FOREIGN COMPANIES AND FOREIGN INVESTMENT IN CHINA

FOREIGN COMPANIES IN CHINA

In 1979, there were 100 foreign-owned enterprises in China. In 1998, there were 280,000. As of 2007, foreign companies employed 25 million people in China. U.S. companies with offices in Beijing include Google, Microsoft, FMC, Cigna, Unisys and General Electric. U.S. companies with major production facilities in Shanghai include Dupont, Rohm & Haas and General Electric. As of early 2010, Fortune 500 companies had 98 research and development facilities in China.

Foreign companies in China include Coca Cola, Pepsi Cola, Nike, AT&T Corp., Bristol-Myers Squibb Co., Citibank, Morgan Stanley & Co., Volkswagen AG, Unilever, Toshiba Corp., Matsushita Electrical Industrial Co., General Motors, France's Citreon, Philips Electronics, Cisco, Microsoft, Motorola, Samsung Electronics, NEC. Proctor and Gamble, Wringley chewing gum.and Hitachi Ltd.

Western products---especially cigarettes, liquor, cameras, watches and designer clothes---have traditionally been are seen as a statues symbol. a Western analyst told the Washington Post, "Anything foreign is a cachet. Rightly or wrongly, it's considered to be of better quality."Among the American products that have been available for some time in China are Head and Shoulders shampoo, Raid insecticide, Camay soap, Milky Way candy bars and Dove ice creams bars. For a while Chinese companies Americanized their products and logos, putting statues of Liberty on their packages. The flying red horse symbol of the Mobile Corp. has been in China since the late 1800s. [Source: Peter Behr, the Washington Post]

As of 2010, 300,000 foreign companies had invested in China. United States companies with the biggest investment in China (1998): 1) General Motors ($2 billion), with a massive Buick plant in Shanghai; 2) Motorola ($1.2 billion), cell phones and pagers; 3) General Electric ($1.1 billion), high-tech medical equipment and CD plastic; 4) Arco ($620 million), oil exploration in the South China Sea; 5) Coca Cola ($500 million); 6) Hewlett-Packard ($400 million); 7) Proctor and Gamble ($360 million), with a huge shampoo plant; 8) Amoco ($350 million), polyester plant supplies clothes factories; 9) United Technologies ($250 million). [Sorry for the dated data, but I haven't found any good recent data]

Foreign companies doing business in China are generally required to form joint ventures with Chinese companies instead of forming wholly owned subsidiaries. Entrance by foreign companies to the Chinese market is often determined by how much technology and know-how the Chinese can get from the foreign company. Many Chinese worry that foreign companies are posed to take over entire sector of the economy.

In 2010, China announced plans to require Western companies doing business in China to turn over sensitive technologies and patents to Chinese competitors in exchange for access to the country’s markets. According to a 2010 American Chamber of Commerce report, U.S. businesses were losing Chinese sales because of rules to support homegrown technologies.

Japanese companies are put under more scrutiny than Chinese companies or companies from other countries. If something goes wrong with a Japanese product, particularly a car, the problems get a lot of attention. Advertisement by Japanese companies are also scrutinized carefully for anything that might be perceived as anti-Chinese.

American companies doing business in China have to assure Washington that their dealings will not compromise American national security in any way.In 2006, the Chinese government placed limits on real estate investment and tightened controls on mergers involving foreign firms. The Carlyle Group bid for 85 percent of Xugong, China’s biggest maker of construction equipment, was abandoned.

Most goods that U.S. companies manufacture in China are sold in China not exported to the United States.

Websites and Resources

Good Websites and Sources on Foreign Companies: Foreign Investment in China, Rules, Regulations, Procedures escapeartist.com ; Foreign Direct Investments, What the Figures Don’t Tell Us dur.ac.uk/resources ; China Today (Chinese Government site) Investments Info and Links chinatoday.com ; 2008 Library of Congress Report on Sovereign Wealth Funds pdf file fas.org/sgp/crs ; Wikipedia article on China Investment Corporation Wikipedia ; New Bureau of Asia Report in Understanding China’s Sovereign Wealth Funds pdf file nbr.org/publications Good Websites and Sources on Foreign Trade: China Today (Chinese Government site) Trade, Export and Import Info chinatoday.com/trade ; IMF Report on Chinese Trade and the WTO pdf file ppl.nl/bibliographies ; U.S. Commerce Department’s Office of China Economic Area (OCEA) export.gov/china ; Office of the U.S. Trade Representative ustr.gov ;

Business and Economics: Business Directory for China business-china.com ; U.S. China Business Council uschina.org ; China Business Services Blog chinabusinessservices.com/blog ; Economic and Business News Related to China jlmpacificepoch.com ; Small and Mid Size Businesses in China english.sme.gov.cn ; Asian Development Bank adb.org/PRC ; World Bank China worldbank.org ; International Monetary Fund (IMF) on China imf.org/external/country/CHN ; China Economic Information Office cei.gov.cn ; U.S. Commerce Department’s Office of China Economic Area (OCEA) export.gov/china ; Statistics: China’s National Bureau of Statistics stats.gov.cn/english ; Chinability Blog chinability.com/ ; Nationmaster nationmaster.com ; Economic and Business News The Economist on China economist.com ; China Economic Net en.ce.cn ; China Economic Review chinaeconomicreview.com ; Far East Economic Review feer.com ; Economic and Business News Related to China jlmpacificepoch.com ; China Daily Coverage of Economic Issues chinadaily.com.cn ; Financial Times China ft.com/world/asiapacific/china ; China Perspective thechinaperspective.com ; China Economics Blog china-economics-blog.blogspot.com

Links in this Website: CHINESE BUSINESS Factsanddetails.com/China ; CHINESE STOCK MARKET Factsanddetails.com/China ; CHINESE BANKS Factsanddetails.com/China ; CHINESE RETAIL BUSINESSES Factsanddetails.com/China ; Factsanddetails.com/China ; CHINESE TOURISM BUSINESS Factsanddetails.com/China ;CHINESE TRADE Factsanddetails.com/China ; CHINESE TRADE WITH THE U.S., EUROPE AND JAPAN Factsanddetails.com/China ; FOREIGN COMPANIES AND INVESTMENT IN CHINA Factsanddetails.com/China ; BUSINESS CUSTOMS IN CHINA No. 1 Factsanddetails.com/China ; BUSINESS CUSTOMS IN CHINA No. 2 Factsanddetails.com/China ; GLOBAL ECONOMIC CRISIS OF 2008 AND 2009 IN CHINA Factsanddetails.com/China ; BASIC ECONOMIC INFORMATION ON CHINA Factsanddetails.com/China ; MACROECONOMICS AND ECONOMIC POLICY IN CHINA Factsanddetails.com/China ; THE YUAN, FOREIGN RESERVES AND SOVEREIGN WEALTH FUNDS IN CHINA Factsanddetails.com/China ; CHINESE REGIONAL ECONOMICS Factsanddetails.com/China ; CHINA AND ASIA RELATIONS Factsanddetails.com/China ; CHINA AND JAPAN RELATIONS Factsanddetails.com/China ; CHINA AND INDIA RELATIONS Factsanddetails.com/China ; CHINA, RUSSIA, EUROPE AFRICA AND THE MIDDLE EAST Factsanddetails.com/China ; Factsanddetails.com/China ; CHINA AND UNITED STATES Factsanddetails.com/China ; AMERICAN AND CHINESE POLICY Factsanddetails.com/China ;UNITED STATES, CHINA AND SPIES Factsanddetails.com/China

Attractions of China for Foreign Companies

China’s rate of return on capital---a basic measure if investment efficiency---far outstrips that of most developed nations. Foreign businesses are anxious to move in on China's immense market and take advantage of 1.3 billion person population and its sizable and growing middle class, which for the first time in the country's history, has a large disposable income.

Many businessmen find totalitarianism to be an advantage. There are no labor unions to worry about and elections that might produce an unfriendly government. Incentives offered the government include tax breaks, low import duties, low-cost land and low construction costs for new factories.

The mix of cheap labor and stable prices and stable politics is what foreign companies find appealing. A Wal-Mart execute told the Washington Post, “There might be places in other parts of the world where you can labor cheaper...If we have to look have at a country that’s not politically stable, you might not get your order on time If you deal with a country where the currency fluctuates, everyday here is a lot of risk. China happens to have the right mix.”

In a Time magazine essay John Rothchild, "The future that everybody says will be great for China is a long term one. China will be the economic success story of the 21st century, the way the U.S. was in the 19th, but that doesn't necessarily help investors now. After all, it was foreign capital (mostly British) that built our canals and railroads, but between the scams, panics, recessions and depressions, it was the rare 19th century investor who made any money."

Strategy for Foreign Companies in China

The general strategy for doing business in China seems to be gain a toehold there, whether some tough times and be prepared to seize the moment when the market bursts open.

Jeffrey E. Garten of Wharton School of Business told the New York Times, "The Pepsis, the AT&Tts, the Honeywells and General Electric are really in it for the long term. They have very sophisticated strategies. They have really dug in and invested in Chinese communities built education institutions in China and developed webs of connections with all levels of Chinese society."

He also said, "many small companies tend to get carried away by the hype that China has suddenly become a market economy...There are pockets of it. But in order to succeed in China today, you have to establish yourself as an entity that is aligned with the government's long term goals. That does not mean Communism but it does mean training people and showing you are not a fly-by-night company and you actually care about Chinese society."

The Western companies who made the greatest profits are those that sell cheap consumer items such as Coca Cola and McDonald's, and have utilized China's cheap labor. Many companies that have made money in China have used China as a platform for manufacturing or exporting. Few have been able to cash in China 1.3 billion person market as has been hoped.

Foreign companies try to create strong bonds with the leadership in Beijing for no other reason than to sweep away obstacles created by local officials.

The head of the United States of America-China Chamber of Commerce, which primally represents U.S. companies in China, told AP, “As long as you aren’t involved in politics, the media or pornography, the government will leave you alone.” But that isn’t always the case. Communist authorities have pressured foreign companies in their choices of local partners, where they can operate and what products to sell. Company usually tow the lines out of fear of doing anything that might prompt retaliation.

By 2010, the hard work and commitment to China seemed to be paying off. The American Chamber of Commerce reported that three quarters of the companies it surveyed were making money in China and almost half were making more than the global average, up from 13 percent a decade earlier.

Western Firms under Scrutiny in China

Major Western firms are under scrutiny from China's state media and face criticism over issues including food safety and garment quality. Some executives complain privately that their companies are subject to stricter enforcement than local firms. [Source: Melanie Lee and Donny Kwok, Reuters, October 17, 2011]

In the summer of 2011, oil company ConocoPhillips was roundly criticized by Chinese media over a June oil spill off China's east coast. The State Oceanic Administration has threatened to sue ConocoPhillips, but not its state-owned partner, CNOOC.

In October 2011 European luxury group Gucci said it had replaced two managers in southern China after former workers at a store released an open letter alleging employee abuse.

Complaints by Foreign Companies in China

Even though there are huge markets to gain access to and huge potential for growth and profits, many companies are asking themselves if it is worth it when faced with human rights concerns, threats to intellectual property infringement and the unpredictable nature of doing business in China. James McGregor, senior counselor for Apco World wide in China and author of One Billion Customers, told the Washington Post, “Many companies came here because they believed they couldn’t afford not be here given China’s booming growth. If trends don’t change, we may see companies considering that maybe they can afford not to be here.”

Foreign companies doing business in China complain of unpaid bills, piracy, counterfeiting and theft of ideas and technologies. Chinese insist that the foreign companies share their technology secrets. They then learn from these secrets and produce cheaper products that compete with those of the foreign company. Some companies complain that pirated or counterfeited copies of their products appear with a couple of months after they begin production in China. Others are reluctant to do business in China out of concern that their methods, patents and intellectual property will be stolen or compromised. Foreign companies often complain they are required to pay fees and taxes without warning and explanation (See McDonald’s Under Food). Corporate names in Roman letters alone are not allowed.

In a 2010 report, the American Chamber of Commerce warned of increased protectionism in various industrial sectors in China, promotion of domestic technology and blocking foreign rivals. On the issue of technology theft and intellectual property infringement, Kevin Smith, head of GM in China, told the Washington Post, “If you don’t go in with the best technology, you’re going to be at a competitive disadvantage. We have protection for all our IPR [intellectual property rights], and we’ve had no issues but added “it’s a factor that everyone is aware of in emerging markets, and that “there are different rules in China.”

Different foreign companies have different experiences with their China partners. An employee for an architectural firm that did work in China told the Los Angeles Times, “I was a very bad experience for us. They’d yell at us, scream at us, demand things and say you couldn’t leave the country...until you finish the job. They expected us to work 14-, 16-hour days. They had some of my designers in tears.” An employee of another firm had nothing but good things to say. “They treated us like celebrities,” he said.

Levi Straus stopped making clothes in China in 1993, citing human right concerns, and then returned in 1998 with the company saying it could do more good for human rights by working in the country. The company later returned to China. Today Chinese students are reporting on Coca Cola's abuse of workers' rights.

Unilever suffered in China as it was forced in into partnerships with less-than-ideal partners. Pepsi went to the WTO to seek arbitration to break up a joint venture with one of it 14 partners, Sichuan Radio & Television, after becoming fed up with the way it lavishly spent money, made deals without Pepsi’s approval and refused to open its books to Pepsi auditors.

By mid 2000s, there was a growing trend of favoritism to Chinese companies at the expense of foreign ones. New regulations issued in June 2007, for example, required rigorous safety inspections of medical technology imported into China but didn’t require the same of Chinese-made products. Medical technology is one industry that the United States has had great success exporting to China.

Enthusiasm for investing in China goes in cycles. Disappointed by their profits and frustrated by the problems of doing business in China, many foreign investors and foreign companies have pulled out of China. General Electric, L’Oreal and New Balance are among the companies that are looking to Vietnam, Indonesia and other countries as places to locate their factories. Among the reasons they are looking outside of China are cuts in tax rebates for exporters, accelerating inflation, stricter labor laws, labor shortages in the coastal areas and beliefs that the yuan is going to appreciate, making exports more expensive.

See Problems with Doing Business in China.

Serious Problems Faced by Foreign Companies in China

Mr. China is a funny, disturbing real-life memoir of doing business in China by Tim Clissorld, a representative of the investment fund Asimco in China in the 1990s. It describes a series conflicts with a series of shady, underhanded, untrustworthy Chinese partners who used Asimco money to enrich themselves and build rogue factories making competing products. Asimco lost hundreds of millions of dollars before it withdrew from China.

In a case described as “economic terrorism” an American inventor opened a machine shop outside of Shanghai. Once the shop started making money the American’s Chinese partner began making move to take the American’s stake, even hiring thugs-armed with guns, to take over the factory and shut it down, in the process scuffling with workers and damaging machinery. The police refused to do anything because local officials had close ties with the businessman trying to take over the factory.

See Danone, Food

China Imposing New Market Barriers

in September 2011, AP reported: “China is imposing new obstacles to access to its markets, including sweeping national security rules, raising questions about its promises to treat companies equally, the European Union Chamber of Commerce in China said. [Source: Joe McDonald, AP, September 8, 2011]

The European group cited restrictions including a proposed limit of 50 percent foreign ownership in new energy vehicle companies. It said Beijing also has made little progress on long-standing complaints about market barriers in construction, banking and other fields. Such limits "raise questions about stated intentions to create lasting opportunities for all market actors to compete on an equal footing," the group said in a statement. Its report echoed complaints by American and other business groups about lack of clarity in Chinese regulations and uncertainty about how Beijing will apply its 3-year-old anti-monopoly law and other possible restrictions.

The European group pointed to increased use of "vague and unprecedented" national security regulations that limit access to areas from computers to wind farms. It noted Beijing has told banks and other companies to limit use of foreign data security products and caps foreign ownership of wind farms to 50 percent on national security grounds.

"There are alot of funny restrictions in the construction sector," said Piter de Jong, managing director of Dutch investment bank ING NV in Shanghai, who chairs the EU Chamber's Shanghai branch. He pointed to a requirement that companies seeking Chinese licenses provide portfolios of projects already done in China.

Chinese leaders including Premier Wen Jiabao, the country's top economic official, have promised to treat foreign companies equally. But business groups say Beijing has yet to take action on major problem areas and in some cases is imposing new restrictions on access to the world's second-biggest economy.

Automakers must have approvals from four different government agencies to get a vehicle on the roads, de Jong noted. "There is no shortage of regulations or regulators in China but we feel there is a need for more efficiency," he said.Foreign companies also are locked out of China's booming telecommunications industry because they are permitted to operate only through joint ventures with the three state-owned carriers, which refuse to open up their networks, the report said.

Protecting Chinese Markets

Fareed Zakaria wrote: “The CEO of General Electric, Jeff Immelt, told the Financial Times in 2011 that it appeared that China did not want Western companies to succeed in that country anymore; he was voicing the feelings of many foreign CEOs. There is growing evidence in many areas that Beijing is favoring locals over Western companies, even violating the rules of market access and trade. The World Trade Organization ruled recently that China's regulations on foreign movies were a form of illegal protectionism and had to end. So far, Beijing has done nothing to abide by that ruling, though it is likely to expand its quotas to mollify the WTO. [Source: Fareed Zakaria, Fareed Zakaria.com July 14, 2011]

In April 2011 a study by the European Union Chamber of Commerce in China reported that foreign companies are being treated unfairly in the huge and rapidly growing Chinese market, AP reported. The study said opaque bidding laws, outright favoritism and other practices by China effectively bar foreign companies from winning public procurement contracts, a market equal to a fifth of the Chinese economy. Public procurement is particularly important because government agencies play a major role in the economy, both as funders and arbiters of bids, the EU Chamber said. [Source: AP, April 20, 2011]

In bidding on public contracts, "at every step of the process, you have flaws and difficulties and room for a non-equal playing field," chamber president Jacques de Boisseson said at a news conference. A European information technology executive cited in the study said the bidding process "can seem like pure protectionism and it's really frustrating."

Even after three decades of free-market reforms, the government and state-owned companies dominate vital parts of China's economy. The EU Chamber's study takes an expansive view of the state involvement, defining public procurement as encapsulating everything from infrastructure projects to some purchases by state companies and public institutions. In trying to win public contracts, foreign companies often have difficulty getting information on bid requirements, the study said, while practices outlined in laws and regulations are implemented unevenly, often to the favor of local firms.

Public procurement has become one of several prominent irritants in China's relations with trading partners in recent years as the size of the Chinese market soared while developed economies tottered. The authoritarian government has used potential access to the growing market as leverage, crafting policies to persuade multinational companies to turn over technology and open up more factories and research facilities.

Preferences to Local Companies in the Wind and Solar Energy Markets

Preferences given to domestic companies through government procurement and policies have drawn complaints from major multinationals and the U.S., Japanese and European governments, AP reported. Washington filed a case in the World Trade Organization last year challenging subsidies China gives clean-energy makers that the complaint says allows them to sell solar and wind power equipment at unfairly low prices. [Source: AP, April 20, 2011]

In an example cited by the EU Chamber study, wind turbine manufacturers face rules requiring that 70 percent of wind farm equipment had to be made locally---a requirement some local governments interpreted so strictly that Chinese manufacturers from other provinces were sometimes excluded. Though Beijing scratched the requirement last year, some local governments seemingly continued to apply it, the study said.

The study doesn't name names. But Denmark's Vestas Wind Systems A/S, the world's biggest maker of wind turbines has had trouble elbowing aside Chinese competitors in China and increasingly faces them abroad. "It seems we are never 'domestic' enough," the study cited a wind power manufacturing executive as saying.

Before Hu Jintao visited the United States in 2010, China promised to not favor domestic companies in “innovation” contracts.

Smuggling and China

Many Chinese are getting by rich by selling items smuggled into the country from Hong Kong, Taiwan and elsewhere. One industrious entrepreneur told the New York Times about his relationship with a fisherman: "I tell him what I want, where to get it, who to pick it up from in Hong Kong. Then I give him a deposit, and when he brings the merchandise to me, I pay him the rest."

When asked if he thought the smuggling operation was run by the Mafia the entrepreneur said: "I don't know what this mafia is that everyone refers to. You call my small-time peasant fishermen the Mafia? I don't think so. He just wants to make some money...What's the Mafia then? Maybe it's the people who smuggle heroin, maybe it’s the pimps and prostitutes, the weapons dealers.”

Tens of thousands of people in southeastern China are involved in smuggling. Many smuggled items come through the port of Fangcheng in Guangxi province. Here smuggled goods easily enter the country because many customs officials are involved in small sideline brokerage companies.

Most of the foreign cigarettes have been smuggled in.

In the late 1990s, the government began cracking down on smuggling because smugglers had cost the government billions of dollars in lost tax revenues. The crackdown paid off. Customs revenued in 1999 were $19.2 billion, an 81 percent increase from the year before. Crackdowns on smuggling and corruption have hurt the economic of southeastern China.

Foreign Investment in China

China received about $100 billion in direct foreign investment in 2010, up 11 percent from the previous year. The $100 billion figure includes investments by overseas companies in industries such as manufacturing, real estate and agriculture but excluding money put into banks and other financial institutions. Foreign investors invested $60.89 billion in China between January and June 2011, up from $51.4 billion in the same period in 2010.

Foreign investment in China was $75 billion in 2007. As of the late 2006, China had attracted $622.4 billion in investment since foreign investment was first allowed in 1980. As of late 2004 504,568 foreign-invested companies had registered with the Chinese Ministry of Commerce.

China attracted $70 billion in direct foreign investment in 2006, compared to $73 billion in 2005, $60 billion in 2004 and $53 billion in 2003, when it surpassed the United States for the first time as the largest recipient of foreign investment. Foreign investment in 2001 was $47 billion, a tenfold increase from 1991. In 1995, there was more direct foreign investment to Denmark than China.

China is taking investment money and jobs that could go elsewhere. Between 1990 and 2001 China absorbed 45 percent of the total of $719 billion of foreign investment. More moneys pours into China in two months than flows in sub-Sahara Africa an entire year.

Many of the Chinese companies that make products for foreign companies are backed by foreign investors. If these companies do well the foreign companies that support the, also make money. Retailers outside of China rely on Chinese products. If restrictions are put on Chinese exports foreign companies and businesses often suffer as much as the Chinese ones. The Chinese government is trying to steer investments towards less developed areas and the manufacturing of higher-value products.

Foreign Investment in China 2011 Reaches $116 Billion

Foreign direct investment in China rose 9.7 percent in 2011 to a record $116 billion, though December's inflow of $12.24 billion was down 12.7 percent versus year-ago levels, the Commerce Ministry said according to Reuters. It was the second consecutive month that China's non-financial foreign direct investment (FDI) fell versus year-ago levels, signalling that once unabated capital flow into the world's second-biggest economy is stuttering. [Source: Zhou Xin and Nick Edwards, Reuters, January 18, 2012]

FDI inflows from the United States sank 26.1 percent in 2011 to $3.0 billion, while those from the European Union fell a more modest 3.65 percent to $6.3 billion,the Commerce Ministry said.

The Commerce Ministry said earlier it aimed to attract an average of $120 billion FDI in each of the next four years. It also unveiled new rules to encourage foreign investment in strategic emerging industries, particularly those that bring new technology and know-how to China.

Investment inflows, which surged in the years after China joined the World Trade Organisation in 2001, have recovered strongly after being hit hard by the global economic slowdown in 2008/09.

Resistance to Foreign Investment in China

In the mid 2000s, nationalist sentiments and complaints that foreigners were getting the hands of formally state-owned assets for too cheap a price, interfered with deals by large multinational corporations and overseas buyout funds like Ewing Management Over 70 percent of acquisitions announced in 2006 had failed to be completed by the end of the year.

In August 2007, after many years of welcoming and even courting foreign investors, Beijing announced it would begin carefully scrutinizing foreign acquisitions and investments on security grounds. The primary concern was that important industries were not taken over by foreigners. One analyst told the New York Times, “There is certainly a desire by the Chinese government to ensure the crown jewels ate not pillaged by foreign invaders.” Even seemingly innocuous deals such as the purchase of a Chinese cookware company by a French company have been held up by security reviews The move has come as China has enough money now to support investment and feels it does need foreign nohow as much as it use to.

Some bloggers launched nationalist campaigns to block foreign investment into companies deemed to be vital to China’s national interests. Among the targets was the purchase of China’s largest crane maker by Carlyle, the U.S. equity group, and the purchase of a large stake in China’s largest ball bearing manufacture by a German firm. There are also worries among some Chinese that foreign firms would strip asset and laying off workers.

Ownerships Rules in China, VIEs and Foreign Investment

As of 2010, 300,000 foreign companies had invested in China.In August 2002, China allowed foreign companies to buy stakes in publically traded state-controlled enterprises. In November 2003, China relaxed restrictions on overseas investment. Local Chinese companies and officials were given more freedom to approve deals without okay from Beijing. In January 2008, the Chinese government announced that it would allow limited foreign investment in the Chinese securities industry. A foreign company can own no more than 20 percent of a Chinese securities firm and that firm must have a Chinese owner with at least a 33 percent stake.

In July 2011, The Economist reported: “Foreign investors face problems with China’s ownership rules. Several Chinese industries, such as mining, steel, education, telecommunications and the internet, are both capital-hungry and politically sensitive. They need foreign investment, but the law bans foreigners from owning stakes in them. [Source: The Economist, July 7, 2011]

Eager investors and canny locals have found ways around the rules. Perhaps the most important is the creation of a complex investment vehicle called a “variable interest entity” (VIE). It works like this: valuable Chinese assets are placed in a Chinese company. This entity, the VIE, must be run by a Chinese citizen. A series of contracts are then arranged, shifting the returns from the VIE first to a foreign-owned company registered in China and then to an offshore company, perhaps in the Cayman Islands.

This structure---a Chinese-owned company in China, a foreign-owned company in China and an offshore parent---is known as the “sina” model, after the first Chinese internet company to be listed overseas. It is used by about half of the Chinese companies listed in America, says Paul Gillis, a professor at Peking University. Numerous other unlisted companies use it as well. It allows Western companies to invest in China without breaking local ownership restrictions.

There are signs, however, that the Chinese government has begun to frown on VIEs. In 2006 the Ministry of Information, which regulates internet firms, said it was taking a look at them. In 2009 three other ministries announced that VIEs were banned for companies involved in internet games.

In March 2011, says Thomas Shoesmith, an attorney with Pillsbury, a global law firm, a $38 million bond offering in America for a company called Buddha Steel was withdrawn after authorities in Hebei province blocked its VIE with a local steel plant. Officials said that the very existence of a VIE contravened Chinese management and public policies. An anxious debate followed: was this the random act of a single region, or a wake-up call from Beijing?

A dispute between Alibaba, a Chinese internet group, and Yahoo!, an American firm that owns 43 percent of Alibaba through a VIE, suggests the latter. The Alibaba VIE recently transferred a valuable asset (Alipay, an online-payments firm) to a local Chinese company controlled by Jack Ma, Alibaba’s chairman. Yahoo! was outraged. Alibaba claims it had no choice. It says it was warned by China’s central bank that Alipay would not be allowed to operate if it was, in effect, partly foreign-owned.

In theory, the same problem could afflict the rest of the Alibaba Group. But Alibaba says its other operations will be unaffected because they fall under a less fussy regulator, the Ministry of Information.Perhaps so, but Mr Gillis, who has long blogged about the potential pitfalls of VIEs, is suddenly getting lots of attention. Alibaba is not unique. Other firms with VIE structures are also involved in electronic payments. At least one has a foreign partner. Now that the issue is in the news, China is under pressure to spell out what is permissible, and what is not. The risk that big foreign firms will suddenly find that their investments in China are illegal or worthless is surely remote. Or is it?

Main Foreign Investors in China

China was the No. 1 recipient of U.S. foreign investment in 2001. The amount of American money invested in China increased from $3.4 billion in 1990 to $69.7 billion in 2001.

Japanese corporations invested $5.4 billion in China in 2004.

Foreign Investment from Taiwan

See Taiwan

Image Sources:

Text Sources: New York Times, Washington Post, Los Angeles Times, Times of London, National Geographic, The New Yorker, Time, Newsweek, Reuters, AP, Lonely Planet Guides, Compton’s Encyclopedia and various books and other publications.

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© 2008 Jeffrey Hays

Last updated April 2012


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