A window into the future

Bearing the above in mind, it would be easier to understand that the General Plan – besides touching upon the routine topics of a free trade zone such as easier trading and less customs and quarantine control – focuses more on outlining liberalisation of investment access, financial de-regulation and the promotion of maritime and service activities. Accordingly, it is also not a surprise to see that manufacturing is not mentioned by the General Plan at all.

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Obsolete approvals: a complete turnaround

The General Plan is a guide for the SH FTZ project. Instead of the traditional preferential treatment such as tax incentives, this plan focuses more on creating a new regulatory framework for the experiment. In particular, it brings some significant breakthroughs which will greatly facilitate foreign investment activities.

The most remarkable breakthrough is the introduction of the so-called negative list approach to regulating foreign investment access. On August 30 2013, the standing committee of China's top legislative body officially endorsed this new approach for the SH FTZ, to be implemented within a three-year trial period. Shortly following that on September 29 2013, the Shanghai Municipal Government issued Special Administrative Measures for Foreign Investment Access in the China (Shanghai) Pilot Free Trade Zone (Negative List) (上海市中国（上海）自由贸易试验区外商投资准入特别管理措施 (负面清单) ). According to this list, foreign investment in those areas explicitly addressed by this list will be subject to access control (i.e. approval requirement). The others only need to follow a filing procedure. This is almost a complete turnaround of the present practice in the rest of China, which in general requires administrative approvals for all foreign investment projects. Such an approach is very close to that in the West, and fits the goal of the General Plan to reform the government to be more market oriented. Although the first Negative List still appears long, it was stated that it “will be updated in a proper time”. Based on the policy trend of further opening-up, it is foreseeable that the Negative List will gradually become shorter (though difficult to predict exactly when) and will facilitate foreign investment access in the long run.

Another significant development is the creation of a more flexible company law regime, which corresponds to another pilot scheme contemplated by the State Administration for Industry and Commerce (SAIC) and presently implemented in Shenzhen and Zhuhai. More detail is found under the Several Opinions on Supporting the Establishment of the China (Shanghai) Pilot Free Trade Zone (国家工商行政管理总局关于支持中国（上海）自由贸易试验区建设的若干意见) issued by SAIC on September 26 2013, which substantially reduces shareholder's obligations connected with a company's registered capital (see figure 1: Shareholder obligations).

This reform – applicable to both Chinese funded companies and foreign investment companies – is strongly influenced by the common law system, which enables easier company establishment and will increase the competitiveness of the Chinese jurisdiction to attract foreign investment. To better protect creditors' interest under such a system, all companies are required to annually submit a report to a centralised system which will be published to the public. Companies shall be responsible for the trueness and legitimacy of the information it represents under its annual report. Information on a company's credit track record will further go into this system for easier reference by third parties dealing with the company. Compared with the present annual inspection system which is cumbersome and inefficient, the new system obviously is much better suited to the demand of a market economy.

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Good start, but still more to come

To execute the General Plan, various rules have been formulated or adjusted at the local-level to push the project forward. However, irrespective of these efforts to substantiate the content of the SH FTZ, the project is still more like a conceptual design rather than a concrete business opportunity for most foreign companies. Although foreign communities have shown great interest, there have been few reports of foreign companies taking concrete steps to restructure their business using the SH FTZ. Based on our analysis, we believe the major reasons for this include

• Strong governmental control still remains, e.g. antitrust review and national security are still applicable. In addition, the first Negative List is quite lengthy which appears to be a simple reiteration of the restrictions and prohibitions under the present Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录), plus even more restrictive or prohibitive items which were previously not explicitly addressed by this catalogue. Although it is understandable that the Shanghai experience - if successful - might be extended to the whole country, it is still questionable whether it is necessary to cover all those restricted industries which anyway do not exist in the SH FTZ (e.g. mining and most manufacturing activities).
• Any major breakthroughs depend not only on local vision at the Shanghai-level, but more importantly the attitude and support from the various central ministries in Beijing. Any deregulation would mean the loss of power and influence, which is always a challenge difficult to manage. A typical example is financial deregulation and the lifting of capital account control, which will be indispensable if Shanghai really plans to become an international financial centre. Policy support has so far been limited and expressed only by a few financial regulators. This support mainly concerns banks and insurance companies but has no general relevance to foreign companies not in the financial sector.
• The project does not provide for quick profitability which can immediately be sensed by the business community. Although foreign investment company set up and restructuring becomes much easier than before, the limited tax incentives so far offered do not appear to create a model for foreign companies to restructure their business in China using the SH FTZ. The new technical possibility to use a pure holding vehicle established with the SH FTZ to go around the approval requirement of a share restructuring deal in other locations of China is unfortunately not tax competitive against a similar set-up via Hong Kong. In addition, the 15% corporate income tax reduction as anxiously expected by the outside was finally struck out under the General Plan.
• The three-year trial period endorsed by the national legislator still poses a threat to the future. Although there is no doubt about the Chinese government's strong will to push this project forward, the fact that it is a pilot means there are a lot of policy uncertainties ahead. A back and forth, which could potentially mean loss of investment, cannot be excluded. The picture may look even trickier when one critically reviews the project's conflict with existing national laws, which is not fully remedied by endorsement from the standing committee of the National People's Congress. The latter's legitimate competence to suspend the application of national law enacted by a full assembly of the National People's Congress may potentially be deficient from a constitutional point of view.

There could certainly be more reasons behind the scenes. Above all, the most critical challenge is that the SH FTZ project will encounter a number of obstacles under existing national legal framework and practice. Quite a few questions at the technical-level are yet to be answered before proper solutions for these issues can be worked out. At this stage, a wait-and-see approach appears sensible for most foreign companies. On the other hand, the comparably open-minded attitude of the governmental authorities in Shanghai creates a good chance for the foreign community to contribute their ideas and influence the rule-making process. Since the whole project has picked up its speed within a very short timeframe, which creates massive pressure on the local authorities, a business friendly and interactive approach will also help them to better handle the challenges under this project. Irrespective of all the uncertainties and risks ahead, the greatest thing to come out of the General Plan is that it signals a strong national will of China to further open up to the outside world. In this context, the SH FTZ is no doubt a window for the outside world to see the future of China better and to get prepared.

Michael Tan, Sophie Wei, Stephen Wu, Taylor Wessing, Shanghai