Blueprint for China's post-WTO Telecom Competition Framework

As a sign of foreign interest, for eight years US telecommunications giant AT&T pursued a joint venture with China Telecom's subsidiary Shanghai Telecom to provide broadband services in Pudong, Shanghai. Government approval was finally granted for the joint venture, Shanghai Symphony Telecom, in December 2000. Most large international operators have also done some groundwork and are making their move. A recent notable example is Alcatel of France, which signed a Memorandum of Understanding with the MII on October 23 2001. Alcatel agreed to pay US$312 million for a majority stake in its successful joint venture, Shanghai Bell, which will be consolidated and renamed Alcatel Shanghai Bell. That joint venture presently employs 4,500 people, has annual sales of US$1 billion and holds a 33% market share for voice switching equipment used in fixed and mobile applications. Head of MII Wu Jichuan stated: "Establishing [Alcatel Shanghai Bell] is an important milestone in China's telecoms industry and will contribute to the development of world-leading telecoms technologies in China."⁷ In a convergence environment, it was also welcoming to see that media giant AOL Time Warner on October 22 2001 reached a groundbreaking deal with the state-run China Central Television to allow its cable television channel to be broadcast in China with the sanction of the State Administration of Radio, Film and Television (SARFT), China's broadcasting regulator.

Improving the Domestic Industry and the Overhaul Plan

China has experienced gradual introduction of competition into the telecommunications sector and is aware that competition brings positive results. In 1994, the government established China Unicom to introduce competition to the monopoly held by China Telecom. This led to a quick 80% drop in installation and subscription costs. China clearly recognizes the need to make local companies more competitive in preparation for a WTO-induced level playing field. In the 10th Five Year Plan (2001-2005) issued by the State Development Planning Commission, it was categorically stated that industrial monopolies must be broken up and competition ushered in.

Which Chinese companies currently dominate the domestic fixed line and mobile telecommunications sector? We've broken them down as follows:

Fixed line Operators

China Telecom - A virtual monopoly with 170 million fixed line subscribers and annual revenue of US$20.8 billion in 1999. It plans to list in Hong Kong and New York.

Jitong Communications - Founded by the then Ministry of Electronics Industry in 1994. Its plans for a US$250 million listing in Hong Kong and New York in December 2000 was withdrawn due to poor market conditions.

China Netcom - Backed by the Chinese Academy of Sciences, the Ministry of Railways, SARFT, the Shanghai municipal government, and with a 12% stake held by Rupert Murdoch's News Corporation. Jiang Zemin's son serves on the Board of Directors of this company. The company is the main competitor to China Telecom in data business. Led by Edward Tian, a visionary CEO, and a team of ex-McKinsey consultants, this company has been fighting aggressively and successfully to win market shares from China Telecom.

China Unicom - Founded by the then Ministry of Electronics Industry, the Ministry of Electric Power and the Ministry of Railways in July 1994. It has captured about 4% market share. It is also the dominant paging service provider.

China Railcom - The company was spun off from the Ministry of Railways in 2000. While China Railcom has been offering fixed line service to businesses and residences connected to its railway network in 1,300 cities and towns in China since March through its 138 subsidiaries, China Railcom's planned July 2001 nationwide launch was delayed after it had failed to reach interconnection agreements with local and provincial subsidiaries of China Telecom.

Mobile Operators

China Mobile - The company was spun-off from China Telecom in April 2000. Its revenue in 2000 was US$15 billion. It has captured about 78% market share and is listed in both Hong Kong and New York.

China Unicom - Has about 22% market share after MII's order to the People's Liberation Army to exit its cellular network company Great Wall. It is listed in Hong Kong and New York.

The landscape is likely to change significantly. The next local entrant will probably be the State Power Corporation, the largest power company in China, which has applied to the MII for a licence to operate internet services as well as both local and long distance basic services. With China recognizing the need to strengthen its domestic industries because of WTO, there have been in recent months unconfirmed rumours in the industry of a government plan to restructure and merge the existing nine active operators in the sector into four fully integrated domestic telecommunications service providers. Head of MII Wu Jichuan made this public when interviewed by China Central Television on November 26 2001.⁸ Under terms of the draft plan, details of which have not been made public and which may change, China Telecom will be split into two arms (a northern unit with assets in ten provinces and a southern unit with assets in 21 provinces), and there will be six main groups of domestic operators, as follows:

i) the northern units of the present China Telecom will be renamed as China Netcom Jitong Communications Group, after having merged with Jitong Communications and China Netcom and taken over all their backbone infrastructure;

ii) the southern units of the present China Telecom will remain as the new China Telecom, although it may take over about 30% of the existing backbone of the northern units at the present China Telecom;

iii) China Mobile is now likely to be able to avoid any merger, contrary to earlier rumours for it to be merged with Jitong Communications;

iv) China Unicom is now likely to be able to avoid any merger, contrary to earlier rumours for it to be merged with ill-performing China Railcom;

v) China Railcom will likely be able to avoid any merger, again contrary to rumours, that it would be merged into China Unicom. However, without a merger, it is questionable whether it can fund a nationwide network build-out unless it is able to raise more capital by way of public listing or working with foreign investors after liberalization of the industry;

vi) China Satellite is now likely to be able to avoid any merger.

It was widely reported that each of the six main groups of domestic operators listed above will receive nation wide licences to provide a full range of telecommunications services under the draft plan. If the plan goes ahead, it may make it much harder thereafter for new players to enter the market. Details have not been made public and it is still unknown how foreign and private investors, such as News Corp. and their 12% shareholding in China Netcom, will be treated. It will also be interesting to see whether the new China Netcom Jitong Communications Group and/or the new China Telecom will be classified as a "Dominant Telecom Operator" and hence be subject to more stringent regulation.

The plan is seen by many as a way of implementing an early administrative restructuring and consolidation to avoid price wars and other destructive forms of competition from taking their toll on domestic players in the industry. It is expected that the plan will take months or even years to implement, as the north-south geographic split is a Herculean task involving separation of millions of accounts, customers, physical assets and the world's largest single backbone network. The plan should finally allow China Telecom to proceed with its planned US$4 to $6 billion overseas initial public offering in Hong Kong and New York.

From a competition standpoint, potentially the biggest loss as a result of the present draft plan is the loss of a strong and innovative alternative carrier, China Netcom, as it is merged into the new China Netcom Jitong Communications Group, potentially a new duopoly player with the new China Telecom. There are rumours that the new China Netcom Jitong Communications Group will be headed by a senior person from China Mobile. We would have preferred that the plan go further to fully open up China's cable television network to facilitate full cable-telecommunications convergence in 130 million households that are already connected to the cable television network.

Rewriting the Rulebook: Emergence of a FCC-type Regulatory Body

As in the case of many other countries, China's telecommunications networks have for years been operated and regulated by a single entity, thus giving the networks a widely perceived lack of accountability, impartiality and efficiency. The then Ministry of Post and Telecommunications (MPT) was the sole provider of public telecommunications services in China until 1993 when the State Council required it to transfer its business operations to China Telecom,⁹ an entity under the MPT. At the same time, the Directorate General of Telecommunications was established as the regulatory authority. In 1994, China Unicom was established as the only real competitor to China Telecom. However, China Unicom was at that time also controlled by a government organization, the former Ministry of Electronics (MEI), until MEI's operations were merged with the MPT to form the MII in 1998.

Given the historical circumstances, many MII officials are ex-China Telecom staff. The north-south reorganization plan may finally put an end to any doubts on the impartiality of the regulator and the problem of incessant feuding between the MII and the SARFT. The plan envisages the creation of a new supra-ministerial body, the State Council Information Management Commission (IMC). The function of the IMC is likely to be similar to that of the Federal Communications Commission, the US telecommunications regulator. Premier Zhu Rongji and state vice-president Hu Jintao are likely candidates to head the IMC. Industry observers anticipate that the MII will be disbanded and replaced by the IMC in 2002.

Updating Unfair Competition Laws

Since 1993, China has had legislation against unfair business practices in the form of the PRC, Anti-unfair Competition Law (the UCL). The UCL is a generic (rather than sector specific) competition law that applies equally to all sectors.

The UCL sets out broad principles that prohibit monopoly operators from engaging in anti-competitive practices such as "lock-ins" that prevent customers or partners from purchasing goods or services from other operators, use of predatory pricing to squeeze out competitors, and imposition of unreasonable conditions of sale and product bundling against the will of consumers.

As competition becomes fiercer in China post-WTO, the limits of the UCL will be tested. While the principles in the UCL are sound, they have little bite. Generally speaking, the maximum fine under the UCL for abusing a monopoly position is only Rmb200,000. Only if an operator is held to have taken advantage of its monopoly status to sell goods of low quality at high prices, or has indiscriminately and illegally collected fees, will the fine be increased to three times the illegal earnings plus the confiscation of the illegal earnings. We are not aware of the dominant telecommunications player, China Telecom, ever having been liable for the more severe three times earnings fine. The Rmb200,000 maximum penalty in most cases is merely loose change in China's multi-billion renminbi telecommunications industry.

Industry observers have commented that the MII presently lacks the enforcement capability to limit predatory pricing, and has to rely on telecom operators to police their own ranks. If positive steps are not taken this situation will worsen as profit margin declines and competition intensifies when China Unicom launches its CDMA (code division multiple access) services¹⁰ and as foreign players enter China post-WTO.

It may be time to update the UCL. Indeed, the Chinese authorities have already adopted some basic rules against restrictive practices, illegal cross-subsidies and predatory pricing in the PRC, Telecommunications Regulations (issued by the State Council in September 2000). These regulations call for a maximum penalty of Rmb1 million and cessation of business operations if contravention of regulations is found to have occurred. Observers who specialize in competition law will quickly point to the much more stringent US laws: corporations found in violation of the US antitrust Sherman Act may face a felony conviction and a fine of US$10 million. Furthermore, US antitrust enforcement agencies also have the explicit power to break up companies that violate antitrust laws, the right to approve buyers up-front as part of a divestiture order and a requirement that companies sell entire operating units, rather than a medley of assets, to resolve antitrust concerns. International best practices, recent sector-specific proposals by OFTA in Hong Kong and the recently introduced Telecom Competition Code of Singapore's Information Development Authority may serve as a good basis for discussion and adaptation for China.

Post-WTO Supervision: Sector Specific Competition Law and Merger Review

While present legislative efforts and the plan for the reorganization of the current nine operators discussed above are making progress in China's commitment to open the telecommunications sector post-WTO, the focus has all been on the "front-end" rather than the "back-end" of WTO entry. What happens post-WTO?

Though most mergers and acquisitions, whether involving foreign funds or not, are likely to enable the relevant Chinese operators to rationalize their businesses and achieve the necessary economies of scale to be competitive after WTO accession, some mergers and acquisitions may result in the creation or strengthening of a dominant player. This would obviously jeopardize the maintenance of effective competition in the Chinese telecommunications market. How would China guard against horizontal and vertical mergers that may have the effect of inhibiting competition and creating new monopolies post-WTO? This is a big question that lacks an answer currently.

Still, plans by the central government to overhaul the telecommunications sector in China are taking shape and in our opinion will lead to positive results with far reaching consequences. In preparing for WTO and the expected wave of mergers and acquisitions in the Chinese telecommunications market, Chinese authorities must also make an urgent critique of prevailing international practices and establish its own rules to foster healthy competition post-WTO.

Endnotes

1 National treatment is the principle of giving foreign nationals the same treatment as one's own nationals. For example, General Agreement on Tariffs and Trade (GATT) Article 3 requires that imports be treated no less favourably than the same or similar domestically-produced goods once they have passed customs. General Agreement on Trade in Services (GATS) Article 17 and Agreement on Trade-related Aspects of Intellectual Property Rights (TRIPS) Article 3 also address national treatment for services and intellectual property protection.

2 Chinese-Chinese-Foreign ownership structures consisted of a Sino-foreign equity joint venture or cooperative joint venture (under the terms of the PRC, Company Law) that brought in a second Chinese enterprise to the shareholding structure to create the appearance of a predominantly Chinese ownership structure. For discussion of a particular example, see Tibor Baranski and Taili Wang, "The Chinese-Chinese-Foreign Incident of China Unicom," China Law & Practice, December 2000/January 2001, 14(10), pp.
62-66.

3 See also Nancy Leigh, "New Telecom Circular Offers More Value-Added Services," China Law & Practice, September 2001, 15(7), p. 95 and Winston Zhao & Maggie Lee, "Market Access Report: Telecommunications," China Law & Practice, October 2001, 15(8), p. 76.

4 The Ministry of Information Industry (MII) is the government ministry that regulates China's telecommunications (including internet) industry.

5 A widely-circulated draft of the Administrative Regulations on Foreign-invested Telecommunications Enterprises that contained onerous qualification criteria for would-be foreign investors in the Chinese telecommunications market after WTO entry, said to have been leaked to members of the industry in June 2000, was never acknowledged by the MII.

6 Teledensity is defined as the number of telephones per 100 people in a region. China's current teledensity is at a level similar to that seen in the United States in the 1920s. China currently has 164 million fixed line subscribers and 117 million mobile phone subscribers.

7 Mark O'Neill, "Alcatel Takes over Controls of Shanghai Venture," South China Morning Post, October 24 2001.

8 Christine Chan and Eric Ng, "Fixed-line Break-up Confirmed," South China Morning Post, November 27 2001.

9 At the time, China Telecom was a new entity known as the China Post and Telecommunications Administration.

10 Industry observers have commented that the use of CDMA technology will give China Unicom a technological lead over rival China Telecom, which uses the older GSM (Global System for Mobile) communications standard. China Unicom plans on introducing its CDMA service beginning in January 2002. See Hui Yuk-Min, "Unicom to Launch CDMA in January," South China Morning Post, November 21 2001.