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Shanghai Free Trade Zone: Do Companies Really Benefit?

Here on out referred to as the FTZ, the Free Trade Zone in Shanghai is a pilot program undertaken by the Chinese government to put a number of reforms on trial in a bid to modernize certain industries, revitalize the Chinese economy (whose growth rate slowed to just above the 7.5% minimum) and spread the influence of the Chinese currency, the Renminbi.

The reforms will deal with customs and tax supervision, simplification of administrative processes for licensing and the financial industry.

The FTZ, opened on the 29th of September 2013, is actually divided into 4 separate areas: the original Waigaoqiao Free Trade Zone (opened in 1990), the Waigaoqiao Bonded Logistics Park, the Pudong Airport Bonded Logistics Centre and the Yangshan Bonded Port Area.

What makes the SH FTZ different?

Over the years, China has opened a number of supervisory zones with some characteristics of a free trade zone, such as bonded areas, or let other regions have their own economic systems, like the famed Shenzhen. The Shanghai Free Trade zone is different in that will offer preferential policies and will be about creating a testing ground for new legislation and administrative processes. A fundamental principle of this new FTZ is not to implement or adopt any new policies which cannot be applied elsewhere in China.

The SH FTZ will focus on implementing trial reforms largely different from those of other special trade zones in the country. The financial industry is specifically targeted by these reforms, as cross-border Renminbi (RMB) trades and freedom to set interest rates will provide financial institutions new sources of income and reasons to invest in China (Zhang, 2014).

There are unique advantages the SH FTZ presents over other special trade and customs zones.

Financial Reforms: i) Foreign banks will be able to establish WFOE or majority-controlled subsidiaries within shorter time frames; ii) The financial institutions are expected to progressively be granted licenses for cross-border financial products; iii) The promotion of renminbi convertibility and relaxed administrative controls will greatly facilitate treasury cross-border fund management for companies –financial and non-financial alike – with regional headquarters in China. Different than other bonded areas, the biggest feature of FTZ is the special custom monitoring system called “Domestic but out of Customs”, which means “open the A line (Free Trade Zone and boarder line) and control the B line (Free Trade Zone and Non Free Trade Zone)”. This expedited clearance of goods and materials is beneficial in terms of cost and time for logistics companies specifically.

Upgrading of customs supervision frameworks: Overseas shipments will not need customs clearance until a later stage, simplifying the operation of logistics companies within the FTZ. Reducing costs and complexities involved in the logistics could further encourage international manufacturers to set up a regional manufacturing and  logistics hub in Shanghai.

Simplification of administrative systems: An important reform which will attract foreign investors is a drastic simplification of the administrative burden of applying for approval and registration within the FTZ. Foreign investors within the zone will be subject to the same application procedure and requirements as domestic investors and the process will require a single application at a single location, provided their business scope is not contained within the “Negative List” for which special approval is needed.

Competitive regulatory and tax environment: generally reducing tax rates in the FTZ is not an option which could be implemented across the country, so, instead, new tax policies are being adopted to support innovative business models. Firms may choose to pay Import taxes that apply to imported components, or the Import taxes applying to the finished components.

Another important advantage for foreign companies within the FTZ is also being legally allowed to own controlling stakes in previously protected industries. Certain industries, such as Healthcare and Shipping, will be able to set up Wholly Foreign Owned Enterprises for the first time.

Which industries will be favored?

The reforms are meant to relax policies in favor of some 12 industries.

  • Banking & Financial Services
  • Value-added Telecommunication
  • Shipping & Logistics
  • Credit Investigation/Reporting
  • Engineering & Construction
  • Medical/Healthcare Services
  • Insurance
  • Educational & Vocational Training
  • Legal Services
  • Recruitment
  • Video Game Console Sales & Services
  • Travel Agencies

The reforms already in place will most benefit the banking and shipping industries. Streamlined incorporation, however, thanks to the abolition of minimum requirements on registered capital. The new registration system greatly reduces the amount of time to obtain a license.

Do companies really benefit?

Of the 4600 companies which were registered by mid-January 2014, only 300 were foreign-invested enterprises. Despite appearing to relax the regulation, specifically for foreign companies, the Chinese government is progressing with the reforms slowly and detailed regulation is still largely unavailable prompting foreign investors to caution and deterring some potentially interested parties.

Early expectations have not been met, whereas the Negative List was originally thought to be limited to certain traditionally problematic industries such as arms, pharmaceuticals, the list is actually quite exhaustive. Moreover, Beijing will not be suspending the Great Firewall within the SH FTZ and the telecommunications. Enthusiasm is waning as foreign companies wait for further reforms and more detailed policies.

Given the real limits still imposed on foreign companies, it is clear that, for now, domestic companies are still favored by policies, as supported by the overwhelming majority of domestic enterprises within the zone.

What can we expect from the SH FTZ?

As with special trade zones in China in the past, the development of the SH FTZ will be a slow process which will progressively incorporate more reforms.

There are mixed feelings about the government’s commitment to the Shanghai endeavor: the zone has the backing of no less than the Premier Li Keqiang, who failed to show up at the opening ceremony. Beijing’s seemingly reluctant support of the opening of China’s market, and more importantly, its financial system through such zones will impede the pace of development.

It is without doubt, however, that the FTZ will be a testing ground for new policies. Already, trials have proven successful within the zone and, as of March 2014, several have been implemented nationwide.

By Nicolas Roux, Launch Factory 88. 

Duco van Breemen

Duco van Breemen

Duco is project & marketing manager at Launch Factory 88. He has lived in China since 2008 and has worked with both state-owned and private Chinese and foreign enterprises.
Duco van Breemen