(Reuters) -China's automakers are outpacing foreign rivals in their push for assisted-driving technology, eager to woo motorists hungry for rapid innovation.

Yet, Beijing has a nuanced message for its rising stars: move fast - but be careful.

Regulators this week have been finalising new safety rules for driver-assistance systems as Beijing sharpens scrutiny of the technology following an accident involving a Xiaomi SU7 sedan in March. That incident killed three occupants when their car crashed seconds after the driver took control from the assisted-driving system.

While Chinese officials want to prevent carmakers from overselling the capabilities of such systems, they are also threading the needle between innovation and safety to ensure their automakers don't lose out to U.S. and European rivals.

Setting clear regulations for assisted-driving tech without slowing its advancement could give China's industry an edge over global competitors, analysts say. This approach is in stark contrast to the U.S. market, where companies pursuing autonomous cars have expressed frustration that the government has not implemented a regulatory system to validate and test the technology.

Markus Muessig, auto industry lead at Accenture Greater China, said China's regulators and industries have long followed former Chinese leader Deng Xiaoping's "feel the stones to cross the river" philosophy. The expression means to steadily explore new, uncertain technologies, which "has proven very successful for this market," he said.

Current Chinese regulations allow systems that automatically steer, brake and accelerate under certain conditions while requiring the driver to stay engaged. For that reason, marketing terms such as "smart" and "autonomous" are banned.

The new rules will focus on hardware and software designs that monitor a driver's state of awareness and their capacity to take control in time.

To do this, regulators enlisted Chinese automaker Dongfeng and tech giant Huawei to help draft new rules and have sought public input over a month-long period, ending Friday. 

At the same time, government officials are pressing Chinese automakers to rapidly deploy even more-advanced systems, known as Level 3 assisted-driving, which allow drivers to take their eyes off the road in certain situations. Level 3 is the midway point on the industry's autonomous-driving scale, from basic features like cruise control at Level 1, to self-driving capability under all conditions at Level 5.

The Chinese government had tapped state-owned Changan to be the first automaker to begin Level 3 validation tests in April, but the plan was paused after the Xiaomi crash, said a source familiar with the regulatory planning process.

Beijing still hopes to resume such tests this year and approve the country's first Level 3 car in 2026, the source said.

China's Ministry of Industry of Information Technology and Changan did not respond to requests for comment. Xiaomi has said it is cooperating with a police investigation into the accident.

Driver-assistance systems are seen by industry analysts as the next big battleground in China's hyper-competitive car market.

Over the past decade, Level 2 systems have proliferated in China, including Tesla’s Full Self Driving system, as well as the Xiaomi feature involved in the March crash. The capability ranges from basic vehicle following on highways to handling most tasks on busy urban roads, under driver supervision.

Automakers have pushed down hardware costs to levels that allow them to offer Level 2 features at little or no extra cost. China's No. 1 automaker BYD has rolled out its "God's Eye" assisted-driving software for free across its entire product line-up. More than 60% of new cars sold in China this year will have Level 2 features, according to an estimate from research firm Canalys.

GLOBAL RACE

In its push for assisted-driving technology, and ultimately fully self-driving cars, Beijing is seeking to help homegrown carmakers just as it supported China's rapid rise to become the world's electric-car juggernaut.

Last year, China's government lined up nine automakers for public tests to advance the adoption of self-driving cars.

In their Level 3 push, Chinese regulators also are upping the regulatory ante by holding automakers and parts suppliers liable if their systems fail and cause an accident. Legislation passed in Britain last year adopted a similar approach to liability.

At the Shanghai auto show in April, several companies touted progress toward rolling out vehicles with Level 3 capability. Tech giant Huawei said it is ready to introduce a Level 3 system for highways after simulated testing of more than 600 million kilometers. It showed a video of drivers and passengers singing karaoke as the car drove itself.

Geely's Zeekr brand debuted the luxury SUV 9X, featuring Level 3 software the automaker said is ready for mass production in the third quarter if regulations allow. Zeekr is also applying to be part of a second batch of automakers to undergo government Level 3 validation tests.

Meanwhile, traditional automakers at the Shanghai auto show such as Mercedes-Benz and Volkswagen said they were pushing their most advanced assisted-driving features but stopped short of crossing the Level 3 liability line.

Getting there is a challenge as they are already at a cost disadvantage against their Chinese rivals, analysts say.

Mercedes-Benz CTO Markus Schaefer told Reuters that while chip and computing power prices have fallen, the additional safety required for Level 3 will cost much more.

"It's a moving target," Schaefer said.

(Reporting by Zhang Yan, Victoria Waldersee and Nick Carey; Editing by Mike Colias, Brenda Goh and Sam Holmes)