Since the establishment of the Shanghai Free Trade Zone (“Shanghai FTZ”), investors have been closely monitoring the liberalization policies in the telecommunications sector. Historically, given the highly sensitive nature of the telecommunications sector, foreign participation has been very limited in this highly regulated industry. In China, telecommunication services are divided for regulatory purposes into basic telecommunication services (“BTS”) and value-added telecommunication services (“VATS”). The provision of either BTS or VATS in China requires the service provider to obtain a BTS operating permit or a VATS operating permit (“VATS Permit”) respectively, each of which is issued by the Ministry of Industry and Information Technology (“MIIT”) at the central level or by its local branches. The types of telecommunication services falling under BTS and VATS are listed in the Circular of the Ministry of Information Industry on the Readjustment of the Classification Catalogue of Telecommunication Services (“Telecoms Catalogue”) issued by the predecessor of the MIIT, the Ministry of Information Industry. The most recent version of the Telecoms Catalogue was issued on April 1, 2003. MIIT has issued a draft version of the 2013 Telecoms Catalogue, but the final version has not yet been issued.
Under existing telecommunications laws and regulations, in order to apply for a VATS Permit, a foreign investor must establish a foreign invested telecoms enterprise (“FITE”) in the form of a Sinoforeign equity joint venture (“EJV”) with a Chinese partner in which the foreign shareholding is capped at 50% (the foreign shareholder is capped at 49% in applications for a FITE holding a BTS operating permit).
Following the issuance of the Opinions on Further Opening Value-added Telecom Business Sector to Foreign Capitals in the Shanghai FTZ (“Opinions”) by MIIT and the Shanghai municipal government on January 6, 2014 which removed the foreign shareholding caps for certain VATS (i.e., internet information services delivered through app store platforms, store and forwarding services, call centres, domestic multi-party communications and internet service (access) provider services) and increased foreign shareholding caps in others (i.e., online data processing and transaction processing (operational e-commerce) and domestic IP-VPN) (the types of VATS specified in the Opinions being the “Liberalized VATS”), investors have been waiting patiently for specific rules to be issued by MIIT to clarify the requirements and procedures in order to apply for a VATS Permit in the Shanghai FTZ. The wait ended on April 15, 2014 when MIIT released the China (Shanghai) Free Trade Experimental Zone Foreign-Invested Operational Value- Added Telecommunications Services Administrative Procedures for Trial Operation (“Pilot Measures”).
Shanghai MIIT steps in but MIIT is still in charge
Investors had hoped that MIIT would delegate to the Shanghai Municipal Communications Administration Bureau (“Shanghai MIIT”), the Shanghai counterpart of MIIT, the authority to determine the scope of foreign participation in the telecommunications industry in the Shanghai FTZ. To some extent, this has been achieved. Under the Pilot Measures, foreign-invested enterprises (which comprise EJVs, co-operative joint ventures and wholly foreign-owned enterprises (“WFOE”)) within the Shanghai FTZ will submit applications for a VATS Permit to Shanghai MIIT. Approved applications only need to be record-filed with MIIT. However, MIIT retains ultimate control on decisions regarding the types of VATS which are open to foreign investors and the amount of foreign participation allowed.
Foreign investors may have won the battle in that applications are no longer being vetted by MIIT (the hope here being that Shanghai MIIT will be more efficient and less restrictive in reviewing applications for VATS Permits), but the all-important decision on which VATS sectors are open to foreign investors and the foreign shareholding caps (if any) in the Shanghai FTZ continues to rest with MIIT.
Applications to be made by existing companies in the Shanghai FTZ
The key laws and regulations in relation to foreign participation in the VATS sector are the Telecommunications Regulations issued by the State Council effective September 25, 2000, the Provisions on the Administration of Foreign-Invested Telecommunications Enterprises issued by the State Council effective September 10, 2008 (“FITE Provisions”) and the Measures for the Administration of Telecommunications Service Operation Permits issued by MIIT effective April 10, 2009 (“Telecoms Permit Measures”, together with the Telecommunications Regulations and the FITE Provisions, the “China Telecoms Rules”). Under the China Telecoms Rules, it is not entirely clear whether an application for a VATS Permit has to be made by an existing legal entity.
The Pilot Measures clarify that applications can only be made by existing companies which have been established in the Shanghai FTZ. Under the list of materials to be submitted to Shanghai MIIT (described below), the applicant (i.e., the FITE) will need to submit its “Foreign-invested Enterprise Approval Certificate or its China (Shanghai) Free Trade Experimental Zone Foreign Investor/ Hong Kong/ Macao/ Taiwaneseinvested Enterprise Record Filing Certificate, its Enterprise Legal Person Business License official duplicate and a photocopy.” These are essentially the documents and certificates issued on establishment of the company. Importantly, where the application is for a VATS Permit which imposes a cap on foreign shareholding (i.e., the applicant must be an EJV and cannot be a WFOE), our understanding from inquiries made with Shanghai MIIT is that the applicant must be an existing EJV with the foreign shareholding not exceeding the applicable foreign shareholding cap.
As a follow-on from this, it would mean that where the application is for a VATS which imposes a foreign shareholding cap, the Chinese joint venture partner must already be identified so that an EJV can be established to apply for the VATS Permit in question. The process therefore involves establishing a ‘shell’ company (preferably in technology services or technical consulting which are activities not on the Special Administrative Measures (Negative List) on Foreign Investment Access into the China Shanghai FTZ (2013) and with a business scope which does not include regulated telecoms services or other services requiring approval (for example from MIIT) so as to speed up the application process) which must be an EJV if the VATS Permit applied for imposes a foreign shareholding cap, but which can be a WFOE if there is no foreign shareholding cap. The ‘shell’ company applies for the VATS Permit and once this has been obtained, the ‘shell’ company will then apply for a change of its business scope with the Ministry of Commerce. Where the application is for a VATS Permit which does not impose any foreign shareholding cap (i.e. one of those mentioned in the Liberalized VATS which has no cap on foreign shareholding), an existing WFOE within the Shanghai FTZ can apply for the relevant VATS Permit.
The process for obtaining a VATS Permit has been simplified and, as a result, requires significantly less time than under the existing regime as provided under the China Telecoms Rules. Currently, under the FITE Provisions, in order to apply for a cross-provincial VATS Permit, the applicant has to go through a ‘pre-approval’ process with MIIT which can take up to 90 days to complete. The process for obtaining the actual VATS Permit is separately provided under the Telecoms Permit Measures whereby another 60 days is allocated for the approval process. Both of these processes have been combined under the Pilot Measures so that only 60 days is allocated to Shanghai MIIT. If approval is granted, a China (Shanghai) Free Trade Experimental Zone Foreigninvested Operational Value-added Telecommunications Services Trial Approval Letter (with a validity period temporarily fixed at 3 years) (“Trial Approval Letter”) is to be issued.
Unfortunately, the Pilot Measures provide little in explaining the previous requirement to have facilities established within the Shanghai FTZ. It states that the “service facilities” must be within the Shanghai FTZ, and hence we presume that, at the very least, the client-facing facilities must be physically located within the Shanghai FTZ.
Similar requirements and conditions with an increased focus on protection of personal information
The Pilot Measures list out the requirements and conditions in order to apply for a VATS Permit. These are, in general, the same as those provided under the existing China Telecoms Rules, except for additional requirements on location, network security mechanism and personal information protection as listed below:
- the operating entity (i.e., the FITE) must be a company that has been established in accordance with the law law within the Shanghai FTZ
- it has the funds and specialised personnel commensurate with engaging in operational activities
- it has the credibility and ability to provide services to users over the long term
- its registered capital is no less than RMB 1 million – the registered capital requirement is consistent with the China Telecoms Rules which states that if the VATS are limited to within a single province (Guangdong, Zhejiang and Fujian for example), autonomous region (Xinjiang, Inner Mongolia, Ningxia, Guangxi and Tibet) or municipality under direct central government administration (Beijing, Shanghai, Tianjin and Chongqing), the minimum registered capital is RMB 1 million. The RMB 10 million requirement applies to where the VATS are provided across provinces, autonomous regions or municipalities under direct central government administration
- it has the necessary premises, facilities, technical plan as well as network and information security safeguarding systems and measures, amongst which the service facilities must be established within the Shanghai FTZ
- the applicant, its main investors and main operations and managerial personnel have no records of unlawful conduct for violation of the telecommunications supervision administration system during the last three years
- other conditions set out in provisions of the State – this is a standard catch-all that basically allows Shanghai MIIT to apply its discretion to impose other conditions and ultimately allowing it to reject an application which would otherwise be approved.
In terms of documentation, these are also largely similar to those under the China Telecoms Rules but again with an increased focus on personal data protection.
In terms of the actual application, a website in Chinese has already been set up to accept applications for VATS Permits in the Shanghai FTZ.
Annual inspection requirement
The Pilot Measures also include a requirement for FITEs established within the Shanghai FTZ to undergo an annual inspection system with the Shanghai MIIT. This is consistent with the requirement under Chapter 7 of the Telecoms Permit Measures and the documentation requirements are basically similar.
The outcome of the annual inspection will be recorded in the Trial Approval Letter, made public (possibly through Shanghai MIIT’s website) and reported to the industry and commerce administrative organs. The intention here appears to be that VATS operators who do not follow Shanghai MIIT’s requirements will be “named and shamed.” The Chinese authorities appear to be taking the view that a public relations backlash and negative publicity may be more effective weapons in ensuring compliance as compared to rather modest monetary penalties and fines.
Except for the combining of the pre-approval and VATS Permit application procedures, the Pilot Measures do not stray very far from the requirements under the China Telecoms Rules. Certain commentators have expressed disappointment: they expected more given the trumpeting of liberalization and free market opportunities by the Shanghai FTZ. In our view, the real test is whether Shanghai MIIT will actually follow through with the granting of VATS Permits to FITEs and allowing foreign participation in the telecommunications industry in practice. The Pilot Measures are a critical piece in the puzzle and the coming months will see a number of foreign telecoms players applying for VATS Permits in the various sectors. Opening its doors to foreign players will not only bring in investment and employment, but will also much needed competition and innovation to China’s telecommunications market.