---

Recently, the PRC government promulgated two new laws that promise to change the retail and wholesale sector. On April 6, 2004, the Standing Committee of the National People's Congress promulgated amendments to the Foreign Trade Law (the "FTL Amendments"). On April 16, 2004, the Ministry of Commerce ("MOFCOM") promulgated Notice [2004] No. 8, entitled The Regulations on Management of Foreign Investment in the Commercial Sector (the "FICE Regulations").

The FTL Amendments and the FICE Regulations represent not only the implementation of China's existing WTO commitments, but also a significant and symbolic step towards granting full PRC market access to foreign-invested enterprises. The purpose of this article is to summarize the features of the FTL Amendments and the FICE Regulations, to describe the significance of the new laws to foreign enterprises that desire access to the PRC retail and wholesale markets, and to illustrate the continuing restrictions and open questions that are presented by these new regulations.

Summary Of The Significance Of These New Regulations To Foreign Investors

• Subject to certain restrictions, the FICE Regulations permit wholly-foreign owned enterprises to engage in domestic wholesale and retail distribution in the PRC
• The FICE Regulations eliminate or reduce existing restrictions in the retail and wholesale distribution sector and leave relatively few restrictions, most of which are designed to regulate large, "big box" U.S. and other foreign retail chain stores
• The FTL Amendments grant "trading rights" to all enterprises in China, including enterprises established under the FICE Regulations
• An enterprise established under the FICE Regulations (a "FICE") will, subject to certain restrictions, have the ability to import finished 3rd party goods, and distribute such goods within China via wholesale and retail distribution channels

The FTL Amendments

As many of our readers know, international "trading rights" have traditionally been viewed as distinct from "distribution rights" in PRC commercial parlance. "Trading rights" are understood to include the right to import or export goods manufactured by third parties into or out of the PRC. In acceding to the World Trade Organization, the PRC committed to grant all enterprises international trading rights following December 11, 2004.[fn1]

This commitment was further solidified with the passage of the FTL Amendments, in which the PRC government committed to allow the free import and export of goods and technologies.[fn2] All enterprises, including a FICE established pursuant to the FICE Regulations, have been granted full trading rights under these Amendments following December 11, 2004. This grant, coupled with the subsequent grant of distribution rights discussed below, will allow foreign companies unprecedented access to the Chinese market.

The FICE Regulations

Whereas the FTL Amendments concern trading rights, the FICE Regulations concern the "distribution rights" of foreign-invested enterprises. "Distribution rights" are understood to include the right to engage in the internal sale, offering for sale, purchase, distribution or use of those goods that have been imported into the PRC. In acceding to the WTO, the PRC committed to accord national treatment to all goods in respect of their internal distribution.[fn3]

Prior to the passage of the FICE Regulations, PRC rules required foreign companies to distribute goods within the PRC through joint ventures with a Chinese partner. The FICE Regulations abolish this requirement, and introduce a new type of foreign-invested enterprise, the "FICE", which will be permitted to distribute products within the PRC. In the past, this type of change has been implemented gradually by the PRC government, with new regulations introduced on a trial basis only, or with significant restrictions, such as high registered capital requirements and steep qualification requirements for investors. However, the FICE Regulations introduce significant changes that will be implemented on a permanent rather than experimental basis, and with relatively few restrictions, following December 11, 2004.[fn4]

The key features of the FICE Regulations are as follows:

• Limitations on foreign ownership are abolished; entry thresholds lowered
• Business scope expanded
• Geographic restrictions abolished
• Streamlined Application/Approval Process
• Import/Turnover ratio restrictions removed
• Certain Restrictions Remain

Limitation on Foreign Ownership Abolished

The FICE Regulations generally allow wholly foreign-owned enterprises to distribute their full portfolio of goods throughout China, whereas prior to the promulgation of the new rules, a foreign company had been required to enter into a joint venture with a Chinese partner to access to the Chinese domestic market.[fn5]

The distribution of certain goods remains restricted, although certain of these restrictions will be lifted within the next several years.[fn6] For example, retail merchants may deal in chemical fertilizer after December 11, 2006, and wholesale distributors may deal in chemical fertilizer, refined oil or crude oil after that same date. The remaining categories of restricted merchandise - books, periodicals, newspapers, pharmaceuticals, tobacco, and salt - will continue to be subject to regulation involving limits on foreign ownership of entities that sell or distribute such goods within the PRC.

Entry Thresholds Lowered

The FICE Regulations also reduce--or eliminate altogether--certain quantitative entry barriers that are in place under existing PRC rules. Columns one and two below describe current PRC requirements in respect of registered capital, average annual turnover and assets for foreign entities (the "WTO" column) and Hong Kong Service Suppliers (the "CEPA" column), respectively. Column three describes the restrictions following December 11, 2004 in respect of all foreign entities. Significantly, following December 11, 2004, the FICE Regulations eliminate all turnover and assets requirements and reduce the minimum registered capital requirements to RMB300,000 (retail) and RMB500,000 (wholesale).

	Restrictions		WTO (restrictions as of December 2003)		CEPA		New FICE Regulations (effective December 11, 2004)
	Minimum Registered Capital		RMB50 million for any retail enterprise RMB80 million for any wholesale enterprise		RMB50 million		RMB300,000 for any retail enterprise RMB500,000 for any wholesale enterprise
	Average Annual Sales		US$2 billion for retail US$2.5 billion for wholesale		In the preceding 3 years, greater than $US30 million		No restrictions on annual sales for either retail or wholesale enterprises
	Assets		US$200 million for retail US$300 million for wholesale		In the immediately preceding year, greater than US$10 million		No restrictions on assets for either retail or wholesale enterprises

Business Scope Expanded
Retail

The FICE Regulations permit a retail FICE to sell products for its own account, import products for the enterprise's own sales, purchase domestic products for export, and perform related services.[fn7]

Wholesale

The FICE Regulations permit wholesale enterprises to sell products on a wholesale basis, act as a sales agent (excluding auction services), import and export products, and any other related services.[fn8]

Franchising

The FICE Regulations grant the right to open and operate franchises, with no geographic, quantitative or equity restrictions. Note, however, that the implementing regulations for franchising have not yet been released (See the last section of this article, Open Questions).[fn9]

Elimination of Geographic Restrictions

Prior to the promulgation of the FICE Regulations, foreign-invested retail and wholesale operations were restricted to all provincial capitals and two other cities, Chongqing and Ningbo. With the passage of the new FICE Regulations, these geographic restrictions will be abolished[fn10], and wholly-foreign invested enterprises may set up operations throughout China.[fn11]

Delegation of MOFCOM Authority/Streamlined Application Process
Delegation of Authority

The application process for obtaining FICE status involves two steps. The application must first be submitted to the provincial level Commission of Foreign Trade and Economic Cooperation ("COFTEC")[fn12] approval committee for preliminary review. Thereafter, the application is submitted to central level MOFCOM for approval. The FICE Regulations, however, permit MOFCOM to delegate the task of final approval to the provincial COFTEC. [fn13] This delegation of authority is significant. First of all, it may speed up the application process, but also, and more importantly, it places the fate of foreign-owned enterprises in the hands of the provincial authorities rather than the central government. The provincial authorities may have a better understanding of (and strong interest in) how such enterprises will contribute to the region, and may therefore be more willing to grant approval.

Streamlined Application Process

The application process for FICE status is straightforward. With the passage of the FICE Regulations, the requisite aspects of approval--project approval, feasibility study approval and enterprise establishment approval--are combined into one step instead of two.[fn14]

In general, the application documents required in order to obtain FICE status are identical to the requirements for other FIEs.[fn15] However, the FICE Regulations introduce one notable addition to the requirements for retail FICE operations: foreign companies must now obtain a letter of approval from the local government(s) where the outlets are to be located, indicating that proposed new retail stores adequately conform to the urban and commercial development plans of the local government(s).[fn16] It is yet unclear whether or not this requirement will pose a substantial barrier to entry, in the form of either timing delays or logistical barriers. (See the last section of this article, Open Questions).

Removal of Import/Turnover Ratio Requirements

Previously, PRC retail enterprises were permitted to import only up to 30% of its annual turnover. However, with the passage of the FICE Regulations, the 30% cap on the annual imports of overseas merchandise has been removed.[fn17]

Key Restrictions

While the FICE Regulations undoubtedly allow foreign companies much greater access to the PRC domestic market, it should nonetheless be noted that certain significant restrictions exist.

First, FICE's may not engage in sales via television, telephone, post, the Internet, or vending machine.[fn18]

The FICE Regulations also contain several general geographic restrictions designed to limit, or at least manage, the influx of large-scale U.S. and European retailers. For example, there are significant restrictions on the size of foreign distribution outlets that will be permitted. A retail FICE may occupy up to, but not in excess of, 3000 sq. m. provided that the FICE has no more than 3 stores in the same province and no more than 30 stores in all of China. Similarly, occupation of up to 300 sq. m. is permitted provided that the company has no more than 30 stores in the province and 300 in all of China.[fn19] If a retail FICE wishes to exceed any of the foregoing thresholds, the special approval of central level MOFCOM will be required.

Furthermore, the FICE regulations continue to limit foreign-ownership of "chain stores" that sell certain types of restricted goods. The regulations stipulate that foreign investment in any company that has more than 30 stores in China is limited to 49% if those stores distribute multiple brands from multiple suppliers of restricted products.[fn20] This means that a wholly foreign-owned company may not, without special approval, set up more than 30 stores if, for example, it sells the magazines or the pharmaceutical products of multiple different suppliers.

Finally, as described above, any new retail store must conform to the urban and commercial development plan of the local government.

Open Questions

Though both the FTL Amendments and the FICE Regulations represent significant steps forward in the liberalization of China's import and distribution sectors, several questions remain unanswered.

First and foremost, the FICE Regulations are new. As with any new rules in the PRC, a certain amount of time and further interpretation and discussion with PRC authorities is necessary to determine how they will be applied in practice.

In this regard, it remains to be seen how certain, discretionary rules contained in the FICE Regulations are applied in practice. For example, it is possible that the requirement that a potential retail or wholesale outlet conform to the existing development plans of the local government may be used as a means for denying wholly foreign-invested companies permission to set up operations in certain areas. At a minimum, such rules will affect strategic approaches to entering a market. For example, to avoid or minimize potential local land use issues, investors may favor openings in shopping malls or other larger developments rather than establishing stand-alone stores,.

In addition, the regulations governing the establishment of franchise operations have yet to be released. Since many foreign retailers operate on a franchise model, they must await the franchising rules for progress in their industry.

Similarly, it is not yet clear what will become of the foreign-invested companies already in operation in the free-trade zones that currently exist in China. In certain free trade zones, such as the Waigaoqiao trade zone in the Shanghai region, foreign companies have been effectively distributing their goods domestically. With the passage of the FICE Regulations, the status of these entities is unclear. Certainly, the new rules would suggest that it may no longer be prudent for foreign companies to establish wholesale or retail enterprises in these areas.

Finally, it is also not clear whether a foreign company that currently has FIE (foreign invested enterprise) status will be permitted to apply for FICE status in the same manner as companies that have no prior presence in the PRC. The FICE Regulations indicate that any existing FIE company engaged in retailing, wholesaling, franchising or representative transactions should conform to these new regulations and adjust their existing business plans accordingly, but there is no indication of how this should be done, or whether approval will be automatically be granted to such companies. It remains to be seen whether this process will be relatively straightforward or will prove more arduous than has been suggested.

---

Footnotes

1: See Article 5, paragraph 1 of the Protocol on the Accession of the People's Republic of China to the World Trade Organization (the "Accession Agreement").

2: See Chapter 3, Article 14 of the FTL Amendments. 3: See Article 5, paragraph 1 of the Accession Agreement.

4: Note that, under the FICE Regulations, "Hong Kong Service Suppliers" (as such term is defined in the Mainland Hong Kong Closer Economic Partnership Agreement ("CEPA")) are permitted to obtain FICE approval on an accelerated timeline. These CEPA-qualified are permitted, under the FICE Regulations, to establish wholly foreign-invested distribution enterprises in China beginning 1st January 2004 (effectively June 1st in light of the effective date of the FICE Regulations).

5: See Article 2 of the FICE Regulations.

6: Under Article 17 of the FICE Regulations, the following merchandise is subject to special and separate restrictions: books, newspapers, periodicals, pharmaceuticals, automobiles, chemical fertilizers, salt, tobacco, and oil.

7: See Article 3, paragraph 3, of the FICE Regulations.

8: See Article 3, paragraph 2, of the FICE Regulations.

9: See Article 3, paragraph 4, of the FICE Regulations.

10: Note that retail stores are restricted to provincial capitals, capital cities of autonomous regions, municipalities, planned separate cities and SEZs until December 11, 2004. Hong Kong Service Suppliers (as defined under the Closer Economic Partnership Agreement) may immediately operate retail outlets at the district level and in country level cities in Guangdong.

11: See generally, Article 22 of the FICE Regulations and the Accession Agreement.

12: Also known as the Commerce Commission/Bureau. COFTEC is par of the local government but is under the supervision of MOFCOM in connection with the foreign investment approval process, among other things.

13: See Article 10, paragraph 2, of the FICE Regulations.

14: See Article 10, paragraphs 1 and 2, of the FICE Regulations.

15: For a complete list of the required application documents, please refer to Articles 12, 13 and 14 of the Regulations on Management of Foreign Investment in the Commercial Sector (FICE Regulations).

16: See Article 8 of the FICE Regulations.

17: The 30% limitation was contained in the Trial Measures on Foreign Invested Commercial Enterprises, jointly issued by the former State Economic and Trade Commission and the former Ministry of Foreign Trade and Economic Cooperation (the "Trial Measures"). The Trial Measures are abolished pursuant to Article 29 of the FICE Regulations.

18: See Article 10, paragraph 3, of the FICE Regulations.

19: See Article 10, paragraph 3 of the FICE Regulations.

20: See Article 18 of the FICE Regulations. These products include books, newspapers, magazines, automobiles (restricted until 12/11/06), pharmaceutical products, pesticides, agricultural film, fertilizer, refined oil, grains, edible sugar or cotton.