China: China’s (Shanghai) Free Trade Zone Paves Way for Foreign Investment in China’s Value-added Telecommunication Service Market

Last Updated: 13 May 2014
Article by Wang Rui and Ge Yibo
  1. Introduction

China's (Shanghai) Pilot Free Trade Zone ("FTZ") has attracted global media attention ever since it was established in September 2013. This can largely be attributed to the new FTZ rules that relax restrictions on foreign investment in China's markets. In particular, the value-added telecommunication services ("VATS") sector in the FTZ opens up foreign investment in two main ways: (1) lifts bans on foreign investment in foreign invested telecom enterprises ("FITE") in certain service areas, e.g., in information services (only applicable to application stores); and (2) opens up four new types of VATS services previously closed to foreign investment (i.e., call center services, internet access services, domestic multi-party communication services, and domestic internet VPN services). In mid-April of 2014, the government further issued detailed procedures and guidelines on the establishment of FITEs in the FTZ. This Article aims to provide an update of these new developments in the FTZ.

  1. FTZ opens up VATS to foreign investment

On January 6, 2014, the Ministry of Industry and Information Technology ("MIIT") and the Shanghai Municipal Government issued the Opinions on Further Opening up Value-added Telecommunication Business to Foreign Investments in the China (Shanghai) Pilot Free Trade Zone («关于中国(上海)自由贸易试验区进一步对外开放增值电信业务的意见») 1 ("Opinions"). The Opinions introduce a number of new initiatives that increase participation by foreign investors in the telecom industry.

For example, the Opinions open up seven types of VATS services to FITEs that are incorporated in the FTZ and that have all their service facilities located in the FTZ. More specifically, a FITE incorporated in the FTZ is authorized to provide:

  • five kinds of telecom services without any restrictions on foreign investment, i.e. the foreign investor can make up to 100% investment in the FITE, including in: (i) application store services, (ii) store-and-forward business services, (iii) call center services, (iv) internet access services (provision of internet connection services to online users), and (v) domestic multi-party communication services2;
  • two kinds of telecom services, subject to restrictions on foreign investment, including: (i) online data and trade processing services (i.e., operating e-commerce businesses), subject to a 55% investment restriction, and (ii) domestic internet virtual private network (VPN) services, subject to a 50% investment restriction.3

All of the above mentioned services can be provided on a nationwide basis, except internet access services which are only allowed to be provided to customers in the FTZ. Since the FTZ is a pilot zone to test reform initiatives that may significantly impact China's relevant markets, the Opinions serve as an important signal to show that the government is moving towards liberalizing the telecom industry.

  1. More specific guidelines for FITEs in the FTZ

The procedures and requirements to establish FITEs in the FTZ are now different from the general requirements to establish FITEs in China in several aspects. On April 15, 2014, to provide foreign investors with more detailed rules on investment in the VATS sector in the FTZ, the MIIT issued the Administrative Measures for the Pilot Operation of Value-added Telecommunications Business by Foreign Investors in China (Shanghai) Pilot Free Trade Zone («中国(上海)自由贸易试验区外商投资经营增值电信业务试点管理办法») ("FTZ FITE Measures"). In addition to the general requirements on FITEs under the current Administrative Provisions on Foreign Invested Telecom Enterprises («外商投资电信企业管理规定») 4 ("General FITE Provisions"), the FTZ FITE Measures provide the following specific requirements for the establishment and operation of FITEs in the FTZ:

  • The registered capital of a FITE incorporated in the FTZ must be 1 million RMB or more.5 This is only 10% of the registered capital required by a FITE (providing VATS nationwide) under the General FITE Provisions. 6
  • The Shanghai Branch of the MIIT ("MIIT Shanghai Branch") is the competent authority to examine and approve applications to operate VATS businesses in the FTZ. Under the General FITE Provisions, the competent authority to deal with similar issues (for FITEs providing VATS services nationwide) is the MIIT.
  • The MIIT Shanghai Branch is empowered to decide whether or not to approve an application for operating VATS businesses within 60 days. This is significantly less than the time needed for the MIIT to make such decisions under the General FITE Provisions (around 5 months in total)7.
  • The license to be granted by the MIIT Shanghai Branch to qualified applicants for operating VATS businesses is called the License for Pilot Operation of Value-Added Telecommunications Business by Foreign Investors in China (Shanghai) Pilot Free Trade Zone («中国(上海)自由贸易试验区外商投资经营增值电信业务试点批复») ("FTZ VATS License"). The MIIT Shanghai Branch needs to file the information of each FTZ VATS License with the MIIT within 10 days after the license has been issued.
  • An FTZ VATS License is valid for a period of 3 years8, which is 2 years shorter than that of a VATS license under the Measures for the Administration of Telecom Service Operations («电信业务经营许可管理办法») 9.
  1. Influence of the FTZ regulations in practice

In general, the new FTZ regulations open up foreign investment to various businesses involved in the Chinese telecom industry, e.g., cloud computing, and more specifically, e-commerce. However, since the release of the Opinions in January 2014, the government has taken a cautious regulatory approach in approving the establishment of FITEs in the FTZ. In the approval process, the government authorities will consider the investor's reputation and creditworthiness in the industry, as well as the potential influence of the project. Consequently, up until the FTZ FITE Measures were issued, the government rarely granted FITEs with VATS licenses in the FTZ.

E-commerce market

In recent years, foreign investors have shown increasing interest in the Chinese e-commerce market – in particular in operating online platforms to sell third party goods in China. However, this is considered to involve a type of VATS ("online data and trade processing services"), which is generally subject to a 50% restriction in foreign investment under China's WTO commitments.

In theory, the Opinions bring good news to foreign investors that seek to gain a foothold in the e-commerce business as they can now hold majority shares (55%) in e-commerce businesses based in the FTZ. However, as mentioned above, the government has currently adopted a strict regulatory approach that makes it difficult for foreign investors to obtain the relevant license(s) in practice.

One company that successfully acquired a VATS license to provide e-commerce services in the FTZ is Newheight E-Commerce (Shanghai) Company Ltd. (纽海电子商务(上海)有限公司) ("Newheight E-Commerce"). Newheight E-Commerce was established on November 14, 2013. This company intends to support the technical operation of a well-known online supermarket called "YHD" (一号店) (http://www.yhd.com/), which is controlled by Wal-Mart Stores, Inc. ("Wal-Mart"). The two shareholders of Newheight E-Commerce include (i) a Chinese domestic company and a (ii) Hong Kong incorporated company named Newheight Corporation Limited, which is ultimately controlled by Wal-Mart10. Newheight E-Commerce is currently permitted to provide information services (excluding fixed network telephone information services) and online data and trade processing services. Now, the online platform (http://www.yhd.com/) effectively integrated the access to the web-mall business of Wal-Mart (platform for independent third party vendors) ("1MALL"一号商城) and its core web-store business (online store selling its own products) ("YHD"一号店).

Cloud computing

China's cloud computing industry has experienced fast and dynamic growth in recent years, which has attracted an increasing amount of interest from foreign investors. Although there is no specific telecommunication legislation that covers cloud computing yet, the majority of cloud computing services fall under the PRC Telecommunication Regulations («中华人民共和国电信条例»)as VATS, which are tightly restricted in China. Since cloud computing services encompass a wide range of services, market suppliers may need various kinds of VATS licenses to provide these services (depending on the type of their cloud computing services).

The Opinions open up several kinds of VATS businesses to foreign investment in the FTZ that may allow foreign investors to provide certain cloud computing services (if they can obtain the corresponding VATS license(s)). For example, foreign investors may now provide "domestic multi-party communication services" (e.g., audio/visual conference call services) through a FITE business structure within China.

Nevertheless, against many expectations, certain key VATS businesses that are required to provide certain cloud computing services remain closed to foreign investors. For example, internet data center services ("IDC"), which are largely used as the fundamental IT infrastructure in the provision of cloud computing services, are still closed to foreign investors. As a result of the existing restrictions, foreign investors tend to use other structures to enter China's VATS markets.

One of the ways foreign investors can enter the VATS market is to partner up with Chinese companies that can obtain (or already have obtained) the relevant VATS licenses required to provide cloud computing services. In June 2013, Microsoft launched 'Microsoft Azure' in China, together with Chinese partner 21Vianet, to provide businesses with computing, storage, database, integration, connectivity and support for open-source software over the internet.11 In December 2013, Amazon.com signed a memorandum of understanding with the Beijing and Ningxia governments to develop cloud computing services in China. To do so, Amazon.com will partner up with several Chinese providers, including ChinaNetCenter and SINNET, who will provide the IDC and ISP services required to deliver the relevant cloud computing services in China.12 On the exact same day of the Amazon.com announcement, IBM also announced its agreement with Chinese partner, 21Vianet, to provide 'IBM SmartCloud Enterprise', private cloud infrastructure and managed services in China.13

  1. Comments

The FTZ rules are fairly new and there are not many examples available to show how the government adopts the rules in practice – but it does introduce a new trend. That is, the adoption of the FTZ rules illustrates part of a wider effort of the Chinese government to liberalize foreign investment in China's VATS businesses. In line with this trend, we expect to see more VATS businesses opening-up to foreign investment nationwide in the future. It will be interesting to see what this trend will mean for the Chinese telecom industry and what kind of opportunities it will bring to both foreign and domestic players in the market.

Footnotes

1Promulgated on January 6, 2014 and became effective on the same date.

2See Article 2 of the Opinions.

3Ibid.

4Promulgated by the State Council on December 11, 2001 and last revised on September 10, 2008.

5See Article 3 of the FTZ FITE Measures.

6See Article 5 of the General FITE Provisions.

7See Article 11 and 17 of the General FITE Provisions.

8See Article 6 of the FTZ FITE Measures.

9See Article 13 of the Measures for the Administration of Telecom Service Operation, which was promulgated by MIIT on March 1, 2009 and became effective on April 10, 2009.

10See < http://finance.ifeng.com/a/20131212/11262595_0.shtml > and < http://it.southcn.com/9/2013-12/12/content_87041184_2.htm >

11See http://www.scmp.com/business/companies/article/1271351/microsoft-promote-cloud-computing-china.

12See http://www.noodls.com/view/9641BFF4004BB085814C1FC04FF3046B3D4D1708?5876xxx1387358190.

13See < http://usa.chinadaily.com.cn/business/2014-01/02/content_17210951.htm >, and < http://www.thewhir.com/web-hosting-news/ibm-enterprise-cloud-services-available-china-via-21vianets-beijing-data-centers >.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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