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:
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
2. Professional healthcare medical insurance
3. Financial leasing
4. Ocean cargo transportation
5. International ship management
Trade and Commerce Services
6. Value-added telecommunications
7. Selling and servicing of gaming consoles
8. Legal services
9. Credit investigation services
10. Travel agency
11. Human resource agencies
12. Investment management
13. Engineering design
14. Construction services
15. Performance brokerage
16. Entertainment venues
17. Educational and vocational training
18. Medical service
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:
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.
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:
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.
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The overall lack of clarity aside, there is some good news concerning foreign manufacturers of video games. China’s ban on video game consoles is coming to an end with the new regulations as we cite above that will allow foreign-funded companies in the Shanghai FTZ to sell gaming hardware in the country, although this too will be phased in over the next two or three years.
The lifting of the ban was confirmed on Friday in the same statement by the State Council. The rules permit foreign companies that run production and sales in the zone to sell game consoles, once the hardware receives approval from China’s Ministry of Culture. China’s prohibition on game consoles began in 2000, but despite the ban, sellers have been able to bring game systems to China through Japan and Hong Kong. Online and mobile games have been permitted in the country and have become popular, bringing in high revenue with “freemium” models.
Lifting the ban will create a major opportunity for console companies as the Chinese market opens. However, manufacturers will need to adapt their business models to suit Chinese gamers – many of which are accustomed to free-to-play games. Typically however, market adjustment issues remain. Chinese gamers may be willing to pay for the console hardware, but they don’t have a habit of buying expensive games. That said, Microsoft announced it would invest USD237million in a joint venture with Chinese Internet TV company BesTV New Media within the Shanghai zone. The partnership will develop “family games and related services” as well as adapt the X-box for Chinese usage. – CDE
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