Background of Free Trade Zones in China
The story of China’s economy since the start of reforms in 1978 has been characterized by reiterated cycles of controlled policy experimentation followed by adjustment.
Deng Xiaoping put it more eloquently when he likened China’s reform process to “crossing the river by feeling the stones”. The introduction and subsequent expansion of China’s Free Trade Zone (FTZ) program represents another stone or two.
The Chinese government introduced the Shanghai FTZ program in 2013, with the intention to expand to other cities using lessons learned there. Among the factors motivating this were excess production capacity, stagnating reforms, and rising labor costs. Initially, the main goals of the FTZ program were to provide a controlled environment for policy reform, to promote the internationalization of the RMB, and to reduce capital outflows. Today, there are 11 free trade zones in China, each with different industry focuses, incentives, and rules. The government hopes that policy successes in the FTZs will guide reforms in the rest of China, similar to the role of Special Economic Zones (SEZs) in the beginning of the reform period.
Key Aspects of China’s FTZs
The “Negative List”
The Pre-establishment National Treatment system (PENT) was established for the Shanghai FTZ in 2013 and provided the contours of liberalization. The industries that do not enjoy national treatment (and are thus still restricted) fall on the Negative List. In a testament to the progress of trade liberalization in the FTZ, the negative list is gradually shrinking. In 2015, the items on the Shanghai FTZ negative list decreased from 139 to 122. Investments outside those industries do not need to go through the onerous “approval process” that investors outside the FTZ face. These investments are subject to no restrictions or joint venture requirements. In contrast to the relatively fast and efficient registration system that investments into the FTZ go through, the investment approval process elsewhere is carried out on a case-by-case basis.
An objective of the FTZ program is to experiment with financial reform, which has lagged due to fears of destabilization. The FTZ program has or plans to run pilot programs for interest rate liberalization, capital account convertibility, cross-border RMB cash pooling, facilitation of the growth of the international RMB reinsurance market, and easing of restrictions on commodity derivatives transactions.
Nonetheless, the business community has expressed disappointment regarding the pace of financial reforms in FTZs and, in particular, the lack of capital control removal. To stem capital outflows in 2016, the People’s Bank of China established restrictions on cross-border RMB pools to which the FTZ were subjected.
Another stated goal for FTZs is on the implementation of pro-business legal reforms. Better IP enforcement is, at least in theory, a major selling point for the FTZs. Thus far, the primary advantage of FTZs with regard to intellectual property is the establishment of a new kind of IP office. Most FTZs have a consolidated IP office which handles trademarks and copyrights, patents, and disputes. Consolidating these functions under one roof greatly reduces the bureaucratic burden for business.
However, this can barely be called progress on IP enforcement, as much as it may reduce administrative hardship for companies. On the enforcement front, the Shanghai Pudong New People’s Area Court administers the IP tribunal for the Shanghai FTZ. Generally, the FTZ authorities’ strategy is to reduce IP enforcement efforts where goods enter and exit the FTZ from overseas, while increasing such efforts where goods enter and exit the FTZ from elsewhere in Mainland China. For businesses concerned with weak IP legislation and enforcement in China, this may be a very welcomed development.
Perhaps more significant have been reforms to the commercial dispute system. In 2016, the Supreme People’s Court established a new regime to liberalize the arbitration administration in China’s FTZs.
Incentives and Benefits for Foreign Investors
Some of the details regarding benefits in FTZs will vary from zone to zone. Here is an overview of the benefits offered.
► Reduced market access restrictions All industries not on the negative list do not need approval and can be fast-tracked to registration. The establishment of the Shanghai FTZ in 2013 is notable for opening up 6 infamously restricted industries; shipping, financial services, commercial services, professional services, cultural services, and social services. Though significantly liberalized, these industries still face some restrictions on the negative list.
► Streamlined customs procedures Companies can enter the FTZ and declare later. A single customs form can be used to declare multiple batches of good and companies can pay tax in one-off lump sums. There is also faster clearance of goods.
► Ease of registration For registration, an online application should be made on the website of the FTZ. The FTZ upholds a national treatment, as it were, for registration, wherein foreign and domestic investors are required to undergo the same registration procedure.
► Lower Capital Requirements for Incorporation Standard capital requirements for incorporation (RMB 30 million minimum for an LLC, RMB100 million for single shareholder companies, and RMB 5 million for joint stock companies) are eliminated (Shanghai FTZ).
► Free trade account Authorities permit banks to offer a “free trade account” within the FTZ. Currency between free trade and overseas accounts can be moved without restriction. In addition to simplifying banking procedures for companies, this system allows for much easier access to foreign loans. Additionally, given lower interest rates, loans originating inside the FTZ may be used to pay off debt borrowed outside the FTZ.
► Consolidated IP office The “three-in-one” FTZ IP office handles trademarks and copyrights, patents, and IP disputes.
► No import tax on goods between the FTZ and overseas.
► International trading center Goods from abroad can be stored in the FTZ without paying customs tax. Customs tax applies when those goods go elsewhere in China. This can help facilitate logistics and export processing.
► Industrial clusters Businesses can benefit from the nearby presence complementary companies and services as well as customers.
► Easier currency conversion and cross border RMB pooling
► Bonded warehouses available
Many of these industries still face some restrictions on the negative list, though in the FTZ they are liberalized by comparison to the rest of the country. Here are some of the major industries opened up in the FTZ.
Accounting/Auditing: The managing partner must be a Chinese national.
Aerospace: Must be a joint-venture (equity or cooperative).
Automotive: Must be at least 50 percent owned by a Chinese partner.
E-commerce: Wholly Foreign Owned ventures are accepted. The Shanghai FTZ has established an E-commerce pilot-zone. Chinese E-commerce giants JD.com and Suning have established operations there.
Entertainment and Culture: Foreign and domestic enterprises to be treated equally.
Financial Services: Online foreign financial institutions can invest in financial operations in the area (investors from other sectors are not permitted). For rural credit banking, currency brokerage, and others, only entities that are already in the respective niche are permitted to invest.
Legal: Law firms are only permitted as a representative office of the firm.
Medical: Wholly Foreign Owned ventures are permitted, as long as the investors meet a number of requirements stipulated by FTZ authorities, including RMB20 million in investment capital.
Oil and Gas: Exploration ventures are permitted as equity or cooperative joint venture.
Rail Transportation: 100% foreign ownership is permitted in some areas of rail transportation manufacturing. Must be joint-venture (Equity or cooperative) for other areas.
Shipbuilding: Controlling stake must be with the Chinese investor for most kinds of shipbuilding operations.
Shipping: In the FTZ, foreign investors may hold a controlling stake (up to 51%) on international shipping ventures. Domestic shipping remains off limits.
Telecommunications Services: For non-core telecommunications services, foreign investor ownership may not exceed 51%.
Guide to the FTZs
Chongqing The Chongqing FTZ is focused on facilitating the Belt and Road initiative with the development of a logistics hub and other infrastructure connecting the new silk road with the Yangtze river. It has subzones in Liangjiang (focused on Biotech), Xiyong (focused on microelectronics), and Guoyuangang (focused on logistics).
Fujian The Fujian FTZ has sites in Xiamen, Fuzhou, and Pingtan. It is geared towards developing the Maritime Silk-Road and leveraging its proximity with Taiwan. The target industries are shipping, aviation, high-end manufacturing, and finance. The Xiamen zone has a “three-in-one” IP office (covering trademark and copyright, patents, and disputes).
Guangdong The Guangdong zone has locations in Guangzhou, Shenzhen, and Zhuhai. Its aim is to increase economic (and particularly financial) integration with Hong Kong and Macau. Focus industries include financial services, global supply chain, and logistics. For special talent in short supply, the Shenzhen government will subsidize the IIT on income greater than 15% of taxable monthly wages.
Henan With locations in Zhengzhou (focused on advanced manufacturing, pharmaceuticals, and automotive), Luoyang (focused on robotics and material science), and Kaifeng (focused on service sector and logistics), the Henan FTZ will help integrate infrastructure with more remote parts of the country and serve to develop the Belt and Road initiative.
Liaoning The main goal for the Liaoning FTZ is to help reinvigorate the Northeast region, which is China’s historic rustbelt. The FTZ has locations in Dalian, Shenyang, and Yingkou. Industry focuses will include logistics, automotive, and IT. Liaoning province has consistently reported among the worst economic performance in recent years. The traditional heavy industry base has eroded and electronics manufacturing has lost out in competition with the Pearl River delta and Tianjin. It is hoped that the FTZ will help the region regain contemporary relevance and attract more foreign capital.
Shanghai FTZ As the first FTZ, the Shanghai zone incorporated 4 existing trade zones, the Waigaoqiao Free Trade Zone, Waigaoqiao Free Trade Logistics Park Yangshan Free Trade Port Area and Pudong Airport Comprehensive Free Trade Zone. One benefit unique to the area is easier visa policy. Employment visas can be granted electronically and port visas can be issued on arrival.
The Shanghai FTZ introduced arbitration reforms with the following advantages:
- Emergency arbitration.
- Permits parties to handle disputes through a combination of mediation and arbitration. Where mediation cannot allow the parties to come to an agreement, arbitration is employed.
- Arbitrators can be appointed from outside the list maintained by the Shanghai International Economic and Trade Arbitration Commission.
In the Shanghai FTZ, companies can benefit from relaxed restrictions on foreign currency accounts. The People’s Bank of China has removed deposit interest rate ceilings on deposits below USD 3 million.
Shaanxi: The Shaanxi FTZ will develop an inland port, bringing foreign investment to northwest China. Authorities have announced that the rule of law will be a focus of reforms with the planned establishment of the Shaanxi Free Trade International Commercial Conciliation Center and the Shaanxi Free Trade Zone Arbitration Court.
Sichuan: Subzones of the Sichuan FTZ will include Chengdu Tianfu New Area, the Chengdu Qingbaijiang Railway Port Area, and the Chuannan Linggan Area. In the short to medium term, the FTZ is intended to boost development in western China. In the long term, this area is intended to serve as a hub for the eastern end of the contemporary silk route and Eurasian rail networks.
Tianjin The Tianjin FTZ is focused on the economic corridor with Mongolia. The FTZ is also intended to help strengthen the integration of the Tianjin-Beijing-Hebei region as an economic powerhouse similar in stature to the Pearl River Delta and Yangtze River Delta. Focus industries include advanced manufacturing, research and development, and international shipping and logistics.
Zhejiang The Zhejiang FTZ will include three subzones: the Zhoushan Outlying Islands Area, the Northern Zhoushan Island Area, and the Southern Zhoushan Island Area. Focuses will include maritime industries, international oil storage, and logistics.
China’s FTZs are an ambitious effort to raise the standards of business policy in the country. As seven of the zones have only come into being this year and the oldest one (Shanghai) was only set up in 2013, it is too early to tell if the program as a whole will live up to the hype and bring transformative benefits of policy experimentation to the entire country. Nevertheless, there are some tangible benefits that companies can already benefit from especially for administrative procedures, customs and taxes, and market access.