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CHINA OPENS RETAIL/WHOLESALE MARKETS
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On June 25, 1999, the State Economic Trade Commission (SETC) and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) of the People’s Republic of China (PRC) jointly issued.
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Steven Blayney
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1. Retailing Pilot Test Program
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C. Impetus Builds for a Crackdown
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4. Equity requirements for chain stores
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a. Wholesaling joint ventures
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a. Joint venture establishment procedures
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b. Modification of existing joint ventures
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On June 25, 1999, the State Economic Trade Commission (SETC) and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) of the People’s Republic of China (PRC) jointly issued
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1 This article first appeared in the October 1999 edition of Hong Kong Lawyer and is reprinted here with minor changes by permission of the author.
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2 Steven Blayney is an attorney with White & Case in Hong Kong.
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the Foreign Investment Commercial Enterprises Pilot Project Measures (Measures). The Measures expand the scope of foreign participation in the PRC retailing sector and, for the first time, permit foreigners to establish wholesaling operations in the PRC. The following is a brief synopsis of foreign investment in the PRC retailing and wholesaling sectors followed by a discussion of the Measures.
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The PRC administers a pilot test program for foreign investment in retailing and wholesaling enterprises (collectively “Commercial Enterprises”). The pilot test program scheme permits a limited number of select foreign investment projects on an experimental basis. This experimental approach affords PRC regulatory authorities an opportunity to perfect laws, regulations, and regulatory mechanisms prior to opening up the Chinese market further to foreign investment.
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1. Retailing Pilot Test Program
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The PRC retailing sector was first opened to foreign investment with the promulgation of the Foreign Investment in Retailing Provisions issued by the State Council on November 23, 1992 (“Provisions”). The Provisions allowed foreign investors to establish equity joint ventures and cooperative joint ventures on a trial basis in Beijing, Shanghai, Guangzhou, Dalian and Qingdao, as well as in China’s five special economic zones. The Provisions specifically provided that applications to establish Chinese-foreign retailing joint ventures must be examined and approved by the State Council. According to MOFTEC officials, China had contemplated the establishment of fewer than twenty Chinese-foreign retailing joint ventures under the pilot program. Foreign involvement in establishing chain stores was even more circumscribed. According to officials of the now defunct Ministry of Internal Trade, as of December 1997, China had only approved two Chinese-foreign pilot test chain store joint ventures: a joint venture between MOFTEC and Makro, and a joint venture between the Ministry of Internal Trade and a Japanese retailer. Until the recent promulgation of the Measures, foreign participation in wholesaling operations was prohibited as a matter of policy.
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Despite strict limitations placed on foreign involvement in China’s retailing and wholesaling sectors, foreign investors, nonetheless, could establish a motley of retailing and wholesaling operations across China. Foreign investors employed a myriad of investment strategies to avoid central government scrutiny, such as reliance on local government approvals, management contract arrangements, and joint operation enterprises. As a result, in spite of China’s pilot program limiting the number of Chinese-foreign Commercial Enterprises to fewer than twenty, 277 Chinese-foreign Commercial Enterprises were operating illegally in China by August 1998, according to the China Daily.
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PRC regulatory authorities, for a variety of reasons, were impotent to stop these illegal investments. Local governments keen on developing their respective economies simply ignored national policy and issued approvals to foreign investors ultra vires. Because of the phenomenon of “many heads administration” (duo tou guanli), jurisdictional feuds among multiple government authorities frustrated a coordinated, coherent approach to sanctioning unauthorized foreign investments. China’s decentralized administrative structure, which gives local governments a high degree of control over local law enforcement agencies, exacerbated the problem of “many heads administration.” For example, the fact that local Administrations of Industry and Commerce (AICs) are under the administrative control of local governments rather than the national State Administration for Industry and Commerce (SAIC) denies Beijing an important lever of control over local activities.
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C. Impetus Builds for a Crackdown
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In spite of the Chinese government administrative structure, given the scale of irregularities in the PRC commercial sector, a consensus gradually began to build for a rectification campaign to standardize illegal Commercial Enterprises.
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On May 4, 1997, the State Council issued the Urgent Notice of the General Ofice of the State Council on the Immediate Cessation of the Examination and Approval of Commercial Enterprises with Foreign Investment by Local Authorities or Departments at their Own Discretion (“Urgent Notice”). The Urgent Notice ordered local governments to stop issuing approvals
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for foreign investment Commercial Enterprises and provided that such enterprises already approved would be rectified. The Notice of the State Council on Issues Concerning the Rectification of Non-Pilot Test Commercial Enterprises with Foreign Investment (Guoban Fa [1997] No. 26) (August 5, 1997) (“Notice No. 26”) followed the Urgent Notice. Notice No. 26 reiterated that foreign investment Commercial Enterprises improperly approved by local authorities were to be rectified. Despite the Urgent Notice and Notice No. 26, it was not until a year later that China finally began to take concrete steps to rectify illegal foreign investment projects. Notice No. 26 required the establishment of a rectification work group (qingli zhengdun xiaozu) to produce specific rectification proposals. Representatives from relevant local governments, and government authorities including the State Planning Commission (SPC), Ministry of Internal Trade, MOFTEC, and SAIC composed the rectification work group. The composition of the rectification work group reflects the problem of “many heads administration.”
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In March 1998, the First Session of the Ninth National People’s Congress announced a profound restructuring of China’s central government organs. The number of government authorities was consolidated from forty to twenty-nine ministries, commissions, and other organs. In the course of these reforms, the Ministry of Internal Trade was renamed the State Internal Trade Bureau and subsumed under the powerful SETC.3 This restructuring of authorities regulating Commercial Enterprises paved the way for a rectification of illegal foreign involvement in the PRC retailing and wholesaling sectors.
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On July 1, 1998, the State Council issued the Notice of General Ofice of the State Council Regarding Rectifying Non-Test Pilot Project Foreign Investment Commercial Enterprises
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3 In China’s administrative hierarchy, commissions outrank ministries.
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(Guoban Fa [1998] No. 98) (“Notice No. 98”). Notice No. 98 elucidated measures for dealing with the 277 illegal foreign investment Commercial Enterprises in China. Of these 277 foreign investment Commercial Enterprises, Notice No. 98 provided that forty-two enterprises would be allowed to continue their operations while 199 such enterprises would have to be restructured. Of those restructured, the Chinese party must have at least a 51% equity interest in the joint venture. For foreign investment enterprises in Central and Western regions of China, the Chinese party’s equity stake must exceed 40%. With regard to chain stores and warehouse-type stores, the Chinese party must have a controlling interest, and the term of the joint venture must not exceed thirty years (forty years in Central and Western regions).
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Notice No. 98 further provided that foreign investors may not engage in wholesaling and that wholly foreign owned Commercial Enterprises must be converted into Chinese-foreign joint ventures. With regard to the thirty-six foreign investment Commercial Enterprises approved after issuance of the Urgent Notice that have not made their capital contributions or have not undergone annual inspection, the local Commissions of Foreign Trade and Economic Co-operation (COFTECs) and AICs must revoke the approval letters for such enterprises and cancel their registrations.
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The depth of unofficial foreign penetration of the PRC commercial sector in the context of China’s bid for WTO accession presents a dilemma for PRC regulatory authorities. One the one hand, China must enforce its laws and rectify such activities. On the other hand, China cannot afford to appear to be slamming its doors to foreign investment in the midst of sensitive WTO negotiations. It is in this milieu that China has issued the Measures.
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The Measures allow China ostensibly to pursue its on-going rectification of illegal foreign investment Commercial Enterprises while, at the same time, further opening its commercial sector to foreign investment. As such, the Measures dovetail with requirements imposed by Notice No. 98 and represent a further standardization of the PRC retailing market. Significantly, the Measures expand the scope of foreign involvement in retailing as well as open up the PRC wholesaling sector to foreign investment. The following is a synopsis of the Measures.
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Under the Measures, approved foreign investors may establish equity joint ventures and cooperative joint ventures to engage in retailing and wholesaling business operations. Wholly foreignowned enterprises are currently prohibited. Branch stores of joint ventures adopting the chain store structure must be directly invested in and operated by the Chinese and foreign joint venture parties. Other forms of chain stores such as independent chain stores (ziyou liansuo dian) and franchise chain stores are currently prohibited.
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In addition to satisfying general criteria of creditworthiness, technical sophistication, and profitability, the foreign joint venture party must have a substantial international sales network capable of promoting exports of Chinese products.
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A foreign partner to a retailing joint venture must have had an average annual commodity sales turnover of more than US$2 billion for the three years prior to the application to establish the joint venture and must have assets of more than US$200 million for the previous year.
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A foreign party to a wholesaling joint venture must have had an average annual commodity wholesale turnover of more than US$2.5 billion for the three years prior to the application and must have assets of more than US$300 million in the previous year.
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A Chinese party to a commercial joint venture must also satisfy general criteria as to creditworthiness, capitalization, and profitability. In addition, a Chinese party must have assets of RMB 50 million (RMB 30 million in Central and Western regions) in the previous year. Where the Chinese joint venture party is a Commercial Enterprise, it must have had an average annual sales turnover of more than RMB 300 million (RMB 200 million in Central and Western regions). Where the Chinese
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joint venture party is a foreign trade enterprise, it must have had annual import and export turnover from its own operations of more than US$50 million of which export turnover must not be less than US$30 million for the three years prior to the application.
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Joint ventures engaged in retailing must have registered capital of not less than RMB 50 million (not less than RMB 30 million in Central and Western regions). Joint ventures engaged in wholesaling operations must have registered capital of not less than RMB 80 million (not less than RMB 60 million in Central and Western regions).
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4. Equity requirements for chain stores
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For joint ventures adopting the chain store structure consisting of more than three branch stores (excluding convenience stores, specialized stores (zhuanye dian), and exclusive stores (zhuanmai dian)), the Chinese party to the joint venture must have not less than a 51% equity interest in the joint venture. Upon approval of the State Council, a foreign party may have a controlling interest in such joint ventures where the foreign party can expand exports of Chinese products.
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For joint ventures with three or less branch stores, convenience stores, specialized stores, or exclusive stores, the Chinese party’s equity stake must not be less than 35%. For joint ventures engaged in wholesaling (including retail enterprises engaged in wholesaling as an ancillary business (jianying)), the equity stake of the Chinese party to the joint venture must be not less than 51%.
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The term of Chinese-foreign commercial joint ventures must not exceed thirty years. For such joint ventures established in Central and Western regions of China, the joint venture term must not exceed forty years.
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The Measures expand the geographic scope of foreign involvement in the PRC retail and wholesale sectors from Beijing, Shanghai, Tianjin, Guangzhou, Dalian, Qingdao, and five Special Economic Zones to the capitols of provinces and autonomous regions, directly administered municipalities such as Chongqing, and cities directly under central planning (collectively “Pilot Test Areas”).
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According to Deputy Director of SETC, Chen Bangzhu, each Pilot Test Area may set up one to two Chinese-foreign commercial joint ventures. Beijing, Shanghai, Tianjin, Chongqing, Guangzhou, Shenyang, Zhengzhou, Wuhan, Lanzhou and Chengdu will be allowed to establish one to two additional Chinese-foreign commercial joint ventures.
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a. Wholesaling joint ventures
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According to Deputy Director Chen, each of the four directly administered municipalities (Beijing, Shanghai, Tianjin and Chongqing) may establish one wholesaling Chinese-foreign joint venture. Such joint ventures may be either a retailing Chinese-foreign joint venture engaging in wholesaling as an ancillary business or a newly established wholesaling joint venture.
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Previously only two pilot test chain stores were approved by the State Council: a joint venture between MOFTEC and Makro and a joint venture between the defunct Ministry of Internal Trade and a Japanese retailer. Now, according to Deputy Director Chen, foreign investors may establish chain store joint ventures in Beijing, Shanghai, Tianjin, Chongqing, Guangzhou, Shenyang, Zhengzhou, Wuhan, Lanzhou, and Chengdu.
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The Measures stipulate the procedures and documentary requirements for applying to establish a Chinese-foreign commercial enterprise, to expand the scope of an existing Chinese-foreign commercial enterprise to engage in wholesale operations, to open branch stores or to change joint venture parties.
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a. Joint venture establishment procedures
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The procedures for establishing a new commercial joint venture are relatively straightforward. The Chinese party to the joint venture must submit the feasibility study report (in lieu of the project proposal) and other relevant documentation to the Economic and Trade Commission of the Pilot Test Area in which it is located. The relevant Economic and Trade Commission and the department in charge of internal trade will then report to SETC in Beijing. After soliciting MOFTEC’s opinion regarding the project, SETC will examine and approve the joint venture. After SETC approves the project, the relevant authority in charge of economy and trade in the Pilot Test Area where the joint venture will be located will submit the joint venture contract and articles of association to MOFTEC in Beijing for approval. The approved joint venture must then register with SAIC within one month of receiving approval by submitting the approval certificate issued by MOFTEC to the SAIC.
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b. Modification of existing joint ventures
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Existing commercial joint ventures may apply to engage in wholesaling operations as an ancillary business, to open branch stores, or to change one of the joint venture parties. Such amendments are approved by MOFTEC, which will consult with SETC prior to issuing such approvals. A joint venture must register all amendments within one month of obtaining MOFTEC’s approval of the amended joint venture contract and articles of association.
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Under the Measures, a properly approved Chinese-foreign retailing joint venture may engage in the following business activities:
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* commercial retailing (including agency sales and consignment sales)
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* organizing the export of domestic Chinese products
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* importing and exporting of commodities for its own operations
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* supporting services. A Chinese-foreign joint venture approved to engage in wholesaling operations may:
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* engage in wholesaling of domestic Chinese commodities and commodities for its own operations
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* organize the export of domestic Chinese products. b. Restrictions
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Chinese-foreign commercial joint ventures may not engage in commodity import/export agency business. Joint ventures dealing in commodities subject to special regulations of the State or dealing in the import and export commodities involving quotas and licenses must complete the examination and approval procedures pursuant to relevant State regulations.
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The importance of the Measures to foreign investors is that they significantly expand the permitted scope of foreign investment in the PRC retailing sector and, for the first time, open the door to foreign involvement in wholesaling. For foreign investors caught in the on-going crackdown on illegal foreign invested Commercial Enterprises in the PRC, the Measures present an opportunity not only to allow foreign investors to legitimize their operations via restructuring, but also to allow them to expand the nature and geographic scope of their operations in China. As such, the Measures strike a convenient balance between China’s need, on the one hand, to standardize its commercial sector with, on the other hand, to make negotiated market-opening overtures required for WTO accession.
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