FTZ – The New Way to Do Business in China

What can we do to increase sales and profitability when the European economy is treading water, and the U.S. economy is growing in the low single digits?  Where will my new customers come from and how can I market them?  Where will the most significant growth of middle class buyers come from?  Where is the discretionary middle-class buying power increasing faster than anywhere else?  The answer, of course, to all these questions is China.  However, the mechanics of how this can be accomplished presents yet another set of complicated questions like: how can we do it successfully?  Will there be language or cultural barriers?  Is doing business in China, just a trap for the unwary? 
 
Doing business in China has a significant upside, but there is also a downside.  The downside risk can be mitigated and managed by working through competent and trustworthy advisors, experienced in doing business in China.  Effective advisors are able to bridge the language, cultural and business gaps, and anticipate issues before they occur.  One of the most effective ways of putting your company’s toe in the water in China is through the Shanghai Pilot Free Trade Zone (“FTZ” or “Zone”). 
 
In addition the advent of the Free Trade Zone, particularly, the FTZ provides unique opportunities which save money, save time, avoids common pitfalls an creates greater certainty in several important areas, all of which can reduce the risk of doing business in China and enhances the opportunity for success.  What follows is an introduction to the workings and benefits presented by the FTZ.
 
The FTZ was launched by China’s central government in September 2013 as an incubator and, if you will, represented a “beta test” for reform of China’s law governing domestic business and investment.  The Zone’s purpose is two-fold: (i) to promote foreign investment in China by liberalising the rules on foreign ownership of numerous types of business enterprises and by streamlining certain administrative measures applicable to foreign companies, and (ii) to promote Chinese investment in foreign markets by increasing access of Chinese private enterprises to capital for foreign investment and the ability of Chinese private enterprises to invest overseas. 

What follows is a brief summary of some of the key benefits offered by the FTZ to foreign, including U.S., enterprises, seeking to do business in China.

One of the major aspects of the opening of Chinese markets to foreign investment is the concept of the “Negative List,” which provides much greater freedom for foreign investors to establish businesses in China than was previously generally available under Chinese law.  Unlike Chinese law, which significantly restricts the industries and types of businesses which are open to foreign investment as well as those which may be wholly owned by a foreign invested enterprise “FIE”, in the FTZ, an FIE can establish and conduct any type of business unless foreign investment or foreign ownership is specifically restricted or prohibited by the Negative List, which is published annually by the central government. 

The Negative List has had the effect of relaxing restrictions on foreign ownership of enterprises in a number of key Chinese industries, including banking and financial services, telecommunications services, shipping and logistics, entertainment, real estate, e-commerce, engineering and construction, medical and healthcare services, insurance, educational and vocational training, manufacturing, transportation services, professional services, wholesale and retail businesses, and video game sales.  In some areas, the Negative List permits foreign investment to be made jointly with Chinese partners and other types of businesses may be either operated as foreign-Chinese joint ventures or as wholly owned foreign enterprises “WFOEs”

FIEs which register in the Zone, and are not subject to the Negative List, receive “national treatment,” i.e., they generally are to be accorded the same rights and privileges as domestic Chinese enterprises and are subject to similar registration and administrative procedures. 

Since the Zone was established in 2013, the Negative List has been slowly reduced by the central government.  The original list encompassed 190 areas, and was reduced to 139 in 2014 and 122 in 2015.  Among the most significant areas made more accessible to foreign investment since the original Negative List was published are the pharmaceutical industry, the healthcare services sector, the e-commerce sector and the legal services sector.  In addition, the financial industry received a strong boost in the 2014 revised Negative List, which mandated greater freedom of operations to foreign investment into investment banks, financial companies, trust companies, and currency brokerage companies. 

Another important reform designed to attract foreign investors is the FTZ’s streamlining and simplification of the administrative process for registering foreign enterprises in China.  Foreign enterprises registering within the Zone are subject to similar application procedures and requirements as are applicable to Chinese investors, meaning that they will only be required to complete a single application at a single location, provided the scope of their business activities is not within the “Negative List” for which special approval is required. 

This so-called “one-stop” service platform, in which a registration requirement replaces the traditional approval system, applies to the creation as well as the modification, merger or termination of FIEs.  This is a considerable advantage in that the traditional Chinese approval system for FIEs required undergoing a detailed process of obtaining approval from numerous governmental agencies before being permitted to commence business operations. 

Under one-stop filing, an FIE makes a single consolidated filing with the FTZ, which it coordinates with other governmental agencies to obtain various business licenses and tax certificates required for the FIE to engage in business.  Under this one-stop filing, the authorities only review basic information about the enterprise.  By contrast, the typical review process, which often served as an impediment to establishing an FIE in China, included a detailed review of an entity’s investment, capital contribution, articles of association, etc.  However, the one-stop registration within the Zone is not a substitute for obtaining the various business licenses and certificates otherwise required by Chinese law if the enterprise wishes to conduct business operations outside the zone.

The FTZ pronouncements also liberalise China’s rules on the required amount of registered capital necessary to start certain types of foreign invested business enterprises.  Although a number of industries, including banking, finance and insurance, remain subject to specific registered capital requirements, FIEs established in the FTZ, unless specifically restricted by other provisions of Chinese law, are generally free to establish their own registered capital requirements in their articles of association, including the amount of registered capital, terms and the duration of the enterprise.

The FTZ also has introduced a number of customs and tariff reforms for foreign enterprises designed to expedite the clearance of goods through customs and to reduce related costs.  Since overseas shipments do not require customs clearance until a later stage, operations within the FTZ are simplified.  Reducing costs and complexities involved in the logistics could further encourage international manufacturers to establish a regional manufacturing and logistics hubs in Shanghai.  Only a shipping bill is required for importation into the Zone, rather than needing a formal customs declaration.  The streamlined customs procedure is expected to result in reduced inspection times for imported goods.  In addition, bonded goods can be held for more than six months in warehouses within the Zone, unlike other bonded zones within China.  In addition, the customs supervision process has been streamlined and is now electronic, with no in-person applications being required.  The FTZ customs procedures also facilitate e-commerce and online trade, by allowing e-commerce companies to hold their goods tariff-free in bonded warehouses within the Zone, facilitating direct mailing from overseas.

Companies doing business within the free trade zone generally do not have to obtain approval from the State Administration of Foreign Exchange (SAFE) to convert U.S. dollars into RMB in order to deploy their capital within China to support their business.  This is a significant advantage. 

Last but not least, the original Shanghai FTZ as established in 2013 encompassed 29 square kilometres within the greater Shanghai/Pudong area.  In April 2015, the government quadrupled its size to 120 square kilometres.  The Zone now includes Shanghai’s Lujiazui financial hub, home to numerous banking and financial services companies, the Jinqiao manufacturing zone, the Zhangjiang high-tech zone, as well as the initial three bonded areas of Waigaoqiao, Yangshan and Pudong International Airport. 
 
The expanded zone is managed by the FTZ’s administrative committee and the Pudong government, with five regional committees responsible for sub-zones.  The enlarged Zone has more than 73,000 business enterprises, of which 22% are foreign funded.  The expansion of the zone reflects the government’s desire to expand the Zone‘s use beyond its core base of trade and logistics companies to include companies in the financial, advanced manufacturing, high-tech and other important sectors.
The bottom line is this unique entry platform into doing business in China by non-Chinese companies can be cost effective, reduce execution risk and enhance the chances of achieving a successful outcome.
 
Mr. Genkin current serves as the Asia Practice Chair.  He most recently served as the head of Blank Rome's Business Department, consisting of more than 240 attorneys practicing globally in numerous industries.  He has more than 30 years' experience advising public-company clients in public and private offerings of equity and debt securities; mergers, acquisitions, and joint ventures; corporate governance; and doing business inbound to China and outbound from China.  Mr. Genkin is a trusted advisor of CEOs, CFOs, boards of directors and audit and special board committees, who rely upon him for providing practical solutions to complex legal and business matters.  His strong business and financial acumen, coupled with years of high level experience, enable him to be a creative problem solver, especially when the stakes are high.  His common sense approach, strong communication skills and calming style create client confidence and make him a persuasive advocate.  He typically functions as the lead lawyer in transactions requiring a multi-faceted team approach and prides himself on being responsive to client needs. 
 
Barry’s accomplishments have been recognised by Chambers USA, corporate M&A and Private Equity and Securities, Legal 500 USA, Mergers, Acquisitions and Buyouts and Best Lawyers in America®, Corporate Law and Securities Law. 
 
Awarded Lawyer of the Year by “Best Lawyers” for Securities/Capital Markets.  Only one lawyer in each practice area in a designated metropolitan area is honored as “Lawyer of the Year.” Attorneys are selected based on exhaustive peer review.
 
The Legal Intelligencer awarded “Best Law Firm” (Pennsylvania) – Corporate Practices/Corporate Governance to Blank Rome, highlighting Barry’s leadership and achievements.
 
Martindale-Hubbell^TM “Top Rated Lawyer” AV Preeminent@peer review rating.