Regulation of Tech Business in China
Legal Nodes Team
Regulation of Tech Business in China
It has been reported that the People’s Republic of China (the PRC) accounted for 47% of the global venture capital funding, surpassing North America for the first time in 2018. Evidently, an increasing number of international companies are looking to do business in Mainland China and we decided to find out legal peculiarities that arise when you start operating in this market.
To find out answers, we consulted an expert from our Legal Nodes network, who has extensive experience in defending international companies’ rights in Mainland China as well as in legal support of international investment deals - Lei-Lei (Edward) LU, Dispute Resolution Associate at Fangda Partners.
In January 2019, the PRC has adopted the “Regulations on the Management of Blockchain Information Services”, which applies to blockchain information service providers. Are there any other specific legal acts that might apply to tech-powered companies in China?
It is indeed that the application of blockchain technology in China has been expanding to various industries, ranging from finance, e-commerce, food, education, and even court practice. It is under this background that the Cyberspace Administration of China (CAC), a governmental institution specifically tailored for the formulation and implementation of policies and regulations in connection with Mainland China Internet, released the Regulations on the Management of Blockchain Information Services (the “Blockchain Regulations”, effective as from 15 February 2019). As China’s first official rules to regulate the blockchain industry, the Blockchain Regulations lay down the framework for the regulatory requirements on blockchain information services providers in Mainland China. Encouraging as it is, more specific rules for implementing the Blockchain Regulations are needed.
Apart from the Blockchain Regulations, tech-powered companies in China shall also take note of and comply with the following major regulations related to the Internet industry:
- China Cyber Security Law (the “CSL”, effective as from 1 June 2017). As China’s first comprehensive privacy and security regulation for cyberspace, the CSL has provided a framework for security protection and data regulation on the Internet in connection with entities doing business in Mainland China. With the promulgation of other related rules and regulations, international businesses with operations in China must prioritize their cybersecurity issues and make efforts to abide by the requirements set forth in the CSL and other related rules.
- Financial Information Services Regulation (the “Financial Regulation”, effective as from 1 February 2019). The Financial Regulation was released by the CAC and sets out rules applicable to the provision of financial information services in China. Fintech companies with operations in China shall pay special attention to this regulation.
In addition to the rules above that have been put into effect, the CAC is also working on several other related regulations on various aspects including data security management, Internet information security for children, cross-border data transfer, and etc., which are expected to come out in the near future.
What do you find to be the biggest legal pain-points for foreign businesses that are entering the Chinese market?
Personally, I think the biggest legal pain-points will be that the legal practice in China departs from, to a certain degree, the written regulations, thus adding unpredictability on law enforcement for foreign companies doing business in China.
Though not an issue solely with China, the Chinese government and judiciary bodies have been consistently working on the formation and implementation of laws and regulations related to foreign investment, for example, the newly-released Foreign Investment Law, aiming at promoting and protecting foreign investment. Gradually, the business environment for foreign companies’ operation in China will become more commercially attractive and legally protective.
What challenges do Chinese companies face when scaling to other countries?
The fact that Chinese companies do not prioritize the necessity of high-quality legal services may be a major challenge for Chinese companies investing overseas.
Investing in other countries can be profitable but also quite risky, which is especially the case with China since Chinse outbound investments mainly target areas in developing countries where the political and legal environments tend to be unstable and unpredictable. Accordingly, comprehensive legal due diligence and legal contract drafting with the help of experienced outside legal counsel would be essential for the success of the investment, and that is something that Chinese companies shall pay closer attention to.
I have had experience counselling a Chinese energy company in its dispute with its local partner in a middle-Asia nation in connection with an oilfield drilling dispute. One of the main reasons giving rise to the dispute was that the underlying contract puts far more obligations on the Chinese party which could have been avoided or balanced had they engaged a well-trained legal counsel with local expertise in the beginning.
On top of the legal risk above, risks related to political instability, cultural and religious differences in nations receiving investments will also impose challenges on Chinese companies doing businesses abroad.
In your experience, are there any peculiarities in structuring cross-border investment deals with Chinese companies?
It is recommended to choose arbitration, rather than local litigation, as a dispute resolution method for cross-border investment deals with Chinese companies. Arbitration, compared to local litigation, provides a more neutral forum for parties in cross-border transactions to settle their disputes. Other advantages of arbitration include the confidentiality, party-autonomy in arbitration procedures, right to appoint its own arbitrator, and world-wide enforceability of the arbitral award, etc.
As you have mentioned, not long ago the PRC has adopted the Foreign Investment Law. What positive changes will it bring to the regulation of foreign investments?
The Foreign Investment Law (that will come into effect on 1 January 2020) aims at further enhancing the business environment for foreign investments in China by setting out rules for foreign investment promotion, protection, and management. In particular:
- Foreign investments will generally be able to enjoy equal treatment as domestic investments, other than investments in industries that have been included on the "Negative List" for foreign investments.
- Foreign investors are now only required to register their investments with, rather than obtain approval from, the relevant government agencies.
- Foreign-invested entities will be required to follow the corporate governance rules under the PRC Company Law once the Foreign Investment Law comes into effect.
- Principles for encouraging and rules for protecting foreign investment are included in the Foreign Investment Law.
By introducing the Foreign Investment Law and its relevant implementing rules (to be released soon), foreign investors will be able to participate in and benefit from a more commercially-friendly business environment, and by extension, empowering China to continue to develop and foster a more open and transparent foreign investment environment.
Do U.S.-China sanctions have to be considered when choosing a market strategy by companies, who reside in these states?
To act in a prudent manner, the tension between US-China during trade war, of course, shall be considered when making a market strategy for companies, in a short period. Nonetheless, when planning for market strategy and development, companies are suggested to consider things in the long run and shall not be influenced by temporary issues. Eventually, the adverse effect of U.S.-China sanction on companies doing business in these two nations will diminish.
Lastly, do you find Mainland China to be more welcoming towards innovation and technology than its special administrative region, Hong Kong? Are there any instances when a company would choose to enter one market or another, or have offices both in Mainland China and Hong Kong?
The indisputable fact is that Mainland China takes a bolder and more active stand towards innovation and technology than Hong Kong, though Hong Kong is catching up with the current technology trend in various ways.
Fintech companies tend to choose Hong Kong as their preferred base for entering into the Chinese market, primarily due to the relatively loose regulation and fewer restrictions in Hong Kong than in Mainland China. For companies in other industries, I personally think that both locations work, and there is a growing trend that international start-ups tend to operate directly in Mainland China, largely for the purpose of staying closer to their clients.
Legal Nodes Team would like to thank Lei-Lei for agreeing to do this interview with us and sharing his insights on the regulation of tech business in China.
In our previous article, we have analysed blockchain regulation and legislative initiatives in Switzerland and Liechtenstein.
Disclaimer: the information in this article is provided for informational purposes only. You should not construe any such information as legal, tax, investment, trading, financial, or other advice.
Lei-Lei (Edward) LU, Dispute Resolution Associate at Fangda Partners
Interviewed by Nik Kliapets, Legal Counsel at Legal Nodes