Telecoms: The Door Slowly Opening to Foreign Investment

Small Step Forward

A closer analysis of the two deals reveals that they are actually limited in their size and scope when compared to the Chinese-Chinese-Foreign (CCF) structure used with China Unicom several years ago or other subsequent modified foreign investment structures. Furthermore, both deals appear consistent with the agreements reached in the WTO negotiations.

First, the foreign equity shareholding percentage is relatively low. In contrast to the CCF structure, in which the foreign investors' stake (or profit-share entitlement) in the joint venture holding the network infrastructure typically reached at least 75%, AT&T's share in the JV is only 25%. In the China Netcom venture, the foreign party (in addition to the two domestic banks) will only hold a paltry 12.5%.

The AT&T JV is consistent with the Sino-EU WTO Accession Agreement, which permits an initial 25% foreign equity share upon accession and leasing of capacity from domestic operators to foreign-invested companies. PRC policy makers have expressed concerns about foreign control over PRC network assets. CCF structures permitted control of network assets through the foreign majority-owned joint venture, causing fears that the joint venture might deny China Unicom of network access, even though such denial would be in breach of its contractual obligations to China Unicom.

Secondly, the AT&T JV's services appear to be fairly restricted in scope. Apparently the JV is not allowed to acquire its own backbone infrastructure, and will have to provide some of its services over its Chinese partners' network. The quality and reliability of the JV's services would, to a degree, depend on the local service quality. In terms of infrastructure development, no major inroads into the domestic telecom sector appear to have come from these developments.

Furthermore, the operational and geographical restrictions will reduce the customer base. This will avoid direct competition with the former monopoly operator China Telecom in the main domestic market. Reports indicate that the AT&T JV will provide the vast bulk of its services to multinational corporations in the Shanghai Pudong New Area. Likewise, while China Netcom possesses a world-class backbone network, it does not always own the "last mile"access to the customers, and it will still have to go through China Telecom or other domestic operators for connection to households.

The AT&T and Netcom deals do not appear to threaten China Telecom's dominant position, and their early approval is probably due in part to the fact that they are not going to rock the boat at least in the short term. This is significant in light of the China Unicom CCF structures, which were viewed as competing with the mobile division of the former China Telecom, and were not looked upon favourably by either MII or its predecessor.

Looking Forward

The two deals are milestones in PRC telecom services history, and strongly indicate that China is ready to deliver on its WTO commitments. However, with the legal basis still unclear, the developments seem to be setting the precedent for situations where China is ready to bend the rules. For example, the investments fall foul of the Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录), in which the management and operation of telecommunications business is still listed in the prohibited category. This casts further doubts over China's resolution to offer a "level playing field", one of the greatly celebrated principles enshrined in the September 2000 PRC Telecommunications Regulations (中华人民共和国电信条例). Still, the early establishment of the ventures by two parties that have worked hard to enter the Chinese market, despite their limited scale, should stand as indicators that the investment environment is one step closer to realizing its WTO market reforms.

By Colin Law and Zachary Tyler,
Freshfields Bruckhaus Deringer, Hong Kong

Endnote:

1 The JV is the first significant foreign investment in the PRC telecom service sector after the buy-out of all foreign interests in China Unicom mobile operations immediately prior to its flotation on the Hong Kong and New York Stock Exchanges.