CEPA: A Shortcut to PRC Market Entry?

Retail business for unrestricted commodities is currently open to foreign service providers in limited areas such as Beijing, Shanghai, provincial capitals and the five special economic zones, in the form of JVs only. Hong Kong service providers, however, are allowed to do such business in the form of either JVs or wholly owned enterprises, in broader geographical areas such as cities at the district level, and at the county level in Guangdong province. This difference in terms of time and geography may give Hong Kong companies an opportunity to establish an advantageous position in the mainland market ahead of their overseas competitors.

Thresholds

CEPA also lowers the thresholds for Hong Kong service providers to enter into the mainland¡¦s trading sector. While China¡¦s WTO commitments only promise to open general trading to foreign service provider JVs by December 2002, to permit foreign majority holding JVs by December 2003 and wholly foreign-owned trading companies by December 2004, China has set relatively high establishment thresholds. For the wholesale business sector, foreign investors may only establish JVs and their average annual sales can not have been less than US$2.5 billion in each of the previous three years and their assets¡¦ value can not have been less than US$300 million in the previous year.

Few Hong Kong companies would be qualified for such requirements, but CEPA substantially lowers the thresholds. Hong Kong companies with average annual sales of US$30 million in each of the previous three years and assets value of US$10 million in the previous year would be permitted to engage in wholesale business in mainland China. For retail businesses, the thresholds have been reduced from US$20 billion to US$100 million for the past three years¡¦ sales and from US$200 million to US$10 million for assets in the past year. It is reported that dozens of Hong Kong retailer groups would now qualify under the CEPA structure, including brand names familiar to mainland consumers such as Sasa cosmetics, New World Department Store, Giordano clothing and Watsons, all of whom may be considering establishing wholly owned shops in mainland China.

A Shortcut for Market Entry?

For foreign service providers or investors, CEPA could be an alternative to China¡¦s WTO commitments or a shortcut for entry to the China market if these entities acquire Hong Kong companies that satisfy the CEPA requirements. CEPA defines a ¡§Hong Kong service provider¡¨ as either a Hong Kong permanent resident or a Hong Kong corporate entity. Qualified entities should be incorporated in Hong Kong and have had a valid business registration certificate for three or more years; be engaged in substantial business operations for three or more years; pay profit tax; have Hong Kong operating premises; and Hong Kong residents without limit of stay and/or people from mainland China staying in Hong Kong on one-way permits should make up at least 50% of the workforce.

The Hong Kong Companies Ordinance treats all foreign investors equally in terms of incorporating companies in Hong Kong. Foreign investors may consider establishing a Hong Kong company or acquiring Hong Kong companies that are qualified under CEPA so as to obtain access to the mainland market ahead of others. To incorporate a new Hong Kong company may not be acceptable, as CEPA requires three years¡¦ deal history. Acquiring an existing Hong Kong entity, on the other hand, could provide such records, but would involve other difficulties.

Annex 5 to CEPA provides that if a foreign party has acquired more than 50% of the equity interest in a Hong Kong corporate entity, the Hong Kong company may only be qualified as a Hong Kong service provider one year after the acquisition. Further, qualified target companies may not agree to surrender the whole interest and the acquisition may result in a JV in Hong Kong instead of in mainland China. Although there are expected to be several acquisitions for this purpose in the near future, potential acquiring parties need to determine whether the premium paid in such an acquisition is worthwhile in comparison with the benefits.

Endnote

1 Trading of restricted commodities such as books, newspapers, magazines and pharmaceuticals is subject to a different, more restrictive, timetable.