New Telecom Enterprise Regulations: The Door is Opened, but MII Still Keeping the Gate
January 31, 2002 | BY
clpstaff &clp articlesNew regulations reflect a gradual opening of the telecom sector to foreign participation, but that's just the beginning as China faces the challenges of reform.
By Robert Lewis, Lovells
In the past three months, the entire face of the China telecom market and regulation regime has been changed. First, in October of last year, a massive overhaul of China Telecom and several other domestic basic telecom operators was announced, purportedly to improve their competitiveness in anticipation of foreign competition following China's World Trade Organization (WTO) entry. Then with the publication in November of the WTO Working Party report on China's accession to the WTO at the Doha ministerial conference, China officially committed for the first time to open up its telecom operation sector gradually to foreign participants. This had long been reported but never officially confirmed by China. Following the WTO Working Party report, the Ministry of Information Industry (MII) formally rescinded the prior notices banning foreign investment in the PRC telecom sector. Most recently, on December 11 2001, the State Council approved the new Administration of Foreign-funded Telecommunications Enterprises Provisions (New Telecom FIE Regulations), which took effect on January 1 2002.
With entry into the WTO, China has committed to open its telecommunications market to foreign investment and participation on a gradual basis. With the adoption of the New Telecom FIE Regulations, China has demonstrated that the emphasis should be on "gradual" rather than "open", as these new regulations vest the MII with substantial discretion to extend its "managed competition" model to foreign-invested telecom operations in China.
NEWLY PERMITTED FOREIGN INVESTMENT LEVELS UNDER CHINA'S WTO COMMITMENTS
On the face of China's WTO commitments, almost all the news for foreign telecom operators is good. Up to 25% foreign investment in mobile telecommunications operations in Beijing, Shanghai and Guangzhou was permitted immediately upon China's formal accession to the WTO in December 2001. This will expand to 35% foreign investment in 14 additional major Chinese cities within one year. Within three years post-WTO, foreign investors will be able to own up to 49% of a mobile telecom company operating in the same 17 cities, and within five years, there will be no geographical restrictions.
The news is even better for value-added telecom investments (see Chart 1 on the following page).1 Under relevant PRC regulations, value-added telecom services operation includes, among others, operation of internet service providers (ISPs), internet content providers (ICPs), internet data centres (IDCs) and applications service providers (ASPs). Basic telecom services operation includes operation of mobile or fixed line voice and data networks and satellite operation. Customer premises networks (CPNs) and resale of basic telecom services are classified as basic telecom services under PRC regulations but under some MII notices (but not under the New Telecom FIE Regulations) are to be managed as value-added services for administrative purposes.
The outlook is not as favourable for foreign investors in fixed-line telecom operations (see Chart 1). No foreign investment is permitted for the first three years after China joins the WTO. Unfortunately, China has not made a distinction between the more sensitive residential and commercial "retail" fixed line telephone and data services and the "wholesale" activities of backbone operators like Qwest, Global Crossing, Level 3 and others who supply network capacity to other basic and value-added telecom service operators and major public and private institutional users. Although backbone network construction and operation would seem to be ripe for foreign investment in China, it will be subject to the same three-year ban. Unless foreign investors in this sector can find stable alternative investment structures, they risk losing this market to the domestic players.
THE NEW TELECOM FOREIGN INVESTMENT REGULATIONS
The "Unofficial" Draft Telecom FIE Regulations
In China, there is always another "shoe" waiting to be dropped. In the case of the opening of the telecom operation sector in China to foreign investment, the other shoe takes the form of the New Telecom FIE Regulations.
A draft of the Telecom FIE Regulations was leaked in the summer of 2000 at the same time as a draft of the PRC Telecom Regulations. The PRC Telecommunications Regulations (中华人民共和国电信条例) (which provide for separate licensing schemes for basic telecom services operators and value-added telecom services operators) took effect on September 25 2000. But the MII never acknowledged the existence of the draft Telecom FIE Regulations.
The draft Telecom FIE Regulations contained several onerous provisions that all but shut the door to foreign telecom investment, a door China had committed to open. The foreign investor qualification requirements under the draft Telecom FIE Regulations limited foreign investors in the China telecom market to licensed foreign telecom operators with an average annual turnover of US$10 billion for the prior two years and a representative office in China for the prior three years. This minimum turnover requirement would have eliminated all but a dozen or so foreign players, and the representative office requirement would have narrowed the field of potential foreign telecom investors even further. Not surprisingly, even while he refused to acknowledge that any draft of the Telecom FIE Regulations had been prepared or circulated, Minister Wu Jichuan of the MII denied publicly that any such minimum turnover requirement would be imposed.
The draft Telecom FIE Regulations also imposed certain qualification requirements on the domestic partner in a basic telecom operations joint venture (JV). Under the draft, the Chinese investor would have to be a licensed telecom operator with a minimum average annual turnover of Rmb3 billion. This minimum turnover requirement would have eliminated the smaller Chinese telecom operators that needed strategic foreign investment the most.
The telecom operation licence requirement for domestic investors under the draft Telecom FIE Regulations itself presented a significant hurdle. This would have eliminated non-telecom players as potential partners in a basic telecom JV.
Under the draft Telecom FIE Regulations, minimum turnover requirements were also imposed on both foreign and domestic investors in a value-added telecom JV. However, pursuant to subsequent MII announcements, it was expected that all investor qualification requirements for value-added telecom projects would be eliminated for both foreign and domestic investors.
The draft Telecom FIE Regulations also did not contemplate the possibility of investment by a foreign investor consortium. Each foreign investor either did or did not meet the qualification requirements. This presented obstacles to participation by foreign financial players and other non-operator foreign technology companies that otherwise would have legitimate roles to play in many telecom investment structures.
In addition, for both basic telecom and value-added telecom JVs, under the draft Telecom FIE Regulations the project vehicle was required to be an equity joint venture (EJV) and not a cooperative joint venture (CJV), and the chairman of the board and the general manager of the EJV were to be appointed only by the Chinese investor. The EJV requirement would mean that the Chinese party would be required to fund its majority share of the capital in cash or assets of ascertainable value and that the foreign party's share of the profits would be limited to its percentage ownership as in the case of standard "western" companies. While this may not seem unusual outside of China, most foreign investment in the PRC telecom sector to date (notwithstanding the total ban on such foreign investment prior to China's joining WTO) has been via the CJV structure in order to permit the foreign party to invest all of the required capital and receive the majority of the profits. With an EJV requirement, this would change.
Under the draft Telecom FIE Regulations, when read in conjunction with the September 2000 regulations, a foreign operator was required to complete the process of establishing the telecom EJV prior to applying for a telecom operating licence. The implicit rationale was that the EJV was the licence applicant and had to be in legal existence before it could submit an application.
Unfortunately, this resulted in an unwieldy two-step examination and approval process in which it was possible (but perhaps not likely as a practical matter) that a telecom FIE could be approved and established but not be granted an operating licence. This was further complicated by the provision of the September 2000 regulations that indicated that all basic telecommunication licences were to be issued by tender (with no further clarification). This theoretically led to the unwelcome possibility that a foreign operator would have to jump through all the hoops to set up a telecom FIE just to get a place in the queue to submit a bid in response to a basic telecom operating licence tender. Understandably, many foreign commentators objected to this and recommended a consolidated process.
New Telecom FIE Regulations
In the New Telecom FIE Regulations, many of the most objectionable and onerous provisions of the draft have been eliminated or improved. However, in some cases, the qualification process has simply been moved "behind the curtain". Mll has extensive discretion to determine whether a foreign or domestic investor satisfies the subjective prudential tests.
More importantly, MII controls the number of licences to be issued and can simply declare that market conditions in China (still an oxymoron) will not support the issuance of additional licences at a particular point in time regardless of investor and applicant qualifications. The New Telecom FIE Regulations also set new minimum registered capital requirements and dictate a deliberate (and arguably deliberately slow) timetable for approvals of telecom FIEs. However, to be fair, the minimum capital requirements appear to be prudential in nature and not out of line with actual capital requirements, and the approval timeline prescribed in many respects is consistent with historical practice for similar foreign investment projects in China.
The key provisions of the New Telecom FIE Regulations perhaps can best be illustrated by Chart 2 (see page 34), which presents a comparison of certain provisions in the draft and final versions of these regulations.
As Many Questions as Answers
The New Telecom FIE Regulations still leave many questions unanswered, including the following (with MII's preliminary responses following):
Will direct strategic foreign investment in an existing PRC licensed operator be permitted?
The preferred investment structure will be a separate EJV that will obtain a separate telecom operating licence. Foreign investment in an existing licensed PRC telecom operator listed offshore will be permitted in accordance with relevant securities and company law regulations, but this may raise other issues with respect to geographical limitations on operation by telecom FIEs in the initial periods following China's entry into WTO since any listed telecom operator will hold network assets outside the permitted areas of operation.
Can the minimum capitalization amounts be phased in to match the step-up stages for the foreign investment caps?
MII has not considered this issue and may defer to MOFTEC on this point.
When will the detailed schedules on foreign investment levels referenced in the New Telecom FIE Regulations be issued?
It is expected that MII will issue detailed schedules incorporating the WTO market access commitments in the first half of 2002.
What standards will MII use to determine whether the principal foreign investor (PFI) and principal Chinese investor (PCI) meet the vague qualification tests?
MII expects to issue more detailed qualification standards in the first half of this year.
Can the PFI invest with other foreign investor consortium members in an offshore SPV and still satisfy the PFI qualification tests?
Probably not, although again MII may defer to MOFTEC on this point.
For local value-added telecom projects (to be vetted first by provincial-level telecom authorities before being passed to central MII), will central MII defer to local telecom authorities as a practical matter?
This will be handled on a case-by-case basis.
Will the MII conduct a second evaluation at the time the application for an operating licence is submitted or will this be more ministerial in nature in reliance on prior MII preliminary project approval?
The MII will not re-evaluate the telecom FIE project at the time of the application by the telecom FIE for the telecom operating licence.
The September 2000 PRC, Telecommunications Regulations indicated that resale of basic telecom services would be managed as value-added services, but the New Telecom FIE Regulations do not provide for this. How will this apparent conflict be resolved?
The MII has indicated that there is no conflict and that resale will be handled as value-added services as indicated in the September 2000 regulations. The MII has not addressed the issue of whether mobile virtual network operation will be treated as resale and thus as value-added.
The September 2000 Telecommunications Regulations also provide that the authorities will issue basic telecom services operating licences by tender. How would such a tender process fit in with the project approval process under the New Telecom FIE Regulations?
This issue is under consideration by the MII, which has engaged an outside consultant to advise it on this point.
Can foreign investors expect that value-added telecom FIEs will be approved more easily and in greater numbers than basic telecom FIEs, or will both basic and value-added telecom FIE projects be approved on a "managed competition" basis?
Value-added telecom FIEs should be approved more readily than basic telecom FIEs, and local value-added telecom FIEs should be approved more easily than national value-added telecom FIEs.
FURTHER RESTRUCTURING OF CHINA TELECOM
As was stated at the outset, in October of 2001 PRC sources reported that China Telecom was to be further restructured.
The new China Telecom restructuring plan still is not set in stone. MII sources indicate that the broad outlines have been settled, but that the details may change. The most recent press reports indicate that China Telecom's fixed line business would be split along north-south lines, with the northern portion to be merged with Jitong into China Netcom to form the new China Netcom Jitong Communications Group (CNC Jitong Group) and the southern portion to form the new China Telecom Group (CT Group). CT Group is to hold 70% of the original China Telecom national backbone network and the remaining 30% is to go to CNC Jitong Group, which will also retain the original CNC and Jitong backbone networks. CNC Jitong Group, CT Group, China Mobile, China Unicom, China Railcom and China Satellite all are to receive full national licences for both fixed line and mobile (although most reports indicate that CNC Jitong Group and CT Group may not receive mobile licences until 2003 or 2004).2
Even prior to the announced further restructuring of China Telecom, it was not clear that China Mobile or China Unicom would be interested in doing a joint venture with a strategic foreign partner. China Mobile and China Unicom already have access to foreign capital via offshore listings, so it was not clear why they would want to enter a joint venture with a strategic foreign telecom investor since they already had access to "silent" foreign cash through the offshore sale of shares.
Ironically, the recently announced further restructuring of China Telecom may open more opportunities for strategic foreign investment in the PRC mobile and (eventually) fixed-line network markets. The new CNC Jitong Group and the new CT Group each will eventually be permitted to offer mobile services, but they will lag far behind China Mobile and even China Unicom in the mobile services market. Consequently, CNC Jitong Group and CT Group may now have an incentive to find a foreign mobile operator to act as a strategic partner in order to set up a mobile telecom operating JV that can help compete against China Mobile and China Unicom. China Railcom and China Satellite will also need help from strategic foreign partners in mobile operations, but they may need more help than foreign partners can afford to give.
Correspondingly, China Mobile and China Unicom may find it attractive to work with a strategic foreign partner to develop non-core fixed line operations, such as carrier's carrier or optical fibre access projects. Unfortunately, as noted above, no foreign investment in fixed-line operations will be permitted until 2005 (unless creative work-around strategies are employed).
Even though foreign investment in mobile operations JVs with CNC Jitong Group or the new CT Group is available immediately under China's WTO market access commitments, given the reported delay in the issuance of a mobile licence to these operators and all of the distractions attending the internal restructuring activities and planned IPOs (and current negative market reaction to the possibility of their commencing such mobile operations), these entities likely will not be in a position to talk about setting up mobile JVs for the next 12 to 18 months, or even longer. In addition, China Railcom and China Satellite may not be prepared institutionally or operationally to discuss a strategic JV in the early stages, so foreign investment in mobile operations in China may not be as active as quickly as many would expect.
Even so, the government-driven consolidation of domestic telecom players may provide a glimmer of hope. The initial consolidation in the industry appears to be a preliminary step toward further deregulation and issuance of additional licences to JVs between existing domestic non-telecom companies and foreign telecom companies now that the domestic qualification requirements have been relaxed, at least on the surface.
In fact, the liberalization of the domestic investor qualification requirements under the New Telecom FIE Regulations reflects China's general commitments in connection with its WTO accession. The WTO Working Party report indicates that China committed to allowing foreign service suppliers in all industries complete freedom in selecting a Chinese partner, even from industries and service sectors separate from the proposed JV's scope of operation. However, unless clearer qualification standards are issued as promised, the vague Chinese investor qualification requirements under the New Telecom FIE Regulations may simply have moved the express requirements under the draft regulations to internal, unpublished policy standards hidden from public view. This will become clearer only after clarification schedules are issued and foreign investors have some direct experience with the new rules.
THE OPERATING LICENCE REQUIREMENT
No matter what potential partners are available for a foreign operator in the telecom network operation sector, it should be anticipated that the number of new licences for basic telecom operation services will be limited as China continues to pursue a "managed competition" model for government-driven deregulation. This is a matter strictly within the control of MII or any successor telecom regulatory body (widely rumoured to be the State Council Information Management Commission with jurisdiction over both broadcast and telecom operation). China has not made any commitments under WTO with respect to issuance of any minimum or maximum number of licences, so this will be a key choke point for foreign investment in telecom network operations in China.
CONCLUSION
Even with the significant strides China has taken under the WTO market access accords in the telecom sector, the China investment equation remains unchanged in one key respect: the lure of the immense China market coupled with the legal and practical realities for the foreign investor will send most foreign investors looking for a side-door entrance. But the long-term winners will find the creative yet stable solution. This remains the challenge and the opportunity.
Robert Lewis is the former General Counsel Asia for Nortel Networks and is now Managing Partner of Lovells' Beijing office. He was a featured speaker at the China Telecom Conference in January 2002, addressing the new Telecom FIE Regulations and structuring strategies for foreign investment in mobile network operations, internet data centres, mobile virtual networks, carriers' carrier operations and other telecom projects in China. He can be reached at [email protected].
Endnotes
- 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.
- For an overview of the current domestic players in China's telecom industry and a review of restructuring in the industry, see Nicholas Chan, "Blueprint for China's post-WTO Telecom Competition Framework," China Law & Practice, December 2001/January 2002, 15(10), pp. 22-25.
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