The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) ultimately went into effect at the end of 2018 following a protracted negotiating process and evolution from the Trans-Pacific Partnership (TPP). This multilateral free trade agreement (FTA) includes a chapter on investments and, for the first time ever, a standalone chapter on State-owned enterprises (SOEs). The chapter is largely regarded as the most advanced and innovative set of regulations for SOE investors in the current body of foreign investment agreements (IIAs, including investment chapters in FTAs). Many advanced economies, most notably the US and the EU, have developed SOE regulations in their own FTAs, such as the US-Mexico-Canada FTA and EU-Japan FTA, which are largely based on the CPTPP SOE chapter. This supports the widely held belief that the CPTPP chapter is effective at regulating the cross-border trade and investment activities of SOEs among the Parties.

According to the United Nations Conference on Trade and Development, China has become the world’s largest source of foreign direct investment (FDI) in 2020. It is worth noting that a significant portion of Chinese FDI was made by SOEs, which have been the backbone of China’s economy since the nation’s founding. However, many host States have viewed the proliferation of Chinese SOE FDI as problematic due to the SOEs’ institutional closeness to the government owner and general operational opacity, which raise concerns over the policy drivers for Chinese SOE investment and the competitive distorting effect of Chinese SOE FDI backed by government financial support. Despite these widely held concerns, there is currently no IIA with regulations specifically aimed at Chinese SOE FDI.

Though China has not yet joined the CPTPP, the SOE chapter was largely shaped by the United States who took Chinese SOEs as perceived targets prior its withdrawal from the TPP. In September 2020, China officially applied to join the CPTPP. This indicates that the nation indicated a preliminary readiness to accept, at least in part, the SOE disciplines thereof.  A significant question then arises: Can the CPTPP SOE chapter efficiently restrict Chinese SOEs’ behaviour with regard to FDI?

Prior to evaluating the effectiveness of the SOE disciplines, it is necessary to identify the issues to be addressed. In this article, government financial support and non-commercial FDI motivations—two of the most concerning issues that Chinese SOE FDI has exposed to host States—are put to evaluation. The assessments that follow, however, show that neither issue can be addressed by the CPTPP SOE chapter.

I.   The narrow application scope of the SOE chapter

In the first place, the general effectiveness of the SOE chapter is significantly hampered by its overly narrow definition of SOE. CPTPP article 17.1 defined SOE as an enterprise ‘that is principally engaged in commercial activities’ and ‘in which a Party: (a) directly owns more than 50 per cent of the share capital; (b) controls, through ownership interests, the exercise of more than 50 per cent of the voting rights; or (c) holds the power to appoint a majority of members of the board of directors or any other equivalent management body’. This definition establishes four main criteria for an enterprise to be identified as an SOE under the CPTPP. However, arguably none of these criteria fit China SOEs’ circumstances.

The first criterion is the requirement of being ‘principally engaged in commercial activities’. However, in China’s ongoing SOE reforms, Chinese SOEs are categorized into ‘Public Welfare’, ‘Special Commercial’, and ‘General Commercial’ SOEs depending on their roles in national economic and social development.  Briefly, SOEs that provide public utilities are typically categorized as ‘Public Welfare’ and tasked with policy missions to serve society and the national standard of living. SOEs in critical industries, such as telecommunications and defence, are generally categorized as ‘Special Commercial’. They are assigned with a range of policy responsibilities, such as ensuring national security and facilitating macroeconomic adjustments. The Chinese government has also designated many major SOEs as State-owned Capital Investment and Operation Companies (SCIOs) and entrusted them with the authority to operate State-owned capitals and exercise shareholder rights in other SOEs, with the tasks of advancing national strategies and increasing the returns on State-owned capital.  Due to their clearly assigned policy tasks, it is difficult to ascertain if China’s Public Welfare and Special Commercial SOEs, and SCIOs are principally involved in commercial activities and so fall under the CPTPP’s definition of SOE. This is problematic due to the fact that a lot of well-known Chinese global investors are Public Welfare and Special Commercial SOEs or SCIOs. For instance, China Minmetals, the acquirer of Australian company OZ Minerals, is categorized as Special Commercial SOE, and Chinalco, which invested in Australian mining company Rio Tinto, is designated as a SCIO.

Although the CPTPP panels will not determine the nature of a Chinese SOE’s operational activities exclusively based on its categorization or designation under Chinese laws or regulations, but rather by scrutinizing its practical operations, the enterprise’s categorization would be prima facie evidence of a non-commercial nature.

The second criterion is that the State owns an absolute majority of the enterprise’s share capital. However, as part of the SOE reforms, China is promoting a mixed ownership reform that aims to diversify the ownership structure of SOEs. As the reform advances, an increasing number of Chinese SOEs have reduced their State ownership to a relative minority level. For example, China Unicom, the second-largest wireless telecom in China, has reduced its State ownership to 36.8 percent, a relative majority stake, by bringing in non-State-owned shareholders such as Baidu, Alibaba, and Tencent. As a result, these SOEs would fail this criterion.

The last two criteria requiring that the State controls a majority of appointment and voting rights. In the context of China’s SOE reforms, however, the Chinese government mandates SOEs to establish a Chinese Communist Party (CCP) cell known as ‘Party Committee’ within their governance structure, which functions as a separate decision-making organ parallel to the board of directors. This CCP cell has precedence over the board in deciding major company affairs, thereby ensuring the enterprise’s political adherence in operations. However, the internal operations and member appointment mechanism of Party Committee remains largely opaque. Therefore, it is difficult to determine the percentage of appointments and voting rights that the State holds within the organ.

II.   Prevent Chinese SOEs from distorting competition?

Since the era of the command economy, Chinese SOEs have enjoyed significant preferential treatment from the government, including financial assistance in the form of loans with below-market interest rates. Their easy access to funds enables Chinese SOEs to outbid foreign competitors in overseas acquisitions or unfairly compete with local firms in host countries.

In order to address this issue of competitive distortion, the CPTPP article 17.6 prohibits Parties from providing their SOEs with non-commercial assistance (NCA) that causes ‘adverse effects on the interests of another Party’ or ‘injury to a domestic industry of another Party’.  Putting aside the complicated application requirements of this rule, CPTPP article 17.1 specifies that only government assistance to SOEs can be identified as NCA. As analysed above, the CPTPP definition of SOEs is so limited that it excludes a substantial portion of Chinese SOEs. Consequently, the NCA rule’s practical applicability is limited.

In addition, the effectiveness of the NCA rule is largely dependent on China’s compliance with the transparency obligation in the SOE Chapter, which provides that a Party shall, upon the request of another Party, provide information on its policy and programme regarding the provision of NCA. When China joined the WTO in 2001, it made similar trade-related transparency commitments, which were, however, not fulfilled satisfactorily. Considering Chinese SOEs’ sophisticated funding arrangements through which government assistance is provided publicly or covertly, if China does not fully disclose all NCA-related information, it would be practically challenging for the CPTPP panels to determine the extent to which China complies with the transparency obligation.

III.   Curbing Chinese SOEs’ policy-driven investments?

Despite decades of economic liberalisation since 1978, Chinese SOEs continue to have inextricable links with the government. This political proximity has generated widespread concerns among host States that Chinese SOEs may undertake commercial activities on behalf of the owner government in pursuit of policy objectives. This is evidenced by the peculiar FDI behaviour patterns of Chinese SOEs, particularly their preference for investing in strategic sectors and acquiring foreign targets at inflated prices while disregarding commercial risks..

The CPTPP SOE chapter does not stick to the commercial nature of SOE investments, nor do any other current IIAs. Article 17.4 obliges Parties to ensure that their SOEs act in accordance with commercial considerations when engaging in commercial activities, however, only ‘in purchase or sale of a good or service’.

The absence of a prohibition or restriction on policy-driven investments in the CPTPP is not a ‘loophole’ for regulating Chinese SOEs in the future. Hot destinations for Chinese SOE investments with a robust foreign investment screening regime, such as the US and Australia, also do not raise a red flag for foreign investments driven by non-commercial objectives, so long as the transactions are determined not to be contrary to their national security or interest. In fact, operating in a socialist economy, Chinese SOEs are inevitably influenced by national policies or strategy, such as the ‘Go Global’ strategy and ‘Belt and Road’ Initiative. Curbing all policy-driven investments would be an indicium of economic protectionism and neglect of the diversity of political regimes, if such investments could be compatible with the national interest of the host States.

Conclusion

Chinese SOEs, which play a central role in China’s socialist economic development, have so many idiosyncrasies that resulting in intricacies in crafting effective IIA resolutions. The CPTPP SOE chapter is a satisfactory advancement in the international regulatory agenda due to its innovation and comprehensiveness. However, the analyses above demonstrate that even if China accepts the entire chapter without reservations, the rules are less likely than might be expected to effectively regulate the FDI behaviour of Chinese SOEs and alleviate the problems they cause. More ‘comprehensive and progressive’ SOE disciplines are awaited.