Foreign investment in China's e-commerce

This article was last updated in December 2004

A recent survey discovered that China's favourite leisure activity for young people was surfing the internet. Although the internet is seen primarily as an information resource there is a growing interest in e-commerce applications in China. Foreign investors wishing to establish an e-commerce operation in China, however, need to consider several significant commercial, practical and legal issues before investing.

Is an e-commerce business viable?

Any company looking to invest in China must first be satisfied that there is sufficient business in its market to justify the investment. E-commerce, by its very nature, is limited to those people who have both access to the internet, either through their own computer or via an internet café, and a credit or debit card. In China, historically this has narrowed the potential customer base substantially as it targeted the more affluent Chinese with higher disposable incomes. However, with the rise of internet cafés and Chinese computer manufacturers like Lenovo (formerly Legend), China is now the world second largest market for personal computers.

Another practical concern is the delivery of goods ordered on-line. If time is not of the essence the normal Chinese postal service may be satisfactory. In other circumstances an express delivery company like Speedpost, DHL or FedEx will be needed. The geographical coverage of these companies, particularly DHL and FedEx, is limited to the principal cities and they are also comparatively expensive, decreasing the attractiveness of on-line shopping (or cutting into profit margins).

An e-commerce business needs to ensure that it secures payment for goods sold on-line. Worldwide, credit and debit cards are used for payment. In China, such cards have been issued by individual banks with little compatibility with cards issued by other banks. This has led to difficulties in processing payments. Although the major commercial banks have now all joined the National Bank Card Network Service Centre and the VISA brand is establishing a strong presence it could be another year or more before there is full compatibility of all credit cards.

Foreign investment

Having considered some of the practical difficulties, we now turn to the legal concerns. The extent to which foreign investors can participate in China's internet sector is always the subject of much debate. From being completely State-run, other enterprises are now being allowed to operate in certain telecommunications sectors.

Foreign ownership of network access providers has always been and continues to be prohibited. The position regarding internet information services providers has recently become less ambiguous with the accession of . The Ministry of Commerce's Foreign Investment Industrial Guidance Catalogue and the attached Telecoms Services Catalogue (the "Catalogue"), which identifies business sectors open to foreign investment, was revised in February 2003 to divide telecoms services into basic services (encompassing the provision of the infrastructure for public networks, public transmission of data and basic voice telephony services) and value added services (which include telecommunications or information services provided using the public network infrastructure).

The importance of the distinction is that the two types of service are regulated differently in the PRC – basic service providers must be at least fifty-one percent State-owned (therefore the JV partner to be selected by the foreign investor must be State-owned). On the other hand, foreign investors can take up to a fifty percent stake in a value added service JV and the state-owned requirement does not apply.

One other factor determining the nature of a foreign party's proposed investment is the geographical reach of the services. The Rules on the Control of Foreign Invested Telecommunications Enterprises (the "Rules") provide for different application procedures depending on whether or not the service is to be provided within a province or municipality or across many provinces or municipalities. Furthermore, municipal authorities (notably the Beijing Municipal Telecommunications Administration) have formulated their own provisional measures for administration of, for example, mobile network VASs which provide for operating permits to be applied for in relation to such services to be provided within Beijing.

Despite these restrictions, in practice some local authorities, notably Shanghai, have issued licences to foreign invested enterprises ("FIEs") to operate as internet information services providers. Normally, the FIE has already been registered as a business with the local authority and its website and associated e-commerce activities could be said to be ancillary to its principal activities. In other instances, foreign investors have chosen to use more informal structures to invest in China's internet sector, investments and registrations being made in the name of a friend or relative in China. Such structures have obvious inherent risks and cannot be recommended as a safe business solution.

Regulation of internet information services providers

Any FIE internet information services providers must comply with the provisions of the Procedures when operating its web-sites. In addition to the normal approval and registration procedures for FIEs, any enterprise operating as an internet information services provider must obtain a licence to do so from the local government IT bureau. Any changes to the scope of the business or the type of content provided on the web-site require further approval from the IT bureau making rapid changes difficult.

Internet information services providers are responsible for monitoring the content of their web-sites to ensure that they do not contain prohibited material. This includes anything that might hurt the national interest or damage the national reputation, state secrets, material which might cause racial conflict, material which might subvert the government and material contrary to national religious policy or which promotes cults and superstitions. The widely defined categories give considerable discretion to officials responsible for implementing the Procedures. Any such material must be removed from the web-site and reported to the appropriate governmental authority. Certain internet information services providers must keep a copy of the content of their websites and all users who access their servers for 60 days and provide it to the police on demand.

Penalties for failure to comply with the Procedures range from confiscation of illegal profits to fines of up to RMB 1 million. Personal liability and criminal liability can be imposed in serious cases.

Internet information services providers must also be careful not to infringe other parties' copyright when operating their web-sites. The Beijing No.2 Intermediate Court found Sohu.com, a popular Chinese search engine similar to Yahoo, liable for not acting quickly enough to discontinue linking to another web-site after it learned that the other site was infringing the plaintiff's copyright. This case was followed closely by an Opinion of the Supreme People's Court setting out its interpretation of the law relating to resolving copyright disputes.

Advertising

A feature of many e-commerce websites is the ancillary advertising revenue generated from third party adverts posted on the site. On-line advertising spend in China is expected to continue its exponential rise. There are no specific regulations relating to on-line advertisements and until recently, the Chinese authorities had done little to control advertising in cyberspace. With the dramatic expansion in value of this business, however, it is attracting more attention. The Advertising Law, which requires companies that publish adverts to obtain a licence to do so and to verify the content of the adverts for accuracy, is drafted widely enough to cover cyberspace advertising. The Commercial Industrial Administrative Bureau has begun issuing certificates of approval to websites in Beijing, Shanghai and Guangzhou and intends to expand coverage of the certification scheme to all websites.

Product liability

Goods sold through a web-site will be subject to China's product liability and consumer protection regime. The back-bone of the regime comprises the Product Quality Law, the Law on the Protection of the Rights and Interests of Consumers, the Contract Law and the General Principles of Civil Law.

Detailed regulations and standards regarding labeling, performance and health and safety are supplemented by statutorily implied warranties. These warranties are, in general, similar to those found elsewhere although several are much more stringent. You cannot contract out of the implied warranties but their affect may be ameliorated to some extent by reasonable contractual conditions. Such conditions could include requiring goods to be stored in a particular manner or operated and maintained in accordance with the manufacturer's instructions.

Other matters

The above are only a few of the matters that require consideration. Others include identifying suitable joint venture partners (if required), negotiating the structure of the FIE particularly the size of each party's equity stake and degree of management and control, registering a domain name in China (in English and in Chinese) and financing through an off-shore holding company.

For more information contact: Derek Roth-Biester