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：[email protected]

Mengsi GUO          Associate      Tel: 86 21 2208 6000      Email: [email protected]

Zhenzhen LIU        Intern            Tel：86 21 8883 8243              Email：[email protected]