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China's underdeveloped distribution sector has massive
potential, yet official figures show that Hong Kong
and other foreign-invested retail and wholesale activity
accounts for less than five percent of total sales.
The reason: practical restrictions on foreign entry.
In June, new PRC regulations will change that. In this
article, we look at how the new regulations may affect
your China-distribution strategy, and we compare the
advantages they offer retailers and wholesalers to those
offered under CEPA.
The old regulations
Until recently, opportunities for Hong Kong companies
to establish retail and wholesale businesses on the
Mainland have been severely limited. Prior to the Closer
Economic Partnership Arrangement (CEPA), regulations
governing commercial distribution in China kept out
everyone except the multinationals. Pre-existing regulations
gave effect to China's WTO commitments, with restrictions
being gradually phased out.
A glance at the WTO framework and pre-existing regulations
(see chart on p.34) explain why so few retailers and
wholesalers have entered the PRC market. Most Hong Kong
retailers and wholesalers were unable to meet annual
sales turnover and net asset requirements. They were
also put off by restrictions on the percentage of foreign
ownership (including Hong Kong investment), which PRC
entities could be partnered with, and where the businesses
could be located. Moreover, many of our clients have
been discouraged by lack of a clear legal framework.
Advantages under CEPA
CEPA sought to relax many of these restrictions, giving
Hong Kong service providers several advantages when
establishing mainland operations.
Hong Kong companies received a head start on some of
the liberalizations China promised to all its trading
partners upon joining the WTO. Hong Kong retailers and
wholesalers, for example, received a one-year lead over
foreign companies in setting up businesses without any
PRC partner(WFOE). Overseas rivals had to wait until
China's Year three WTO commitments came into effect
in December '04.
Secondly, entry thresholds for Hong Kong retailers
and wholesalers were lowered.
Finally, CEPA permitted Hong Kong companies to establish
operations in more Chinese cities, and earlier, than
permitted under the WTO timetable.
Despite these advantages, Hong Kong companies have
hesitated to establish mainland retail or wholesale
operations, mainly because CEPA did not sufficiently
roll back market-entry restrictions: CEPA's reduced
entry thresholds are still considered too high for most
Hong Kong businesses in the retail and wholesale sectors.
CEPA also failed to introduce a clear legal framework
or a fast-tracking procedure for Hong Kong investment
in China. Consequently, in most cases, Hong Kong companies
have faced the same rigorous and time-consuming approval
procedures as foreign investors.
The new regulations
New regulations, issued in April, appear to have redressed
CEPA's shortcomings. Starting June 1, any company wanting
to establish a mainland retail or wholesale business
can do so more easily and cheaply than ever before.
The new regulations eliminate CEPA's minimum sales
and asset requirements for retailing, wholesaling and
commission - agency businesses. A retail business can
be established with as little as Rmb300,000 in paid-up
capital; wholesale businesses with only Rmb500,000.
Retailers may set up a WFOE (wholesalers must continue
to form joint ventures until December this year). Retailers
are restricted to provincial capitals and other main
cities until December, but wholesalers are unrestricted
on where they locate a business or how many outlets
can be opened. Additionally, the regulations set out
clear, streamlined approval procedures for setting up
new businesses or converting existing ones. Most companies
can expect to be granted approval sooner.
The good news gets better. Under the new regulations,
retailers and those in the restaurant trade can open
their own franchised outlets or arrange for franchisees
to do so. China's long-awaited Foreign Trade Law also
comes into effect on July 1 and in principle allows
all businesses China to handle imports and exports on
their own account without
the need to use separate trading intermediaries. Coupled
with expanded rights to retailing and wholesaling activities,
these new import/export rules allow foreign-invested
businesses in China greater flexibility to integrate
sales and distribution with existing manufacturing /processing
operations.
Is CEPA irrelevant?
Many may conclude that since these new regulations
offer more favourable terms than CEPA, that CEPA is
now obsolete. Nothing could be further from the truth.
Although the new regulations erase most of the head
start CEPA gave to Hong Kong investors in China's retail
and wholesale sectors, all of the key advantages under
CEPA still remain valid for companies in other industries.
Foreign rivals will still need to wait between six months
and 40 months to establish WFOEs in these other industries,
but under CEPA, Hong Kong companies have a choice between
setting up a WFOE or joint venture. Also, the reduced
entry thresholds mean that more Hong Kong companies
are eligible to enter the China market-and for less
initial capital-than previously.
Another bonus for Hong Kong (and Macau) investors is
they alone may establish automobile retail businesses
and small-scale sole proprietorships. Neither of these
opportunities are available to foreign investors.
At first glance, the new regulations appear to level
the playing field for both Hong Kong and foreign companies
in the distribution sector. Hong Kong investors will
nevertheless have a 'home field' advantage through their
proximity to the Mainland, language ties, personal connections
and longer experience conducting business there. In
reality, most foreign companies investing in this sector
will be large multinationals and will not compete directly
with Hong Kong retailers and wholesalers, which are
likely to be SMEs
Conclusion
For retailers and wholesalers in Hong Kong and overseas,
the new regulations are a significant step. Establishing
and operating a business in China in this sector has
never been easier. China's strong economic growth and
rapid improvement of logistics and infrastructure present
Hong Kong investors with lucrative opportunities to
establish new mainland operations or invest in existing
businesses.
The direct benefits to Hong Kong companies under CEPA
and the new regulations will yield indirect benefits
for thousands of businesses. Hong Kong-owned retailers,
wholesalers, advertisers, restaurants, hotels and other
service businesses will require logistical and other
support in China. Mainland consumers and businesses
on both sides of the border will benefit from a more
developed distribution sector.
For Hong Kong companies seeking entry to China's retail
or wholesale sectors, or simply those wanting to add
local distribution or import/export functions, now is
the time to re-evaluate your business strategies.
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