The success of the pilot Free Trade Zone (FTZ) and

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1 imaginechina The Third The Shanghai pilot Free Trade Zone is billed as a major economic reform initiative and while foreign companies appear optimistic, many are waiting for the details to emerge By TIMOTHY P. STRATFORD AND SCOTT LIVINGSTON The success of the pilot Free Trade Zone (FTZ) and its impact on foreign companies may take years to fully evaluate, but it s certain that the experiment is an important part of Xi Jinping s reform priorities aimed at liberalizing the flow of goods and services and developing Shanghai into an international financial center. Officially launched on September 29, the FTZ provides an opportunity for Chinese leaders to test and refine these economic reform initiatives before their potential roll-out nationwide. For foreign investors, the zone has the potential to provide a number of new investment opportunities. As set forth in the State Council s Notice of the General Plan of the China (Shanghai) Pilot Free Trade Zone, the Shanghai FTZ will loosen restrictions for foreign investment in 23 service sectors, including banking, financial services, healthcare and technology. The zone will also replace the current investment approval process required of all foreign direct investment with a negative list approach that eliminates all but ministerial filing obligations for investments in industries not included on the list. According to officials from the Ministry of Commerce and the National Development and Reform Commission, China has adopted a negative list approach in part to help it prepare to conclude a bilateral investment treaty (BIT) with the U.S. that is likely to include commitments defined on a negative list basis. Additionally, these same officials have said that the zone will help position China to join the Trans-Pacific Partnership (TPP) currently being negotiated by the U.S. and 11 countries in the region. Despite these positive steps, initial reactions to the Shanghai FTZ have been reserved, with investors concerned that vested interests and a lack of implementing specifics may hinder the zone s full development. Still, domestic and foreign investors assessing the prospects for the zone should find encouragement in the lessons of history. Since the opening of the Shenzhen Special Economic Zone in May 1980, Chinese leaders have demonstrated a preference for managed incremental economic reforms launched initially on a 22 insight NOVEMBER 2013

2 cover story Wave? pilot basis, over sudden, broadly-implemented reforms, and their associated risks to economic and social stability. In addition, past leaders have successfully used external pressures and opportunities, such as the WTO accession process during the late 1990s, to drive a domestic reform agenda. The Shanghai FTZ shares the hallmarks of these past initiatives and, as the most visible expression of Xi s economic reform policies to date, could signal the launch of a third wave of economic reform following Deng s original reform and opening 35 years ago and China s 2001 entry into the WTO. Investors should not dismiss its potential significance at this early stage. Contemplated reforms China s plan for the pilot Shanghai FTZ provides a first indication of the economic reforms being contemplated by Xi. Of its several aims, three stand out as being most significant for foreign investors. First, the plan anticipates China s conclusion of a BIT with the U.S. and adopts a negative list approach for investment approvals that eliminates, for all non-listed industries, the current approval process required for inbound foreign investment and Timothy P. Stratford Scott Livingston Timothy P. Stratford, managing partner at Covington & Burling in Beijing, previously served in Washington, D.C. as the Assistant U.S. Trade Representative responsible for U.S.-China trade relations from Scott Livingston is an associate at Covington & Burling and advises international clients on regulatory compliance, government affairs and corporate matters. replaces it within the zone with a filing for the record requirement. Foreign parties contemplating investment in industries listed on the negative list, however, will need to apply for investment approval as before. For investment in non-listed industries, this imaginechina Potential investors register at the pilot Free Trade Zone november 2013 insight 2 3

3 FTZ Measures in Focus The following list was excerpted from the government-issued lists that may be of interest to foreign enterprises looking at exploring opportunities within the pilot Free Trade Zone. These measures apply only to enterprises that are registered in the Shanghai FTZ. Banking Services Permit qualified foreign-invested financial institutions to establish foreign-invested banks. Permit qualified Chinese private investors to jointly establish Sino-foreign equity joint venture banks with foreigninvested financial institutions. When conditions are met, banks with restricted licenses may be established in the FTZ at the appropriate time. Subject to the strengthening of effective supervision and the improvement of related administrative measures, permit qualified Chinese-invested banks in the FTZ to carry out offshore business. Professional Medical Insurance Establish foreign-invested professional medical insurance organizations on a trial basis. Financial Leasing Remove the minimum registered capital requirement for financial leasing companies establishing a single aircraft or single vessel subsidiary within the FTZ. Permit financial leasing companies to concurrently engage in commercial factoring business that is associated with its principal business. Ocean Cargo Transportation Loosen equity restrictions for foreign investors in Sino-foreign joint venture (cooperative or equity) international shipping enterprises. Relevant pilot administrative measures shall be formulated by the competent department in charge of transportation under the State Council. Ships operating under a foreign (non-prc) flag that are wholly Chinese-owned or owned by an enterprise where the Chinese party is the controlling party are permitted to carry foreign trade import/export containers between Chinese domestic coastal ports and the Port of Shanghai on an initial pilot basis. International Shipping Management Permit the establishment of wholly foreign-owned international shipping management enterprises. Value-Added Telecommunication Sectors Subject to the guarantee of network information security, permit foreigninvested enterprises to engage in certain designated sectors of valueadded telecommunication services. State Council approval shall be obtained where such business conflicts with administrative regulations. Gaming Consoles Permit foreign-invested enterprises to engage in the production and sale of game consoles. Following content examination by the department in charge of culture, the gaming consoles can be sold to the Chinese domestic market. Legal Services Explore means and mechanisms to strengthen cooperation between Chinese and foreign (including Hong Kong, Macao and Taiwan) law firms. Credit Investigation Services Permit the establishment of foreign-invested credit investigation companies. Travel Agencies Permit qualified Sino-foreign equity joint venture travel agencies registered in the FTZ to engage in outbound tourism business (except to Taiwan). Representatives of two companies show off their business license at Shanghai Waigaoqiao Free Trade Zone on September 29 Human Resource Agencies Permit the establishment of Sino-foreign equity joint ventures for human resources intermediary agencies, provided the foreign-owned equity does not exceed 70%; permit service providers from Hong Kong and Macao to establish wholly-owned human resources intermediary agencies. Reduce the minimum registered capital requirement for foreigninvested human resources intermediary agencies from US$300,000 to US$125,000. Investment Management Permit the establishment of joint-stock foreign investment companies. Engineering Design The requirement to show engineering design achievements for the initial qualifications application will be eliminated for foreign invested engineering design enterprises (not including engineering surveying) established in the FTZ and providing services to Shanghai. Construction Wholly foreign-owned construction enterprises within the FTZ carrying out Sino-foreign joint construction projects in Shanghai will not be subject to equity restrictions for the construction projects. Performance Brokerage Agencies Eliminate equity restrictions on foreign-invested performance brokerage agencies, and permit the establishment of wholly foreign-owned performance brokerage agencies to provide services for Shanghai. Entertainment Venues Permit the establishment of wholly foreign-owned entertainment venues to provide services in the FTZ. Educational and Vocational Training Permit the opening of Sino-foreign cooperative commercial educational training institutions. Permit the opening of Sino-foreign cooperative commercial vocational skills training institutions. Healthcare Permit the establishment of wholly foreign-owned medical agencies. Courtesy Covington & Burling LLP imaginechina 24 insight NOVEMBER 2013

4 Restricted Zone: Salt, Subways and Villas cover story Some items on the negative list that some may not expect: Wholesale of salt (prohibited) Publishing of books, newspapers and periodicals (prohibited) Construction and operation of golf courses (prohibited) Construction and operation of villas (prohibited) Investment in venues to provide Internet access (i.e., cybercafé) (prohibited) Construction and operation of nuclear power stations (equity controlled by Chinese party) Construction and operation of large-scale theme parks (restricted) Erotic industry (prohibited) Construction and operation of city subways and light railways (equity controlled by Chinese party) remain unclear. Within the zone, the plan also permits foreign investors to open foreign-invested banks, and Chinese banks to carry out improved offshore banking business. The combination of enhanced banking services and capital account convertibility could limit some of the challenges to outbound investments currently faced by Chinese companies. Political context The prospects for the zone s success are best understood by placing it within its greater economic and political context. For the past several years, there has been growing recognition that China s present investment-led growth model has run its course and that further market reforms are needed to sustain China s historic 30-year growth trend. Now in the initial phase of a likely 10-year presidential term, President Xi Jinping has placed economic reform at the forefront of his domestic agenda. He is assisted in this effort by Premier Li Keqiang, who is widely understood to be the driving force behind the establishment of the Shanghai FTZ. As vice premier in 2012, Li sponsored an influential reformreform should significantly decrease the time and uncertainty associated with setting-up and opening a business in China. The negative list for the Shanghai FTZ was released on September 30 and classifies nearly 200 sectors as either restricted to foreign investors or permitted only with government approval. Government officials have acknowledged that while the first iteration of the negative list is somewhat lengthy, it will be pared down in subsequent versions following the further development of the Shanghai FTZ. Second, the plan relaxes restrictions on 23 service industries previously restricted or prohibited to foreign investment such as banking and financial services, certain value-added telecommunication services (e.g., cloud computing and other Internet-based service offerings), healthcare and entertainment (see side box for complete list). Third, the plan champions the acceleration of innovation within the financial system through, among other measures, allowing RMB capital account convertibility, market interest rates and cross-border RMB handling within the zone. However, how such measures will be opened to foreign investors, and how they may be cordoned off from affecting the rest of the country, Premier Li Keqiang november 2013 insight 2 5

5 imaginechina Many are comparing Shanghai s pilot FTZ to Shenzhen s special economic zone established 30 years ago oriented report entitled China 2030: Building a Modern, Harmonious, and Creative High-Income Society. Jointly drafted by the World Bank and the Development Research Center of China s State Council, the report called for significant structural and economic reform, a strengthening of China s financial system, and the accelerated development of China s innovation capacity. Xi s decision to use the Shanghai FTZ as a testing ground for economic reform echoes Deng Xiaoping s use of similarly purposed special economic zones beginning in the late 1970s. As such, it is but one example of how Xi s administration has used historically successful reform models to push forward its reform agenda. This appeal to historical models was first seen in December 2012, shortly after his appointment as General Secretary of the Chinese Communist Party in March, when Xi chose Shenzhen as the destination for his first inspection tour. Shenzhen is closely linked in China s collective memory with Deng s reform and opening initiatives, both as the first special economic zone opened in 1980, and as one of the more significant stops on Deng s 1992 Southern Tour, which reaffirmed China s commitment to market reforms following the uncertainties of the post-1989 era. Xi s visit paid homage not only to Deng, but also to Deng s commitment to reform. Second, the leadership s striking interest in concluding certain previously resisted trade agreements with the U.S. and other countries parallels Chinese Premier Zhu Rongji s use of the WTO accession process to drive domestic reform during the late 1990s. In July at the U.S.-China Strategic and Economic Dialogue, for example, China surprised many observers by accepting preestablishment coverage and a negative list approach as a basis for negotiating a U.S.-China BIT. The significance is that China would be required to grant national treatment not only to American investments after they are established in China but also to American companies and individuals seeking to invest in China (i.e., during the preestablishment phase), except in sectors and subject to conditions specifically listed in an annex to the treaty. Also during the past three months, Chinese leaders have for the first time expressed serious interest in joining the TPP, an ambitious treaty currently being negotiated by Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the U.S. and Vietnam. In addition, China has very recently expressed interest in participating in the Trade in Services Agreement (TISA) currently being negotiated at the WTO. Xi s decision to simultaneously push both a new pilot FTZ and trade negotiations with other countries may indicate an effort to buttress each initiative in anticipation of possible resistance to such reforms by state-owned enterprises or other powerful vested interests. Linking the two initiatives increases the visibility of each, and further suggests the depth of Xi s commitment. Prospects for economic reform Despite the support of the two highest ranking officials in China s political and party hierarchy, the long-term impact of the Shanghai FTZ remains uncertain. The South China Morning Post indicated that Li faced considerable domestic opposition from China s financial industry regulators, who are hesitant to open the sector to foreign investment. The Wall Street Journal added that Li s 26 insight NOVEMBER 2013

6 G204 cover story absence from the official opening of the Shanghai FTZ on September 29 suggests to some that the zone had been effectively demoted or that it was a focus of top-level disagreement. Clearly, Xi and Li face an uphill battle in convincing China s entrenched bureaucratic interests (most likely, various regulators and China s prominent state-owned enterprises) to support the economic policies planned for the zone. G312 G204 G318 G312 Waigaoqiao Bonded Logistics Park Hongqiao Airport Downtown Shanghai Waigaoqiao Free Trade Zone G318 Pudong Airport Free Trade Zone This reform should significantly decrease the time and uncertainty associated with setting-up and opening a business in China. G320 G320 Shanghai Hangzhou Bay Yangshan Free Trade Port Area (Land) East China Sea Yangshan Free Trade Port Area (Harbor) What is the Shanghai FTZ? In the face of this uncertainty, foreign investors on the outside of China s opaque decision-making process will want to look for signals over the next few months to gauge whether the Xi administration is investing the necessary political capital to drive reform within the Shanghai FTZ and for the country at large. Three potential events may signal likely success for the reforms: Adoption of Shanghai FTZ-like Market Reforms at the Third Plenum In November, the Chinese Communist Party (CCP) will meet at the Third Plenum of the 18th CCP Central Committee. CCP plenums are generally held on an annual basis and provide an opportunity for the party s top leaders to discuss major matters and plan reform. The Third Plenum is particularly significant as it is generally used by incoming officials to promote their vision of China s future and the proposed reforms needed to attain their goals. Indeed, it was at the Third Plenum of the 11th CCP Central Committee that Deng took control of the CCP and launched China s reform and opening movement. Expressions of support for reform policies similar to those found in the Shanghai FTZ particularly a nationwide streamlining or removal of administrative approvals, or liberalization of financial controls may indicate further room for experimentation in Shanghai s FTZ. Appearance of a High-Profile Leader in Support of the Zone The Shanghai Free Trade Zone is, effectively, a merger of the four bonded zones currently located on the far eastern borders of the Shanghai municipality. Its expected total geographic area of square kilometers makes it approximately one-third the size of Hong Kong Island (81 square kilometers). When China s economic reform initiatives slowed in the post period, it was Deng s Southern Tour that was widely seen as reigniting market reforms. The appearance of Li or another high ranking official at the zone would be a strong signal that internal opposition to the zone has weakened or been defeated. Release of Specific Implementing Regulations Finally, and most importantly, the success of the Shanghai FTZ will ultimately be determined by the type of investment and regulatory environment established for investors. If forthcoming regulations give full play to the ambitious goals of the FTZ, then many of the concerns currently surrounding the zone will diminish. Failure of any of these three events to materialize, however, may signal the presence of significant domestic opposition to the Xi administration s reform initiatives. The zone will thus serve as a canary in the coal mine for the fate of China s economic reforms as a whole, and the associated opportunities for enhanced foreign participation in the China market. november 2013 insight 2 7

7 What Do You Think? Several senior executives offer their take on the pilot FTZ Tom Liu CEO of ChinaScope Financial Limited The FTZ s establishment is an important step toward China s financial reform. What excites me about it is the currently unanswered question about whether the capital raised in the zone can be used outside the zone via business activities (e.g., can you drive outside the zone a car leased from a leasing company that is set up in the zone and that purchases foreign cars at a much lower cost; can banks that are set up in the zone and enjoy open forex exchange fund companies outside the zone, etc.). In practice, the answer to this question would be very difficult to deviate from yes, and once that happens, the competitive playing field in China will alter dramatically and the country will face the level of reform that can only be rivaled by the Reform and Open Door Policy engineered by Deng Xiaoping. This reform will invite the world into China s backyard with few restrictions and it will force the lazy and non-competitive to either shape up or give way to those who can. For companies like ChinaScope that thrive off the advancement of the financial sector, which is a leveraged play off the general economy, we are excited by the establishment of the FTZ, because it marks the beginning of a structural change that will fundamentally prolong the sustainability of China s economic growth. Andrew Au Chief Executive Officer, Citi China Citi China is delighted to be the first global bank approved to establish a presence in the China (Shanghai) Pilot Free Trade Zone (FTZ). We applied for this license in support of the government s move towards economic reform and the promotion of Shanghai as a competitive international financial center. The FTZ will be a test bed and directionally it is the right thing to do. For the financial services sector, the FTZ is expected to provide foreign and domestic, public and private sector players a level-playing field. Citi is well positioned to participate in and contribute to the development of various areas, including trade finance, cash management, RMB internationalization and convertibility, as well as interest-rate liberalization. We will bring our global network and capabilities to China, and leverage our century-long local knowledge and experience to play an active role in the process. We are confident of the prospect of China s economy and the capability of the Chinese leaders. Citi China has always been at the forefront of the financial services industry in China, and we believe the FTZ will offer us great opportunities to further grow our franchise in China for many years to come. 28 insight NOVEMBER 2013

8 cover story Vivian Jiang Deloitte National Leader of Tax and Legal Services for Mainland China, Hong Kong SAR and Macau SAR The launch of the China (Shanghai) Pilot Free Trade Zone has been likened to the establishment of the Shenzhen SEZ and some are saying: no change. We still believe that the pilot will come to signify the start of the transformation of China s economy into a developed global market-driven economy. Reform is a must for sustainable, strong growth of China s economy. Many at the highest level of government believe undertaking reforms now is necessary. Further, global trends (e.g., Japan but not China was invited to join the Trans-Pacific Partnership) and the pace at which China s major trading partners are concluding trade pacts is forcing China to open up. The Changjiang Delta The Changjiang Delta contains all of the elements required to drive super economic growth: large pools of capital for investment, world class manufacturing capacity, an educated and entrepreneurial talent pool and a large and wealthy consumer base. The pilot FTZ s Overall Framework Plan integrates all the necessary key reforms. The Pilot FTZ possesses the attributes critical for success: right timing, right location and the right people. As one of the leading professional services firms in China, we welcome and enthusiastically support the opening up of China s economy and its transformation into a developed, global market-driven economy. Our advice to business: Although you might ultimately decide not to proceed for the time being, the pilot FTZ should nonetheless now be on your list of opportunities for serious consideration. Kelvin Lee Head of Multinational Corporates, China, BNP Paribas The pilot FTZ represents a positive step forward in the development of the financial sector itself and concurrently accelerates product innovation while following the changing needs of customers operating in this FTZ. Areas such as cross-border (i.e., overseas FTZ, FTZ onshore) liquidity management, commodity trading, inventory financing, capital account and debt capital markets are expected to be granted more flexibility of which its development, to a large extent, has been constrained by current regulations onshore. Free RMB convertibility and a market-driven interest rate regime are of immense importance to Shanghai in its journey to become an international financial center by The pilot initiative offers an experimental ground for the government to test run those concepts. Meanwhile, foreign banks are given a unique opportunity to participate and contribute to its refinements. With much of the details and specificity yet to be revealed at this point, key questions remain on: What different values will it bring as compared with special administrative regions, e.g., Hong Kong? Are we going to see more profound changes coming out of the Shanghai pilot FTZ as compared to Tianjin Binhai Financial Innovation and the Shenzhen Qianhai Economic Zone? How will the FTZ interact with China onshore? Will some of the cross-border constraints we see today be removed or softened to create new possibilities? Overall, we are still in an initial phase of this plan. The government remains open and it is our role to propose and promote new ideas that are consistent with the outlined framework and yet groundbreaking to instill changes with more substance over form. november 2013 insight 2 9

9 Anthony Couse is managing director of Jones Lang LaSalle for Eastern China. Couse heads the Investment Business for China and Commercial Leasing Business for Shanghai. One Step at a Time Anthony Couse BY ANTHONY COUSE The FTZ s announcement is a signal of the government s continued commitment to moving forward with financial reform and to positioning Shanghai as a global financial center. It is expected that the zone will allow for experimentation with pilot reforms in financial deregulation, RMB convertibility and interest rate reform that eventually could be expanded to the rest of Shanghai. This would benefit the city s financial services industry, and could help attract a larger presence of financial and downstream professional service firms, increasing office demand in the city s existing central business districts (CBDs). However, it is important not to oversell the zone s immediate impact on the Shanghai office market, and instead to view the project as one step in a process that will play out over the course of several years. First, it will take time for the pilot reforms to be rolled out to the other areas of the city to make sure the reforms are manageable and sustainable. Second, the experience of existing global financial centers shows that most house a large population of specialized workers, including lawyers, accountants and other financial experts something that Shanghai still lacks. Third, a mature financial center requires business transparency and a mature legal system. Shanghai will be hard-pressed to upgrade its workforce and business environment simply by changing a set of laws and regulations. For these reasons, we do not see the FTZ as a replacement for Hong Kong nor does it challenge the role of Hong Kong, due to Hong Kong s mature base of talent, legal infrastructure and regulatory institutions. There is limited possibility that the three coastal areas that comprise the FTZ will become new CBDs. The question has been posed by some of our clients, who have compared the FTZ to the situation about 20 years ago in Lujiazui, an underdeveloped area which has grown into the financial center of Shanghai. There are two main reasons that another Lujiazui is unlikely to emerge in the FTZ. First, in terms of the location, the three areas of the FTZ are all situated along the coastal edge of the city and are about 25 to 50 kilometers from the closest Pudong decentralized Grade A submarkets, let alone CBD areas. In addition, these zones are currently occupied in large part by warehouses and lack a business environment that could compete with downtown. Finally, from a city planning perspective, the government does not intend to build a new financial or business center in the new FTZ. As a result, there are restrictions placed on the type of real estate allowed to be developed in the FTZ. The FTZ s location, land availability and existing business environment mean that the government will not look to create new competition between the FTZ and the existing Lujiazui or even the future Qiantan submarkets. The prospects are somewhat better for the FTZ s impact on the warehouse sector, particularly the bonded market, much of whose properties lie within the FTZ s boundaries. We do not expect the FTZ to become a major shopping destination. At this stage, there is no indication that a special tax regime will be in place to enable duty-free shopping or duty-free outlets. However, preliminary reports do suggest that select e-commerce sites will partner with the zone, but this does not extend to any particular tax benefit. We do see opportunities, however, to invigorate sales of imported items if any tax reductions are granted in the future. 30 insight NOVEMBER 2013

10 cover story Goods, Customs and Taxes How will the pilot Free Trade Zone impact the trade in goods? Damon Paling Jieying Ni Damon Paling is a partner at PwC China and Jieying Ni is a senior manager at PwC China. BY DAMON PALING AND JIEYING NI Subsequent to the State Council approving the establishment of the pilot Shanghai Free Trade Zone in August 2013, a series of administrative measures have been issued by the State Council, Shanghai Municipal Government and other authorities covering both trade in goods and trade in services and that are designed to: Maintain the leadership of inbound investment while competing against other economies Transform from government-oriented to market -oriented environment Further internalize the RMB Be a testing ground for duplication in two to three years We will first offer an overview of the new Shanghai Free Trade Zone or FTZ and an overview of what may be considered with respect to trade in goods. According to the measures, the following areas will be opened up: Finance (banking, health medical insurance, financial leasing) Shipping (ocean transportation, international ship management) Commerce and trading (value-added telecommunication operation, sales and service of game and amusement machines) Professional services (lawyer service, credit information survey, travel agency, talents intermediary service, investment management, engineering design, construction) Cultural services (performance brokerage, entertainment venue) Public services (education and job skill training, medical service) Current foreign investment policies applied to companies outside of Shanghai FTZ will be suspended subject to any exclusion as documented in the much-discussed negative list. The production and distribution of game and amusement equipment by foreign-invested companies registered in the Shanghai FTZ is allowed. The game and amusement equipment and devices can be sold in the domestic market after approval from the Ministry of Culture. In the current regulatory framework, such machines are prohibited from importation and distribution in China. National treatment National treatment from an investment perspective refers to the treatment granted to foreign invested companies; i.e., these are now in principle the same as those granted to domestic companies. Except for sectors specified in the negative list issued by the Shanghai Municipal Government and other prohibited sectors, foreign-invested enterprises in almost all sectors only need to make a record-filing or registration procedure (the same as their domestic counterparts) instead of the normal review and approval procedure. Sectors subject to national treatment cover various industries. In this regard, the Standing Committee of the National People s Congress approved that the three pieces of law on foreign-invested companies, Sino-foreign joint ventures and Sino-foreign cooperative companies would be suspended to implement the Shanghai FTZ. National treatment is expected to largely alleviate foreign investor administrative burdens. Tax environment Key tax policies and incentives are to support innovative business models that are encouraged investments in the Shanghai FTZ, rather than to provide generally reduced tax november 2013 insight 3 1

11 For Shanghai to compete regionally with the likes of Hong Kong and Singapore in the logistics area, red tape at the border needs to be reduced. rates or universal incentives to all sectors. For instance, the Overall Plan granted the export VAT refund to financial leasing companies in the Shanghai FTZ, which is not possible in mainland China currently except for the pilot domestic companies in Tianjin Binhai New District. Investors injecting non-monetary assets as capital into companies registered in the Shanghai FTZ may average the premium arising from the asset appreciation over five years for CIT and Individual Income Tax (IIT) purposes. High-demand talent or professionals in short supply may enjoy preferential IIT treatment equivalent to those available in Zhongguancun in Beijing in respect to gains derived from share-based payment granted by companies registered in the Shanghai FTZ. Additionally, industry is expecting further preferential tax policies to be granted by the central government in subsequent announcements, such as for the ones for offshore business and overseas equity investment. Attractive local incentives in the form of financial subsidies are also anticipated. Trade in goods and customs For Shanghai to compete regionally with the likes of Hong Kong and Singapore in the logistics area, red tape at the border needs to be reduced. The following actions will be taken by Customs and imaginechina The registration center is also a popular attraction for local residents 32 insight NOVEMBER 2013

12 cover story Commodity Inspection and Quarantine (CIQ) in the Shanghai FTZ to facilitate trade: Simplified Customs procedures and requirements such as enter first, register later for incoming overseas shipments Single electronic Customs/CIQ window for document submission Classified supervision on the goods for bonded warehousing and manufacturing, goods for international transit and certain goods sourced domestically with a risk-based approach Improved supporting measures such as single office for Customs/CIQ with common working hours and designated areas for physical goods inspection In short, Customs supervision on the border between overseas and the Shanghai FTZ will be loosened or even eliminated significantly while the enforcement of Customs (e.g., collection of duty) will still exist when the goods are moved between the Shanghai FTZ and locations outside of it in China. CIQ measures The measures allow companies registered in the Shanghai FTZ to choose the time to make the CIQ declaration before the goods are moved out of the Shanghai FTZ. Setting up a third-party CIQ authentication institute for imported and exported commodities in the Shanghai FTZ is encouraged. A credit mechanism regarding the test result will be established. This means that a third-party certificate on goods quality may be accepted by CIQ during the import CIQ declaration and inspection, which will save delivery lead time during the import/export declaration process. Both existing and new trading companies, including thirdparty logistics providers, can expect to benefit from these reform measures for international trade. However, companies registered in the Shanghai FTZ that intend to only import goods into the domestic market may not benefit from the aforesaid CIQ inspection-friendly measures until the thirdparty verification system is well established. Continuous monitoring of the implementation regulations in the future is necessary as the above Customs and CIQ reform measures are likely to be rolled out over a period of time. It is also worth noting that Shanghai Customs has been active in recent times to enhance trade facilitation such as through the deployment of a paperless clearance system to selected companies. What else can companies trading in goods expect? The establishment and operation of the new Shanghai FTZ is a milestone for the government to promote and deepen ongoing reform. The procedure for companies set up in most sectors should become as simplified and comparable to that The new Shanghai FTZ may have to be physically expanded so that available supply can match increased demand. adopted by domestic counterparts. Such foreign direct investment policies may help relevant companies save logistic costs when operating a regional distribution center and similar operations such as a bonded repair center. Wider commercial factors should also be considered such as the location of suppliers, destination markets, schedules for aircraft and vessel arrivals, departures and routes, utilization of free trade agreements and so on. One area for trading companies to monitor is the rising cost for operating or leasing a bonded warehouse within the Shanghai FTZ. With land supply of only square kilometers and certain areas, such as Waigaoqiao Bonded Logistics Park already running at full capacity, any increase in demand is likely to increase prices. The new Shanghai FTZ may have to be physically expanded so that available supply can match increased demand. Trading companies in certain retail sectors may also have to monitor and work with Shanghai Customs to control any grey channel imports that might arise under new e-commerce business models. The new Shanghai FTZ also allows companies to establish a Bonded Exhibition and Trade Platform (BETP) in designated areas. Our observation is that such designated areas are likely to be approved within or even outside the premises of the Shanghai FTZ, provided that import tax collection can be secured firmly according to relevant taxation policies. In other words, American companies may have a chance to perform and extend bonded exhibition activities to outside of the Shanghai FTZ. Customs and CIQ reform does not happen overnight, so companies trading in goods should continue to monitor the various trade facilitation reform measures that will be implemented. The AmCham Shanghai Trade Facilitation Task Force will continue to work closely with Shanghai Customs and CIQ to assess these developments. november 2013 insight 3 3

13 Christopher Wingo is managing director of China Sage Consultants (Shanghai), which helps U.S. SMEs sell more effectively in China. Big Benefits Eventually A longtime China executive says SMEs could reap wide benefits in the FTZ if they qualify Christopher Wingo BY Christopher Wingo The government s plan to launch a pilot Free Trade Zone (FTZ) in Shanghai has created a buzz among foreign businesses engaged in China. As is typical of many big Chinese government initiatives, however, no one is sure what to expect. While the foreign business community, especially big financial firms, is hoping for something revolutionary, a review of the information released to the public suggests for the FTZ something more evolutionary will take place. This begs the question: if large multinationals and investors are unsure of how to proceed, what are small- and mediumsized businesses to think? The impetus China s old export-driven model is dying off and the government knows it. According to The Wall Street Journal, without substantial changes in the next five years, IMF economists estimate, Chinese growth could fall to an average of 4 percent annually through 2030, which is down from a high of 14.8 percent in Premier Li Keqiang and Liu He, President Xi Jinping s purported economic handyman, have been pushing hard for market-oriented changes. They and their allies believe allowing foreign capital a bigger role and making banks compete on interest rates, among other changes, would funnel more money to privately owned high-technology and service firms and help remake the economy, the article says. Visionary reformers know changes are in order but vested interests and left-leaning officials keep pushing back. Unable to roll out far-reaching national reforms without major resistance, reformers are approaching the problem in a pragmatic, metered way. Just like the Shenzhen SEZ in 1980, the new FTZ will be the first of many small steps ultimately adding up to a reformed national economy. Policy changes The exact policies are still vague. While the preliminary rules keep almost all non-chinese entities sidelined, local media are reporting that Chinese companies, from places such as investment-oriented Wenzhou, are scrambling to register in the FTZ. The prevailing attitude among these companies is get in now, worry about the details later. On the surface, the new FTZ is a business in China s dream. The zone has been widely reported to be the brainchild of Premier Li Keqiang and is expected to have the biggest impact on the financial sector. Though still non-specific, government published financial sector goals include: Freer conversion of RMB to foreign currencies Interest rate liberalization allowing the market to set rates Fewer investment restrictions on incoming foreign investment and outgoing Chinese investment (specific to companies inside the zone) Domestic banks have been quick to move, but, only two foreign banks, Citigroup and Singapore s DBS, reportedly have so far committed to open branches in the zone. Other objectives Making international trading more efficient and easy with easier import and export processing as well as movement of 34 insight NOVEMBER 2013

14 cover story goods within the zone Developing the area into an internationally recognized shipping hub Facilitating the development of the services sector, law, architecture, financing, leasing, credit rating and insurance, healthcare, high-tech, HR and trade services, etc. Gaming? Yes, you will be able to manufacture and buy a legal copy Xbox in the zone. One thing not talked about in the media but identified with our own research is a government sponsored e-commerce platform to facilitate international e-commerce transactions for companies selling both to and from China. SME perspective Overall, the proposed policy changes could eventually afford big benefits to foreign SMEs operating within China. Consider the benefits of available, reasonably priced financing for capital investment and business transactions; a more efficient importation process that affords lower costs, reduced time and ultimately more competitiveness in the market; available, competitively priced and more professional services including HR, credit checks and insurance; and much easier RMB conversion to foreign currencies that will facilitate international transactions and possibly even profit repatriation. If these policy changes materialize, SMEs should be able to focus more on the business at hand and less on inefficient maneuvering to get things done. For those SMEs that happen to be one of the aforementioned service businesses, you can imagine the increase in operational flexibility that theoretically could be enjoyed within the FTZ. As an SME, we are most interested in the potential application of the government sponsored e-commerce platform. Our understanding is the government has established a single entity within the zone that has set up and will manage the e-commerce platform or, more appropriately, an international transaction platform. It seems a company can use the service even if they do not have a business entity within the zone. Consider these scenarios SCENARIO 1: A U.S.-based SME has a U.S.-made product line that Chinese consumers just might like. The SME could use the platform to process RMB transactions, including the A new e-commerce platform could benefit SMEs collection of duties. The SME receives a U.S.-dollar payment. The SME likely has to market its own product because it is not sure if the platform provides for some type of storefront. Apparently, several big handbag manufacturers (not SMEs) will use the platform to sell direct to customers, saving them as much as 30 percent over China retail prices. SCENARIO 2: A China-based SME has China-produced products to sell abroad. In the past, such an SME transacted through an international trading company or, assuming it is licensed, exported directly. With the new e-commerce platform, the export process should be streamlined, resulting in ease of use and lower cost. Now the SME can avoid what has been a complicated, drawn-out and costly export and money collection process. The e-commerce platform is supposed to be ready for business by the end of October 2013, and although many of its capabilities and operational details are yet unknown, it certainly is something to watch. As with many things China, the FTZ initially may be more of a signal of what policymakers want to eventually implement nationwide. It will take years before the zone is set up, tweaked and running according to an understood and stable set of policies. It will take much longer for those thousand steps to a national rollout. For now, all companies engaged in China, including SMEs, should keep their eyes on the zone, watching for the right time to make a move. november 2013 insight 3 5