frequent and consistent enough basis to significantly deter ongoing infringement. Furthermore, when administrative sanctions are issued, the basis for the sanctions is inconsistent and non-transparent, and penalties applied are insignificant, further weakening any deterrent effect. In addition, the award for IPR damage is very low, making civil litigation against IPR infringements an option with limited effect. For detailed information on China’s environment for IPR protection and enforcement, please see the following reports:

Office of the U.S. Trade Representative’s (USTR) 2017 Special 301 Report (see section on China): https://ustr.gov/issue-areas/intellectual-property/Special-301 

USTR’s 2016 National Trade Estimate Report on Foreign Trade Barriers in China (see section on China): https://ustr.gov/sites/default/files/2016-NTE-Report-FINAL.pdf 

USTR’s 2016 Report to Congress on China’s WTO Compliance: http://www.wipo.int/directory/en. 

							6. Financial Sector					

**Capital Markets and Portfolio Investment**

China’s leadership has stated that it seeks to build a modern, highly developed, and multi-tiered capital market. Bank loans continue to provide the majority of credit options (reportedly around 70 percent) for Chinese companies, although other sources of capital, such as corporate bonds, trust loans, equity financing, and private equity are quickly expanding their scope, reach, and sophistication. Chinese regulators regularly use administrative methods to control credit growth, although market-based tools such as interest rate policy play an increasingly important role.

The People’s Bank of China (PBOC), China’s central bank, has gradually increased flexibility for banks in setting interest rates, formally removing the floor on the lending rate in 2013 and the deposit rate cap in 2015 – although is understood to still influence bank’s interest rates through “window guidance”. Favored borrowers, particularly SOEs, benefit from greater access to capital and lower financing costs, as they can use political influence to secure bank loans, and lenders perceive these entities to have an implicit government guarantee. Small- and medium-sized enterprises, by contrast, have the most difficulty obtaining financing, often forced to rely on retained earnings or informal investment channels for financing.

In recent years, China’s “shadow banking” sector, which includes vehicles such as wealth management and trust products, has grown rapidly. Chinese authorities have taken steps to increase the transparency requirements and strengthen supervision of these banking activities, while also permitting these vehicles to continue to develop. These vehicles often provide private firms additional channels to obtain capital, though at higher than benchmark rates. In 2016, worried about increasingly interconnected leverage across China’s corporate sector, the government introduced a new macro prudential assessment tool to take a more comprehensive approach to managing financial risks. Regulators also issued informal “window guidance” to domestic and foreign banks to reduce lending and currency operations.

Direct financing has expanded over the last few years, including through public listings on stock exchanges, both inside and outside of China, and issuing more corporate and local government bonds. The majority of foreign portfolio investment in Chinese companies occurs on foreign exchanges, primarily in United States and Hong Kong. In addition, China has significantly expanded quotas for certain foreign institutional investors to invest in domestic stock markets, has opened up direct access for foreign investors into China’s interbank bond market, and has approved a two-way, cross-border equity direct investment scheme between Shanghai and Hong Kong that allows Chinese investors to trade designated Hong Kong-listed stocks through the Shanghai Exchange and vice versa. Direct investment by private equity and venture capital firms is also rising, although from a small base, and has faced setbacks due to China’s increased capital controls that complicate the repatriation of returns.

**Money and Banking System**

After several years of rapid credit growth, China’s banking sector faces asset quality concerns. For 2016, the China Banking Regulatory Commission reported a rise in the non-performing loans (NPL) ratio to 1.74 percent, up from 1.67 percent at the end of 2015. The outstanding balance of commercial bank NPLs in 2016 reached 1.5 trillion RMB (approximately U.S. $230 billion). China’s total banking assets surpassed 228 trillion RMB (approximately U.S. $35 trillion) in December 2016, a 14.4 percent year-on-year increase. Experts estimate Chinese banking assets account for over 20 percent of global banking assets. China’s credit and broad money supply continue to post low double-digit growth, outpacing GDP growth nearly two-to-one.

**Foreign Exchange and Remittances**

*Foreign Exchange*

In 2016, several foreign companies complained about administrative delays in remitting large sums of money from China, even after completing all of the documentation requirements. Such incidents come amid announcements that SAFE had issued guidance to tighten scrutiny of foreign currency outflows due to China’s rapidly decreasing foreign currency exchange.

Under Chinese law, FIEs do not need pre-approval to open foreign exchange accounts and are allowed to retain income as foreign exchange or to convert it into RMB without quota requirements. Foreign exchange transactions related to China’s capital account activities do not require review by SAFE, but designated foreign exchange banks review and directly conduct foreign exchange settlements. Chinese officials register all commercial foreign debt and will limit foreign firms’ accumulated medium- and long-term debt from abroad to the difference between total investment and registered capital. China issued guidelines in February 2015 that allow, on a pilot basis, a more flexible approach to foreign debt within several specific geographic areas, including the Shanghai Pilot FTZ. The main change under this new approach is to allow FIEs to expand their foreign debt above the difference between total investment and registered capital, so long as they have sufficient net assets.

Chinese foreign exchange rules cap the maximum amount of RMB individuals are allowed to convert into other currencies at approximately U.S. $50,000 each year and restrict them from directly transferring RMB abroad without prior approval from SAFE. While SAFE has not reduced this quota, banks are reportedly being instructed by SAFE to increase scrutiny over individuals’ request for foreign currency and to require additional paperwork clarifying the intended use of the funds.

In 2016, facing significant capital outflow pressure, the government tightened capital controls, including through informal guidance to banks and the introduction of reserve requirements for institutions conducting foreign currency transactions. While the central bank’s official position is that companies with proper documentation should be able to freely conduct business, in practice, companies have reported facing challenges and delays in getting foreign currency transactions approved by sub-national regulatory branches.

China’s exchange rate regime is managed within a band that allows the currency to rise or fall by 2 percent per day from the “reference rate” set each morning. In August 2015, China announced that the reference rate would more closely reflect the previous day’s closing spot rate. Since that change, daily volatility of the RMB has at times been higher than in recent years, but for the most part, remains below what is typical for other currencies.

*Remittance Policies*

The following operations do not require SAFE approval: purchase and remittance of foreign exchange as a result of capital reduction, liquidation, or early repatriation of an investment in a foreign-owned enterprise, or as a result of the transfer of equity in an FIE to a Chinese domestic entity or individual where lawful income derived in China is reinvested.

The remittance of profits and dividends by FIEs is not subject to time limitations, but FIEs need to submit a series of documents to designated banks for review and approval. The review period is not fixed, and is frequently completed within one or two working days of the submission of complete documents.

Remittance policies have not changed substantially since SAFE simplified some regulations in January 2014, devolving many review and approval procedures to banks. Firms that remit profits at or below USD $50,000 dollars can do so without submitting documents to the banks for review. For remittances above USD $50,000, the firm must submit tax documents, as well as the formal decision by its management to distribute profits. However, in 2016, some companies reported increased delays in receiving approval.

For remittance of interest and principle on private foreign debt, firms must submit an application form, a foreign debt agreement, and the notice on repayment of the principle and interest. Banks will then check if the repayment volume is within the repayable principle.

The remittance of financial lease payments falls under foreign debt management rules. There are no specific rules on the remittance of royalties and management fees. However, beginning in 2016, SAFE began requiring banks to hold 20 percent reserves against foreign currency transactions, significantly increasing the cost of foreign exchange operations.

The Financial Action Task Force has identified China as a country of primary concern. Global Financial Integrity (GFI) estimates that over U.S. $1 trillion of illicit money left China between 2003 and 2012, making China the world leader in illicit capital flows. In 2013, GFI estimates that another U.S. $260 billion left the country.

**Sovereign Wealth Funds**

China officially has only one sovereign wealth fund (SWF), the China Investment Corporation (CIC). Established in 2007, CIC manages an estimated U.S. $813.8 billion in assets (as of November 2016) and invests on a 10-year time horizon. China’s sovereign wealth is also invested by a subsidiary of SAFE, the government agency that manages China’s foreign currency reserves, and reports directly to the PBOC. The SAFE Administrator also serves concurrently as a PBOC Deputy Governor.

CIC publishes an annual report containing information on its structure, investments, and returns. CIC invests in diverse sectors like financial, consumer products, information technology, high-end manufacturing, healthcare, energy, telecommunication services, and utilities.

China also operates other funds that function in part like sovereign wealth funds, including: China’s National Social Security Fund, with an estimate U.S. $295 billion in assets; the China-Africa Development Fund (solely funded by the China Development Bank), with an estimated U.S. $5 billion; the SAFE Investment Company, with an estimated U.S. $474 billion; and China’s state-owned Silk Road Fund, established in December 2014 with $40 billion to foster investment in countries along the “One Belt, One Road.” Chinese SWFs do not report the percentage of their assets that are invested domestically.

Chinese SWFs follow the voluntary code of good practices known as the Santiago Principles and participates in the IMF-hosted International Working Group on SWFs. The Chinese government does not have any formal policies specifying that CIC invest funds consistent with industrial policies or in government-designated projects, although CIC is expected to pursue government objectives. The SWF generally adopts a “passive” role as a portfolio investor.

							7. State-Owned Enterprises					

China has approximately 150,000 SOEs, of which around 50,000 (33 percent) are owned by the central government, and the remainder by local governments. The central government directly controls and manages 102 strategic SOEs through the State Assets Supervision and Administration Commission (SASAC), of which 66 are listed on stock exchanges domestically and/or internationally. SOEs, both central and local, account for 30 to 40 percent of total GDP and about 20 percent of China’s total employment. The percentage of SOE revenue spent on research and development is unknown. SOEs can be found in all sectors of the economy, from tourism to heavy industries.

SASAC regulated SOEs: http://www.sasac.gov.cn/ 

China’s leading SOEs benefit from preferential government policies aimed at developing bigger and stronger “national champions.” SOEs enjoy favored access to essential economic inputs (land, hydrocarbons, finance, telecoms, and electricity) and exercise considerable power in markets like steel and minerals. SOEs have long enjoyed preferential access to credit and the ability to issue publicly traded equity and debt. SOEs also are not subject to the same tax burdens as their private sector competitors. According to some Chinese academics, provincial governments have used their power to manipulate industrial policies and deny operating licenses to domestic and foreign investors in order to persuade reluctant owners to sell out to bigger, state-owned suitors.

During the November 2013 Third Plenum of the 18th Party Congress – a hallmark session that announced economic reforms, including calling for the market to play a more decisive role in the allocation of resources – President Xi Jinping called for broad SOE reforms. Cautioning that SOEs still will remain a key part of China’s economic system, Xi emphasized improved SOE operational transparency and legal reforms that would subject SOEs to greater competition by opening up more industry sectors to domestic and foreign competitors and by reducing provincial and central government preferential treatment of SOEs. The Third Plenum also called for “mixed ownership” economic structures, providing greater economic balance between private and state-owned businesses in certain industries, including equal access to factors of production, competition on a level playing field, and equal legal protection.

*OECD Guidelines on Corporate Governance*

SASAC participates in the OECD Working Party on State Ownership and Privatization Practices (WPSOPP). Chinese officials have indicated China intends to utilize OECD SOE guidelines to improve the professionalism and independence of SOEs, including relying on Boards of Directors that are independent from political influence. However, despite China’s Third Plenum commitments – to foster “market-oriented” reforms in China’s state sectors – Chinese officials and SASAC have made minimal progress in fundamentally changing the regulation and business conduct of SOEs. China has also committed to implement the G-20/OECD Principles of Corporate Governance, which apply to all publicly-listed companies, including listed SOEs.

Chinese law lacks unified guidelines or a governance code for SOEs, especially among provincial or locally-controlled SOEs. Among larger SOEs that are primarily managed by SASAC, senior management positions are filled by senior CCP members who report directly to the CCP. SASAC Chairman Xiao Yaqing reemphasized this point during a March 9, 2017 press conference at the National People’s Congress, where he stated newly implemented rules required the chairman of any SOE under his ministry’s control to also be the secretary of the SOE’s CCP committee, as a way of strengthening the Party’s control.

The lack of management independence and the controlling ownership interest of the State make SOEs de facto arms of the government, subject to government direction and interference. SOEs are rarely the defendant in legal disputes, and when they are, they almost always prevail due to the close relationship with the CCP. U.S. companies often complain about the lack of transparency and objectivity in commercial disputes with SOEs. In addition, SOEs enjoy preferential access to a disproportionate share of available capital, whether in the form of loans or equity.

In its September 2015 Guiding Opinions on Deepening the Reform of State-Owned Enterprises, the State Council instituted a system for classifying SOEs as “public service” or “commercial enterprises.” Some commercial enterprise SOEs were further sub-classified into “strategic” or “critically important” sectors (i.e., with strong national economic or security importance). SASAC has said the new classification system would allow the government to reduce support for commercial enterprises competing with private firms and instead channel resources toward public service SOEs.

Other recent reforms have included salary caps, limits on employee benefits, and attempts to create stock incentive programs for managers that have produced mixed results. However, analysts believe minor reforms will be ineffective as long as SOE administration and government policy are intertwined.

A major stumbling block of SOE reform is that SOE regulators are outranked in the CCP party structure by SOE executives, which minimizes SASAC and other government regulators’ effectiveness at implementing reforms. In addition, SOE executives are often promoted to high-ranking positions in the CCP or local government, further complicating the work of regulators.

The Third Plenum Decision emphasizes that SOEs need to focus resources in areas that “serve state strategic objectives.” However, experts point out that despite these new SOE distinctions, SOEs continue to hold dominant shares in their respective industries, regardless of whether they are strategic, which may further restrain private investment in the economy. Moreover, the application of China’s Anti-Monopoly Law, together with other industrial policies and practices that are selectively enforced by the authorities, protect SOEs from private sector competition.

China is not a party to the Government Procurement Agreement (GPA) within the framework of the WTO, although Hong Kong is listed.

*Investment Restrictions in “Vital Industries and Key Fields”*

The intended purpose of China’s State Assets Law is to safeguard and protect China’s economic system, promoting “socialist market economy” principles that fortify and develop a strong, state-owned economy. A key component of the State Asset Law is enabling SOEs to play the leading role in China’s economic development, especially in “vital industries and key fields.” To accomplish this, the law encourages Chinese regulators to adopt policies that consolidate SOE concentrations to ensure dominance in industries deemed vital to “national security” and “national economic security.” This principle is further reinforced by the December 2006 announcement of the Guiding Opinions Concerning the Advancement of Adjustments of State Capital and the Restructuring of State-Owned Enterprises, which called for more SOE consolidation to advance the development of the state-owned economy, including enhancing and expanding the role of the State in controlling and influencing “vital industries and key fields relating to national security and national economic lifelines.” These guidelines defined “vital industries and key fields” as “industries concerning national security, major infrastructure and important mineral resources, industries that provide essential public goods and services, and key enterprises in pillar industries and high-tech industries.”

Around the time the guidelines were published, the SASAC Chairman also listed industries where the State should maintain “absolute control” (e.g., aviation, coal, defense, electric power and the state grid, oil and petrochemicals, shipping, and telecommunications) and “relative control” (e.g., automotive, chemical, construction, exploration and design, electronic information, equipment manufacturing, iron and steel, nonferrous metal, and science and technology). China has said these lists do not reflect its official policy on SOEs. In fact, in some cases, regulators have allowed for more than 50 percent private ownership in some of the listed industries on a case-by-case basis, especially in industries where Chinese firms lack expertise and capabilities in a given technology Chinese officials deemed important at the time.

A key SOE-dominant industry that is insulated from competition is agricultural products. Current agriculture trade rules, regulations, and limitations placed on foreign investment severely restrict the contributions of U.S. agricultural companies, depriving China’s consumers of the many potential benefits additional foreign investment could provide. These investment restrictions in the agricultural sectors are at odds with China’s 12th Five Year Plan objective of shifting more resources to agriculture and food production in order to improve Chinese lives, food security, and food safety.

**Privatization Program**

At the November 2013 Third Plenum, the Chinese government announced reforms to SOEs that included selling shares of SOEs to outside investors. This gradual approach to privatization is an effort to improve SOE management structures, emphasize the use of financial benchmarks, and gradually take steps that will bring private capital into some sectors traditionally monopolized by SOEs like energy, telecommunications, and finance. In practice, these reforms have been gradual as the Chinese government has struggled to implement its SOE reform vision and often opted to utilize a preferred SOE consolidation approach. In the past few years, the Chinese government has listed several large SOEs and their assets on the Hong Kong stock exchange, subjecting SOEs to greater transparency requirements and heightened regulatory scrutiny. This approach is a possible mechanism to improve SOE corporate governance and transparency. The government also committed at the Third Plenum to raise the portion of earnings that SOEs pay out as dividends to the public budget, although here, too, the pace and method of implementation remain uncertain.

							8. Responsible Business Conduct					

For Chinese companies, Responsible Business Conduct (RBC) is a relatively new concept. The degree of understanding and general awareness of RBC standards (including environmental, social, and governance issues) by Chinese firms is extremely low, especially with Chinese companies operating exclusively in the domestic market. Chinese laws regulating business conduct are limited in scope, often voluntary, and frequently ignored when other economic imperatives compete with RBC priorities. In general, China suffers from the lack of independent NGOs, investment funds, worker organizations/unions, or other business associations that actively promote or monitor RBC issues.

The recently implemented Foreign NGO Law restricts certain NGO activities and remains a concern to U.S. organizations, especially with respect to its limiting influence on the promotion, development, and implementation of RBC and corporate social responsibility (CSR) practices. It is especially challenging for U.S. investors looking to partner with Chinese companies, or to expand operations with Chinese suppliers, when few Chinese firms meet internationally recognized standards in areas like labor and environmental protection and manufacturing best practices.

Despite these restrictions, Chinese officials increasingly place emphasis on protecting the environment. This priority was highlighted in the 13th Five Year Plan, which highlighted sustainability as a key priority and area for Chinese companies to enact CSR initiatives.

In 2014, China also signed a memorandum of understanding (MOU) with the OECD to cooperate on RBC initiatives. However, the MOU does not require or necessarily mean that Chinese companies will adhere to the OECD Guidelines for Multinational Enterprises. Industry leaders have pushed to establish a national contact point or RBC center, a key initiative of the OECD guidelines, and China’s Ministry of Commerce in 2016 launched the RBC Platform to raise awareness of RBC issues.

China participated in the OECD’s Global Forum on RBC in 2014 and 2015, including hosting a workshop in Beijing in May 2015. Policy developments from the workshops included incorporation of human rights into social responsibility guidelines for the electronics industry, referencing the United Nations Guiding Principles on Business and Human Rights; mandating social impact assessments for large footprint projects; and agreeing to draft a new law on public participation in environmental protection and impact assessments.

The MOFCOM-affiliated Chinese Chamber of Commerce of Metals, Minerals, and Chemical Importers and Exporters (CCCMC) also signed a separate MOU with the OECD in October 2014, to help Chinese companies implement RBC policies in global mineral supply chains. In December 2015, CCCMC released Due Diligence Guidelines for Responsible Mineral Supply Chains, which draw heavily from the OECD Due Diligence Guidelines. China is currently drafting legislation to regulate the sourcing of minerals, including tin, tungsten, tantalum, and gold, from conflict areas. China is not a member of the Extractive Industries Transparency Initiative (EITI), but Chinese investors participate in EITI schemes where these are mandated by the host country.

							9. Corruption					

Corruption remains endemic in China. The lack of an independent press, along with the lack of independence of corruption investigators, who answer to and are managed by the CCP, all hamper the transparent and consistent application of anti-corruption efforts.

Chinese anti-corruption laws have strict penalties for bribes, including accepting a bribe, which is a criminal offense punishable up to life imprisonment or death in “especially serious” circumstances. Offering a bribe carries a maximum punishment of up to five years in prison, except in cases with “especially serious” circumstances, when punishment can extend up to life in prison.

In August 2015, the National People’s Congress amended several corruption-related parts of China’s Criminal Law. For instance, bribing civil servants’ relatives or other close relationships is a crime with monetary fines imposed on both the bribe-givers and the bribe-takers; bribe-givers, mainly in minor cases, who aid authorities can be given more lenient punishments; and instead of basing punishments solely on the specific amount of money involved in a bribe, authorities now have more discretion to impose punishments based on other factors.

In February 2011, an amendment was made to the Criminal Law, criminalizing the bribing of foreign officials or officials of international organizations. However, to date, there have not been any known cases where someone was successfully prosecuted for offering this type of bribe.

The Supreme People’s Procuratorate (SPP) and the Ministry of Public Security investigate criminal violations of laws related to anti-corruption, while the Ministry of Supervision (MOS) and the Discipline Inspection Commission (CCDI) enforce ethics guidelines and party discipline. China’s National Audit Office also inspects the accounts of SOEs and government entities. The National Bureau of Corruption Prevention (NBCP) is under the direct administration of the State Council and is responsible for improving government transparency and coordinating anti-corruption efforts among different government organizations. In January 2017, China announced plans for a National Supervision Commission, which will absorb the current functions carried out by MOS, anti-corruption units of the SPP, and those of the NBCP, and also pass a corresponding National Supervision Law by as early as March 2018.

*President Xi Jinping’s Anti-Corruption Efforts*

Since President Xi’s rise to power in 2012, China has undergone an intensive and large-scale anti-corruption campaign, with investigations reaching into all sectors of the government, military, and economy. President Xi labeled endemic corruption as an existential threat to the very survival of the CCP that must be addressed. Since then, each CCP annual plenum has touched on judicial, administrative, and Party discipline reforms needed to thoroughly root out corruption. Judicial reforms are viewed as necessary to institutionalize the fight against corruption and reduce the arbitrary power of Party investigators, but concrete measures have emerged slowly**.** To enhance regional anti-corruption cooperation, the 26th Asia-Pacific Economic Cooperation (APEC) Ministers Meeting adopted the Beijing Declaration on Fighting Corruption in November 2014.

According to Wang Qishan, head of the CCDI and also a member of China’s ruling seven-member Politburo Standing Committee, the CCP disciplined around 415,000 officials in 2016, almost a 25 percent increase compared to the previous year. However, over 75 percent of those disciplined received only “light discipline.” Of the officials disciplined, about 11,000 officials were expelled from the CCP and handed over to Chinese courts for prosecution. One group heavily disciplined has been the discipline inspectors, with the CCP punishing more than 7,900 inspectors since late 2012. This led to new regulations being implemented in 2016 by CCDI that increased overall supervision of investigators. Authorities also noted an increase in SOE officials being investigated, including 43 total investigations conducted in 2015, in comparison to 10 in 2014 and just two in 2013. Around 40 percent of SOE corruption investigations were of SOEs in the energy sector.

China’s overseas fugitive-hunting campaign, called “Operation Skynet,” has led to the capture of around 2,500 fugitives suspected of corruption. In 2016 alone, CCDI reported that 1,032 fugitives suspected of official crimes were reprehended. The Chinese government reports that in the first 11 months of 2016, China recovered 2.3 billion RMB (U.S. $334.47 million) in losses from graft, from over 70 countries and regions, through this campaign.

Anecdotal information suggests that China’s anti-corruption crackdown oftentimes is inconsistently and discretionarily applied, raising concerns among foreign companies in China. For example, to fight rampant commercial corruption in the medical/pharmaceutical sector, China’s health authority issued “black lists” of firms and agents involved in commercial bribery. Several of these blacklisted firms were foreign companies. Additionally, anecdotal information suggests many Chinese government officials responsible for approving foreign investment projects are slowing approvals to not arouse corruption suspicions.

While central government leadership has welcomed increased public participation in reporting suspected corruption at lower levels, direct criticism of central government leadership or policies remains off-limits and is seen as an existential threat to China’s political and social stability. Some citizens who have called for officials to provide transparency and public accountability by disclosing public and personal assets, or who have campaigned against officials’ misuse of public resources, have been subject to criminal prosecution.

*United Nations Anticorruption Convention, OECD Convention on Combatting Bribery*

China ratified the United Nations Convention against Corruption in 2005 and participates in APEC and OECD anti-corruption initiatives. China has not signed the OECD Convention on Combating Bribery, although Chinese officials have expressed interest in participating in the OECD Working Group on Bribery meetings as an observer*.*

*Resources to Report Corruption*

The following government organization receives public reports of corruption:

Anti-Corruption Reporting Center of the CCP Central Commission for Discipline Inspection and the Ministry of Supervision, Telephone Number: +86 10 12388

							10. Political and Security Environment					

The risk of political violence directed at foreign companies operating in China remains minimal. Every year, different watchdog organizations report tens of thousands of protests throughout China. The government is adept at handling protests without violence, but given the volume of protests annually, the potential for violent flare-ups is real. Violent protests, while rare, have generally involved ethnic tensions, local residents protesting corrupt officials, environmental and food safety concerns, confiscated property, and disputes over unpaid wages.

In recent years, the growing number of protests over corporate mergers and acquisitions has increased, often with workers and mid-level managers of an acquired firm protesting because they were not included or consulted in the process. There have also been a small number of cases of foreign businesspeople being trapped in China during a business contract dispute.

In the past few years, Chinese authorities have detained or arrested several foreign nationals, including American citizens, and have refused to notify the U.S. Embassy or allow access to the American citizens detained for consular officers to visit. These trends are in direct contravention of recognized international agreements and conventions.

							11. Labor Policies and Practices					

For U.S. companies operating in China, adequate human resources remain a major challenge. Finding, developing, and retaining domestic talent, particularly at the management and highly-skilled technical staff levels, remain a difficult challenge often cited by foreign firms. In addition, labor costs continue to be a concern, as salary and other inputs of production have continued to rise. In addition, foreign companies continue to cite air pollution concerns as a major hurdle in attracting and retaining qualified foreign talent to relocate to China. These labor concerns contribute to a small, but growing, number of foreign companies relocating to the United States, Canada, Mexico, or other parts of Asia.

Chinese labor law does not protect rights such as freedom of association and the right of workers to strike. China to date has not ratified the United Nations International Labor Organization conventions on freedom of association and collective bargaining, but it has ratified conventions prohibiting child labor and employment discrimination. Foreign companies often complain of the difficulty of navigating the ever-evolving labor laws, social insurance laws, and different agencies’ implementation guidelines on labor issues. Compounding the complexity, local characteristics and the application by different localities of national labor laws often vary.

Although required by national law, labor contracts are often not used by domestic employers with local employees. Without written contracts, employees struggle to prove employment, thus losing basic labor rights like claiming severance and unemployment compensation if terminated, as well as access to publicly-provided labor dispute settlement mechanisms. Similarly, regulations on dispatch agencies that provide temporary labor (referred to as “labor dispatch” in China) have tightened, and some domestic employers have switched to hiring independent service provider contractors in order to skirt the protective intent of these regulations. These loopholes incentivize employers to skirt the law because compliance leads to substantially higher labor costs.

Establishing independent trade unions is illegal in China. The law allows for worker “collective bargaining”; however, in practice, collective bargaining focuses solely on collective wage negotiations—and even this practice is uncommon. The Trade Union Law gives the All-China Federation of Trade Unions (ACFTU), a CCP organ chaired by a member of the Politburo, control over all union organizations and activities, including enterprise-level unions. The ACFTU’s priority task is to “uphold the leadership of the Communist Party.” The ACFTU and its provincial and local branches aggressively organize new constituent unions and add new members, especially in large multinational enterprises, but in general, these enterprise-level unions do not actively participate in employee-employer relations.

ACFTU enterprise unions issue a mandatory employer-borne cost of 2 percent of payroll for membership. While labor laws do not protect the right to strike, “spontaneous” worker protests and work stoppages occur with increasing regularity, especially in labor intensive and “sunset” industries (i.e., old and declining industries such as low-end manufacturing). Official forums for mediation, arbitration, and other similar mechanisms of alternative dispute resolution have generally been ineffective in resolving labor disputes in China. Some localities actively discourage acceptance of labor disputes for arbitration or legal resolution. Even when an arbitration award or legal judgement is obtained, getting local authorities to enforce judgments is problematic.

							12. OPIC and Other Investment Insurance Programs					

The United States suspended Overseas Private Investment Corporation (OPIC) programs in China, in the aftermath of China’s crackdown on Tiananmen Square demonstrators in June 1989. OPIC honors outstanding political risk insurance contracts. The Multilateral Investment Guarantee Agency, an organization affiliated with the World Bank, provides political risk insurance for investors in China. Some foreign commercial insurance companies also offer political risk insurance, as does the People’s Insurance Company of China.

							13. Foreign Direct Investment and Foreign Portfolio Investment Statistics					

*Table 2: Key Macroeconomic Data, U.S. FDI in Host Country/Economy*