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Is China Taking Over the World?

Is China Taking Over the World?. Edward E. Lehman Managing Director of LEHMAN, LEE & XU Past Vice Chairman of the ABA China Law Committee April 5 - 8, 2006. What is happening in China?. Spectacular macroeconomic evolution

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Is China Taking Over the World?

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  1. Is China Taking Over the World? Edward E. Lehman Managing Director of LEHMAN, LEE & XU Past Vice Chairman of the ABA China Law Committee April 5 - 8, 2006 LEHMAN, LEE & XU

  2. What is happening in China? • Spectacular macroeconomic evolution • Economic reforms process market economy but strongly monitored and controlled by gov’t • Integration into the world’s economy • Deep social changes change in consumption patterns • Risks: political instability, regional imbalances, financial systems, concealed deficit... LEHMAN, LEE & XU

  3. Macro Environment • Social stability (priority) requires strong growth rate (minimum 7%), to create employment due to: • Restructuring State Owned Enterprises • Increase of urban population • Growth based on foreign trade and investment (public and foreign) • Overheating • Weak consumption due to uncertainty • Lack of welfare system • Savings of 40%, but problems with financial system LEHMAN, LEE & XU

  4. FDI Forecast in China • For 4th consecutive year China is the most preferred FDI location worldwide • Global executives are more eager to commit FDI in China than anytime since 1998 • Also, China is seen as source of innovation and attractive R&D location • Lower R&D costs • Availability and quality of local R&D labour • IP protection • China FDI destinations (next 3 years): • 48% product manufacturing • 18% R&D • 13% distribution and logistics LEHMAN, LEE & XU

  5. China Integration in World’s Economy • Exports 2004 → 593 billion USD △ 2004 / 2003 → 35.4% • Imports 2004 → 561 billion USD △ 2004 / 2003 → 36% • Foreign Direct Investment 2004 → 60.6 billion USD • Access to WTO: standardization of regulatory framework LEHMAN, LEE & XU

  6. Deep Social Changes • Appearance of a young middle class • Increasing urbanization • Assimilation of Western life • Quick development of a private industrial sector • Appearance of a service and leisure culture • One-child policy LEHMAN, LEE & XU

  7. Economic Imbalances: Overheating Soft or hard landing? Geographic Imbalances Financial System Tax Balances? Contingent liabilities: Welfare networks Banking recovery Local government investments Variations in the exchange rate? The Risks • Political stability? LEHMAN, LEE & XU

  8. How does it affect us? • China will be one of the most dynamic areas in the world during the next 20 years • China’s Economy will be the World’s Second-largest by 2030 • How it affect us: • China as a market • China as productive base / provider • China as competitor • China as partner • Not only affects each particular company, also to its competitors, providers and clients. LEHMAN, LEE & XU

  9. 1. China as a Market:Advantages • Market with great opportunities • 1.3 billion people, myth and reality • Dynamic Evolution • Opportunities and challenges • Foreign presence in the market • Successful • More than 400,000 FIEs • Presence of big multi-nationals • Presence of main companies in each sector LEHMAN, LEE & XU

  10. Market Advantages • Reputable: good reputation of financing institutions • Continued liberalization • Political decision • WTO commitments • More integrated in global economy • Good infrastructure • Telecommunications • Transport • A country “which works” • A safe country LEHMAN, LEE & XU

  11. Difficulties • Very demanding market • Clients want the best • Idea of “middle technology” is rejected • Clients know what they want • Very competitive • Wide foreign presence • Chinese client knows foreign markets • Compete with Chinese prices • Clients with negotiating experience • Changing • Frequent changes in national and regional legislation • Political changes LEHMAN, LEE & XU

  12. Difficulties • Costly • Geographic distance • Establishment costs are high • Time factor. Lengthy: • Project planning process • Project approval process • Project negotiation process • Project implementation process • Increasing capacity of Chinese companies • Powerful and competitive companies • Increasing industrial and technological capacity LEHMAN, LEE & XU

  13. Chinese Market in numbers (2004) LEHMAN, LEE & XU

  14. Continental China (mainland China). Hong Kong: Redistribution Center and service provider. Hong Kong and Taiwan: FDI main origin. “Overseas Chinese”: 60 million, 3rd world economy. 65% of FDI comes from Asia. Development is concentrated in east coastal cities: Priority: Development of the Center-west and Northeast areas. Chinese Market: Geographic Delimitation Gulf of Bohai area (Beijing-Tianjin corridor). Yangze delta area (Shanghai, Nanjing, Hangzhou...). Pearl River’s delta area (Guangdong and Fujian provinces). LEHMAN, LEE & XU

  15. Strengths Size Growth and Opening Modernization and dynamism Multiple opportunity areas Liquidity (cash) Human Capital and organization The Market Weaknesses • Fragmentation • Competition • Immaturity in the distribution channels • Logistics Insufficiency • Quick changes and volatility of commercial regulations • Financial system insufficiencies • State owned enterprise reform LEHMAN, LEE & XU

  16. China: Business opportunities • Process of public investment, concessions and privatizations:  Infrastructure Projects. • Roads and Highways • Railway Energy Projects  Hydraulic Projects  Center and west country development • Growing environmental demands: Garbage collection and treatment systems  Water treatment systems  Alternative Energies LEHMAN, LEE & XU

  17. China: Business opportunities • Fast Urbanization (population in rural areas 66%): • Attention to collectives and public services • Transport urban infrastructures: subway and railway • Strong construction process • Increase in living standards: • Diversification and increase of consumption • Sophistication of distribution channels • Increase on vehicle demand • Potential in the tourist market LEHMAN, LEE & XU

  18. China: Business opportunities • Access to WTO: • Increase opening to exports: • Tariff reduction in more than 150 key products. Average tariff from 17% in 2000 to 10% in 2005 • Progressive quota increase (i.e. annual increase of import vehicles by 15%) • Service sector opening: Distribution (2004), Banking (2006), Telecommunications, Logistics,... • Clarification of the distribution system • Standarization of legal system regarding foreign investments: • Same rights and liabilities for foreign and national companies LEHMAN, LEE & XU

  19. Urban supply projects 6% Sport Facilities 7% Comunication Systems 17% Transport Projects 50% Environmental projects 20% Olympic Games 2008 Beijing Investment area: 27.5 billion USD LEHMAN, LEE & XU

  20. Opportunities for Olympic Games 2008 • 32 Sport facilities (19 new) • Property and management • Conceptual design • Beijing Public services: • Transport (subway) • Environment • Parking and traffic control LEHMAN, LEE & XU

  21. But some problems… • Technical barriers: the other side of the opening process within WTO • Certifications: • Industrial Products (CCC) • Cosmetics • Food • Packing • Contingent management • Capital requirements • Banking • Distribution • Construction • Local Competition LEHMAN, LEE & XU

  22. But some problems… • IPRs. Counterfeiting problems before WTO’s challenge: • Not only bags, watches, DVDs or software. • Affects everything: from elevators to pastries or wine, books... • Notable improvements in legislation and applicable penalties. • However, penalty enforcement is still weak. • Lack of “social censorship”. LEHMAN, LEE & XU

  23. China as a Market:Access Strategies Export Advantages: • Small investment.  Problems: • Market fragmentation and real size • Strong foreign and local competition • Tariff and non-tariff barriers • Lack of distribution networks and few specialized distributors. • After-sales service. • Continuous trips needed. • Language. LEHMAN, LEE & XU

  24. China as a Market:Access Strategies Investment Advantages: • Permanent presence in the market. • Huge market (unlimited). • Lower competition. • Better competitive position. Tariff and non-tariff protection • Tax relief • In most sectors it is possible to invest in the form of WFOE (80% of investors choose this way) LEHMAN, LEE & XU

  25. China as a Market:Access Strategies Investment Problems: • Search for the right partner, if necessary. • Legal framework still under development. • Not all sectors are open to FDI • IPR problems. • Personnel problems • Language LEHMAN, LEE & XU

  26. FDI Divisions Encouraged Agriculture New/high technology Industries which develop Western/Central regions Restricted Technologically-backward industries Resource-intensive/wasteful enterprises Prohibited Industries which cause pollution and ruin natural resources Projects which utilize processes/technologies which are unique to China Permitted All other industries not listed in the Catalogue. LEHMAN, LEE & XU

  27. FDI Operating Structures • Representative Office • Equity Joint Venture • Cooperative Joint Venture • Wholly Foreign Owned Enterprise • Holding Company LEHMAN, LEE & XU

  28. Representative Office Advantages • Quick and simple. • No minimum registered capital. • Allows for collection of market information and preparation for direct market entry. Disadvantages • Cannot engage in revenue generation. • Taxation regardless of prohibition on profit making activities. LEHMAN, LEE & XU

  29. Representative Office Set-up Requirements • Application letter signed by Chairman of the Board. • Certificate of incorporation. • Credit report by bank. • CV of foreign representatives and photocopy of passport. • Business license in home jurisdiction • Signed Power of Attorney, allowing agent to legally act on the company’s behalf. • Lease agreement LEHMAN, LEE & XU

  30. Equity Joint Venture • Most commonly used among the two types of Joint Ventures • Main distinction between EJV and CJV is the requirement that profits must be shared in proportion to capital contributions. • Key considerations: • Selection of Chinese JV Partner after a full due diligence of partner/assets. • Selection of location. LEHMAN, LEE & XU

  31. Equity Joint Venture Advantages • Chinese partner will bring connections and an established sales and distribution network; • Local partner will bring local and particularized knowledge of both market and bureaucracy. • Chinese partner will usually have or can easily obtain an operational site, which aides in efficient start-up Disadvantages • JV contract often difficult to negotiate • Differing objectives and management styles often result in conflict. • Lack of control by foreign party • Difficulty in selling shares in venture. LEHMAN, LEE & XU

  32. Equity Joint Venture Setup Requirements • Project Proposal • Feasibility Study • JV Contract • Articles of Association • Letter of intent • Business License • Capital investment requirements. • Minimum equity investment by Foreign investor is 25%. LEHMAN, LEE & XU

  33. Cooperative Joint Venture • Similar to Equity Joint Venture in structure but with more flexibility because of the following: • Sharing profits is governed entirely by contract • Foreign partner can obtain return of investment in priority to Chinese partner. • Setup requirements similar to that of Equity Joint Venture. LEHMAN, LEE & XU

  34. Wholly Foreign Owned Enterprise (WFOE) • Essentially a wholly owned subsidiary of a foreign enterprise • By far, the most commonly used investment vehicle • If there is a significant amount of IP held by the corporation then the WFOE would be the primary selection • Generally, WFOE approval is more difficult to obtain than JV approval. LEHMAN, LEE & XU

  35. Wholly Foreign Owned Enterprise (WFOE) Advantages • Quicker setup as there is no Chinese partner • Simpler management structure and objectives which are simply those of the parent organization. Disadvantages • Independence is often, in itself, a shortcoming because of lack of connections, established markets, and local knowledge. • WFOEs cannot operate in some sensitive areas such as securities. LEHMAN, LEE & XU

  36. Wholly Foreign Owned Enterprise (WFOE) Setup Requirements • Application Letter • Feasibility study • Articles of association • Evidence of solvency from bank • Business License • Name of the legal representative • CV and copies of passport LEHMAN, LEE & XU

  37. Exit Strategy • Mauritius holding company for conducting operations in China. • Benefits: • Cost establishment is US $1,500 (company secretary, nominee shareholders and bank account) • Exit Strategy 1) easy transfer of interests in the China operation 2) no approval needed for divestiture of interest in case of direct investment relationship • Transfer Pricing LEHMAN, LEE & XU

  38. Exit Strategy Limiting Liability liabilities incurred by the Chinese entity will be the liability of the holding company rather than the parent Tax Benefits • In Mauritius: any money held by the holding company will be tax free • In China: impact of China taxation can be managed by licensing the IP from parent company. • In Spain: money can be repatriated at a tax advantageous time or reinvested in other international operations. Parent Company Mauritius Company Chinese WFOE IP IP LEHMAN, LEE & XU

  39. 2. China as a Productive Platform • Competitiveness of China production implies not only potential on producing to supply local market, but also positions: • China as a competitor • China as a provider • China as a platform to third markets LEHMAN, LEE & XU

  40. China as a Productive Platform • Competitiveness derived from: • Labour costs: Unlimited labour reserves (lower wage preassure). • Technology contributions and Western management through FDI. • State policies to support foreign sector, critical for its growth (tax relief...). LEHMAN, LEE & XU

  41. China as a Competitor • WTO entry also opens international markets to Chinese products • Foreign Trade evolution • FDI resounds in technological development: quality products... • Development of its own industrial infrastructure • Protection instruments (anti-dumping measures...). Market Economy? LEHMAN, LEE & XU

  42. China as a Provider • Competitiveness of Chinese products is not only a threat but also an opportunity. • Wide and increasing range of products • Need to make purchasing process more competitive • Another way of investing in China: central purchasing office • Cooperation agreements, licensed production. Risks LEHMAN, LEE & XU

  43. China and Third Markets • Production investment in China, not only for Chinese market but also to export • As Chinese industrial network improves, the foreign projection will be wider • FDI companies in 2004 carried out 57% of the total exports (54.8% in 2003) • Foreign companies are already taking profit from Chinese foreign competitiviness. LEHMAN, LEE & XU

  44. 3. China as a Partner • Official interest for the Internationalization of Chinese companies. Supporting measures: • Goal: establish 6,000 multinationals by 2015 • Sectoral Priorities: • Electrical appliances in developing countries • High technology in developed countries • Mining, hydrocarbon, raw materials • New aspects which can include: • Chinese companies investing abroad • Chinese companies interested in partnership with foreign companies to make use of their knowledge and experience of international markets. LEHMAN, LEE & XU

  45. Some advice... • 1- Get rid of the myths • 2- Get trustworthy information • 3- Identify the oportunities • 4- Have a clear strategy • 5- Professional assesment • 6- Conduct market research and due diligence on partners • 8- Long term commitment is necessary • 9- Ensure that IP is fully protected • 10- Watch for personal relations and local customs • 11- Success in China implies dedication and big effort LEHMAN, LEE & XU

  46. Challenges for China to Take Over the World • China must modify its development model to: • resolve the new problems created by the actual growth • avoid jeopardizing the country’s stability • Objective: SUSTAINABLE DEVELOPMENT • Social point of view; Minimize social differences • Improve welfare services • Increase public expenditure in health and education • Unemployment • Environmental point of view • Avoid exhaustion of energy resources • Use of new renewable energies • Fight against environmental pollution LEHMAN, LEE & XU

  47. Challenges for China to Take Over the World • Change from extensive growth (exports and FDI) to intensive growing (internal demand and local companies) • Reduce export participation in its GDP • Increase local consumption • Increase income in rural areas • Increase expenditure on social welfare, health and education • Maintain growing stability Soft landing process • Reduce growing rates • Not affect social and economic stability LEHMAN, LEE & XU

  48. THANK YOU 谢谢! LEHMAN, LEE & XU 10-2 Liangmaqiao Diplomatic CompoundNo.22 Dongfang East Road Chaoyang DistrictBeijing 100600 ChinaTel: (86)(10) 8532-1919Fax: (86)(10) 8532-1999E-mail: elehman@lehmanlaw.comWeb site: http://www.lehmanlaw.com LEHMAN, LEE & XU

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