Four years following the establishment of China’s first Internet-connected commercial computer network in 1995, Internet use in China has grown rapidly from 900,000 to more than four million Internet users in 1999—a number that is expected to grow almost ten times by 2003. /1 The surge of users in China has stimulated growth in the electronic commerce market, which is expected to grow from around US$42 million in 1999 to over US$4 billion by 2003./2 As a result of the explosively increasing business opportunities on the Internet in China, a wide range of foreign and Chinese companies have sought to expand into the Internet business. Many of the Chinese companies are start-up companies run by an emerging group of Internet entrepreneurs, many of whom rely upon foreign investment in order to establish and expand their businesses.
However, foreign investment in Internet-related business endeavors in China is handicapped by China’s tight regulatory control over the Internet sector. Recent public pronouncements have made clear that the Ministry of Information Industries (“MII”), the Chinese ministry that has at least partial responsibility for the regulation of Internet-related businesses, believes that foreign investment in Internet content companies is not permitted under Chinese law. In addition, foreign investment in Internet access companies is strictly prohibited as a type of investment in the telecommunications industry. In recent weeks, the agreement between China and the United States on China’s accession to the World Trade Organization (the “WTO”) seems to promise a significant loosening of these restrictions. In principle, this agreement will allow foreign investors to own up to 49% of both telecommunications companies and Internet companies, with the permitted ownership interest rising to 50% after two years. At present, though, the details of the new rules have not been made public, and no legislation or regulations have been drafted to implement the new rules.
This article will present a general picture of China’s regulation as it exists today over Internet businesses and will also identify major legal issues which foreign investors will face if they wish to invest in China’s Internet businesses under current regulations. While the WTO agreement may result in changes to this regime, we believe that the changes are likely to be based upon the existing regulatory structure, and therefore any understanding of how future regulations may be formulated will depend upon an understanding of the existing regime.
Control over Internet Content Providers
China’s controls over the Internet reflect China’s general control over the telecommunications industry. Before 1993, the telecommunications industry was exclusively controlled by the Ministry of Post and Telecommunications (“MPT”), the predecessor of MII. In September 1993, MPT opened a door to allow certain approved domestic entities to operate certain portions of telecommunications businesses. In this regard, the milestone was the Provisional Rules for Approval and Administration of Operations of Liberalized Telecommunications Businesses (the “Liberalized Telecom Rules”) promulgated by MPT on September 14, 1993 /3. However, the scope of liberalization under the Liberalized Telecom Rules was limited, and the Liberalized Telecom Rules specifically prohibit foreign investment in any of these liberalized telecommunications businesses.
Since the liberalization of the government’s monopoly control over telecommunications, China has adopted a number of regulations and rules governing the approval process and general administration of those liberalized telecommunications businesses, including a considerable body of regulation governing the information industry and the Internet industry./4 However, China currently does not have a definitive set of laws or regulations specifically addressing the issues relating to the establishment and operation of Internet content companies (also known as Internet content providers (“ICPs”)). Theoretically, ICPs do not own or operate any telecommunications networks or facilities in China, which leads to the argument that ICPs should not be classified as engaging in the telecommunications business and therefore should not be subject to restrictions against foreign investment in China’s telecommunications business.
However, most Chinese attorneys have not taken the position that foreign investments in Chinese ICPs are permissible under Chinese law. Their concerns arise not only from MII’s recent negative policy announcements, but also from certain provisions contained in the existing regulations and rules.
As early as 1995, the Telecommunications Administrative Office of MPT (the “Telecom Office”) issued a guideline in an attempt to define each liberalized segment of the telecommunications business./5 The Telecom Office’s guideline explicitly classified the computer information service business and the e-mail business as two of five value added telecommunications services liberalized for operation by non-State owned enterprises. Under Section 6 of the Telecom Office’s guideline, “computer information service business” is defined as using database technology to collect, process and deposit data to form a user database, using the public telecommunications network to connect the database to users’ computer terminals and allowing users to use telephone lines to access the database by entering user names and passwords and to search and retrieve information contained in the database. It is apparent that Internet content services would fall within the definition and therefore would be considered to be value added telecommunications services, which are barred from foreign investment. Given the breadth of the definition, even if a foreign investment enterprise wishes to set up its homepage only to provide Chinese Internet users with information on itself or its parent company and on its manufactured products, it may not be allowed to do so, as such activities could be classified as telecommunications services pursuant to the definition of the Telecom Office.
Apart from the guideline of the Telecom Office, Article 13 of the Administrative Measures for International Connections of China Public Computer Interconnected Networks (the “Public Network Measures”)/6 also provides that all domestic computer information service operators utilizing information resources on the international Internet shall be subject to approval in accordance with pertinent rules applicable to the liberalized telecommunications businesses, indicating that Internet content services are to be treated as telecommunications businesses and that ICPs are treated the same as other telecommunications operators.
However, in practice MII has not been firm in enforcing its policy of treating ICPs the same as other telecommunications operators. During the past two years, ICPs operating in China, including the Ministry of Foreign Trade and Economic Cooperation (“MOFTEC”), which in early 1999 set up a business-to-business e-commerce Web site,/7 have run their ICP businesses without any special licenses or approvals from MII. There has been no report of any of such ICPs being challenged by any government authority, while during the same period all ISPs and other telecommunications business operators have been strictly required to obtain approvals and special licenses granted by MII in order to legally run their businesses.
It was not until recently that MII started to initiate an ICP licensing process by which a small number of ICP operators eventually obtained their ICP operation licenses. However, to date, the details of the ICP licensing process are still unknown to the public and, furthermore, it remains to be seen how China’s entry into the World Trade Organization will affect the ICP licensing process as well as the licensing controls for other telecommunications businesses.
Favorable Policy for Internet Technology Providers
China generally encourages foreign investment in the development of telecommunications technologies, as opposed to services. The Guideline Catalogue of Foreign Investment Industries (the “Investment Guideline”), as amended and approved by the State Council on December 29, 1997 and effective January 1, 1998, lists micro-electronic technology and information and communications system network technology as two of the newly emerging industries in which foreign investments are encouraged. The Investment Guideline also lists the manufacture of digital communications multi-media systems and the manufacture of equipment for network accessing communications systems as industries in which foreign investments are encouraged.
The favorable policy of the Chinese government toward foreign investment in Internet technology development in China provides an opportunity for foreign investors to enter China’s Internet industry as Internet technology providers (“ITPs”). With only four years of development and a strong desire to expand China’s undeveloped Internet market, both the Chinese government and the China Internet industry are keen to acquire internationally advanced Internet-related technologies in order to increase on-line transmission speed, improve data processing and improve on-line security measures. A foreign ICP that has know-how, technology, software or other intellectual property for running Internet portals may, through careful structuring, be able to partner with a Chinese domestic ICP and obtain a royalty for the use of its intellectual property.
It should be noted, however, that ITPs may not make their royalties contingent on the profits or revenues derived from the operations of the domestic ICP or ISP. Such an arrangement may constitute a violation of China’s restrictions on foreign investment in telecommunications.
Lack of Regulations on Internet Advertising
Internet advertising revenues have become one of the most important revenue sources for ICPs. According to International Data Corporation, China Internet advertising revenue in 1998 amounted to US$6.2 million and is projected to be nearly US$750 million in 2003. However, the legal foundation for Chinese ICPs to carry on their on-line advertising businesses is still a question to many Chinese ICPs and their existing and potential foreign investors or partners.
All existing Chinese laws and regulations relating to advertising were promulgated before the introduction of the Internet in China. Under these laws and regulations, advertising operators normally are required to obtain an advertising license from the local administration of industry and commerce. In addition, advertising operators are also required to issue a specially designated invoice to advertising clients. Only licensed advertising operators can issue such invoice. It is unclear how these administrative measures apply to Internet advertising activities. It appears that the majority of China’s domestic ICPs do not possess an advertising license, nor do they have the specially designated invoices. However, some Chinese legal experts predict that a new set of regulations will be introduced soon to regulate Internet advertising activities. Until the introduction of the new rules, there is no mechanism for an ICP to obtain an advertising license in order to conduct its advertising business.
Regulatory Uncertainties for Foreign Investment in China’s E-Commerce Market
Purchasing and selling goods and services, or even trading stock, over the Internet is increasingly common in China. On-line bookstores have started operations in both Beijing and Shanghai, and on-line booking of train tickets became available to passengers early this year in Beijing.
However, the development of e-commerce in China faces a number of legal uncertainties and technical obstacles. First, there are no comprehensive e-commerce regulations in China. For ICPs providing on-line auction or on-line shopping services, it is unclear whether such e-commerce activities should be treated as conventional retail businesses which require operators to acquire a business license that specifically covers retail sales. For ICPs providing business-to-business (“B-to-B”) e-commerce services, conventional retail or wholesale concepts may not even properly apply to this new Internet business model, and it is difficult to apply current Chinese business regulations to Internet B-to-B services.
Due to the regulatory ambiguities in connection with e-commerce in China, foreign investors contemplating investments in Chinese ICPs need to be aware of the broad range of regulations that might be applicable to the line of business that the ICP is engaging in. For example, on-line auctions or on-line shopping could potentially be deemed to be commodity trading businesses in which foreign investment is prohibited. Currently, foreign investors as well as foreign investment enterprises established in China are not permitted to engage in any international or domestic trading activities in China unless specially approved by MOFTEC. Unless the policy changes after China’s entry into WTO, even though foreign invested ICPs may be permissible, their delivery of any on-line auction, on-line shopping or even B-to-B services may still not be permissible.
In addition to on-line auctions, on-line shopping and B-to-B services, investors are also looking into on-line securities trading services targeted to Chinese securities investors, who tend to be better paid and better educated than the average population, and who also have better access to the Internet. According to International Data Corporation, approximately 30% of Chinese stock investors currently have either email accounts or Internet access.
The Chinese government maintains extensive control over the Chinese securities market. In China, a securities brokerage firm must obtain government approvals to operate. Such approval requirement gives rise to an issue of whether, by providing an on-line stock trading platform to allow Chinese stock investors and brokerage firms to exchange orders and confirmations on the Internet, an ICP would be classified as a broker, and would therefore be subject to the government approval process for brokerage firms. In addition, in March 1999 a regulation was released suggesting that brokerage firms must obtain approval to conduct online securities trading, although no approval process has been announced. It is difficult to predict how this regulation will affect the development of the on-line securities trading business in China.
In addition to a great deal of regulatory uncertainty, the development of e-commerce in China is also subject to certain technical obstacles. One of the major concerns of engaging in e-commerce relates to the security technology used in transmission of financial or other confidential information over the Internet. According to the survey released by China National Network Information Center (“CNNIC”) in July 1999, 30% of the Internet users in China feel that the legal and technical structures securing the safety of information transmission are inadequate./8 In addition, the facts that only a small portion of the Chinese population owns credit cards and that the banking system in China is still relatively underdeveloped make on-line shopping and auctions less efficient or unavailable for most Chinese consumers. Therefore, any further development of e-commerce in China will rely not only on development of a sound e-commerce regulatory system but also on improvement of China’s on-line security technology and its banking system.
Regulation of Internet Service Providers
Currently, there are about 200 ISPs providing Internet access to users in China./9 However, there are only five approved backbone network operators, among which three of the networks are for commercial uses. The two major regulations governing access to the Internet in China are the Provisional Administrative Regulations of the People’s Republic of China on International Connections to Computer Information Networks (the “Internet Provisional Regulations”) and their Implementation Measures (the “Implementation Measures”)./10 Pursuant to these two regulations, all connections to overseas Web sites are required to go through international gateway channels (“Gateways”) controlled by MII, and only backbone operators are allowed to directly connect to the international Internet by going through Gateways. Accordingly, ISPs and their customers have to connect through one of these five backbone network operators to obtain access to overseas Web sites. The current three commercial backbone networks are all controlled by China’s three telecommunications giants (namely, China Telecom, China Unicom and Jitong Telecom), each of which has special approvals from MII. Recently, MII granted its approval to establish China Netcom Corporation, which plans to construct a fourth commercial backbone network for Internet services./11
The Internet Provisional Regulations and the Implementation Measures set forth a set of detailed approval procedures for the establishment and operation of ISPs. Currently, no foreign investment is allowed in the operations of any ISPs in China. However, as mentioned above, it is possible that foreign investors may find a way to partner with Chinese domestic ISPs by providing technology in order to position themselves in China’s Internet market while waiting for China to open its ISP market to foreign investment.
Regulation of Domain Name Registration
Internet domain name registration in China is subject to the Provisional Administrative Measures on Registration of China Internet Domain Names (the “Domain Name Registration Measures”) promulgated by the State Council Information Leading Group on May 30, 1997. CNNIC subsequently issued the Detailed Implementing Rules on Registration of China Internet Domain Names (the “Domain Name Registration Detailed Rules”). CNNIC is the designated agency in charge of domain name registrations in China. Pursuant to these two regulations and CNNIC’s practice, foreign companies are not permitted to register a domain name in China unless they use their Chinese established subsidiaries or representative offices as the applicants. It is interesting that while the Domain Name Registration Measures require that the applicant have the capability to independently assume civil liabilities, CNNIC does accept domain name applications from foreign companies’ representative offices, which cannot independently assume civil liabilities under Chinese law. In addition, it should be noted that China strictly prohibits any sale, transfer or assignment of Chinese registered domain names. As a result, one can acquire an existing domain name registered in China only after the registration of such domain name has been cancelled by the existing registrant.
Other Issues
There are several other Internet-related issues which have regulatory implications. We highlight some of them as follows:
Intranets. It is common for a foreign investor to want its offices and employees in China to be connected electronically to its headquarters or affiliated offices located outside China. This may be accomplished by establishing a network used internally within an enterprise (an “Intranet”) to access an overseas network through a dedicated line. China does not have a separate set of regulations dealing with Intranets. Although there are certain intranet-related provisions in the Implementation Measures, there is no express uniform guidance on how to obtain approvals for setting up an intranet or how and where to obtain a dedicated line, and therefore different locations may have different practices.
On-line Censorship. All ISPs, ICPs and Internet users in China are subject to Internet censorship pursuant to a series of Internet-related security protection regulations./12 Any violation by any ISP or ICP of such Internet security protection regulations will lead to serious legal consequences such as revocation of such ISP’s or ICP’s operational license or imprisonment of the responsible personnel of such ISP or ICP. Although such regulations expressly afford legal protection to Internet users against infringement of communication freedom and confidentiality, they do not make users immune from interference by the State in the name of protection of national security interests.
Internet-related IP Issues. Generally, trademarks, service marks and copyright of Internet operators and users are protected by Chinese intellectual property laws. However, protections afforded by Chinese law to intellectual property rights arising from certain Internet works such as Web page design have not been sufficient. For example, Chinese law only protects copyrights of works in the fields of literature, art and the sciences which display originality and reproduce the results of intellectual creation in a tangible form./13 Article 3 of the Copyright Law of the PRC (the “Copyright Law”) specifically lists nine kinds of works to be protected by the law. Internet Web page design fits in none of these nine categories. The list is by no means meant to be exhaustive, so that it is left for court judges to gauge whether the legal protections afforded under the Copyright Law can be extended to Internet Web page design.
Conclusions
Given the size of its vast population and the fact that it continues to be one of the world’s fastest growing emerging economies, China offers great market potential for Internet development, in which foreign investors can participate in many ways. Although it is anticipated that further liberalization of the Internet industry will follow after China enters the WTO in the new century, it is likely that China will still have one of the world’s tightest regulatory regimes for control over its Internet industry. Therefore, with Internet regulations in China evolving continuously, foreign investors must be well aware of various legal risks involved in their investments in China’s Internet businesses and should carefully analyze and devise appropriate means to mitigate these risks.