(By Julia Ya Qin)

1. Liberalization of entry restrictions

Ever since China opened up to foreign investment in 1979, the government has maintained restrictions on the entry of foreign capital through an elaborate examination and approval system.62 Since 1995, foreign investment projects have been classified into the categories of encouraged, permitted, restricted, and prohibited. The classification is based on considerations such as the State’s industrial policies, technology advancement, use of natural resources, environmental impact, national security and public policy interests. The sectoral restrictions on FDI range from a straight ban to equity limits and other conditions. The government maintains and publishes the Catalogue for the Guidance of Foreign Investment Industries, which provides a detailed list of specific industries under each category.

Market access for foreign investment is not subject to WTO discipline except to the extent covered by the General Agreement on Trade in Services (GATS). Under GATS, members negotiate their market access in services, which include commitments on ‘commercial presence’ of foreign services in their territories (i.e., foreign investment in service industries). A WTO member is obligated to provide national treatment to foreign service suppliers in its territory, but only to the extent covered by, and subject to the conditions specified in, its service schedule attached to GATS. Hence, the scope and terms of market access for foreign investment in services sectors vary from member to member, depending on their specific commitments under GATS.

As noted above, China made extensive market access commitments in services. Of the 12 service sectors classified under GATS, China is bound by specific commitments in nine, including crucial areas in distribution, construction, transport, communication, and financial services. To implement these commitments, China has substantially revised the Industry Catalogue following WTO accession. Under the most recent Catalogue, the number of encouraged industries increased from 186 to 262, while restricted industries decreased from 112 to 75. As an indication of increased market access for foreign investment, some 75% of foreign investment in China is now in wholly foreign-owned companies.

One of the most significant changes, for example, is the opening of distribution services. Previously, FIEs were not permitted to sell products in China other than those of their own production, and foreign investment in retail business was strictly restricted. After WTO accession, distribution sector has been liberalized according to a specified timetable. Today, FIEs can engage in wholesale and retail distribution of all kinds of products in China, without limitation on the percentage of ownership or geographical location.70 Distribution rights, together with foreign trade rights, are arguably the most important of China’s WTO entry obligations for foreign investors, since most of them are interested in selling directly into the vast domestic market in China. Another example is the opening of the banking sector. China made a commitment to allow foreign banks to operate fully in its territory - without geographic, client or ownership restrictions – within five years of its accession. Evidently, this bold commitment was designed to stimulate the ailing state-owned banking sector that dominated finance in China. To prepare the state-owned banks for the forthcoming foreign competition, the government has injected massive amounts of cash into the banks to clean up their balance sheet and diversified

their ownership through private placements and public offerings. A full implementation of the banking commitment can have a major impact on China’s banking and financial industries. It should also be mentioned that, in addition to market access in service sectors, China undertook to reduce entry restrictions on foreign investment in the auto industry. The auto-industry commitments of China are unique within the WTO framework, given that the WTO does not currently cover market access for investment in non-service sectors.

2. Elimination of performance requirements

Aside from GATS, the WTO has only a narrow set of rules regulating foreign investment. Under the Agreement on Trade-Related Investment Measures (TRIMs), WTO members must eliminate certain performance requirements imposed on foreign investment, including specifically the requirements on export performance, local content (import substitution), and foreign exchange balancing. These performance requirements are prohibited because they have the effect of either discriminating against imported goods, or restricting imports or exports, all in contravention of GATT obligations. For developing countries, the TRIMs Agreement provides certain exceptions as well as a five-year transitional period for compliance.

Prior to its WTO accession, China imposed many performance requirements on FIEs, including those regarding export performance, local content, foreign exchange balancing, and technology transfer. For example, a wholly foreign-owned enterprise (WFOE) was required to either import advanced technology or export more than 50 percent of its output every year; and preferential terms on land use, tax refund and imports were granted to the Chinese-foreign equity joint ventures (EJV) and contractual joint ventures (CJV) that were export-oriented or utilized advanced technology.75 While FIEs were allowed to purchase materials in either domestic or international markets, previous laws required them to give priority to the purchase of domestic products over imports under the same conditions.

In its accession protocol, China specifically agrees that it shall, upon accession, comply with the TRIMs Agreement without recourse to the transitional period granted to developing country members. Furthermore, China has agreed not to enforce provisions of contracts imposing performance requirements, which means that FIEs may cease to honor the obligations to comply with these performance requirements under their existing contracts. The most remarkable, however, is China’s pledge not to condition the approval for foreign investment on ‘performance requirements of any kind’, including not only those covered by TRIMs, but also ‘the transfer of technology’ and ‘the conduct of research and development in China.’ This commitment to abolish performance requirements of any kind is one of the WTO-plus obligations of China that no other country has undertaken under WTO law.

To implement its broad commitments, China has revised its foreign investment laws to eliminate the mandatory requirements regarding export performance, local content, foreign exchange balancing, and technology transfer. After the WTO accession, the government has also reformed the approval system for technology transfer. Previously, all contracts for technology import or export must be approved individually by the relevant authorities. This system has been replaced by a new catalogue system under which the government publishes a list of prohibited and restricted technologies. While the transfer of technologies listed in the catalogue still requires government approval, any technology that is not listed in the catalogue can be imported or exported freely, subject only to the requirement of contract registration with MOFCOM.

Despite the revisions of the foreign investment laws, however, China has not eliminated all performance requirements in practice. For instance, the new automobile industry development policy issued in 2004 contains a provision requiring newly established automobile enterprises to set up their own research and development institutions. Tax benefits and other incentives are still offered to FIEs and domestic enterprises contingent upon the use of domestic over imported equipment. Such measures have given rise to challenges at the WTO, as will be further discussed below.

3. National treatment of foreign investment

WTO accession has significantly expanded China’s obligations to accord national treatment to foreign investment. Prior to the accession, China had only granted national treatment to foreign investors of selected countries through bilateral investment treaties. The scope of the national treatment clause in these treaties is typically limited to the protection of investment against expropriation or nationalization. By contrast, the accession protocol requires China to extend to foreign investors national treatment with respect to the market access commitments in services,86 and further, to the conditions affecting their production and sales in China. Specifically, the latter obligation requires China to accord foreign investors and FIEs treatment no less favorable than that accorded to domestic entities with respect to the procurement of goods and services necessary for production, the conditions under which their goods are produced, marketed or sold in the domestic markets and for export, and the prices and availability of goods and services supplied by government and SOEs in areas including transportation, energy, basic telecommunications, other utilities and factors of production.87 Since WTO national treatment rules do not cover investment activities beyond the provisions of GATS and TRIMs, this production-based national treatment obligation is another WTO-plus obligation of China.

An interesting phenomenon associated with China’s WTO obligations on national treatment of foreign investors has been the demand for ‘national treatment’ (or more precisely, equal treatment) of domestic enterprises. Historically, China has maintained different treatment between foreign and domestic firms, and between SOEs and other domestically-owned enterprises. To attract foreign investment, the government has provided FIEs with substantial tax benefits and other privileges that are not available to domestic enterprises.88 On the other hand, SOEs traditionally enjoyed more favorable treatment than FIEs with respect to market access, performance requirements, supply of production inputs and state bank credits. With China’s entry into the WTO, FIEs have gained national treatment in new areas while maintaining their old preferences. In contrast, SOEs have lost many of their privileges; and domestic private enterprises, the number of which is fast growing, continue to receive less favorable treatment than both FIEs and SOEs in terms of market access, bank financing and access to capital markets. As a result, there have been increasing calls for leveling the playing field for all players in the economy, especially between foreign and domestic firms.

Under WTO rules, China is only obligated to accord foreign interests treatment ‘no less favorable’ than that accorded to domestic interests, and is therefore not prohibited from granting more favorable treatment to foreign interests. Nonetheless, publicity about the national treatment principle of the WTO has made the Chinese public keenly aware of the issue of unequal treatment of enterprises in China. The pressure, therefore, has been building to remove FDI preferences. In March 2007, the National People’s Congress adopted the new Enterprise Income Tax Law that provides for a uniform income tax system for domestic and foreign-invested enterprises. Once fully implemented, the new law will end the decades-long preferential tax treatment of FIEs.

4. Rise of protectionism

In the past few years, there has been a growing perception in China that decades of economic reform and opening up have benefited foreign interests more than domestic interests. Critics have sounded alarm that foreign investors have bought out name-brand Chinese companies or acquired valuable Chinese assets at bargain prices, leading to foreign domination in industries and disappearance of domestic brands. They also claim that foreign investment has not resulted in significant technology transfers to China and instead has diverted Chinese domestic resources from research and development to low-end manufacturing sectors.

Partially responding to these concerns, the government began to re-caliber its foreign investment policy in 2006. Recent months have seen a host of new regulations and policies that aim to tighten controls over foreign investment and to promote domestic industries. For example, the new regulation on mergers and acquisitions by foreign investors, issued in August 2006, provides MOFCOM with broad discretion to block foreign purchases of domestic companies, if the purchase would result in the transfer of actual control of a domestic enterprise that is involved in a ‘key industry’ or holds famous trademarks or Chinese traditional brands, or if the purchase has elements affecting ‘national economic security’. In September 2006, the government announced a temporary ban on approval of foreign investment in brokerage houses, a move that was partly intended to bolster domestic brokerages ahead of foreign-invested firms as the government attempts to reorganize the industry. In November 2006, the new regulation on foreign-invested banks was issued which, while implementing China’s WTO commitment to completely open its banking industry within five years of its accession, requires foreign banks to establish Chinese subsidiaries, instead of operating as foreign branches, in order to engage in the full range of RMB business with local clients. Also in November 2006, the National Development and Reform Commission (NDRC) issued an important policy document setting forth the foreign investment plan for the next five years. While affirming that China will continue to open its service sectors and strive to improve the business environment for foreign investment, the document outlines a new approach to foreign investment. Under this policy, China will focus on the quality rather than the quantity of FDI, selecting new investments that will bring technology or otherwise fit into China’s development strategy. Furthermore, the government authorities will carefully scrutinize foreign acquisitions of key domestic enterprises, paying special attention to the impact of wholly-owned foreign enterprises on China’s ‘national economic security’ and ‘industry security’. These new policies and rules have already made a difference in practice. For instance, according to Bloomberg data, almost 70% of the $19.5 billion of acquisitions in China announced by foreign investors in 2006 were not completed, whereas all but 25% of the $34.4 billion in purchases were cleared in 2005.

After nearly thirty years of encouraging foreign direct investment, China is entering a stage where it no longer needs to rely on foreign capital to generate growth and employment. Against this economic reality, the tightening of government control over FDI, while evidently a response to a variety of concerns, may signal the rise of a protectionist trend. It remains to be seen to what extent China’s WTO commitments can serve as a check on such trend.

D. Intellectual Property Rights

The development of intellectual property law in China has been closely related to the development of foreign trade and investment. Since the adoption of the PRC Trademark Law in 1982, China has enacted numerous laws and regulations concerning a wide range of IP rights and acceded to most of the major IP international treaties. In the process of building up a modern IP regime in China, WTO accession has played an important role.

The WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) provides a comprehensive legal framework for the protection of IP rights. It does so by incorporating the principles and rules of other major international conventions, and by setting out certain new standards on substantive rights. Furthermore, TRIPS prescribes certain civil, administrative, and criminal procedures and remedies that each WTO member must make available to the IP rights holder under its domestic law. Non-compliance with TRIPS can be addressed through the WTO dispute settlement mechanism and may result in WTO-authorized sanctions. To ensure compliance with TRIPS, China has made impressive efforts on both the legislative and institutional fronts. Legislatively, new amendments have been made to all major IP laws, including the patent law (2000), the trademark law (2001) and the copyright law (2001), and new regulations have been issued, including those on the protection of computer software (2001), layout-designs of integrated circuits (2001), and new plant varieties (2001). In addition to administrative and civil remedies, specific crimes of IP violations have been added to the criminal code. Institutionally, an elaborate government apparatus has been set up to administer and enforce IP laws, including a special IP adjudication division in the People’s Courts. As a result of these efforts, China today has an extensive and basically WTO-compliant legal framework for IP protection.

Despite the presence of a WTO-compliant legal framework, IP violations remain rampant. The main problems identified by China’s major trading partners include: the lack of coordination among the large number of government agencies responsible for IP enforcement; local protectionism and corruption; inadequate deterrence provided by the system of administrative, civil and criminal penalties; and insufficient training of government personnel.101 Although in recent years the government has stepped up enforcement efforts, weak protection of IP rights remains one of the top complaints of the foreign companies doing business in China.

Inadequate enforcement of IP rights in China has prompted the United States to file a formal WTO complaint, charging China for failure to protect IP rights according to TRIPS standards.102 Specifically, the United States claims that the PRC criminal law sets inadequate thresholds for criminal procedures and penalties for trademark counterfeiting and copyright piracy, that Chinese Customs regulations improperly authorize the release into commerce of confiscated IP infringing goods after removing their infringing features rather than destroying such goods, and that Chinese copyright law denies protection for foreign works that have not been authorized for publication or distribution in China. While the Chinese government has formally rejected the U.S. charges and the outcome of the case remains to be seen, this long-threatened WTO complaint has put great pressure on the Chinese government to enhance IP protection and enforcement. Indeed, merely days before the United States filed the complaint, the Supreme People’s Court and the Supreme People’s Procuratorate jointly issued a judicial interpretation which, among other things, substantially lowered the threshold for criminal punishment of copyright piracy.

(Edited by: China West Lawyer)