On 10 April 2024, China's Ministry of Industry and Information Technology (MIIT) issued the Notice on the Pilot Program for Expanding the Opening up of Value-added Telecommunications Services (Notice), aiming to loosen the foreign investment restrictions on certain Value-Added Telecom Services (VATS) in pilot areas. We digest the rules and implications for wholly foreign-owned enterprises (WFOEs) below.
The Rules and What Has Changed
| VATS Category | Existing Restrictions on Foreign Investment | What Happens with the Notice |
|---|---|---|
| B11 - Internet Data Center (IDC) B12 - Content Distribution Network (CDN) |
Generally not permitted, except: - Under CEPA1: by a Hong Kong/Macau qualified investor under the CEPA in the form of a joint venture, with the foreign equity ratio capped at 50% - In Hainan FTP2: if operating within Hainan and providing services only to Hainan and offshore users, no foreign investment ratio cap |
Available for WFOEs in the Pilot Areas |
| B14 - Internet Access Services (ISP) | Generally not permitted, but with some exceptions: - In FTZ3: 100% foreign ownership is allowed if the WFOE is registered in relevant FTZ and only provides access services for Internet users within the FTZ. - Under CEPA: foreign equity ratio should not exceed 50%, but for providing access services for Internet users can be 100% |
For all kinds of ISP Services, WFOEs are allowed in the Pilot Areas, but the ISP business is limited, meaning it can only use the basic lines of the telecom operators (e.g., China Mobile) to provide Internet access services for customers in the pilot areas. |
| B21 - Online Data Processing and Transaction Handling (EDI) | For e-commerce, WFOEs allowed nationwide; For other kinds of B21 services, foreign equity ratio should not exceed 50% | For e-commerce, WFOEs allowed nationwide (no change); For all other kinds of B21 Services, WFOEs allowed in the Pilot Areas |
| B25 - Internet Information Service (ICP) | Generally, foreign equity ratio should not exceed 50%, but with
some exceptions: - WFOEs allowed for operating app stores in FTZ or under CEPA - Investment in Internet news and information services, Internet publishing services, Internet audio-visual program services, Internet culture operations (except for music), Internet information services to the public are generally prohibited. |
WFOEs allowed for: - Information Publishing and Delivery Services - Information Protection and Processing Services However, note that the operation of internet news information, online publishing, online audio and video, and internet culture are still prohibited. |
Background and Context
Since accession to the WTO over 20 years ago, China has opened its telecom and e-commerce sectors to foreign investment on paper, but in practice it has been a huge challenge for foreign-invested companies to apply for relevant licenses. Whether as a general push to be more receptive to foreign investment or in response to restrictions Chinese e-commerce giants are facing as they expand overseas, this Notice is a welcome development to foreign internet businesses. With these new rules, new entrants are welcomed to the market while existing operators may take this opportunity to restructure current operations for more direct control.
Much remains to be seen as to how the Notice's general guidance will be put in practice, as local pilot areas have been instructed to come up with their own implementation rules subject to approval from the central regulator MIIT. Once a system is in place, approvals of individual applications for enterprises in those pilot zones will also be done at the central MIIT agency level, and not by authorities in the pilot zones.
The outcome of this centralized approval process could pan out in one of two ways. On the one hand, where central government approval has been required for licenses in general, this has tended to extend the approval timeline and discourage creative thinking by local government agencies. On the other hand, approvals of internet businesses have always been a cautious endeavor. In our experience, there has been a huge variation from one provincial MIIT to another provincial MIIT on their posture towards what does and does not require, for example, an ICP license.
This variance in turn has created a fair amount of uncertainty for foreign companies to invest and apply for licensing. Having the approval process at the central level should help remove some of that uncertainty. It also clearly shows the central government being aware that while certain VATS categories have been open for foreign enterprises, local approvals have not been granted in practice with administrators either sitting on or denying applications for no clear reason.
Historically then one of the challenges of advising clients has not been whether to apply (in vain), but whether a client should either (1) find a plausible argument why they do not need the license and go ahead to setup a local subsidiary without it, or (2) find a local partner to essentially "borrow" their license under a well-trotted but less than ideal path (see our previous article here). This challenge is compounded by the fact that while we can point to what domestic companies are obtaining as licenses (available publicly on MIIT's website), the caveat is that since domestic competitors can get their licenses much more easily, they will naturally take a more inclusive approach to acquire every license they might plausibly need.
Other Highlights from the Notice
- Pilot Areas
According to the Notice, four areas are selected for this Pilot Program:
- Beijing: All of Beijing Municipality;
- Shanghai: Pudong New District and Lin-Gang Special Area of the Shanghai FTZ;
- Hainan: All of Hainan Province; and
- Shenzhen: All of Shenzhen Municipality.
- Restrictions
The Notice generally only lifts the restrictions on foreign investment ratios, which means that for WFOEs operating VATS in the Pilot Areas, other restrictions generally applicable for VATS will still apply. These include:
- A VATS operator must have funding and professionals relevant for its business;
- A VATS operator must have credibility or capability to provide long-term services to users;
- On the minimum registered capital of an operator:
- If operating within a province or municipality, at least CNY 1 million;
- If operating nationwide or across provinces, at least CNY 10 million.
- Under the new PRC Company Law (effective 1 July) , the registered capital will need to be contributed within 5 years from the company establishment (see our related article here);
- A VATS operator shall employ at least 3 people; and
- It shall have appropriate premises, facilities and technical plans.
- Nationwide Coverage
In addition, the Notice sets the following requirements:
- The WFOE's place of registration and service facilities (generally refers to server rooms or servers) should be within the Pilot Area.
- Except for B14 ISP which can only be run within the Pilot Area, WFOEs operating their VATS can serve customers nationwide.
The nationwide coverage is a critical point that gives the Notice a lot of its real value. This has historically been a point of ambiguity when a company chooses to apply for a local ICP license (as opposed to a cross-provincial one with higher capital requirements) or whether to apply for a license in a FTZ (and whether services can be provided outside the FTZ).
Conclusion
Before this Notice, foreign companies, big or small, have had to carry out business in creative ways when it comes to bringing their VATS services into China, such as running a server offshore, partnering with a Chinese VATS provider, or operating under a VIE structure. None of these solutions has been ideal, either in terms of user experience, control and protection of IPR, revenue sharing, data management etc., not to mention that such solutions run at least some risk of legal non-compliance. The Notice appears to be giving something of a green light to foreign companies to establish wholly owned subsidiaries in the Pilot Areas and apply for relevant VATS licenses directly, which if true would be a remarkable step forward.
Foreign companies that are currently operating commercial APPs or providing other VATS in China will benefit from the Notice by setting up WFOEs and obtaining the relevant VATS licenses in the Pilot Areas. We have written about them specifically here.
We do note that the Notice does not have a specific implementation date, and it defers to each Pilot Area to submit its own implementation plan for MIIT's approval. So it will be worth watching how quickly these Pilot Areas will submit their implementation plans and if there will be differences between their implementation plans.
Finally, it remains to be seen whether the opening will expand to other regions or other VATS categories. We hope so, will be monitoring developments, and plan to keep you posted.
Footnotes
1Closer Economic Partnership Agreement
2 Free Trade Port
3Free Trade Zone
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.