By Stephen J. Petras, Jr. & Sangita S. Patel,
Baker & Hostetler LLP

Since joining the World Trade Organization (WTO) in 2001, China has made measurable gains in meeting its membership commitments with the passage of new laws, regulations and administrative measures. In what is likely to be considered the most sweeping change since its accession to the WTO, China promulgated two new laws that promise to change the retail and wholesale industry.

On April 6, 2004, the Standing Committee of the National People’s Congress enacted amendments to the Foreign Trade Law (the FTL Amendments). On April 16, 2004, the Ministry of Foreign Commerce passed new rules relating to foreign-invested enterprises in the wholesale, retail and franchise industries. These new rules were released on April 19, 2004, and are known as the Administration of Foreign Investment in Commercial Sectors Procedures (FICP Regulations). Both measures represent not only the implementation of China’s existing WTO commitments, but also reflect a significant and symbolic step towards granting full market access to foreign-invested enterprises.

Summary Of The New Regulations To Foreign Investors

Chinese commercial terminology traditionally views international “trading rights” as distinctly separate from “distribution rights.” “Trading rights” are generally understood to include the right to import or export goods manufactured by third parties into or out of China. In acceding to the WTO, China committed to grant all enterprises international trading rights after December 11, 2004. “Distribution rights” are generally understood to include the right to engage in the internal sale, offering for sale, purchase, distribution or use of those goods that have been imported into China. Prior to the FICP Regulations, in order for foreign companies to distribute goods within China, they had to establish joint ventures with a Chinese partner. The FICP Regulations abolish this requirement, and introduce a new type of foreign-invested enterprise which will be permitted to distribute products within China. Taken together, the trading rights coupled with the “distribution rights” granted by the FICP Regulations will allow foreign companies unprecedented access to the Chinese market.

The FICP Regulations also appear to allow wholly foreign-owned enterprises (“WFOEs”) to distribute their goods throughout China. Subject to certain restrictions concerning specific commodities, the new rules eliminate many of the limitations that were imposed in the prior “experimental” rules. According to the Guideline Catalogue for Foreign Investment Industries published by the State Council, the real surprise under the new procedures is that there will no longer be the burdensome investment capital requirements for foreign investors. Foreign investors will, however, need to comply with the capital requirements under existing laws that are applicable to all domestic Chinese companies.

The FICP Regulations expand the business scope of wholesale, retail and franchise industries within China. For example, the FICP Regulations allow retail entities established under the new regulations to sell products for its own account, import products for the enterprise’s own sales, purchase domestic products for export, and perform related services. Similarly, the FICP Regulations permit wholesale enterprises to sell products on a wholesale basis, act as a sales agent (excluding auction services), import and export products, and other related services. The Regulations also grant the right to open and operate franchises, with no apparent geographic, quantitative or equity restrictions. However, the implementing regulations for franchising have not yet been released. The application process for obtaining FICP status has been streamlined, and is anticipated as being fairly straightforward. The FICP Regulations still require project approval, feasibility study approval and enterprise establishment approval, but all are combined into one step instead of two as before.

While it appears as though the FICP Regulations will undoubtedly allow foreign companies much greater access to China’s domestic market, it should be noted that certain significant restrictions still exist. For example, entities established under the FICP Regulations may not engage in sales via television, telephone, mail, or the Internet. There are also several general geographic restrictions designed to manage the influx of large-scale U.S. and European retailers. Among these are significant restrictions on the size of foreign distribution outlets that will be permitted, and the requirement that any new retail store conform to the urban and commercial development plan of the local government.

While both the FTL Amendments and the FICP Regulations represent significant steps forward in the liberalization of China’s import and distribution sectors, there are several issues that remain open. The regulations governing the establishment of franchise operations have yet to be released and since many foreign retailers operate on a franchise model, they must await the passage of these franchising rules. More importantly, the FICP Regulations are new and, as with any new rules in China, a certain amount of time, further interpretation, as well as discussion with Chinese authorities is necessary to determine how they will be applied in practice. It remains to be seen, therefore, how certain discretionary rules included in the Regulations are actually applied in practice.

If you have any questions about investing in China, or about China’s trading or distribution rules, please contact Stephen J. Petras, Jr., a partner with Baker & Hostetler LLP, Cleveland, at spetras@bakerlaw.com.