At the end of 2024, the German Chamber of Commerce in China released its "Business Confidence Survey Report 2024/25"[1] ("the Report"), which highlighted an emerging trend of deeper integration within the business ecosystem among German companies operating in China. Remarkably, 40% of surveyed companies indicated plans to grant greater decision-making autonomy to their China operations, independent of their global headquarters. The Report defines this strategic transformation—driven by evolving domestic market competition and regulatory shifts—as "Localization 3.0." Our latest practice also suggests that this trend has manifested in various forms, including the increasing appointment of local Chinese talent to senior executive positions and the establishment of independent R&D centers within China. These developments have proliferated among foreign-invested enterprises (FIEs) in recent years.

In the context of an evolving global high-tech landscape and escalating geopolitical complexities, localization has become a critical challenge for foreign businesses in the Chinese market. On one hand, localization has emerged as an implicit threshold shaped by the survival and development imperatives of domestic industries; on the other hand, it has become a strategic choice for FIEs seeking to adapt to the intensifying competition within the Chinese market.

This article will trace the emergence and evolution of "localization" from a practical perspective, explore its legal connotation, and highlight some core legal risks that FIEs may encounter during the localization process. It aims to serve as a useful reference for business decision-makers and/or legal compliance in the FIEs that operates in China.

1. External Pressures and Internal Demands Fuel the Evolution Toward Localization 2.0

As mentioned earlier, the Report describes the emergence of "Localization 3.0." Regarding version 1.0, the German Chamber of Commerce in China defines it as focusing on "overcoming market access constraints, such as requirement to establish joint ventures with Chinese partners".

Truly, market access constraints are perhaps the primary - or even the sole - threshold that FIEs would have to address in most countries for extended periods. However, the U.S.-China trade war, which began in 2018 and still not concluded to this day, has profoundly disrupted this paradigm. Beyond the well-known tariff disputes earlier this year, the United States has increasingly deployed economic sanctions and tightened export control frameworks. Although recent tensions between China and the U.S. appear to have eased, hardly could this indicate any shifts from the long-term trajectory—namely, coordinated efforts among the U.S. and its allies to further decouple China from strategic emerging technologies.

It is against this backdrop that Chinese industries commenced to seek domestic alternatives and pursue autonomous and controllable supply chains. On the one hand, establishing self-controlled industrial chains has become a baseline requirement for safeguarding national economic security against acute technology "chokepoint" risks. On the other hand, external market uncertainties have compelled Chinese enterprises to shift their focus toward the domestic market, driving numerous industries to transit from export-dependent models to a new structure characterized by the "domestic circulation as primary, external circulation as supplementary" framework. This also explains the profound rationale behind the German Chamber of Commerce in China's upgrade of the localization definition to version 2.0 in 2021.[2]

Though being greatly accelerated by the external factors above, this transition toward self-sufficiency and home-grown innovation is not actually unpredictable. The 《中华人民共和国国家安全法》 (National Security Law of the People's Republic of China, 2015) laid the legal groundwork for Localization 2.0 by requiring "achieving secure and controllable core network and information technologies, critical infrastructure, and information systems and data in important sectors"[3]. The same year, Made in China 2025 Initiative outlined a policy roadmap for manufacturing localization, with a target that by 2025, 70% of core components and key basic materials would be domestically secured. Fundamentally, this process is also an inevitable result of China's internal development needs. As the saying goes, stagnation is regression. Breaking path dependency and completing industrial upgrades represents an essential strategic move for China.

As a result, under the dual forces of external pressure and internal necessity, recent policies have elevated localization requirements to new heights. In December 2024, China's Ministry of Finance issued a draft government procurement regulation that grants a 20% price discount preference to domestic products. Suppliers can also enjoy this preference when domestically produced components account for 80% or more of total costs.

In critical sectors, localization requirements have been implemented comprehensively. In information technology, for instance, the Secure and Reliable Initiative (later evolved into the Xinchuang Initiative, the literal meaning of Xinchuang is information technology innovation) launched in 2019 covers hardware, software, and cybersecurity domains, implementing phased advancement from the Party and government agencies to eight major industries and then to all industries through a "2+8+N" system. In healthcare, the Guidance Standards for Review of Imported Products in Government Procurement (2021) mandates government institutions to procure domestic medical devices proportionally, involving different levels of requirements such as 100% domestication for 137 types of devices.

2. The Second Half of Localization: From Passive Adaptation to Proactive Embrace

The reader might ask: since Localization 2.0 already captures current trends such as autonomous and controllable core technologies and domestic circulation, what exactly has changed to warrant a "3.0" upgrade? To answer this, let us first examine what transpired at the Shanghai International Auto Show in April this year.

A renowned German automotive enterprise showcased new concept electric vehicles and a fully self-developed intelligent cockpit - both tailored specifically for the Chinese market. These were presented as milestone achievements in its "In China, For China" strategy. It is reported that starting from 2026, the company will launch 10 additional models designed exclusively for China across multiple market segments. A senior executive of the company's Chinese subsidiary noted that it had gradually overcome compatibility obstacles between its global technology system and the local market, significantly shortening its time-to-market. This marks a strategic shift from "Made in China" to "Defined in China."

Similarly, a major Japanese automaker at the same show adopted the theme "Global Vision, China Focus." It is reported that this enterprise made significant adjustments to the management structure of its Chinese subsidiary, unprecedentedly appointing Chinese nationals as vice chairman and general manager. More importantly, the company established an independent R&D system in China, introducing the Regional Chief Engineer (RCE) model, granting local engineers leading authority in key areas such as vehicle definition, technology roadmaps, and budget allocations.

At this stage, industrial upgrading represented by new energy vehicles and consumer electronics has achieved considerable success. Chinese domestic enterprises have rapidly enhanced their technological capabilities and developed unique competitive advantages in supply chain efficiency and market sensitivity. Consequently, market competition in China has become more intense than in many other parts of the world, leaving "time-honored" FIEs struggling to keep pace.

This means that Localization 3.0 is no longer about passively complying with local laws or offering market-specific products. Instead, the core lies in how to incorporate local talents into the R&D stage and design products catering with Chinese market from the very beginning. The answer to these questions may largely decide whether the FIEs or even their foreign headquarters would be able to maintain industrial leadership in the coming era.

Data from the Report further confirms the trend toward voluntary localization among FIEs. The Report shows that 40% of surveyed companies plan to build supply chains that operate independently for different markets, 38% intend to increase local R&D investment, and 71% embrace the "In China, For China" localization concept. These figures reflect not only a growing awareness of China's unique market dynamics but also an urgent strategic adjustment.

In the next topic, we will dive into the legal connotation of localization from a regulatory perspective. In practice, when FIEs attempt to meet various formal and informal localization requirements, we are frequently asked questions such as:

• To avoid being deemed under actual foreign control, should foreign direct or indirect shareholding ratios not exceed 25%, 49%, or some other threshold?

• In multi-layered equity structures, will authorities "pierce the veil" to determine the ultimate controller?

• How to define the nature of a Chinese subsidiary under an overseas-listed companies in the localization context? 

• Are the proportions held by foreign employees in employee shareholding platforms counted as foreign investment?

• Should the chairman and the general manager be Chinese nationals?

• Should core R&D centers be located in China?

• Should core technical personnel be Chinese nationals?

• In mixed domestic and overseas team R&D scenarios, what proportion of domestic personnel would be required for recognition as local achievements?

• Should core algorithm and source code be stored domestically?

• Should core intellectual property rights be owned exclusively by Chinese entities?

• Does transmission of design, R&D, and production process data to overseas parent companies require reporting?

• What are the specific numerical requirements for local procurement ratios of key components and production equipment?

• How should "key" components be distinguished from "general" ones?

• How is "local" interpreted in local supplier certification standards?

• At what percentage of raw material import dependency will trigger disclosure requirement?

Despite a lack of detailed legal or regulatory guidelines for the constitutive requirement of localization, we can still draw useful insights from qualification threshold settings in certain domestic bidding processes or supplier certifications. For example, some healthcare tender notices[4] require suppliers to be "non-wholly foreign-owned or foreign-controlled enterprises established for more than three years." In a previously handled case pertinent to Xinchuang products, we noticed a specific document that required member entities to have Chinese legal person or natural person majority shareholders, a Chinese national as legal representative, and foreign investment ratios not exceeding 25%.

This 25% threshold appears to be significant. Unlike the conventional 50% control benchmark, the 25% limit likely accounts for indirect control through layered structures, where even a 25% stake may theoretically achieve ultimate control. This echoes U.S. regulations under the Committee on Foreign Investment in the United States (CFIUS), which presumes "substantial interest" when a foreign party acquires 25% or more of voting rights, potentially triggering mandatory filings when national security or TID (technology, infrastructure, data) sectors are implicated.[5]

We have also seen clients required by upstream partners to obtain "localization ratio certifications," typically issued by a designated electronics research institute under the Ministry of Industry and Information Technology (hereinafter referred to as the "Electronics Research Institute"). Publicly available information shows the review is primarily based on three dimensions: whether the manufacturer is registered in the mainland of China, the proportion of foreign investment, and the nationality of its legal representative.

In most cases, localization requirements lack quantifiable legal benchmarks and need to be interpreted in light of the underlying policy objectives. From the perspective of the Electronics Research Institute, the primary goal is to maintain the security and controllability of domestic supply chains amid global geopolitical uncertainties.

Based on our experience and market observations, we opine to interpret the legal connotation of localization as follows: FIEs establish local teams in China with genuine R&D capabilities and build up a relatively independent technological and production systems. Under this model, downstream users such as state-owned enterprises can benefit from reliable technical support and supply, mitigating risks of disruption due to trade conflicts, geopolitical tensions, or other external factors. This approach balances open innovation with supply chain control and offers FIEs a more practical and sustainable path to localization.

In the foregoing sections, we analyzed the origins and evolution of localization and examined its legal connotations from a practical standpoint. For FIEs, regardless of industry-specific standards, successful strategic transformation in China generally requires embracing a strategy akin to "In China, For China." This means that the new localization trend—initiating from R&D integration of Chinese talent and market-oriented product design—may expose FIEs to several critical legal risks and challenges, including but not limited to, the following.

1. Intellectual Property Licensing and Secondary Development

To fulfill localization requirements, FIEs may license core technologies to local partners. However, after technology transfer, the foreign licensor often loses effective control over local enterprises' secondary technological improvements. Chinese law prohibits exclusive grant backs, preventing FIEs from restricting licensees' technology improvements or mandating exclusive grant back rights for improved technologies. Even where such terms are permitted, defining the scope of "improvements" is contentious and difficult to enforce. 

This arrangement significantly weakens FIEs' control over technology evolution paths after technology transfer. Local partners may enhance the licensed technology and develop more competitive alternatives, potentially outpacing the foreign licensor in both domestic and international markets, posing generational competitive threats to FIEs. FIEs face the risk of cultivating competitors, with their original technological advantages potentially transforming into competitive disadvantages.

2. Trade Secret Protection

The localization process inevitably requires deep engagement with local partners or recruiting local technical personnel to build technical teams. This involves international technology transfers, personnel training, supply chain integration and other activities that correspondingly lead to the circulation of core trade secrets such as production processes and customer information.

Unlike explicit intellectual property rights such as patents, trade secrets rely entirely on the effectiveness of confidentiality measures; once leaked, legal enforceability is at stake. How to maintain maximum possible control over sensitive information during the localization process will be a key challenging issue. 

Chinese employees participating in projects may bring trade secrets to competing enterprises through job changes, and if FIEs lack systematic management measures suitable for China's legal system, effective rights protection may prove difficult. 

Under joint venture or cooperative equity structures, Chinese shareholders may intentionally or unintentionally leak trade secrets to third parties based on their own interests, and FIEs may lack sufficient control to prevent such risks after equity dilution to satisfy localization requirements. In cross-border cooperation, differences in legal systems further exacerbate this problem. Trade secret leakage not only causes direct economic losses but may also erode FIEs' global competitive advantages.

3. Equity Structure and IP Ownership Issues in China

To satisfy localization requirements, FIEs may face risks of weakened control over their Chinese subsidiaries, which might affect unified execution of global strategies in core matters such as major business decisions, technology transfers, and financial management. Complex shareholding arrangements increase corporate governance difficulty, requiring balance among different shareholder interests and continuous attention to regulatory policy changes to ensure structures comply with the latest localization requirements. This will drive up compliance costs and increase regulatory uncertainty. More critically, once complex equity structures are established, if future business layout adjustments or exits from the Chinese market become necessary, FIEs may face obstacles such as equity disposal difficulties, valuation disputes, and regulatory approvals, reducing strategic adjustment flexibility.

Additionally, for achievements completed under China's R&D system, their intellectual property ownership will very likely have to be vested in Chinese entities as the original holder from both legal and tax perspectives. Considering that localization strategies may restrict FIEs from directly transferring core intellectual property rights back to overseas headquarters, it is necessary to design intellectual property ownership arrangements in advance in combination with local R&D system architecture, thereby satisfying localization requirements while ensuring that FIEs' overseas interests are not adversely affected to the greatest extent possible.

4. Bidirectional Cross-Border Data Transfer

China regulates cross-border data transfer primarily through laws and policy documents such as《中华人民共和国数据安全法》(Data Security Law of the People's Republic of China, 2021),《中华人民共和国个人信息保护法》(Personal Information Protection Law of the People's Republic of China, 2021),《数据出境安全评估办法》(Measures for the Security Assessment of Outbound Data Transfer, 2022), and《促进和规范数据跨境流动规定》(Provisions on Promoting and Regulating Cross-border Data Flow, 2024), with key focus on protecting personal information and important data. Generally speaking, FIEs transferring data that does not involve personal information and important data to overseas entities within their groups during multinational production, manufacturing, and marketing activities will not trigger compliance requirements such as data export security assessments, standard contracts for personal information cross-border transfers, or personal information protection certifications. 

Conversely, data transferred from overseas to China may face stricter restrictions. Advanced foreign technical information, particularly data and technical documentation in semiconductors, artificial intelligence, and other fields, may be unable to be transmitted to China due to export controls, data compliance restrictions, and other limitations from the countries where overseas entities are located.