The Ministry of Science and Technology formulated and had brought into action on July 1st 2023 the Detailed Rules on Implementation of Human Genetic Resource Management Regulations (“Rules”) in order to fully implement the Biological Security Law, Human Genetic Resource Regulations (“Regulations”) and other laws and manage human genetic resources scientifically, rigorously and efficiently.

According to the Rules, the reform to streamline the government, delegate power and improve government services is deepened, the key processes are regulated better, the overall plan to fully implement the policy of streamlining the government and delegating power is made under the commitment to protecting the biological security in China, the application scope of the administrative permit and recordation rules is optimized, and the system works better. It is generally accepted that the Rules is very good for the pharmaceutical industry.

Human genetic resources are important substance and basic information for scientific researches in life science and basic materials used to find out how the physiological mechanism of human beings works, how diseases appear and develop and where people catch diseases. They are also strategic resources concerning national security. Life sciences are in the most active and creative area of science, technology and business and closely connected with personal rights, including lives and health, freedom and dignity, public health, national security, public interests and other significant issues and have been one of the concerns of governments and people of different countries over the past thirty years.

With the advancement of genetic technology, there is some room for legal authorities to interpret human genetic resources laws in most countries. The Rule is more operable than the Regulations, but some of its provisions are still not clear and confusing to the regulated people when working for compliance.

There are a lot of comments on the Rules concerning the government ability, power and measures to perform the regulatory duties from medical and legal professionals on the internet, which will not be repeated in this article. The pharmaceutical industry is bound to fully understand and use the Rules in the pharmaceutical innovation of our country.

This article is intended to deal with two clauses that are unclear but important to the compliance work of pharmaceutical organizations. One is Article 12 in which the meaning of the word “great influence” used to define the actual control of the foreign side is not clear and the other is Article 37 in which the scope of the human genetic resource and information security investigation is not clear. Nothing contained in this article may be considered as legal advice. I hope you find this article helpful to your work.

I. Historical background of the regulation of human genetic resources in China

Before discussing the legal provisions, let’s first look at the legislative background of human genetic resource management and updates in administrative law enforcement in science and technology.

In 1997 the academician Tan Jiazhen who laid the foundation for modern genetics in China suggested the central government protect our genetic resources. For twenty years after the Temporary Rules on Human Genetic Resource Management was published in 1998, the legislative body and the State Council have never stopped working to create and improve genetic resource protection laws. In particular, since we entered the new era of socialism with Chinese characteristics, biological security, including human genetic resource management is part of the general principles of national security. The Covid-19 pandemic makes it more urgent to have genetic resource protection and biological security laws.

In Article 3 of the Biological Security Law brought into action on April 15th, 2021, biological security is an important part of national security, which should be protected by fully implementing the general principles of national security. The Chapter VI of this law includes special provisions relating to human genetic and biological resource security protection. To understand and comply with the Rules, we need to know the aims of the Biological Security Law and the Regulations and realize that as the world is experiencing great changes that are never seen in a hundred years, it is a constitutional obligation of all Chinese citizens and a call for the compliance work of pharmaceutical organizations to protect biological security in our country by following the general principles of national security.

Article 49 of the National Security Law requires that there be a coordination and collaboration mechanism between central and local governments, one department and another, military force and local department and one area and another. The report of the 20th National Congress of the Chinese Communist Party advises improving the distribution of the power of national security and establishing a fully interactive and effective national security and defence system. We have made departments concerned cooperate and coordinate with each other in working together as a whole to protect national security in a coordinated and collaborative way.

Do not underestimate the determination and ability of the State Council’s departments and commissions to establish and maintain a mechanism where they coordinate and collaborate in law enforcement by following the general principles of national security in the new era of socialism with Chinese characteristics. The Ministry of Science and Technology asked the State Council’s departments concerned and other groups and experts for advice on formulating the Rules.

In administrative law enforcement, according to the “general requirements” of the Instructions on Further Implementing Cross-department Integrated Regulation by State Council Office (GBF[2023]No.1), to deal with regulatory issues involving different departments or in a difficult or dangerous situation, we should establish a sound cross-department integrated regulation system, have local authorities work together more closely at both vertical and horizontal levels, improve the coordinated regulatory mechanism and increase the accuracy and efficiency of the regulatory work.

In data resource law enforcement, in March 2023 the National Congress adopted the State Council’s organizational structure reform proposal to set up the State Administration for Data administered by the National Development and Reform Commission, responsible for coordinating and working further to develop basic data systems and making overall plans to integrate, share, develop and use data resources. Administrative and data resources necessary for the Ministry of Science and Technology to perform its administrative powers to manage human genetic resources are not limited to its own. Pharmaceutical organizations should be careful when handling administrative permit and recordation formalities.

II. What does the words “great influence” mean when related to the actual control in Article 12 of the Rules?

In Article 12 of the Rules, an entity whose founder or actual controller is a foreign organization or individual refer to one:

(1) in which such foreign organization or individual directly or indirectly hold 50% or more shares, equity, voting rights, property or similar interests;

(2) in which such foreign organization or individual directly or indirectly hold less than 50% shares, equity, voting rights, property or similar interests but has voting rights or other interests with control or great influence over its decisions, management, etc.;

(3) such organization or individual has control or great influence over its decisions, management, etc. by investment, agreement or other arrangement; or

(4) in other circumstances set out by law, administrative regulation or rule.

Obviously, in the event (1) the actual control is acquired by holding shares or interests in the financial structure as part of corporate governance; in the event (2) “great influence” may come from decision making or management power in addition to shares and interests in the financial structure; and in the event (3) a foreign investor may have actual control with “great influence” over a domestic entity by “other arrangement” without having shares, financial interests or decision making or management power in it.

It is clear that the Ministry of Science and Technology defines the “actual control” in national security in a much broader way than that in corporate governance. In other words, domestic businesses that no foreign shareholders have control over could be found as “foreign entities”. Most people think “great influence” is not clearly defined in Article 12 of the Rules although domestic businesses controlled by foreign investors through VIE agreement will be found as foreign entities.

Based on the general principles of national security, I believe that the Ministry of Science and Technology could define “great influence” that the actual control comes from by referring to national security rules of other departments of the State Council. For instance, in Article 4 of the Foreign Investment Security Review Rules published by the National Development and Reform Commission in November 2020, the foreign investor should be deemed to have “actual control over the foreign funded business mentioned in the second item of the preceding clause” if they (1) hold 50% or more shares in the business; hold less than 50% but have voting rights so that they have great influence over the board of directors or the shareholder meeting making resolutions; or (3) have great influence over business decisions or its personnel, finance, technology, etc.

After comparing with the Rules, we found that the National Development and Reform Commission and the Ministry of Technology defined the “actual control” basically in the same way that is based on the share structure, decisions and management that have great influence and other arrangements that have great influence. The Foreign Investment Security Review Rules gives a little more details of the circumstances of “great influence” than the Rules, without specifying them. Anyhow, it reminds us of understanding the meaning of “great influence” from “decision and management” and “other arrangements” in other foreign investment security related law.

To implement an overall plan to help foreign investment and effectively protect national security, the Foreign Investment Law and the Implementation Regulations of Foreign Investment Law were formulated in connection with the two sets of Rules above mentioned and the Foreign Investment Information Reporting Rules published by the Ministry of Commerce and the State Administration for Market Regulation took effect on January 1st, 2020, under which foreign funded businesses are required to submit true information about the investors and their actual controllers with initial and annual reports. In the legal framework any business set up in a form of foreign investment made in Chinese businesses by foreign funded businesses in any area will be “penetrated”.

The Ministry of Commerce made the No.62 Announcement in 2019 to implement the Foreign Investment Information Reporting Rules. The foreign investment information report form attached to the announcement sets out three ways of control similar to those in Article 12 of the Rules. The second way is to directly or indirectly hold less than 50% shares, equity, property shares, voting rights or other similar interests with (1) the right to directly or indirectly appoint more than half of the board of directors or similar decision making authority; (2) the ability to secure more than half of the board of directors or similar decision making authority by nomination; or (3) voting rights enough to exert great influence on the decision making authority like the shareholder meeting and the board of directors when making decisions. (1) and (2) are events of “great influence” coming from decision making and management activities. (3) is an all-inclusive clause.

In the guide to application of the No.2 Corporate Accounting Guidelines-Long-term Equity Investment published by the Accounting Guideline Commission, a business usually has great influence on the invested entity in one or more of the following events. The business (1) has a representative in the board of directors or similar authority, (2) is involved in the process of formulating financial or business policies, (3) has important dealings with the invested entity, (4) appoints managing director(s) of the invested entity or (5) provides key technical data to the invested entity. The investor may not have great influence on the invested entity in one or more of the above events. The business should make the decision by considering all the facts and circumstances.

In the events (1), (2) or (4) in the application guide, the investor has “great influence” on the invested business for decision making or managerial reasons. The accounting guideline commission believes that the great influence means the power to take part in deciding financial and business policies of a business with no control or common control over formulating such policies. According to how the Ministry of Science and Technology defines the actual control as described above, I believe that in the above events (1), (2) or (4), a person could have the actual control over a business unless definite evidence shows the person cannot take part in deciding production or business matters of and therefore does not have great influence on the business.

It is important, I believe, that according to the Foreign Investment Security Review Rules, if the foreign investment security review work mechanism office requires the parties involved comply with the security review procedures for “key technology and other important areas”, the business will basically be found as “foreign entity” by the ministry. In this case, even if the parties involved file the application voluntarily and pass the security review, the work mechanism office may not change the way they decide the actual control of the foreign entity. The foreign investor may have control over the business in non-important areas.

Admittedly, it is very difficult for domestic pharmaceutical entities to decision making mechanism, management and other business information of their partners. I suggest domestic entities discuss related Chinese regulatory rules in detail with partners before reaching cooperation agreements with them and try not to make any unplanned capital or time investment as it is not difficult for the Ministry of Science and Technology to obtain information of foreign funded businesses because of the collaboration mechanism for government departments within the current legal framework based on the general state security principles.

Domestic entities can appoint law firms to perform due diligence investigations of the actual controllers of their partners. Please note that domestic entities can consult information about partners that are defined as “foreign entities” by share structure directly through the human genetic resource management system. This only applies to businesses that can use the online application system.

In the foreign investment information report form, the third way to gain control is to “have the power to decide operational, financial, HR or technical matters by contract, trust, etc.”. In the guide to application of the No.2 Corporate Accounting Guidelines-Long-term Equity Investment, factors related to “great influence” include (3) important transactions with the invested entity and (5) key technical data provided to the invested entity. The Foreign Investment Security Review Rules provides that the foreign investor’s great influence on the company’s “technology” is actual control. I think “other arrangements” that give a person authority or great influence over the entity’s decisions, management, etc. in Article 12 of the Rules can be construed as including (not limited to) technology and the market.

In the pharmaceutical industry that is closely connected with human genetic resources, technical factors that are usually considered when deciding if foreign investment has “great influence” on a domestic business include but are not limited to: patent and know-how licenses (such as license- in for new drug patent), key technology (such as nucleic acid delivery, rare biomarkers, artificial intelligence driven drug screening platform, etc.), key ingredients (such as chemical inactivators for inactivated vaccine), international supply chain management, etc. The market factors related to “great influence” include but are not limited to sole distribution license for main products of the foreign funded business on the Chinese market through sale networks of the foreign investor, research, development and sale of related products through cooperation (such as cancer targeted drugs and diagnostic products), overseas commercialization licenses, including applications for approval for overseas market launch of main products.

The pharmaceutical industry is highly regulated and professional, in which almost all products must be approved for market-launch, used and regulated after market-launch in an open and transparent way. Only in this way can they be granted administrative approval by the government, generally accepted in the medical industry and sold. On the contrary, the decision-making and management mechanisms of a business are run in a secret way. Before establishing a cooperation relationship with a foreign funded partner, domestic pharmaceutical entities should gather and study full technical and market information to decide if it might have “great influence” on technology and the market. (To continue)