Getting Established in China: Setting up a Foreign Investment Enterprise
Today, the economic frontier is definitely China. Multinational corporations around the globe are jockeying for position in what is already the world’s largest manufacturing hub and what promises to be an enormous new consumer market-1.3 billion people with rapidly growing personal wealth.
Already the world’s sixth largest economy, China also has the fastest growth rate. China grew a stunning 9.1 per cent last year in gross domestic product (GDP), and is projected to grow 8 per cent this year. That growth comes on top of a remarkable 8 per cent average annual growth rate over the past 25 years. At $60bn, it has the world’s highest foreign direct investment (FDI). Chinese youth have adroitly picked up on where their opportunities will lie; 31 per cent of Chinese college students are majoring in engineering, compared to just 6 per cent in the U.S. China recently overtook the US as the most attractive target for direct foreign investment, according to a recent survey of senior executives at large multinational corporations (MNCs). US ambassador Charles W Freeman has predicted that by 2020 China will account for between 50 and 60 per cent of the world’s GDP.
CEOs are hearing one question over and over from directors, investors, suppliers and customers, even from employees: What is your China strategy? They’re stoking up a serious due-diligence process to determine how, when, where and in what form they should extend their footprint to China and how they’ll be able to do business once they get there.
The bad news is that China is still a highly regulated country that has many rules and procedures that will seem cumbersome to western business managers and that has a business infrastructure that can seem like an odd mix of highly advanced and somewhat primitive. Key governing bodies include the Ministry of Commerce for business entry; the central bank – the People’s Bank of China (PBOC) – for funds movement, and the State Administration of Foreign Exchange (SAFE) for foreign exchange. Many of the rules are codified in the PRC Foreign Investment Industrial Catalogue.
The good news: with China’s accession to the World Trade Organization, it is dismantling obstacles to global trade and disincentives to foreign investment. Many of these reforms have a 2006 target date. There’s also a growing array of consulting firms, accounting firms, banks and even business schools that are actively helping businesses without a lot of China expertise negotiate the legal and regulatory maze. The best news of all, of course: China is rich with potential for future sales and profits for MNCs that find the right China strategy.
Getting Started in China: Business Issues to Address
There are two common ways to enter China:
The rep office is the quickest, simplest way to get a China presence. For many, it’s the safest, least risky way to get started. But it is a distinctly limited presence: the office is not permitted to engage in direct profit-making activities. It can be a liaison office between the headquarters of a company exporting to or importing from China, but it is not permitted to issue invoices for sales, accept payment for goods or contract for sales in the name of the home office.
The operations of a rep office have to be funded from outside. It can hold local-currency accounts, both for cash withdrawals and payroll (a basic account) or for domestic expenses and collections (a regular account), and it can hold a foreign currency account for non-trade transactions. It is not required to report its accounts to the central bank, but all banks in China, including foreign ones, are required to inspect renminbi accounts for all foreign enterprises, including rep offices, and report non-compliance issues or doubtful payments to the PBOC. Transactions from foreign currency accounts are monitored for compliance with the State Administration of Foreign Exchange.
To be eligible to open a rep office, your company must have been established for at least a year before application; it must be legally registered in your home country and be untainted by scandal. Even for a rep office, filing the proper applications and registration forms and getting the necessary authorizations will take at least 50 working days and involve at least eight separate steps. The drill includes getting a company seal (a ‘chop’) engraved at a local seal-engraving shop. But approvals for a rep office are normally routine.
If you want more than a rep office, you’re looking at starting a foreign investment enterprise, which can take one of four forms:
The first two of these options are the most popular. Approval is anything but routine. An accounting firm registered in the People’s Republic of China must audit all FIEs.
The equity joint venture in China is set up much like an equity joint venture in North America or Europe, except that the non-Chinese partner must contribute at least 25 per cent of the registered capital and in some industries, must be minority shareholders, leaving the Chinese partner dominant. Capital can be cash, land, buildings, equipment, technology or intellectual property.
A great many MNCs conclude that it is best to ally themselves with a Chinese company in the same line of business and organize a joint venture with a partner who already has experience, market recognition and the trust of the government. But going it alone with a wholly owned FIE is also an option that is widely used. In that case, the FIE puts in all the capital, bears all the risk, and takes all the profits or losses. Wholly owned FIEs are banned for certain industries, including newspapers, TV, radio, film-making, postal services and domestic commerce.
To set up a wholly owned FIE, a detailed application containing specified information must be submitted to the appropriate local government authority. Altogether, 11 steps are typically involved, and a minimum of 55 working days would be required to take the necessary steps and get the required approvals. But expect it to take longer. Local governments usually respond within three to six months, but the central government can take a year to approve applications, and the clock restarts every time changes to any of the documents (feasibility study, contract, articles of association, etc.) are ordered.
To gain approval to organize an FIE, the authorities must be satisfied that the registered capital is sufficient in light of the proposed scale of operations. However well or poorly the business does, registered capital can never be reduced, and any increases or transfers in registered capital must first be approved by the authorities. Like the equity joint ventures, the wholly owned FIE can open both basic and regular accounts in the local currency (renminbi), but it can have capital and loan accounts in foreign currencies, as well as a current account.
For all its rapprochement with free-market capitalism, China remains a state-managed economy, and that means that there are many tax and regulatory incentives for doing what the government wants you to do – and rules to prevent you from doing what the government does not want you to do. Wholly owned FIEs are prohibited or restricted in certain industries and in certain districts of China. No foreign investor can own controlling interest in an automobile assembly plant, for example, but foreign investors can own all of an automotive parts venture. Special development zones exist for foreign investment in trade, technology, export processing and other favoured business activities.
Approvals for foreign-owned trading businesses are particularly difficult to get. Generally, only government-approved Chinese foreign trade companies are allowed to import, and even these companies are subject to import licences and import quotas. FIEs are, however, allowed to import materials and equipment used in their own production processes and to export their own products.
Although not there yet, China is moving toward a rules-based economic system with a gradual easing of barriers to commerce. Every year things get better. For example, until last year, FIEs were not able to get rebates when they exported to offshore markets. Now they can. Conversion of currency in capital accounts from foreign to local doesn’t always require SAFE approval now. A new definition of foreign debt eases a restriction when foreign currency is borrowed from foreign banks within China. China still lacks a good infrastructure for consumer credit but is developing an automobile finance industry and is encouraging foreign investment in this sector.
An immense agricultural nation is transforming itself into an economic powerhouse at a pace that is breathtaking, given the size of the undertaking. While free-market and entrepreneurial are still terms that do not quite fit today’s China, the need for foreign investment is huge, and the rewards promise to be commensurate. With patience and foresight, MNCs are positioning themselves to be part of that wave. It’s one the MNC of the future cannot afford to miss.