02 April 2020

China is reshaping its Auto Industry

This article was written by Mark Schaub and Atticus Zhao.

China is re-shaping its auto industry policy. This follows the announcements in relaxation of key restrictions on foreign investment in the auto sector.

The National Development and Reform Commission (NDRC) is the body tasked in China with laying the direction for industrial policy. On December 10, 2018 the NDRC circulated the Administrative Rules on Auto Industry Investment (“Auto Industry Investment Rules”). The Auto Industry Investment Rules came into force on January 10, 2019.

In short the Auto Industry Investment Rules reform the China approval system for auto investment projects by delegating more authority to local governments, expressly prohibit any new production capacity for fossil-fuelled vehicles and raise the threshold for establishing electric vehicle manufacturing companies.

The key points of the Auto Industry Investment Rules are as follows:                                                                                      

  1. Policy Goal and Approval System Reform

The goal of the Auto Industry Investment Rules is to improve entry standards for auto industry investment projects, guide reasonable investment direction of social funds, tightly control any increase in new production capacity for traditional fossil-fuel burning autos, promote the healthy development of new energy vehicles (NEVs), and establish an innovation system for intelligent vehicles. 

A major reform under the Auto Industry Investment Rules is that the authority for all vehicle and components investment projects will be delegated to local governments and the approval system will be changed to a filing system. Before the effectiveness of the Auto Industry Investment Rules,  projects for Sino-foreign passenger manufacturing joint ventures require approval from the State Council; projects relating to electric vehicle manufacturing company require NDRC approval and other projects require provincial government approval. Accordingly this will be a very meaningful relaxation for some key foreign investments. The change also mirrors China’s decade long move away from approvals towards filing. 

  1. Key Development Areas

The Auto Industry Investment Rules require to focus on the key areas of China auto industry and speed the development of NEVs, intelligent vehicles, energy-saving vehicles and key components and parts R&D.

In the area of intelligent vehicles, the priority is to develop key common technology such as complex environmental sensing, new smart terminals, in-car intelligent computer platforms etc. In particular, the Auto Industry Investment Rules stress the development of chips, CPU and operation systems as being priority projects. This may relate to US’s sanctions on China’s telecoms equipment makers which re-emphasized China’s vulnerability if it does not own core technologies. However, it also does align with the fact that many Chinese companies have been on the hunt for semi-conductor companies in recent years.

  1. Encouraging More Restructuring and M&A

Companies are encouraged to, by way of such as equity investment and production capability sharing, conduct more M&A, strategic cooperation, joint products development and improve industrial concentration.

More notably, the Auto Industry Investment Rules support state-owned automakers and private car manufacturers to engage in a “mixed-ownership reform” in order to create industrial champions to compete with global peers. China is clearly intent in winning the race to become the leading country for autonomous cars and NEV.

Given the technology demands and capital intensive nature of the auto industry this emphasis on creating scale is no doubt necessary for China to create world leading “champions”.

This initiative again follows the long-time Chinese policy. Since 2004, China’s car industry policy has encouraged domestic car companies for restructuring and M&A so as to improve industrial concentration. Currently, the top 10 car makers in China account for 90% of the production capacity. However, in contrast with the highly concentrated Western countries, China still has more than 200 car manufacturers.[1]  As such, it is very sensible for the Chinese government to continue to encourage restructuring and M&A of Chinese carmakers in order to form industry giants which can compete toe to toe with international players.

  1. Restrictions on Fossil-fuelled Cars

Under the Auto Industry Investment Rules, the production capacity for fossil-fuelled cars has been strictly controlled.

The Auto Industry Investment Rules clearly prohibit the following investment projects on fossil-fuelled cars:

    1. establishing any new separate fossil-fuelled carmaker;
    2. existing carmakers to build fossil-fuelled car production capacity across the categories of passenger car and commercial cars;
    3. existing fossil-fuelled car makers to re-locate outside the province where it is located except for projects that have been included into regional development planning at national level or the equity structure of the company in question will not be changed; and
    4. any equity change in “zombie” fossil-fuelled car makers (i.e. in order to prevent companies taking approved but unused capacity to build more fossil fueled cars).

In addition, if an existing fossil-fuelled car maker intends to increase its production capacity then it must meet five key requirements:

    1. the utilisation rate of production capacity in the previous two years is higher than the industrial average of the same product category (passenger cars and commercial cars);
    2. the output of NEVs in the previous two years is higher than the industrial average;
    3. the proportion of R&D expenses in the previous two years to the main business income is higher than 3%;
    4. products are of international competitiveness; and
    5. the utilization rate of production capacity in the two previous years in the province where the project is located is higher than the average level of the same product category, and there is no fuel vehicle enterprise of the same product category that is specifically disclosed by the competent regulator.

The policy is clear.  It is not considered enough to issues policies to encourage NEVs (i.e. carrot) but there will also be policies curtailing fossil-fueled cars (i.e. stick). It seems fossil-fuelled car makers will have to gradually adjust their production away from fossil-fuelled cars as NEVs ascend.

  1. Electric Vehicles Encouraged but the Bar Raised

Under the Auto Industry Investment Rules, electric vehicles remain strongly encouraged by the PRC government. However, the threshold for investing in electric vehicles has been raised. The detailed requirements include:

(1) Project Area

To establish a new electric vehicle manufacturing company, the province where such proposed manufacturer is located has to meet the following conditions:

    1. the utilization rate of automobile capacity in the previous two years was higher than the average level of the same product category; and
    2. The existing investment project for new independent and identical product categories of pure electric vehicle by the enterprise has been completed and the annual output has reached the construction scale

(2) The new electric vehicle manufacturing company

For establishing a new electric vehicle manufacturing project, the new electric vehicle manufacturing company is required to meet the following conditions:

    1. having established a product R&D organization with a specialized R&D team, and having experience and capabilities for pure electric vehicle concept design, system and structural design, and other required capabilities;
    2. having the invention patent and intellectual property rights of the core technology of pure electric vehicles, and having obtained authorization or confirmation; and
    3. having good after-sales service guarantee for products.

In addition to the above, there are specific requirements on manufacturing projects, for example, in terms of construction scale, not less than 100,000 electric passenger vehicles or 5,000 electric commercial vehicles. The raised bar for electric vehicle manufacturing companies will likely be a barrier for many newcomers.

Clearly, the Chinese government has already felt that the investment in electric vehicles in China is a bit overheated considering the growing number of new start-up car makers. The higher thresholds may squeeze out a growing bubble.

NDRC revealed a 5-year transition period on 17 April 2018 to fully end China’s foreign ownership limits on automakers and foreign ownership restrictions on NEVs has been removed in 2018. As such, the requirements on electric vehicles investment project in the Auto Industry Investment Rules apply to international newcomers like Tesla.

  1. Auto Components and Parts Investment Project

The Auto Industry Investment Rules have also set out detailed requirements on investment project in auto components and cars, which primarily cover engine and power batteries.

For fossil-fuelled vehicles, engine directly relating to environmental protection and resources consumption. The Auto Industry Investment Rules require that the engine products must meet the China’s latest emission standard (i.e. China VI Emission Standard). 

For key components and parts of NEVs and power battery, the Auto Industry Investment Rules set out the requirements on production capability, core technology capability, level of intelligence and recycling capability.

These requirements are forward-looking and will upgrade China’s auto industry.

Summary

The Auto Industry Investment Rules continue and extend existing policies in place.

On the one hand China has announced relaxation of restrictions on foreign investment in auto sector with a 5-year transition plan.

On the other hand China is clearly putting in place policies to allow it to have a strong domestic auto market in which it will compete head to head with international competitors. This future competition will be in respect of NEVs and autonomous cars.

 


[1] http://www.jiemian.com/article/2184219.html

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