On 16 June 2011, it was widely reported in the press that the Ministry of Industry and Information Technology was in the process of drafting a proposal which would see private sector permitting to invest in certain basic telecom business. What are the potential implications, if any, for foreign investors that have been eyeing the market for a long time?

Background

Notwithstanding the accession to the WTO in 2002 by the PRC government and the promulgation of a comprehensive set of regulations which is intended to facilitate the opening up of the telecom market in mainland China, to date, the basic telecom business ("BTB") market remains dominated by the three state-owned enterprises: China Mobile, China Unicom and China Telecom.

Domestic private investments have been encouraged at the outset to participate in the value-added telecom business ("VATB") market. This has resulted in an incredibly thriving market with leading non-state owned domestic Chinese companies such as Baidu, Alibaba, Netease and countless other well known companies. These companies have been providing innovative services in the China market. Although few and far in between, foreign investors have occasionally been granted formal approvals to enter the VATB market, in particular, in the mobile and internet content market.

As noted in one of the previous e-bulletins (http://www.herbertsmith.com/NR/rdonlyres/10732599-B0C8-4187-BC28- 351F1F842B9D/16795/1011ApreludetobreakingmonoMC.htm), the BTB market is expected to undergo a new wave of liberalisation. China's 12th five year plan states unequivocally that the information infrastructure will be enhanced by promoting the rolling out of broadband networks across cities and rural areas. Laws and regulations will be promulgated to achieve the convergence and interconnection of the telecom network, the radio & television network and the internet. The proposal, suggested by the various press reports, may be a first step towards the implementation of this policy.

What is being proposed?

The press reports suggest that the proposal being drafted by the Ministry of Industry and Information Technology ("MIIT") is intended to allow domestic private investments to enter into the a specific telecom business market by:

  • establishing a limited liability company jointly with the three existing basic telecom operators and the commercial arm of the State Administration of Radio Film and Television ("SARFT");
  • the limited liability company will be permitted to carry on the business of customer premises network ("CPN") construction (see Box 1);
  • 49% of the equity interest in the limited liability company could be owned by domestic private investors; and
  • 51% of the equity interest in the limited liability company must be owned by the three existing basic telecom operators and the commercial arm of SARFT.

Box 1: What is CPN?

CPN stands for customer premises network, and is defined in the Telecom Business Classification Catalogue as the network facility between the UNI (User Network Interface, i.e. the demarcation point between the responsibility of the service provider and the responsibility of the subscriber) and the terminal users. Customer premises may refer to a residential area, an office building or a number of adjacent office buildings although city-level access network is expressly excluded.

CPN service generally refers to a type of network service (either cable based or non-cable based) provided through the CPN connecting end users with the public networks. A CPN service provider in China is statutorily required to construct its own CPN, and is allowed to sell or lease its CPN capacity to public network providers.

The proposal is generally considered as MIIT's response to the "Opinions on encouraging and guiding the healthy development of private investments" (Guofa [2010] No. 13) issued by the State Council on 7 May 2010. The opinions provide that the entry of private capital in the telecom network construction and the telecom service market in the form of non-controlling shareholding is encouraged. Some however take a more pragmatic view and consider MIIT's proposal simply as a means to promote the development of triple play offerings in China, i.e. the provision of telecom, internet and television services over a single network.

Some observations…

  • 'Private investors'…

It would appear that private investors as referred to in various official documents are unlikely to be intended by the PRC government to cover 'foreign' private investors as well.

  • Treatment of CPN business in the Classification Catalogue

As a general rule, a BTB licence must be approved by central MIIT. Only an application for a VATB licence to operate the business within a province could be approved by the provincial MIIT counterpart. An exception has been created for the "CPN licence", such that the authority to grant approvals has been delegated from MIIT to its local counterparts.

The Telecom Business Classification Catalogue provides that the administration of CPN licences will be similar to that of VATB licences. It would appear that this statement is only intended to be a reference to the exception stated above only, and not from a foreign investment restrictions perspective.

  • The use of VIE model?

The difficulty of obtaining a formal telecom licence in China and the potential restrictions imposed on the foreign investors have resulted in the adoption of the VIE model, i.e. a model pursuant to which the management control of the domestic Chinese telecom licensee is achieved through a series of contractual arrangements. The inherent risk of the model is well recognised: the foreign investor may not be able to enforce the contracts in China in the event that 'something goes wrong'. The recent Alipay case involving Alibaba, Softbank and Yahoo drew the MOFCOM's attention once again to the use of VIE structure in the telecom and internet sectors. No formal statement or opinion has been issued by MOFCOM or MIIT on the legality of the VIE model to date.

With no apparent sign of the opening up of the BTB telecom market to foreign investors, whether the VIE model will also be adopted in the CPN market to allow for private domestic investors to enter the BTB telecom market remains to be seen.