The Shanghai Free Trade Zone (SFTZ) has been introduced by the Chinese government to allow companies to establish and operate their businesses in the same manner as they would in other regions such as Hong Kong or Singapore. Over the years, China has functioned as a production factory that enjoyed the ability to produce goods for a lower price than in many other regions of the world. However, in recent years an increase in the value of the renminbi against the dollar has seen Chinese goods reach near parity in price to those produced elsewhere. The Chinese population’s wealth is also increasing and thus creating a greater demand for imported goods. When these factors are coupled with the import and export restrictions placed on companies, the production factory that is China becomes a less appealing proposition than it once was. The SFTZ has therefore been established to offset these recent changes and is the testing ground for reform that will eventually spread across the whole of China. The goal of the zone is, ultimately, to make Shanghai the most important place in Asia and take the focus away from other regional economic hubs.
Opening a business in China has historically been a long and arduous process, with a number of different licences needing to be obtained before approval from the regulators is granted. The Chinese authorities have streamlined this process in the SFTZ allowing a business to be established in five working days rather than three months. This streamlined process offers corporates a greater incentive to begin operating in China due to the shorter time frame required when establishing a business and the cost-saving this will bring. In addition, a real address is not needed to register a company in the SFTZ. Instead a virtual address can be applied, removing the overheads associated with establishing a physical office based in China.
The SFTZ will also be open to companies that may traditionally have been unable to tap into the Chinese market, thanks to a relaxation of the registered capital laws employed throughout the rest of the country. In China, one will typically have to pay up to $150,000 into the company in registered capital before it can be established and penalties are distributed if this is not complied with. The new regulations introduced in the SFTZ have relaxed this rule and give a company 20 years before they have to invest their registered capital in the business. Furthermore, restrictions on what type of business can be opened in China and what actions can be performed have also been relaxed, thereby opening doors for new companies who previously would have been prevented from operating in the Chinese market.
A key benefit for corporates moving into the zone comes from the opportunity to freely convert the renminbi on the capital account. Historically, releasing money from the country is one of the primary challenges faced by corporates operating in China. The regulations employed in the SFTZ have relaxed the foreign exchange laws allowing a company to transfer up to $50,000 from China to accounts around the world without approval from the State Administration of Foreign Exchange (SAFE). There is no limit on how many transfers can be made, so in theory a few million US dollars could potentially be transferred on a daily basis. This is just the first step by the Chinese authorities and as the zone matures the limits will increase.
Tax incentives are also offered to corporates acting within the zone. A reduced tax rate of 16% will be applied to companies operating in the zone – reduced from the 20% rate that is issued across the rest of China. Furthermore, while import and export tax is currently the same rate as the rest of China, the Chinese authorities have pledged to eliminate this within the zone in the near future.
The regulations that are currently implemented in the SFTZ have already offered huge improvements for businesses wishing to operate in China. Although not all of the zone’s functions have been made clear yet, what the Chinese authorities have proposed will happen. They are determined to make it easier for businesses to operate in China and will not change the policy direction. The full implementation of the reforms promised for the zone may take some time because the authorities will want to make sure of each step before progression to the next. Despite this, companies have not been put off. Those businesses who have expressed an interest in establishing themselves in China are now beginning to see the benefits of Shanghai – it is where they want to be.
Liu Li-Gang, Greater China Chief Economist, ANZ:
The Chinese government launched the SFTZ with a desire to effect change through experiments in the services sector. The SFTZ includes a liberalisation plan covering six service sectors or 18 sub-segments. Following the launch, the Shanghai government also issued a number of specific regulations concerning foreign investments allowed within the zone from 1st October 2013. The regulations include a ‘negative list’ that specifies 190 restricted business lines. It appears that more regulations or guidelines will continue to evolve in order to allow full operation of the zone.
Policy details covering financial, shipping, cultural and professional services have indicated that the SFTZ initiative aims to develop an open geographical zone that allows not only a freer flow of goods but also capital and human resources. In addition, Chinese policymakers have attached great importance to investors’ concerns and are looking forward to creating a business-friendly environment for international investment and trade. Aside from financial liberalisation, the FTZ will help China broaden and deepen reforms of the service industry ranging from shipping to healthcare sectors.
The zone is planned to honour the spirit of the free market, highlighting China’s key financial reform agenda from the recent Communist Party Council (CPC) 18th Third Plenary Session that has set the tone for China’s economic development for several years to come. In three years, the zone’s development has a target to reach a stage that is compatible to other market economies in the world. Additionally, the Chinese currency, the renminbi, will be convertible; interest rates will be market-determined; and other factor prices will be driven by market forces.
The opening of the service sector to foreign capital will also be hugely beneficial for corporates. With the ‘negative list’ approach, foreign investments in industries will face less administrative red tape, thus facilitating the services sector’s convergence with international standards. It will also allow China’s eventual participation in the US-led Trans Pacific Partnership (TPP) trade agreement.
The plan is a bold step to lift China’s economic reform to the next level. After the FTZ trial, successful experiences will be applied to the rest part of China. We believe the Shanghai FTZ will help boost China’s reform process, and return the economy to a more sustainable path.
Jane Wang, China Tax and Business Advisory Partner, PwC and Bill Yuan, China Tax and Business Advisory Director, PwC:
The establishment of the SFTZ has been recognised as a crucial economic reform initiated by China’s new leadership. The ‘pilot experiment’ in Shanghai will include reforms focused on four areas:
Financial reform.
Upgrading of customs supervision framework.
Simplification of administrative systems supporting the further opening up of the services sector.
Creation of a competitive regulatory and tax environment for businesses.
The focus of the SFTZ financial reform is to promote renminbi (RMB) internationalisation. Foreign banks will be allowed to directly establish a branch, wholly-owned subsidiary or majority-controlled subsidiary with Chinese business partners in the region within a shorter time period. This new policy will reduce lengthy approval processes, significantly easing foreign entry. It is noteworthy that domestic private investors are also allowed to participate in the SFTZ in the form of financing services including setting up private banks, financial leasing and consumer financing (sole investment or joint investment with foreign capital).
For multinational companies operating in China that are not in the financial services industry, and who have their regional headquarters in the country, the relaxation of financial and foreign exchange policies could improve their regional treasury management capabilities. As a pilot initiative, RMB convertibility under capital accounts will also have an impact on domestic companies investing abroad. The SFTZ could encourage local enterprises to issue overseas bonds by creating conditions comparable to those present in overseas platforms commonly used by Chinese investors.
The SFTZ will implement a system in which overseas shipments entering the free trade area will not need customs clearance until a later stage. For logistics companies operating in the SFTZ, operational efficiency can be improved with simplified customs, immigration and quarantine (CIQ) procedures and port management.
In the SFTZ, foreign investors will enjoy similar treatment as their domestic counterparts. Foreign enterprises, except for the sectors specified in the ‘negative list’, are subject to a record filing system instead of the usual approval requirements. The simplified rules are expected to alleviate foreign investors’ administrative burden at the entry stage.
Key features of the tax policies and incentives are meant to support innovative business models in the SFTZ, rather than just provide generally reduced tax rates or universal incentives to all sectors which may not be adopted by other regions in China anytime soon.
Foreign investors should start assessing the impact of the SFTZ on their existing or potential business plans and operations in China. If the reform is implemented smoothly, foreign investors will be able to operate more efficiently throughout the SFTZ with the creation of treasury centres, shared service centres, regional headquarters and distribution hubs, as well as trading and investment platforms.
With more SFTZ-related policies to be released in coming months, we expect international investors in the SFTZ to make relevant changes to their future business models. Investors are also encouraged to start open dialogues with relevant stakeholders and Chinese government authorities to better understand the new policies and regulations. Both local enterprises and multinational corporations need to start developing a systematic strategy and step-by-step plan to take advantage of the policies implemented in the SFTZ.
It is also important to note that the SFTZ should be seen as a testing model with policies that could be replicated in other regions in China. This pilot free trade area provides investors with an idea of the changes that could come about in terms of the investment administrative system, financial and foreign exchange control system, international trade model as well as the further opening up of service sectors across China and beyond Shanghai.
Alain Bridoux, International Business Development, GESCO:
The announcement of the Shanghai Free Trade Zone (SFTZ) is an attempt by the Chinese authorities to make Shanghai the economic centre of Asia, or even the world. Regulations surrounding the SFTZ are complicated but, going forward, they will open up most – if not all – of the activities currently restricted to companies operating in China.
While the SFTZ will be useful for companies serving the domestic market, the main benefits will arise for companies who deal mainly in exports. The loosening of regulations in areas such as foreign exchange will allow companies to move their regional headquarters or treasury centres to the FTZ and hedge risk as they would in Western markets. Trapped cash will be less of a problem in the SFTZ compared to mainland China as the relaxation of China’s foreign exchange controls within the zone will see corporates trade and deposit the renminbi in the same manner they would on the offshore renminbi market. Eventually it may be possible for companies in the zone to use the renminbi for all their trade and transactions.
Furthermore, the relaxation of controls will permit companies greater cost-saving as operating and payment processes are simplified and streamlined in the zone. Overall, companies in the SFTZ will have more freedom and be able to behave in a more multinational way than ever before in China.
The zone will also make it easier for foreign companies looking to enter the Chinese market. The opening up of some restricted activities will allow companies to move away from the cumbersome joint venture situations that they have had to manage in the past.
Most CFOs in the West are convinced that the role of Regional Treasury Centres (RTCs) located in Hong Kong and Singapore will dwindle due to the reforms being led by the SFTZ. Although the initial edict remains fairly general and the full-range of benefits are yet to be announced, businesses clearly see a lot of promise in the zone.
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