(Bloomberg) — China is planning to approve new rules for foreign investment in the country this week, a sweeping overhaul of regulations that will affect corporate titans from Ford to Alibaba (NYSE:) and Tencent.
The regulations are slated for passage Friday by the National People’s Congress during a once-a-year gathering of legislators to seal the country’s most important policies. Key pillars of the new law will remove a major threat to investors in its massive technology sector, while putting thousands of overseas companies on notice they may need to renegotiate joint ventures in China.
In the latest draft, Beijing dropped language that would have invalidated the so-called “variable-interest entity” structures employed by Chinese tech giants from Alibaba Group Holding Ltd. to Tencent Holdings Ltd. But it’s also proposing to scrap special laws governing Sino-foreign tie-ups — a move that could force them to re-examine longstanding contracts, lawyers say.
Those twin strands emerged from China’s Foreign Investment Law, intended to govern every aspect of the world’s No. 2 economy for global investors. This particular edict has gained newfound significance as tensions flare between Beijing and Washington; the revisions to VIEs and JVs were little-noticed amid an array of other moves that span curbs on forced technology transfers to leveling the playing field for foreign firms.
In the case of VIEs, the missing language assuages concerns about a corporate structure that circumvented foreign-ownership restrictions. The model has never been formally endorsed by Beijing but has been used by tech titans such as Alibaba to list their shares overseas.
Pioneered by Sina Corp. and its investment bankers during its 2000 initial public offering, the VIE framework rests on shaky legal ground and foreign investors were thus nervous their bets would unwind overnight.
The original version of the legislation was dubbed by a number of “hysterical commentators as ‘the VIE killer,’” said Mark Schaub, a partner at King & Wood Mallesons.
“However, as its successor has dropped any reference to VIEs, we believe it should be business as usual. China’s regulatory position on VIEs may still evolve, but we do not believe there will be a U-turn, ” Schaub said.
The elimination of wording around VIEs also suggests it’s not mandatory that internet companies need to be controlled by Chinese nationals, according to Will Tsai, head of Asia Capital Markets at Cooley LLP. For the past four years, Chinese tech companies going public have operated under that very assumption, as suggested in previous drafts, he said.
However, it may be a matter of time before Beijing revisits the matter of VIEs, argued Adrian Lv and He Huanhao at Han Kun Law Offices, one of the country’s more prolific tech deal advisers. “The current legislation temporarily sets aside issues that still remain controversial but are relatively less urgent,” they wrote. The latest draft allows for future rules to address such issues, they said.
While tech companies and their backers wrestle with that, another key section of the legislation may have far-reaching consequences for the country’s 300,000-plus foreign joint ventures.
If Beijing rescinds dedicated legislation as feared, joint venture partners may be forced to draw up new contracts within five years to comply with the more general company law. In principle, it creates a more level playing field. Yet it also raise issues around execution.
“There will be a period of time without necessary implementing rules and regulations to follow,” the European Chamber of Commerce said in a statement in response to a recent draft of the law, which included the scrapping of JV regulations. “It is therefore necessary for relevant government departments to introduce more detailed supporting regulations as soon as possible to ensure a smooth transition.”
Joint ventures in China are particularly common in older industries such as automobiles, transport, energy and finance. The model was designed to bring in technical expertise from overseas while giving multinationals greater scope to operate in the world’s most populous nation. China had 331,829 joint ventures between local and foreign companies at the end of 2017, according to the Ministry of Commerce.
The potential headache lies not so much in any actual changes required, but the fact that many may need to amend existing contracts to comply — and that could open everything for negotiation, including fundamental commercial agreements, according to Gordon Milner, a partner with Morrison Foerster LLP.
“It’s like re-opening wedding vows. If you have to repeat the wedding vows, maybe your partner doesn’t want to stick by the same terms anymore,” said Paul McKenzie, managing partner at the law firm. “Some of the world’s largest automobile makers and chemical companies, among other international businesses, will be impacted.”
Companies are still studying the potential effects and aren’t yet sure how it would impact existing ventures, said Xu Heyi, chairman of Daimler AG’s partner Beijing Automotive Group Co. Changan Auto, which is allied with Ford Motor (NYSE:) Co., said a half-decade should be more than enough time to avert disruption.
“I can’t speculate about what sort of changes will come after five years,” President Zhu Huarong said. “Our partners so far haven’t expressed any interest in increasing their stake.”