In the wake of Apple Inc. shutting down its iBooks and iTunes Movies services in China, the suspension of DisneyLife, a video streaming service jointly offered by Disney and Alibaba, offers another glimpse at the regulatory challenges faced by foreign investors tapping into the People’s Republic of China’s (PRC) media, cultural services and entertainment sectors.
This article charts the regulatory landscape in this regard and examines the most popular strategies adopted by foreign investors to overcome the regulatory challenges.
Regulatory Framework and Principal Regulators
The media, cultural services and entertainment sectors are amongst the most closely guarded areas for foreign investments, as evidenced by the latest revisions to the PRC Foreign Investment Industry Guidance Catalogue(Guidance Catalogue), published in early 2015. Indeed, the online publication of digital content has been expressly added to the Guidance Catalogue’s “prohibited” category for the first time, whereas most of the pre-existing restrictions and prohibitions relating to these sectors have been kept intact.
The extensiveness of the investment barriers is best illustrated in the “negative list” entry requirement system for foreign investment that was subsequently published in April 2015. This pilot scheme applies only in the four free-trade zones of Tianjin, Shanghai, Fujian, and Guangdong, and it streamlines the “encouraged,” “restricted,” and “prohibited” categories under the Guidance Catalogue by a single list of businesses subject to foreign investment restrictions and qualification requirements. Out of the 119 restricted businesses listed, more than 20 are in the media, cultural services and entertainment sectors, including:
- Internet publication of digital content;
- Broadcasting, transmission, production, and operation of radio/TV programs;
- News publication, radio/motion pictures/TV programs, and financial information;
- Production, distribution, and screening of motion pictures; and
- Culture and entertainment.
Within this framework, there are myriad regulations and rules that deal with specific areas and often impose additional requirements. For instance, the suspension of the iBooks, iTunes Movies, and DisneyLife services in China is, according to media reports, a direct result of the Internet Publication Services Administrative Regulations that came into effect on March 10, 2016. They impose pervasive control measures ranging from operator licensing to content requirements, personnel qualifications, and server location. Most importantly, they toughen up the former legislation’s prohibition of foreign direct investment by requiring any project cooperation between a licensed operator and foreign-invested entities in China or foreign entities/individuals to obtain approval from the central government body.
After a series of intergovernmental agency reshufflings, the principal regulators are now:
- The State Administration of Press, Publication, Radio, Film and Television of the People’s Republic of China (SAPPRFT), which was created in 2013 by merging the General Administration of Press and Publication with the State Administration of Radio, Film and Television;
- The Ministry of Industry and Information Technology (MIIT); and
- The Ministry of Culture (MOC).
These three PRC authorities have overlapping and sometimes competing jurisdictions. Other than the example noted above related to the online publication of digital content, SAPPRFT and the MOC regulate in parallel the publishing and operation of online games in China.
Layering to Get Rid of the “Foreign-Invested” Label
Currently, the PRC foreign investment regime primarily focuses on the entity form established by foreign investors in China. The first-tier vehicles, whether equity/cooperative joint ventures or wholly foreign-owned enterprises, fall within the category of foreign-invested enterprises (FIE). The second-tier entities invested in by FIEs, often referred to as FIE-reinvested enterprises, are subject to a regime similar to what is applicable to FIEs. However, when an FIE-reinvested enterprise sets up subsidiaries in China, those third-tier entities fall outside of the foreign investment framework.
Based on documents publicly disclosed by listing applicants on the PRC stock exchanges, there are a number of ways this layering technique has been used to get around relevant foreign investment restrictions. We are also aware that these third-tier FIEs successfully obtained government permits and licenses that are beyond reach of FIEs.
As with other sectors that are subject to foreign ownership restrictions, variable interest entity (VIE) structures are often used in the media and entertainment sectors so that foreign investors can, through extensive contractual arrangements, exercise de facto control over licensed operators without directly owning the equity interests in them, as well as obtain cash revenue from the licensed operators’ business activities. The online game business, however, is among the few that are subject to specific statutory restrictions against the use of a VIE structure.
In a scenario in which a PRC individual would hold equity interests in the licensed operators as the nominee shareholder, precautionary measures must be adopted to ensure that the contractual arrangements applicable to the nominee also bind his/her successors (in the event that the nominee passes away) and spouse (in the event of a divorce). On one hand, recent reports on arbitration awards in this context confirm that an arbitration agreement that binds the deceased nominee can be used to loop in the deceased’s successors for enforcement purposes. On the other hand, in the absence of a direct contractual relationship between the deceased’s spouse and the foreign investor or its affiliates, Chinese arbitration institutions are generally reluctant to join the spouse as a party to the arbitration for the foreign investor to enforce against the spouse, on the basis that the subject equity interest forms part of the married couple’s marital property, for which the spouse is jointly and severally liable.
For certain restricted industries, qualified individuals and companies from Hong Kong and Macau can take advantage of the Closer Economic Partnership Arrangement (CEPA) entered between mainland China and, separately, Hong Kong and Macau. CEPA is a free-trade agreement that covers trade in goods, trade in services, and trade and investment facilitation. Since the conclusion of the principal agreement in 2003, 10 supplements have been separately agreed upon to accord preferential treatment to Hong Kong and Macau investors.
The latest is the Agreement on Trade in Services, a standalone subsidiary agreement that will be implemented on June 1, 2016. The new liberalization measures in the cultural services and entertainment sectors allow:
- A Hong Kong service supplier to operate on a wholly owned or equity joint venture basis if it has set up more than 30 stores on the mainland for the sale of books, newspapers, and magazines of different brands and from different suppliers;
- Hong Kong service suppliers to engage in the sale and service of amusement game equipment; and
- The distribution in the PRC of Chinese-language motion pictures produced in Hong Kong and imported through the China Film Group Corporation by distributors possessing an Operation License for Film Distribution on a quota-free basis.
At present, only Hong Kong service suppliers are:
- Eligible to engage in the online music business, while in practice the sector is not generally open to any foreign investors; and
- Exempted from the minority shareholding restriction applicable to the printing business of “publications and other types of printing materials” and permitted to invest up to 70% in the relevant Sino-foreign joint ventures located in pilot areas with mainland counterparts.
To qualify as a Hong Kong service supplier, a Hong Kong entity will have to satisfy the applicable qualitative and quantitative requirements and obtain a Hong Kong service supplier certificate from the Hong Kong Trade and Industry Department.
With the Chinese economy transitioning into a consumer-driven phase and the rise of the Internet economy, the fast-growing media, cultural services and entertainment sectors will continue to lure investors to place heavy bets for handsome returns. Foreign investors in particular will have to overcome the regulatory restrictions to stay ahead of competitors.