The much anticipated China-Australia Free Trade Agreement (ChAFTA) was announced on 17 November 2014.  The ChAFTA will secure Australia’s competitive position with its largest trading partner and lay the foundation for a deeper and stronger long-term strategic partnership between the two nations.

The ChAFTA is a major step forward, sending a strong and unmistakable message that China and Australia are committed to developing a deeper engagement – economically, politically and socially – with each other.

This is the first comprehensive free trade agreement that China has concluded with a developed economy.

As a result of the ChAFTA, Australian businesses have been granted unprecedented access to the fastest growing markets in the world, unlocking billions of dollars of exports and investment opportunities. Similarly, Chinese businesses have been granted many benefits by the ChAFTA.

While some industries and products may have missed out, it is important to look at the big picture and remember that the ChAFTA is not an end-point, but rather a base from which to build on.

Next Steps

The Governments of China and Australia should be congratulated on reaching this significant milestone. However, the hard work is not over.  Signing the ChAFTA is just the first step. The ChAFTA is yet to be finalised and ratified by both nations.  Its benefits will also need to be sold to communities in China and Australia.

The next steps cannot be shouldered only by the Governments of China and Australia. It will be necessary for business communities in China and Australia to actively support the case for the ChAFTA. They will need to proactively engage with each other to explore opportunities for integrated partnership models that encompass the entire value chain from research and development all the way through to marketing and sales, moving away from the purely transactional model that has thus far been the hallmark of business relationships between China and Australia.

Australia won’t enjoy the comparative advantage it has won under the ChAFTA for long. China is likely to grant other nations similar trade concessions. While Australia seems to have secured “most favoured nation” protection to share in further concessions, we understand that China is in detailed negotiations with the US and Europe for similar trade agreements.

The sooner the ChAFTA is ratified, the sooner the benefits will flow. Once ratified the key changes will include:

  • Removal and reduction of tariff barriers – Australia’s dairy, beef, sheep meat, live animal exports, wine, seafood and horticulture sectors are likely to be the big winners along with certain resources / energy producers and manufactured products;
  • Relaxation of Australian regulatory barriers to Chinese investment; and
  • Facilitation of Australian investment into China.  

While it will be some time before the benefits of the agreement fully materialise, the significant opportunities which will open up as a result of the ChAFTA not to be underestimated.

1. Relaxation of Australian Regulatory Barriers

FIRB

Australia has matched the same threshold as the US, Japan and Korea for private Chinese investors. This means investment proposals by Chinese businesses to invest in Australia that fall below the AUD 1.078 billion threshold will not require approval under Australia’s foreign investment rules, which are overseen by the Foreign Investments Review Board (FIRB).

The safe harbour investment threshold of AUD 1.078 billion will only apply if the investment in Australia comes directly from China.

Investments by Chinese state owned enterprises (SOEs) and sovereign wealth funds (SWFs) will require approval under Australia’s foreign investment rules regardless of their size. Consistent with the approach in the current FTAs, the ChAFTA will not impact those sectors of the Australian economy which are defined as “sensitive” by FIRB. The ‘sensitive’ sectors include defence related materials and activities, communications, transport, media, most land and uranium and plutonium extraction. This means that any investment by Chinese businesses in the “sensitive” areas will require approval by FIRB under Australia’s foreign investment rules, irrespective of the value of the investment and even if it falls well below the safe harbour threshold of AUD 1.078 billion.

Foreign Government Investment

China hoped to see its SOEs and SWFs treated as private enterprises for investment purposes under Australia’s foreign investment rules.

However, the Australian Government has not agreed to treat China’s SOEs and SWFs as private enterprises under its foreign investment rules and has not agreed to create an exemption for passive investments of less than 10% by China’s SOEs or SWFs.

The effect of this is that any investment in Australia by a Chinese SOE or SWF will require approval under Australia’s foreign investment rules.

The Australian Government has signalled a review of the position after 3 years.

Rural Land and Agribusiness

The Australian Government went to the previous election on a platform that included a substantial lowering of the rural thresholds under the foreign investment regime.

Consistent with the Japanese and Korean FTAs, the ChAFTA includes new investment thresholds of AUD 15 million for rural land and AUD 53 million for agribusiness interests. These new investment thresholds will operate as safe harbours for Chinese investors in rural land in Australia, thereby exempting them from the need to seek approval from FIRB for the investment if the investment is below the thresholds.

Investor-state Dispute Mechanism

The ChAFTA will contain an Investor-State Dispute Settlement (ISDS) mechanism. The ISDS mechanism is designed to protect investors from States changing their investment rules and should promote confidence for investors.

The ISDS mechanism will contain carve outs for legitimate regulation objectives.

This balancing approach is consistent with other modern investment protection treaties. It is particularly encouraging for Chinese investment in Australia because it marks a change from the previous Australian Government’s avoidance of ISDS mechanisms.

Labour

The ChAFTA will introduce measures to reduce some of the barriers to labour mobility between Australia and China through changes to each country’s existing immigration and employment structures. These changes are expected to provide improved access for a range of Australian and Chinese skilled service providers, investors and business visitors.

Specifically, certain Chinese owned companies registered in Australia undertaking certain infrastructure projects above AUD 150 million will also be able to negotiate increased labour flexibilities in some cases (called Investment Facilitation Arrangements).  These arrangements will operate within Australia’s existing immigration system and will need to satisfy Australian employment laws and standards.

Most Favoured Nation Status

In the investment field, although the details have not yet been released, China’s Ministry of Finance and Commerce (MOFCOM) announced that China and Australia have agreed to grant each other “most favoured nation status”.

2. Facilitation of Australian investment in China

In addition to the draft relaxations for all investors announced by the NDRC earlier in November in the form of a draft Catalogue for the Guidance of Foreign Investment Industries to be implemented across China, the ChAFTA has given the Australian services industry a big leg up in the form of market access in China. This is especially the case for Australian financial and professional service suppliers, education, health and aged care suppliers.

Health and Aged Care Suppliers

Under the ChAFTA, wholly Australian-owned hospitals and aged care institutions will be able to establish business operations in China.

We expect Australian service providers to seize these opportunities.

Early movers are already set to benefit from these changes with Ramsay Health Care having previously announced a 50/50 joint venture with Chinese hospital operator, Jinxin.  It is reported that Ramsay hopes to finalise its partnership with Jinxin early next year.

No doubt Australian corporates will wish to partner with experienced locals as they launch into unfamiliar markets, especially now there will be regulatory flexibility on the terms of the venture.

Interestingly, China’s National Development Reform Commission’s (NDRC) draft revisions on foreign investment into Chinese industrial sectors which apply to all foreign investors suggest tighter control over the establishment of foreign invested medical institutions. The benefits to Australian health and aged care suppliers seem to be a unique benefit accorded to Australia.

Financial Services

The outcomes achieved for financial services are much more positive than many commentators had expected.

One of the ChAFTA’s big winners is likely to be the Australian financial services industry, particularly the funds management sector which has gained enhanced access to the China’s growing domestic market. The streamlined licensing requirements and approval process will allow Australian banks and financial institutions to operate on a more level playing field within China.

This is an important part of the step towards opening up China’s services market more deeply.  It broadly coincides with a series of efforts to liberalise China’s capital markets and internationalise the RMB.  While we do not think this will result in Australian financial service providers going head to head with domestic Chinese businesses in China, we do expect Australian banks, insurers and financial service providers to take advantage of the concessions to access China’s emerging service industries before they are offered to competitor nations.

There are also encouraging commitments on transparency, regulatory decision-making and streamlining of licencing in China.  A financial services committee will be established to facilitate cooperation and mutual understanding between Chinese and Australian financial regulators.

Along with the simultaneous announcement that an official RMB clearing bank will be established in Sydney, this will underpin ever greater flows of trade and investment between Australia and the fast growing economies of China and Asia.

Shanghai Free Trade Zone (SFTZ) – Financial Services, Telecommunications, Maritime Transport and Legal Services

The SFTZ is an important testing ground for further liberalisation of financial services, including a greater role for foreign banks and financial service providers. With two of the four major Australian banks established in the SFTZ, Australia is placed to take early advantage of opportunities provided by a more open Chinese market.  Reforms within the SFTZ are, however, moving slowly with Chinese authorities continuing to release further details.

A number of other opportunities have arisen in the SFTZ. For example, in the SFTZ, there will be new access for investment in value-added telecommunications services with improved foreign equity limits, and maritime transport service suppliers will be able to establish wholly owned ship management enterprises.

Close to our heart is the announcement that Australian law firms will be able to tie up with Chinese law firms in the SFTZ. We are delighted with the outcome.

Private Equity

One of the less expected features of the ChAFTA is the proposed cooperation between Australia and China in relation to the export of Australia’s leading PE fund services.

Australian PE funds have outperformed the S&P/ASX 300 Index on a public market equivalent basis over the last ten years by a significant margin, demonstrating that the asset class is a long-term driver of returns. These same Australian PE funds will be able to capitalise on future investment opportunities in China directly and through their portfolio investments will deliver long term benefits to China and Australia.

Education

China is already the Australian education sector’s largest export market (worth $4 billion in 2013). The sector has received a real boost from the ChAFTA.

Australian institutions will have more opportunity to set up an establishment in China to build their brand and network.  Specifically, all Australian high education providers listed on the Commonwealth Register of Institutions and Courses for Overseas Students - will be listed on the Chinese Ministry of Education’s website within one year of the ChAFTA entering into force. This will increase the number of Australian institutions on the website from 105 to 182, with the potential for further additions. The website provides Chinese students and employers with quality and fraud assurance.

Additionally, improved mutual higher education qualification recognition and enhanced mobility of students, researchers and academics at school, tertiary and research levels are expected to be agreed in the form of memoranda of understanding.

3. Tax as an Important Area To Look Out For

Australia and China have agreed to review bilateral taxation arrangements to improve trade and investment conditions following implementation of the ChAFTA. The review will pay due regard to mutual economic objectives and international taxation standards and will cover existing double taxation and prevention of tax evasion.

The current long standing Australia/China double tax agreement (DTA), which does not extend to the Hong Kong Special Administrative Region of the People’s Republic of China, does not yet reflect the (more favourable) terms of agreements that both Australia and China have respectively negotiated with other countries in recent years.

While there is no certainty as to what the specific areas for negotiation will be, based on recently negotiated agreements, some of the areas for discussion may include:

  • Reducing the rate of dividend withholding tax on unfranked dividends from 15% to either 10%, 5% or even zero in specific circumstances (as has been agreed in recent Australian and Chinese treaties);
  • Reducing the rate of interest withholding tax to nil where it is paid to a resident financial institution in the other contracting state;
  • Providing for an exemption from capital gains tax in circumstances where the interest being disposed of is a non-controlling interest in a company (an exemption from tax where the ownership interest in a non-land rich company is less than 25% has been negotiated elsewhere); and
  • Possible negotiation of a DTA with Hong Kong.

Because of the ChAFTA, Australian businesses will be a better position than any of their non-Australian competitors. However, the concessions given to Australian businesses under the ChAFTA will likely very soon become the norm under China’s other FTAs. It was be important for Australian businesses to quickly and effectively use their first mover advantage before it is eroded away.