The Translated Regulatory Plan Plus Additional Commentary
Sept. 28 – China’s Central Government released the “General Plan for the China (Shanghai) Free Trade Zone (guofa  No. 38, hereafter referred to as the ‘Plan’)” late yesterday afternoon, which lists out the reform tasks and liberalizing measures for the Shanghai Free Trade Zone (FTZ). Detailed information on the three main tasks can be found below.
The Shanghai FTZ, the first of its kind in Mainland China, covers an area of 28.78 square kilometers, and consists of the four following existing bonded zones:
- Waigaoqiao Free Trade Zone;
- Waigaoqiao Free Trade Logistics Park;
- Pudong Airport Comprehensive Free Trade Zone; and
- Yangshan Free Trade Port Area.
Task 1: Further Opening Up Investment Sectors
According to the Plan, the Shanghai FTZ will offer easier investment access to both foreign and domestic capital and further open up the following 18 service sectors:
1. Banking services
- Allowing qualified foreign finance organizations to set up foreign banks in the Shanghai FTZ and permitting qualified private capital and foreign finance institutions to set up joint venture banks
- Allowing qualified Chinese banks to conduct offshore business in the Shanghai FTZ
2. Professional healthcare medical insurance
- Allowing wholly foreign-owned professional healthcare medical insurance organizations to be established in the Shanghai FTZ
3. Financial leasing
- Cancelling the minimum capital requirements for the establishment of single aircraft or single vessel company subsidiaries in the Shanghai FTZ by financial leasing companies
- Allowing financial leasing companies to concurrently operate factoring businesses that are associated with their primary business
4. Ocean cargo transportation
- Relaxing the restriction over the proportion of foreign equities in joint venture international shipping enterprises
5. International ship management
- Allowing wholly foreign-owned shipping management enterprises to be established in the Shanghai FTZ
Trade and Commerce Services
6. Value-added telecommunications
- Allowing foreign enterprises to run certain designated telecommunication businesses in the Shanghai FTZ
7. Selling and servicing of gaming consoles
- Allowing foreign enterprises to produce and sell gaming consoles in the Shanghai FTZ
8. Legal services
- Exploring mechanisms to enhance cooperation between mainland Chinese law firms and foreign law firms
9. Credit investigation services
- Allowing foreign investigation enterprises to be established in the Shanghai FTZ
10. Travel agency
- Allowing Sino-foreign joint venture travel agencies registered in the Shanghai FTZ to provide overseas travel services (with the exception of Taiwan)
11. Human resource agencies
- Allowing Sino-foreign joint venture human resource agencies to be established in the Shanghai FTZ (provided that the foreign shares thereof do not exceed 70 percent of the total shares)
- Hong Kong and Macau service provides are allowed to establish wholly self-owned human resource agencies
- Reducing the minimum registered capital for foreign human resource agencies from US$300,000 to US$125,000
12. Investment management
- Allowing joint stock foreign investment companies to be established in the Shanghai FTZ
13. Engineering design
- Cancelling the engineering design performance requirement for foreign engineering design enterprises (excluding engineering investigation enterprises) in the Shanghai FTZ when applying for the qualification to provide services in Shanghai for the first time
14. Construction services
- Cancelling the equity caps for Sino-foreign construction projects in Shanghai taken over by wholly foreign-owned construction enterprises established in the Shanghai FTZ
15. Performance brokerage
- Cancelling the equity caps for foreign performance agencies and allowing wholly foreign-owned performance agencies to be established in the Shanghai FTZ
16. Entertainment venues
- Allowing wholly foreign-owned entertainment venues to be established in the Shanghai FTZ
17. Educational and vocational training
- Allowing Sino-foreign education and vocational training organizations to be established in the Shanghai FTZ
18. Medical service
- Allowing wholly foreign-owned healthcare organizations to be established in the Shanghai FTZ
Moreover, the Plan provides that the Shanghai FTZ will adopt a “negative list” approach towards foreign investment management, meaning foreign investment in all sectors should be allowed unless listed as prohibited or restricted under the “negative list.” A “negative list” which details the different treatment of foreign investors and Chinese investors will be created and issued by the Shanghai government at a later date.
Task 2: Deepening the Opening-up of the Financial Services Sector
According to the Plan, the Shanghai FTZ will implement the following measures to deepen the opening-up of the financial service sectors:
- The Shanghai FTZ will start trial programs of RMB convertibility under the capital account, market-oriented interest rates, and cross-border RMB transactions;
- The Shanghai FTZ will facilitate market-oriented pricing of financial institution assets;
- The Shanghai FTZ will pilot a new mechanism for the management of foreign exchange to facilitate trade investment;
- The Shanghai FTZ will encourage enterprises to take advantage of both onshore and offshore markets;
- The Shanghai FTZ will deepen foreign debt management reform to facilitate cross-border financing; and
- The Shanghai FTZ will encourage multinationals to establish regional or global capital management centers within the zone.
Moreover, the Shanghai FTZ will gradually allow foreign companies to engage in commodity futures trading.
Task 3: Improving and Perfecting the Legal System
With the view to accelerate the formation of a high-standard investment and trade rule system, starting from October 1, 2013, 11 administrative examination and approval items regulated under the following three laws will be suspended in the Shanghai FTZ on a three-year trial basis.
- The Law of the People’s Republic of China on Wholly Foreign-Owned Enterprises;
- The Law of the People’s Republic of China on Sino-Foreign Equity Joint Ventures; and
- The Law of the People’s Republic of China on Sino-Foreign Cooperative Joint Ventures.
In addition, in order to better promote investment into the Shanghai FTZ, the Plan also allows enterprises or individual shareholders registered in the Shanghai FTZ to pay income tax in installments within a five-year period for value-added assets arising from asset restructuring.
Commentary from Dezan Shira & Associates
The new Shanghai FTZ – due to officially open Sunday – issued its first regulatory draft yesterday afternoon (Friday). Yet as is common with many such drafts, much remains unclear and ambiguous other than some grandly-worded statements. The government has left plenty of room to maneuver in the way it has worded the regulatory framework. It said that risks would have to be controlled as a precondition for capital account convertibility and interest rate liberalization. They also did not commit to full convertibility of the RMB or to rate liberalization, instead saying that the Shanghai FTZ would be used to “experiment” with these reforms ahead of other parts of China.
The main issue with these regulations thus far is that many of the so-called “benefits” – and the implementing rules that will govern them – are conceptual rather than financially driven. While it is true that especially for Waigaoqiao, the zone there has been an unqualified success in the past, the majority of its primary benefits – and those of the other zones – were significantly eroded when China effectively equalized its corporate tax rates with the 2008 Corporate Income Tax Law. Prior to this, foreign investors in Waigaoqiao had five-year profits tax breaks and an income tax rate of 15 percent. Those policies made Waigaoqiao the success it is today – but were scrapped years ago – and such tax breaks today no longer apply unless in very specific industries or areas. China’s corporate income tax rate is now a standard 25 percent; and you can add another 10 percent on top of that if profits are to be repatriated out of China.
“China often makes grand statements concerning new areas of reform, only to leave the implementing rules rather woolly,” comments Chris Devonshire-Ellis, founding partner of Dezan Shira & Associates. “We have seen this many times in the past. They like to show off the grand scheme of things, yet leave the road map to getting there only partially completed. In time, I am sure that the grand design for the Shanghai FTZ will materialize, it is just that that time is not now.”
Devonshire-Ellis adds that, in the meantime, what he believes will really make the Shanghai FTZ a success is the State Council providing hard incentives to attract investors. These could include:
- Liberalization of the foreign investment catalogue and the FDIC approval process;
- Removal of the 10 percent dividends tax on companies sited in the new zone;
- Income tax reductions or tax breaks for investments over US$10 million in the first year of operations;
- VAT refunds granted upon entry of goods into zone, not upon shipment;
- Land use right costs fixed by the government and not subject to local market demand by private landowners (local property prices have increased 30 percent since March); and
- Ability for goods to be packed into bonded sealed containers and granted trans-shipment to other bonded zones in China without the need to reopen them.
Other much touted issues, such as the liberalization of the RMB, allowing instant forex, and permitting foreign brokerages also appear on paper to be permitted, but with much remaining to be done to clarify how these will be implemented or developed. The Shanghai FTZ as is contains no infrastructure to house any financial clearing mechanisms and only contains a handful of branch banking operations and a few ATM machines – hardly the RMB forex clearing facilities that are required. Hong Kong, London and Singapore already provide such services, and it would seem unlikely for Shanghai to be left out of the loop.
Yet until the infrastructure can be injected – which needs precision global access and technologies often provided by the likes of Bloomberg (which is currently banned in China) – it appears that much remains to be done to truly lift Shanghai into position as a global trade hub for its own national currency.
UPDATE (Sept. 30, 2013): Shanghai Free Trade Zone “Negative List” Issued
The Shanghai Municipal People’s Government has just released the “Special Administrative Measures on the Entry of Foreign Investment into China (Shanghai) Free Trade Zone (2013 Negative List)” which details the different treatment for foreign investors and Chinese investors in the Shanghai Free Trade Zone. Please click here for full details.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia.
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