Is China Investable - Invest by the Rules--and Invest Smart

Quinn Emanuel Urquhart & Sullivan, LLP

The Chinese government’s recent regulatory actions against major companies in the private sector have sparked concerns among investors.  Some even have gone to the extreme, bluntly asking, “who the hell now wants to invest in a Chinese company, if all of a sudden, China’s going to pull a company out of whatever exchange it’s on?”[i]

We believe that the answer to the question “Is China investable?” remains, from a legal standpoint, yes.  The recent regulatory crackdown may not be as arbitrary as many have claimed.  Nor is it inconsistent with the global trend.  In fact, underlying China’s regulatory moves are some of the common regulatory themes shared by many other jurisdictions—primarily data security and antitrust concerns.  The regulatory frameworks and enforcement actions applied to rein in Chinese internet giants, while aggressive and precipitous, have had the specific purposes of ensuring data security and curbing market dominance, and thus should not be interpreted as unwelcome signs for foreign investment.  Despite occasionally conflicting rhetoric, China did continue to take concrete steps in 2021 to make foreign investment more attractive.  And investors can manage the changing regulatory landscape in China by having robust compliance programs for investment targets that will help manage their risks adequately.  Therefore, despite the noise, China remains subject to the conventional wisdom of investment: choose your investments wisely and manage the risks.

I. China’s Tightened Regulation of Internet Companies Is in Line with Regulation in Other Countries

Over the last year, there is no doubt that the Chinese government has tightened its regulation of internet companies.  On February 7, 2021, Chinese regulators unveiled new anti-monopoly guidelines aimed at the country’s biggest tech companies.  Since then, many of the major internet companies, including Meituan, Tencent, and Pinduoduo, have been investigated or fined for alleged anti-competitive behavior.  China has also ramped up efforts to build a comprehensive data protection, privacy, and cybersecurity legal framework, with the promulgation of the Data Security Law (the “DSL”) and the Personal Information Protection Law (the “PIPL”) in the second half of 2021.  The impact of these goes beyond, but most substantively impact; the internet giants who collect, store, and process enormous amounts of personal data as an essential part of their businesses.

China’s regulators are not alone in moving to rein in the powerful internet companies.  In fact, the underlying concerns of the Chinese regulators—data security and antitrust—echo the legislative agenda and enforcement priorities in both EU and the U.S.

Data Security and Personal Information Regulation

China has been enhancing data protection and tightening cross-border data transfer control since the passage of the Cybersecurity Law of 2017, with an accelerated pace of rulemaking starting in 2021.  In April 2021, regulators at different levels of the Chinese government proposed various administrative measures to ensure data security and protect personal information:[ii]  The State Council first proposed the Guideline to Safeguard Critical Information Infrastructure Operators on July 30, 2021;[iii] four departments—Cyberspace Administration of China (“CAC”), Ministry of Industry and Information Technology (“MIIT”), Ministry of Public Security, and State Administration for Market Regulation (“SAMR”)—then jointly published temporary measures to protect personal information collected via mobile applications;[iv] on June 10, 2021, the Standing Committee of the National People’s Congress passed the DSL, which became effective on September 1, 2021.  The other pillar of the new regulatory framework, the PIPL, was passed on August 20, 2021, and became effective on November 1, 2021.

However, despite the unprecedented speed of these Chinese data security regulatory actions, the substance is not peculiar in today’s global context.  For example, the most recent enactment, PIPL, is largely analogous to the EU’s General Data Protection Regulation (“GDPR”).  Both recognize individual rights regarding personal information, including rights to information, to access and copy, to correction and rectification, to erasure, and to object or restrict processing.[v]  Both impose limits upon cross-border data transfer, with technical differences in the decision-making mechanism and authorization process.[vi]  Both provide a private cause of action against data controllers and processors in addition to governmental enforcement.[vii]  Moreover, the EU has been very active in enforcing the GDPR against tech companies, including fining Amazon $877 million[viii] and WhatsApp $255 million[ix] in 2021.

In the U.S., although no federal regulation is yet in place, some state laws have been inspired by the GDPR, notably the California Consumer Privacy Act, which shares many common traits with PIPL.[x]  U.S. regulators too have imposed record-setting fines on tech companies that failed to protect their users’ data security.  For example, the consumer credit reporting agency Equifax was fined $575 million in connection with its 2017 data breach that resulted in almost 148 million compromised data records.[xi] 

Antitrust Enforcement

China also has aimed in recent years to curb internet companies’ anti-competitive behavior through active enforcement of its antitrust laws and regulations.  In 2020, SAMR closed 109 monopoly cases with penalties totaling $70.6 million USD.[xii]  In April 2021, SAMR reportedly contacted 34 major internet companies in China, including Tencent and ByteDance, asking them to conduct self-inspections regarding compliance with antitrust rules.[xiii]  On July 7, 2021, several leading Chinese internet companies were fined for allegedly anti-competitive conduct.

China is not the only country taking such actions.  In the U.S., a bipartisan group of lawmakers recently introduced a bill that would bar internet companies, such as Amazon and Google, from favoring their products and services over those of other competitors.[xiv]  Similarly, the EU has issued a series of multi-billion-dollar rulings against major internet companies over antitrust violations.[xv]  Most recently, EU has incorporated antitrust principles into its regulation of tech companies: In November 2021, the European Parliament agreed upon a legislative proposal to limit anti-competitive practices in the digital economy, targeting U.S. tech companies such as Alphabet, Google, Amazon, Apple, Facebook, and Microsoft.[xvi]  Antitrust regulators in South Korea, India, Australia, and post-Brexit UK have also started to launch investigations and levy fines in an effort to regulate tech companies’ business practices.

Antitrust regulation across these jurisdictions has been analogous in other aspects.  Both China and the U.S. seek more independence to strengthen their respective antitrust mechanisms.  China’s recent nomination of SAMR’s vice minister as Head of the National Anti-Monopoly Bureau (NAMB) has been interpreted as granting NAMB a semi-autonomous status under SAMR instead of making it a mere division.[xvii]  The FTC’s decoupling from the Sherman Act has also been viewed as a step towards a broader scope of discretion when it comes to regulating unfair competition.[xviii]  As a practical matter, the nature of the major internet companies’ businesses and concentrated power has made them the common targets of antitrust initiatives.  Similar to China’s cybersecurity review of multiple U.S.-listed Chinese public companies, and the EU’s continuous and coordinated investigations by its member states’ competition authorities, the FTC has  made “technology companies and digital platforms” priority targets of its investigation.[xix]

VIE Structure

As Chinese companies face tightened regulation and are caught in the regulatory crossfire between U.S. and China, investors have voiced concerns about the viability of the variable interest entities (“VIE”) structure.  The VIE structure is a complex offshore corporate structure utilized by Chinese companies, especially in the technology sector, to get listed in the U.S.  China’s tightening of its data security regulations, as well as its voiced concern about technology companies leaking data to the U.S. regulators, lead to speculation that China is to ban the VIE structure altogether.[xx] 

The China Securities Regulatory Commission (“CSRC”) cleared up investors’ doubt by explicitly reaffirming at its Dec. 24 press conference that VIE-structured Chinese companies can be listed overseas if they comply with domestic laws and register with the CSRC first. [xxi]  On the same day, the CSRC unveiled its new regulatory framework on companies seeking to sell shares abroad, requiring such companies to file for a registration with the CSRC within three working days after the first filing for an oversea IPO.[xxii]  The draft rules aim to “encourage more overseas listings to take place in a sustainable and healthy manner.”[xxiii]  Although how this framework would be implemented and to what extent the Chinese and U.S. regulators would cooperate remain to be seen, the trend seems to be against a drastic detachment from each other as some speculated.

II. China’s Blueprint for Attracting Foreign Investments Has Not Changed

It is true that signals sent by the Chinese government about foreign investments can conflict and be confusing from time to time.  Yet, just as actions speak louder than words, China’s overall welcoming attitude towards foreign investment should be viewed positively by investors.  In May 2021, the Ministry of Commerce released its plan to revise foreign investment guidelines to “ease restrictions” and to meet the country’s business development needs.[xxiv]  The revision is expected to include terms that reduce asset requirements, shorten the lock-up period for foreign shareholders’ stocks, and remove shareholding limits of foreign strategic investment.[xxv]  Consistently, and as recently as December 15, Chinese Premier Li Keqiang said at the Global CEO Council that “companies from all over the world are welcome to expand investment in China further and deepen cooperation in various fields to achieve common development.”[xxvi] 

Indeed, China has set up a free trade zone in Hainan, which has become an investment magnet with “zero-tariffs, low tax rates, a simplified tax system, and an enhanced legal system.”[xxvii]  China has also unveiled its Guangdong-Hong Kong-Macao Greater Bay Area plan to build a global center for advanced manufacturing and innovation.  The recently announced Pudong New Area in Shanghai is expected to house an international financial asset transaction platform, equipped to manage cross-border capital flow amounting to one trillion yuan in three to five years.[xxviii]  The major issue for investors to consider is more likely how to invest strategically, rather than whether to invest. 

III. Major Players Continue to Invest in China, with Enhanced Caution Toward Compliance and Risk-Management

Many institutional investors apparently share the impression that China’s regulatory actions have not been unusual in today’s global context.  Multiple data sources show that global investors put substantial money into Chinese start-ups in the third quarter of 2021, bringing the 2021 totals through September 30 to higher levels than all of 2020.[xxix]  The total investment in Chinese start-ups for the first three quarters of 2021 rose 75% from a year earlier, and has since been on track to reach the peak set in 2017.[xxx]  Many major players on Wall Street, such as BlackRock, J.P. Morgan, and Goldman Sachs, have expressed optimism in continuing to invest in China.  BlackRock even urged investors to double or triple their exposure in China.[xxxi] 

That said, higher regulatory risks and heightened requirements for compliance are in place, which will mean higher compliance costs, and will call for more sophisticated understanding and planning by investors.  Investors need to develop a good understanding of the new regulations and their underlying policy goals to invest smartly in China.  For example, although it is unclear to what extent the DSL and PIPL will apply retrospectively, tech companies and their investors now must closely follow regulatory updates with respect to data security and cross-border data transfer.  Violation of the new statutes can result in significant civil fines, revocation of business licenses, and even criminal liability.  Companies doing business in China should take into consideration the following measures to ensure DSL and PIPL compliance:

  • Properly preserve data – Data preservation is regulated by multiple laws and regulations in various jurisdictions. Companies should consider establishing or updating their document retention and destruction policies, supplemented by special procedures to suspend ordinary document retention policies and to preserve all relevant data in anticipation of a dispute or investigation.
  • Categorize data pursuant to relevant regulatory regime – It is important for companies to keep in mind that data other than personal information is subject to both national and local regulation, including administrative regulations and industry-specific regulations. Under the new data protection regime, it is essential for companies to categorize their data and adopt corresponding security measures.  A structured categorization of data can help companies better navigate different regulatory frameworks.
  • Establish a compliance program to protect personal information – The PIPL imposes obligations on processors of important personal information to set up compliance systems to protect personal information, to regularly publish personal information protection social responsibility reports, and the like. A company whose business falls in this category needs to identify lawful bases for collection and use of all personal information, evaluate whether it is required to appoint a dedicated representative or an office in charge of personal information protection mechanisms, have a security breach response and notification mechanism in place, and provide individuals with sufficient privacy notices. 
  • Promptly assess the risk of cross-border data transfers with outside counsel – When companies are seeking to comply with U.S. and other foreign regulators’ information requests or to fulfill their discovery obligations in U.S. litigation, it is important that they consult with outside counsel in a timely manner to analyze and assess data compliance risks before transmitting any such information overseas.

Despite its unprecedented regulatory tightening, China continues to present tremendous opportunities for global investors.  The key to success in China is a full understanding of the risks under the new regulatory environment and the ability to manage these risks.

* * *

[ENDNOTES]

[i]   Nguyen, Lananh & Phillips, Matt, With Didi Leaving Wall Street, Trading Edges Closer to Beijing’s Thumb (December 13, 2021), N.Y. Times, https://www.nytimes.com/2021/12/13/business/didi-wall-street-china.html.

[ii]   Yuan, Ruiyang, et al., 如何监管数据? (Nov. 29, 2021), Caixin, https://weekly.caixin.com/2021-11-26/101810157.html.

[iii]   State Council of the People’s Republic of China, Guideline to Safeguard Critical Information Infrastructure Operators, effective as of September 1, 2021, http://www.gov.cn/gongbao/content/2021/content_5636138.htm.

[iv]   State Council of People’s Republic of China, Public Call for Opinion for the “Interim Measures to Protect and Manage Personal Information on Mobile App (Draft for Opinion)” (April 26, 2021), http://www.gov.cn/hudong/2021-04/26/content_5602780.htm.

[v]   Dai, Ken & Deng, Jet, The Comparison Between China’s PIPL and EU's GDPR: Practitioners’ Perspective (October 11, 2021), JDSUPRA, https://www.jdsupra.com/legalnews/the-comparison-between-china-s-pipl-and-2189482/.

[vi]   Id.

[vii]   Id.

[viii]   Burgess, Matt, Why Amazon’s £636m GDPR Fine Really Matters (August 4, 2021), Wired, https://www.wired.co.uk/article/amazon-gdpr-fine.

[ix]   Bourne, Helen & Moore, Garrett, Irish Data Regulator Fines Whatsapp €225m for GDPR Infringements (September 24, 2021), Clyde & Co, https://www.clydeco.com/en/insights/2021/09/irish-data-regulator-fines-whatsapp-%E2%82%AC225m-for-gdpr.

[x]   Woodhard, Mike, Privacy Laws Comparison: Russia vs. China vs. USA (June 17, 2021), SecurityScorecard, https://securityscorecard.com/blog/privacy-laws-russia-china-usa-comparison.

[xi]   FTC, Equifax to Pay $575 Million as Part of Settlement with FTC, CFPB, and States Related to 2017 Data Breach (July 22, 2019), https://www.ftc.gov/news-events/press-releases/2019/07/equifax-pay-575-million-part-settlement-ftc-cfpb-states-related.

[xii]   Chu, Daye & Chi, Jingyi, China Intensifies Antitrust Crackdown with Latest Fines on Internet Giants (July 2, 2021), Global Times, https://www.globaltimes.cn/page/202107/1228110.shtml.

[xiii]   Kharpal, Arjun, China’s Tech Crackdown Has a New Battleground—Data (July 5, 2021), CNBC, https://www.cnbc.com/2021/07/05/china-tech-crackdown-focuses-on-data-after-didi-probe-.html.

[xiv]   Bartz, Diane, Big Tech to Face Another Bipartisan U.S. Antitrust Bill (October 14, 2021), Reuters, https://www.reuters.com/world/us/big-tech-face-another-bipartisan-antitrust-bill-2021-10-14/.

[xv]   See, e.g., Antitrust: Commission fines Google €1.49 billion for abusive practices in online advertising (March 20, 2019), https://ec.europa.eu/commission/presscorner/detail/en/IP_19_1770

[xvi]   Babu, Juby, EU Lawmakers Agree on Rules to Target Big Tech (November 18, 2021), Reuters, https://www.reuters.com/technology/eu-lawmakers-agree-rules-target-big-tech-ft-2021-11-17/.

[xvii]   Emch, Adrian et al., Chinese Antitrust—The Big Reset (November 23, 2021), JDSUPRA, https://www.jdsupra.com/legalnews/chinese-antitrust-the-big-reset-2182078/.

[xviii]   FTC, FTC Rescinds 2015 Policy that Limited Its Enforcement Ability Under the FTC Act (July 1, 2021), https://www.ftc.gov/news-events/press-releases/2021/07/ftc-rescinds-2015-policy-limited-its-enforcement-ability-under.

[xix]   FTC, FTC Authorizes Investigations into Key Enforcement Priorities (July 1, 2021), https://www.ftc.gov/news-events/press-releases/2021/07/ftc-authorizes-investigations-key-enforcement-priorities.

[xx]   Id.; see also Frost, Richard & Horta e Costa, Sofia, Why China and U.S. Are Clashing over Stock Listings (Nov. 26, 2021), The Wash. Post, https://www.washingtonpost.com/business/why-china-and-us-are-clashing-over-stock-listings/2021/11/26/3e5764fa-4eba-11ec-a7b8-9ed28bf23929_story.html.

[xxi]   CSRC, Relevant Responsible Person of the CSRC Answers to Journalists’ Questions (Dec. 24, 2021), http://www.csrc.gov.cn/csrc/c100028/c1662240/content.shtml.   

[xxii]   See CSRC, Draft Regulation by State Council on Chinese Companies Issuing Securities or Going Public Abroad, http://www.csrc.gov.cn/csrc/c101981/c1662244/1662244/files/附件1:国务院关于境内企业境外发行证券和上市的管理规定%20(草案征求意见稿).pdf; CSRC, Draft Measure to Register Chinese Companies Issuing Securities or Going Public Abroad, http://www.csrc.gov.cn/csrc/c101981/c1662251/1662251/files/附件1:境内企业境外发行上市备案管理办法%20(征求意见稿).pdf.

[xxiii] The State Council, The People’s Republic of China, Draft rules to help regulate firms’ overseas listings (Dec. 25, 2021),  http://english.www.gov.cn/statecouncil/ministries/202112/25/content_WS61c64feec6d09c94e48a2ab4.html

[xxiv]   Xinhua, Economic Watch: China to Relax Foreign Investment Rules amid Further Opening Up (May 26, 2021), http://www.xinhuanet.com/english/2021-05/26/c_139971461.htm.

[xxv]   Id.

[xxvi]   Xinhua, China Welcomes Companies from Worldwide to Further Expand Investment: Premier (December 16, 2021), http://www.news.cn/english/2021-12/16/c_1310376905.htm.

[xxvii]   Zhang, Nicole et al., China’s Hainan Free Trade Port: Introducing an Innovative Tax Regime to Attract Investment (September 7, 2020), Int’l Tax Rev., https://www.internationaltaxreview.com/article/b1n8bgfxnnnydw/chinas-hainan-free-trade-port-introducing-an-innovative-tax-regime-to-attract-investment.

[xxviii]   Xie, Jun & Li, Xuanmin, Pudong to Be Global Financial Zone (Jul. 29, 2021), Global Times, https://www.globaltimes.cn/page/202107/1230024.shtml.

[xxix]   Cheng, Evelyn, Investors Pour Money into Chinese Start-ups Despite Regulatory Crackdown (October 27, 2021), CNBC, https://www.cnbc.com/2021/10/27/investors-put-money-in-chinese-start-ups-despite-regulatory-crackdown.html.

[xxx]   Wong, Jacky, Venture Capital Hasn’t Given Up on China (November 2, 2021), Wall St. J., https://www.wsj.com/articles/venture-capital-hasnt-given-up-on-china-11635849723.

[xxxi]   See Goldman Sachs, Is China Investable? (September 13, 2021), https://www.goldmansachs.com/insights/pages/gs-research/is-china-investable/report.pdf; Manoukian, Jacob & Wolf, Alex, Is China Investable? We Think So (July 30, 2021), J.P. Morgan, https://www.jpmorgan.com/wealth-management/wealth-partners/insights/is-china-investable-we-think-so; Kiderlin, Sophie, BlackRock Says Investors Should Triple Their Allocations in Chinese Assets Despite Increasing Regulatory Risks (August 18, 2021), Insider, https://markets.businessinsider.com/news/stocks/blackrock-tells-investors-triple-exposure-chinese-assets-report-2021-8.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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