Twitter Logo Youtube Circle Icon LinkedIn Icon

China > Legal Developments > Law firm and leading lawyer rankings

Editorial

Brief Comment on Easing Restrictions on Foreign Investment in Automotive Manufacturing

October 2018 - Transport. Legal Developments by JunHe LLP.

More articles by this firm.

On April 10, 2018, President Xi Jinping attended the Boao Forum for Asia (“BFA”) Annual Conference 2018 and delivered a keynote speech stressing that “China will remain unchanged its adherence to reforming and opening up, and will continue to launch new, major measures to pursue further opening.” Following this speech, the National Development and Reform Commission (“NDRC”) published its Answers to Reports’ Questions Regarding Promulgating New Negative List of Foreign Investment (“Negative List”) and Opening-Up of the Manufacturing Industry (“Answers”) on the official website of the Central Government. Through this document, the NDRC expressed its efforts to accelerate its pace to formulate a new Negative List along with other relevant departments, which echoed the major measures mentioned in President Xi’s speech. It also stressed that the manufacturing industry will be the priority in the new Negative List, and easing the restrictions on foreign investment in the automotive industry will be the focus in this prioritized area.

Brief Comment on Easing Restrictions on Foreign Investment in Automotive Manufacturing

On April 10, 2018, President Xi Jinping attended the Boao Forum for Asia (“BFA”) Annual Conference 2018 and delivered a keynote speech stressing that “China will remain unchanged its adherence to reforming and opening up, and will continue to launch new, major measures to pursue further opening.” Following this speech, the National Development and Reform Commission (“NDRC”) published its Answers to Reports’ Questions Regarding Promulgating New Negative List of Foreign Investment (“Negative List”) and Opening-Up of the Manufacturing Industry (“Answers”) on the official website of the Central Government. Through this document, the NDRC expressed its efforts to accelerate its pace to formulate a new Negative List along with other relevant departments, which echoed the major measures mentioned in President Xi’s speech. It also stressed that the manufacturing industry will be the priority in the new Negative List, and easing the restrictions on foreign investment in the automotive industry will be the focus in this prioritized area.

I. Easing Restrictions on Foreign Investment in Vehicle Manufacturing: Backgrounds & Current Trends

In the Answers, the NDRC released its orderly plans for relaxing restrictions on the proportion of foreign shares in the automobile Original Equipment Manufacturer (“OEM”) sector, distinguished by different types of vehicles. Specifically, for special-purpose vehicles and new energy car manufacturers, the ratio restriction of foreign shares will be eliminated in 2018. Further, the restriction for commercial vehicles and passenger cars will be removed in 2020 and 2022, respectively. Meanwhile, the rule that foreign car makers shall not have more than two joint ventures on as single vehicle type in China, is also expected to be removed by 2022. The NDRC expects to remove all the foreign investment restrictions on the OEM sector through a five-year transition period counted from 2018.

In fact, it has been a long-standing plan to ease the foreign investment restriction on the automobile OEM sector. In the Plan for the Middle and Long-Term Development of the Automotive Industry jointly issued by the Ministry of Industry and Information Technology, the NDRC and the Ministry of Science and Technology in 2017, the strategy to “improve the domestic and foreign investment administration regime and gradually relax restrictions on the proportion of foreign shares in joint ventures” was clearly mentioned. Moreover, Report on the Work of the Government of this year also pointed out the idea of “substantially reducing restrictions on foreign investors to further open-up the new energy vehicles sector”. However, neither a specific timetable nor a detailed roadmap was formed during those plans and discussions.

President Xi’s declaration in the BFA and the NDRC’s quick follow-up in publishing specific implementation plans coincided with the recent tension in Sino-US trade conflicts. Nobody can tell whether the two events are indeed correlated or just pure coincidence. Still, what has to be admitted is that the Chinese Government is under huge external pressure in further opening-up the automotive industry. There is a long tradition of government protection in the Chinese automotive industry. Foreign car makers have to form joint ventures with Chinese partners to produce cars within the Chinese territory, plus various strict restrictions of share ratio, total number of joint ventures and brand identifications, etc. Furthermore, imported cars that were manufactured overseas have to bear a tariff as high as 25%. All of these restrictions are clearly inconsistent with the Chinese Government’s basic principles of furthering the opening-up of China. On the other hand, the Chinese domestic automotive industry has gained enormous progress in technological development, product manufacturing, talent training and etc. during its practice of forming joint ventures with foreign counterparts, by which the Chinese automotive industry has won considerable competiveness. In this context, as the world’s largest and fastest growing automobile market, removing foreign investment limits is imperative-- at the current stage, discriminations between the Chinese and foreign players in the automotive industry have already drawn skepticism from some foreign car makers and foreign governments. Removing these limits may also clearly illustrate China’s steady determination to open-up its markets and encourage foreign investment.

II. Policy Development: Deregulation towards a More Open Economy

The development of foreign investment policies regarding the Chinese automotive industry over the last 20-plus years could be summarized in the chart below:



Time (Year)

Policy of Automotive Industry

Catalogue of Industries for Guiding Foreign Investment

Other policies

1994

Policy on Automotive Industry 1994

1.       The proportion of shares held by Chinese investors shall be no less than 50% in joint ventures manufacturing vehicles and engines.

2.       Foreign car manufactures shall not have more than two joint ventures for one type of vehicle in China.

 

 

 

1995

1.       Only manufacturing of key automobile components and spare parts (excluding engines) is in the encouraged category.

2.       Vehicles and engine manufacturing are both in the restricted category, allowed only when Chinese parties control the shares or take dominant position consistent with the industry policy.

1997

Almost the same compared to the 1995 version

2001

The 2001 Chinese WTO commitment promised to:

1.       Gradually cancel all restrictions on categories, types and models in automotive industry in two years after entering the WTO, and

2.       Cancel the foreign investors’ 50 per cent investment cap in engine manufacturing joint ventures. 

 

2002

1.       Manufacturing of vehicles, engine, and key automobile components and spare parts is now in the encouraged category.

2.       Retained the restriction on share ratio of foreign investment in vehicle manufacturing, but eliminated the ratio restriction in engine manufacturing.

2004

Aside from cancelling the restrictions on foreign ownership in engine manufacturing, the Policy on Development of Automotive Industry 2004 made no substantial modifications. It only clarified the exceptions to restrictions on car manufacturing: if a foreign investor acquires other car makers in China together with a Chinese joint venture partner, it will not be restricted by the “two joint venture rule”. An overseas enterprise and its controlled subsidiaries shall be regarded as the same foreign investor.

No modifications on foreign ownership restriction compared to the 2002 version

2007

1.       Manufacturing of vehicles, engine and key automobile components and spare parts is still in the encouraged category, while the new Catalogue detailed and narrowed the scope of products. In addition, it added explicit performance requirements for some of the products.

2.       Retained the foreign ownership restriction on vehicle manufacturing.

2009

The Policy on Development of Automotive Industry 2009 made no modifications on the foreign investment restrictions compared to the 2004 version.

2011

1.       Manufacturing of vehicles, engine and key automobile components and spare parts is still in the encouraged category, but the performance requirements for some products are enhanced.   

2.       Vehicle manufacturing was reclassified into the permitted category.

2015

1.       Manufacturing of engine and key automobile components and spare parts is still in the encouraged category. There are minor adjustments on the scope of products compared to the 2011 version.

2.       Vehicle manufacturing was reclassified into the restricted category, and the foreign investment restrictions were retained.

2017

1.       Manufacturing of engine and key automobile components and spare parts is still in the encouraged category. Still some small adjustments on the scope of products compared to the 2015 version.

2.       Vehicle manufacturing was reclassified into the restricted category, and the foreign investment restrictions were retained.

The Plan for the Middle and Long-Term Development of the Automotive Industry suggested relaxing restrictions on the proportion of foreign shares in joint ventures

2018

The Answers promised that China will gradually phasing out of all restrictions on foreign investment in the automotive industry. Predictably, the current Catalogue of Industries for Guiding Foreign Investment and Policy on Development of Automotive Industry will both be revised and updated accordingly during this transition process.

As demonstrated above, regulations on foreign investment in the automotive industry are mainly through the adjustments in the Catalogue of Industries for Guiding Foreign Investment and Policy on Development of Automotive Industry. Although multiple modifications were presented, the core restrictions on share ratio and number of joint ventures in car manufacturing remained the same. The Chinese Government historically has made no compromise on these issues, and only has accepted some insignificant changes, such as shifting the classification of vehicle manufacturing between the restricted category and the encouraged category, and canceling the restriction on foreign investment in engine manufacturing under the pressure of fulfilling WTO commitment. Therefore, the Chinese Government’s determination to remove its longstanding restriction on foreign ownership in car manufacturing entities is considered a significant reform.

III. Possible Impact on Automotive Industry

1. Foreign Investors Flood into the Sector of New Energy Car

The Answers suggested that new energy cars will be the first sector for opening-up in the five-year transition period. Currently, the new energy car market is a favorite of investors, but the key players are mostly state-owned enterprises and private enterprises, while foreign car makers are still largely outside this hot market. However, those foreign car makers are traditional multinational corporations (“MNCs”) with solid foundations of developed technology and products in this sector, thus it is only a matter of time until they finally enter the Chinese market with their new energy cars. As a result, the cancellation of foreign ownership restrictions in new energy car manufacturing is a double dose of good news for those who have been eager to fight a battle over Chinese market shares. Also, other foreign automobile brands who were passively observing in the past may mark “establishing new energy car factories in China” in their calendar. Predictably, foreign investments will flood into the already highly competitive new energy car market with the current players of state-owned enterprises, private enterprises and the so-called “new car-making forces”.

2. Strikes on the Local Automotive Industry

Despite the progress gained through several decades’ cooperation with foreign brands, China’s automotive industry is still famous for its quantity rather than quality, especially concerning the problems in the R&D of key components and spare parts and the influence of its own brands, as well as quality issues. Once the foreign restrictions are all cleared, foreign brands will be in direct competition with the Chinese national brands and joint venture brands. Moreover, for the existing joint ventures, even though their foreign investors will not immediately exist or obtain the majority shares, they could still diminish current joint ventures’ competiveness by controlling the input of either car models or relevant technologies, and thus indirectly may assist the foreign investors’ wholly owned or majority controlled subsidiaries, granting them competitive edges down the road.

3. M&A in the Automotive Industry May Increase

If the Answers are effectively implemented, then foreign investment in new energy cars will be freed from share ratio barriers in this year. In 2022, passenger cars, which occupy the largest market shares, will also face no restrictions in share ratio. Finally, the cap on two joint ventures for a single foreign investor will be removed. Thus, by 2022, foreign car makers will, in theory, have more options and opportunities for investment ahead of them, and will face far fewer restrictions than have existed since they began doing business in China.

However, the foreign car makers still need to be aware that even with the gradual easing of restrictions in share ratio and number of investments, it does not mean that there will be no threshold at all for the foreign investors to manufacture cars in China. The explicit requirements and conditions established by the prevailing automotive industry development policy and planning, regulations on market entrance and project investment, administrative rules on manufacturers and products of different types of vehicles and etc. are still in effect and applicable.

In addition, since risks of excessive production capacity (including new energy car production capacity) are growingly evident, industry regulators such as NDRC and Ministry of Industry and Information Technology have already expressed the principle that no approval will be granted for new investment projects producing traditional fuel cars. It is also noted that the approval for investment projects producing new energy cars has also been suspended and the new criteria on securing the approval, which are expected to be issued in the near future, are very likely to be stricter. As a result, even with all foreign share ratio restrictions removed towards 2022, making greenfield investments (such as setting up a WFOE) to produce traditional fuel car is almost impossible, and in the short run, it largely remains similarly infeasible to produce new energy cars by establishing a WOFE.

Therefore, we predict that M&A may become the main stream for foreign car makers entering the China market by acquiring the existing Chinese companies with proper regulatory approvals, and swapping new energy car capacity with traditional fuel car capacity. M&A may also be more welcome and acceptable to the Chinese authorities from the standpoint of resolving the redundant car manufacturing capacity.

IV. Remarks

Phasing out foreign restrictions in the automotive industry will definitely surge foreign investments in the automotive industry, and on the other hand, it is both an opportunity and a challenge for the growing Chinese automotive industry.  People may need to wait and see how the foreign brands will enter the China market, and how the Chinese brands will cope with this new market dynamic.

Michael WENG           Partner          Tel: 86 21 2208 6264              Email:wengyj@junhe.com

Mengsi GUO          Associate      Tel: 86 21 2208 6000      Email: guoms@junhe.com

Zhenzhen LIU        Intern            Tel:86 21 8883 8243              Email:liuzhzh@junhe.com

GC Powerlist -
China and Hong Kong