The EU China Comprehensive Agreement on Investment – Political disaster or economic success?

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After seven years of negotiations, on 30 December 2020 the EU and China agreed on a Comprehensive Agreement on Investment (CAI). In the news, the CAI has been discussed so far predominantly from a political standpoint. Some of the criticisms levelled at it were that it failed to address China’s human rights violations, that the EU rebuffed the new US administration by not aligning with them, that the CAI was dominated by German interests, and that it brought unnecessary prestige for the Chinese government, etc. Most recently on 20 May 2021, the European Parliament adopted a resolution to formally freeze any discussions on the CAI. Little specific information has been provided on the potential CAI’s actual impact on and benefits for EU businesses in China. It will turn out that EU investors might take advantage of a few improvements from the CAI. On a large scale, however, the situation will remain unchanged, unless the CAI were to undergo a major upgrade before becoming effective.

CAI – recent setback by the European Parliament
Before the CAI suffered this recent setback in the European Parliament, its wording was far from being final or definite. The common understanding reached between the EU and China on 30 December 2020 only encompasses the rough framework of a potential CAI. The object of discussion so far has been a draft version which the European Commission published on its website in January 2021. Translation, legal scrubbing, and final negotiation would have started from then. Following this, China, the European Council, probably the EU member states, and the European Parliament would all have to agree on it, and ratification would then have to take place. Even in an ideal scenario, the CAI would have come into effect several months into 2022 at the earliest.
The European Commission spoke highly of the CAI’s achievements, calling it the “most ambitious agreement that China has ever concluded with a third country” and emphasized China’s commitments on market opening for EU companies. If one goes further into the details, however, there remains not very much other than what the European Commission quite precisely described as the CAI “preventing backsliding” or, as participants to the negotiations called it, “capturing China’s current level of openness”. The actual improvements in market opening, compared with the status quo in China, are indeed not ground-breaking.

When taking a closer look into industry sectors that will fall under the CAI, one will notice that most of the sectors have already been recently opened by China (finance, manufacturing), or will have been opened by 2022 (automotive). In particular, it will not be the CAI that abolishes joint venture requirements on a large scale, neither in the automotive sector nor otherwise. Contrary to a persistent belief in western public opinion, there is no general joint venture requirement for foreign investors in China. Only in a few business sectors, foreign investors must take on board Chinese joint venture partners, whereas in most sectors, wholly foreign-owned enterprises have long been permitted. The best-known joint venture requirement indeed used to exist in the automotive industry. Since the 1980s, foreign OEMs could end-manufacture vehicles in China only in JVs with the Chinese party holding at least 50% of the equity interests. However, China has already abolished this requirement in three steps: for new energy vehicles from 2018, for trucks from 2020, and for combustion engine passenger vehicles from 2022. That is, from 1 January next year – earlier than the CAI would become effective in the most optimistic scenario – all foreign investors, also those not from the EU, will be permitted to produce cars in wholly foreign-owned enterprises. This must be borne in mind when the European Commission gives credit to the CAI for China agreeing to “remove and phase out joint venture requirements in the automotive sector”.

China’s strategy on foreign investments
Sectors which the CAI could indeed help open for EU investors are cloud computing (reportedly subject to a 50% equity cap), hospitals in certain key cities, and environmental services such as waste disposal (either of them without equity cap). However, it remains to be seen if they will not open independent of the CAI anyway. For investment from abroad, China has long established a regulatory framework in form of the PRC Foreign Investment Law and the Negative List for Foreign Investment that contains restrictions and prohibitions on foreign investment in certain sectors. All sectors which are not on the Negative List are open to foreign investment. The Negative List is regularly updated. Its next update is to be expected in 2021/2022 – that is, before the CAI will take effect. It is probable that the sectors mentioned in the CAI will already have been opened by then for all foreign investors, not only those from the EU. The opposite approach, such as China allowing EU investors to establish, for example, wholly owned hospitals, whilst prohibiting investors from, say, the UK, Israel, or Singapore from doing so, seems rather unlikely.
Apart from market opening, the CAI aims at providing a more investment-friendly environment in many respects. The PRC Foreign Investment Law which took effect on 1 January 2020 and several other recent Chinese laws and regulations already include clauses on forced technology transfer – a major concern raised by nearly all China’s western business partners. The CAI also includes several provisions prohibiting forced technology transfer. It remains to be seen whether this actually turns the tide for European businesses in China. In reality, they could seldom complain that they were blatantly forced to transfer their technology to the Chinese government. The problem of knowhow leakages arose more regularly when cooperating with Chinese partners, in joint ventures or otherwise. This will not change much under the CAI.
The CAI sets out regulations regarding EU nationals’ residence in China. Managers and specialists of EU companies will be allowed to work up to three years in Chinese subsidiaries, without restrictions such as labor market tests or quotas. Representatives of EU investors will be allowed to visit freely prior to making an investment. All of the above, however, will be no improvement compared to the pre-COVID-19 status in China.
CAI requests transparency rules and enhances legal certainty
The European Commission further praises the CAI for requesting transparency rules and enhancing legal certainty and predictability of regulatory and administrative measures, as well as generating procedural fairness and the right to judicial review. The foreign business community in China will, of course, highly appreciate any strengthening of the rule of law. In contrast to the civil rights situation, the Chinese business law framework already underwent significant improvements in the previous decades and continuing on that path will be very welcome.

There are other sections of the CAI that will not apply to foreign businesses directly but to their Chinese competitors, aiming at levelling the playing field in the Chinese market. One of those that the European Commission regards as a major achievement is to compel China to transparency and disclosure obligations for subsidies. Two limits, however, have to be noted: First, these obligations will come into effect only two years after the CAI’s entry into force, which means likely only in 2024. Second, they exclusively apply to the service sector – although this is actually of some value as it would encompass the huge Chinese construction services market. But the CAI does not address subsidies in the production sector. Those already are, and will continue to be, governed by transparency obligations under WTO rules. In practice, to date they have not shown great impact, and it is unlikely that the CAI will be more successful in this regard, given that subsidies form the core of China’s state capitalism. Similarly, the CAI’s calls for Chinese state-owned enterprises to act in accordance with commercial considerations and not to discriminate in their procurement activities will probably continue to fall on deaf ears. Notably, China has not yet become a member state of the Government Procurement Agreement that pursues the same objective.

CAI: Labor law and Sustainability
EU-invested companies, like most other foreign-invested companies in China, usually strictly abide by the Chinese labor protection regulations which in a global context are quite employee-friendly. Therefore, EU-invested companies have been experiencing disadvantages when competing in areas where Chinese private competitors or the state did not always uphold a similarly high level of employee protection. That is why the EU pressed for commitments on sustainable development in the CAI. They have made it into the draft, however, only in a very weak form: China shall make “continued and sustained efforts on its own initiative to pursue ratification” of the Forced Labor Convention. Quite the same weight has been given to green growth and the fight against climate change which are being mentioned as the parties’ goals in a few non-binding provisions of the CAI.
Foreign companies are suffering from the current practice of setting industry standards in China and have long been demanding relief. The CAI considers these requests by promising equal access to standard-setting bodies for EU-invested companies in China, and committing China to enhance transparency, predictability, and fairness in authorizations. It will be worthwhile checking after a few years to see if the situation for EU investors has improved.

No investor-state dispute mechanism yet
The CAI does not yet feature any investor-state dispute mechanism. Instead, an Investment Committee on the highest political level will discuss reported breaches of the CAI annually, or more urgent ones in ad hoc consultations. If not resolved, disputes can be brought to arbitration on a state-state level. An investor-state dispute mechanism will perhaps follow later. China and the EU commit to “endeavor to complete negotiations” on such investor-state dispute mechanism within two years of the signature of the CAI which likely means not before 2024.

This all sounds not overwhelming, but the key message to have CAI critics rest assured should be the following: Even if the CAI’s benefits for European businesses are not spectacular, they are gained at a low cost. That is because in return, new commitments to Chinese businesses investing in Europe or to the Chinese state are almost non-existent in the CAI. Reportedly, when during the negotiations on the CAI the Chinese side requested a penalty mechanism for EU states that prohibit procurement from Huawei, the EU negotiators successfully countered this request. Chinese investors have long been enjoying openness and legal stability in the EU market, and after the CAI they will simply continue to do so. The CAI merely opens the EU renewable energy markets to Chinese investors, but is strictly limited to reciprocal opening in China. Security concerns of EU members states against investments in sensitive areas will be sufficiently protected by existing national law such as the German Foreign Trade Act which is currently undergoing another round of strengthening this year, and by new EU screening mechanisms.
Interestingly, the CAI can gain momentum as it coincides with China’s new five-year plan which, inter alia, promotes economic “double circulation”. This buzzword emphasizes China’s need for cross-border exchange of goods and services, in addition to the domestic market, and somehow alleviates recent concerns about completely decoupling from the west. With at best a kind of armistice but no peace treaty on the horizon in the US-China trade war, there are voices in China calling for a softer approach towards its business partners, with very few allies left among the developed countries. In its Phase 1 Trade Deal, the US negotiated beneficial treatment for their companies in the Chinese market. That is why Germany’s Chancellor Angela Merkel, speaking of the US, stated that “our interests will not always converge”. There is no reason for the EU not to seek for comparable advantages to achieve a more level playing field with a “systemic rival”, as the European Commission started labelling China in 2019. This does not mean turning away from the US. Annoyance about China’s “coercive diplomacy” has increased recently, but coercive is simply not a word that could be used to describe the CAI. Casting doubts on China’s compliance with contractual commitments at the very outset of a new deal and vowing to leave the path of mutual agreements is not the right strategy. What would be the alternative? Certainly not cutting off economic ties and treating China like North Korea. The CAI should be worth putting to the test in practice.

Summary
In short, economically the CAI seems to be the optimum achievable at this moment and does not sell EU interests. There is something to gain for EU companies, though not a lot. If properly implemented in practice, the CAI can help to address the parties’ current imbalances and reduce market asymmetries. A key factor in achieving this will be to enlarge the CAI’s coverage in the future by extending the list of eligible business sectors. The CAI could serve as a solid basis for the future economic success of EU companies in China. However, after the recent motion by the European Parliament, its future is more uncertain than ever.

falk.lichtenstein@cms-hs.com

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