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.

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:

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