China e-commerceE-commerce for Foreign Invested Entities (FIEs) in China is in upheaval. Beginning with the much discussed liberalization of the investment cap for foreign entities conducting e-commerce business in China, and most recently with the draft e-commerce law, big changes are afoot. This post briefly summarizes the more important changes, briefly assesses their effect in practice, and speculates as to the underlying trends and future developments.

Backdrop. As pretty much everyone already knows, China’s retail e-commerce market has grown massively in recent years.  Matthew Crabbe gives some interesting totals and projections: firstly the Chinese online retail market was worth a total of 120.8 billion RMB in 2008, rising to 6,433.9 billion RMB in 2017, including B2C and C2C sales, with B2C overtaking C2C in 2015.  Cross-border e-commerce (Haitao –  defined as goods sold from outside China into China, not including foreign goods sold within China) as a proportion of B2C online retail was 1.3% in 2011, growing to 4.8% in 2017. This means the market estimate is 303.8 billion RMB in 2017, which is significant compared even to the total US online retail market, for example.

Summary of China’s e-commerce reforms. Since 2001, the Foreign-Invested Telecom Enterprises (FITE) Regulations have contained an investment cap on foreign investment in Value-Added Telecoms Services (VATS) businesses of 50% ownership.   There is now a limited exception to this relating to e-commerce business. The following brief timeline will illustrate the main events:

14 March 2011: China’s 12th Five Year Plan contains a broad injunction for the economy to move from an export-led manufacturing economy to a consumer economy.

7 January 2014: the “MIIT SHFTZ Opinion 2014” made it possible for Foreign Invested Entities (FIE) in the Shanghai Free Trade Zone (SHFTZ) to own a 55% share in for profit e-commerce businesses with nationwide reach, an increase from the previously allowed 50% investment cap for (VATS) business under the FITE Regulations, thus meaning that a nationwide reaching e-commerce entity could be majority foreign-owned.

13 January 2015: the “MIIT SHFTZ Opinion 2015” took the changes in the MIIT SHFTZ Opinion 2014 further, by allowing 100% ownership of an e-commerce business by a Foreign Invested Entity in the SHFTZ.

10 April 2015: Part IV s20 of China’s 2015 Foreign Investment Catalogue made an explicit exception for e-commerce when discussing the investment cap of 50% in VATS business. This change was widely understood as removing the limitations on investment ratio in the nationwide regime for e-commerce FIEs.

7 May 2015: The State Council E-Commerce Opinions contain an instruction to various Chinese governmental bodies to remove the current investment cap for FIEs in e-commerce businesses, expanding the SHFTZ liberalization nationwide. Various simplifications relating to licensing were also included. (see China E-Commerce: The New Rules for discussion of the State Council E-Commerce Opinions.

19 June 2015: MIIT Circular 196 appears to be the implementation of the State Council E-Commerce Opinions, and it allows foreign equity ratios in e-commerce businesses to be raised to 100%, explicitly stating that this is a nationwide extension of the SHFTZ pilot program.

27 December 2017: the Draft PRC E-Commerce Law was published. It applies to all e-commerce business within China, including e-commerce businesses outside China that sell into China. It differentiates between third-party e-commerce platforms (e.g. TMall and Taobao) and other e-commerce operators, such as self-operated retail portals. Chapter 5 deals specifically with cross-border e-commerce. However, detail is lacking, and its main point seems to be that China wishes to promote development of “cross-border e-commerce,” which is defined as “imports and exports of goods or services through the Internet or other information networks’.” Chapter 5 deals in particular with customs clearance, “electronization,” and personal information.

There have also been a number of other initiatives, such as e-commerce pilot zones, for example in Hangzhou and elsewhere.

What is behind the reforms? On the face of it, there seems to have been major progress in opening the Chinese market to international e-commerce operators. As is so often true when it comes to doing business in China, all may not be as it seems. It is hard to ascertain what is happening fore foreign companies seeking to do e-commerce in China, but since the above changes were implemented, very few VATS licenses have been issued to FIES. One example is Heiwado (China) Co., Ltd, a Chinese WFOE reported to have two Japanese shareholders and a market capitalization of around US$50 million, and which has been involved in traditional and online retail in central China for several years. See First WFOE Obtains VATS License From MIIT.

So what is going on?  There are several possibilities.

Firstly, one factor may be “bringing order to the market” and eliminating legal grey areas. Much of the selling of foreign goods online in China has consisted of informal grey-market imports, often brought into China as personal goods in suitcases and then retailed on Taobao via “Taobao Agent Purchasing.” This means goods are entering the Chinese market without the relevant customs clearance, duties, and product standard compliance. China has a strong incentive for bringing this industry within the scope of its regulation.

A related point is that although the FITE Regulations contain strict investment caps in telecoms business, foreign investment in telecoms is in fact pervasive in China, through the controversial Variable Interest Entity (VIE) structure. Another argument is that removing the investment cap for e-commerce companies is a pragmatic move to enable full compliance by foreign-invested e-commerce businesses. Why though bring e-commerce businesses under the regulatory umbrella, but not other internet businesses? One hypothesis is that full compliance in e-commerce is seen as an achievable and desirable medium-term aim, with overall benefits to China, whereas the policy pressure on other areas of the internet pushes in the opposite direction, with no desire to liberalize and allow foreign participation.

It is also important to remember that discussion of “cross-border e-commerce” in China includes outbound as well as inbound e-commerce. In fact, the focus of the policy seems to be on encouraging outbound e-commerce. One much-discussed theme in the development of China’s economy has been inviting foreign partners in, learning from them, then applying this knowledge internationally once it has been digested by Chinese entities. Opening the market with one hand, and yet maintaining restrictions with the other hand gives the illusion of liberalization while allowing domestic companies to dominate the market. With respect to examples like Heiwado, it is really a very minor player. One interpretation could be that an example like this makes little impact overall, and yet helps maintain an illusion that the market is opening.

Interestingly, online selling on domestic Chinese third-party retail platforms like Taobao is now relatively easy for foreign businesses. This in some ways represents an ideal scenario for China. If inbound cross-border e-commerce takes place under supervision of a Chinese entity, Chinese government oversight is much easier and Chinese businesses get a piece of the pie. For the foreign retailer, this is also a low-risk strategy. The availability of this alternative may be a strong factor in the apparent lack of applications for e-commerce VATS licenses by WFOEs. Does conducting standalone e-commerce in China as a WFOE even make commercial sense?

From the point of view of foreign investment in third-party retail platforms, the dominance of the domestic players presents formidable obstacles to the market. It is probably more plausible for Alibaba to take on eBay and Amazon internationally than vice- versa. Interestingly, Alibaba, the owner of Tmall and Taobao, is itself structured as a VIE. See Why Alibaba is good for China VIEs.

Future developments. China’s removal of its e-commerce investment cap does not appear to have led to any great increase in market access for foreign investors. However, it does fit into a general picture of increased access to the Chinese market for foreign goods, albeit on Chinese terms. Although the e-commerce market as a whole will continue growing, Matthew Crabbe’s prediction is that the Haitao market will peak at about 5% of total online retail sales in China. If that is correct, China’s e-commerce gold rush may not be quite what everyone expected, and today’s status quo is also the shape of things to come. The future of China’s e-commerce market lies largely in selling through established Chinese channels.

* This post was written by Edward Hillier, a New Zealand-qualified lawyer and researcher. This post is based on academic research he submitted to Anglia Ruskin University in 2017 for his LLM dissertation entitled New Opportunities in Online Retail For Foreign Investors in China. The author would like to thank Matthew Crabbe of Mintel for market and retail industry insight.