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New Rules Provide a Framework for Shanghai FTZ to Open the Doors on VATS: A Cause for Optimism?

22 April 2014

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 the People's Republic of China ("PRC" or "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 ("BTS 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. MIIT is the main regulator of the telecommunications and Internet industries in China. 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 ("MII"). The most recent version of the Telecoms Catalogue was issued on April 1, 2003 ("2003 Telecoms Catalogue"). MIIT has issued a draft version of the 2013 Telecoms Catalogue, but the final version has not been issued as of the date of this note.

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 Sino-foreign 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 Permit). Notwithstanding the letter of the law, MIIT and MII have historically taken a very protectionist stance in opening up the telecommunications industry to foreign investment. Since China became a member of the World Trade Organisation ("WTO"), it appears that only 20 or so FITEs have been formed, all in the VATS area. The reluctance of MIIT to open up the telecommunications sector to foreign investors accounts at least in part for the large number of Variable Interest Entity structures which have been adopted in this area.

Following the issuance of the Opinions on Further Opening Value-added Telecom Business Sector to Foreign Capitals in the Shanghai FTZ (the "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 (the "Pilot Measures").

With the issuance of the Pilot Measures, the hope is that MIIT will finally open its doors to foreign participation in the VATS industry. Given the publicity and attention that the Shanghai FTZ has attracted worldwide, investors are optimistic that this will happen, particularly with the strong central government support which the Shanghai FTZ has received to date. Expectations are that at the very least, foreign investors will be able to set up FITEs in the Liberalized VATS sectors. We set out here an analysis on the key provisions under the Pilot Measures.

The team

Jun Wei

Jun Wei

Office Managing Partner

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