By Steve Dickinson and Mathew Alderson

In the first part of this two part series, in a post entitled “China’s Film Industry Promotion Law. A Discussion Of The Discussion Draft,” we discussed the Discussion Draft of the China Film Industry Promotion Law. Concern has been expressed about a provision of the law that would prevent online film download sites from providing unlicensed foreign films on their websites. In fact, however, this provision of the discussion draft would simply clarify existing law. It therefore does not reflect a substantive change. Much of the current regulation of film in China is based on agency regulations rather than statute. One purpose of the new law would be to take these regulations and increase their authority by raising them to the level of statute. Thus, some parts of the law are merely a codification and clarification of existing practice. The controls on download sites falls into that category.

The discussion draft would establish a two tier licensing system. Under current rules, all films produced in China must obtain a Film Production License. The script for such films must be approved by Beijing SARFT. After completion, the completed film must be reviewed by SARFT. Films that survive such review receive a Film Public Screening License. No film can be “publicly screened” or “shown” in China without such a license. This includes foreign films imported into China for screening.

The discussion draft simply repeats this basic rule, with some clarification, as follows in draft Article 26:

Article 26, Par 2: 未取得《电影公映许可证》的电影,不得发行、放映、参加电影节(展),不得通过互联网、电信网、广播电视网等信息网络进行传播,不得制作音像制品;但是,法律、行政法规另有规定的,从其规定。
With respect to films that have not received a “Film Public Screening License”, such films (1) may not be distributed, shown, entered into film festivals (exhibitions), (2) may not be broadcast over the telecom networks, such as the internet, telecom networks or broadcast television, and (3) and may not be manufactured into audio-visual products.

The commentators focus on Provision (3) from Article 26. It is our understanding that a vast amount of the online content provided by Tudou, Youku and others does not have a Film Public Screening License. Much of this unlicensed content consists of movies and TV shows from Taiwan and Hong Kong. Another substantial portion of this unlicensed online content consists of foreign films from North America and Europe. If China were to begin enforcing its ban on unlicensed content, we would expect the revenue of Tudou, Youku, and others to be substantially reduced.

The important point though is this. Article 26 does not change current law. Current film regulation provides that no film can be “shown” (fang ying 放映) absent a license. No one in China has any doubt that “showing” a film on the internet or on TV is any different from “showing” that film in a theater. Thus no one in China has any doubt that the current practice of Tudou and Youku providing unlicensed films and TV shows for download violates the law. Video sites like Tudou and Youku might argue that they don’t “show” any films at all. Rather they provide films for download and people “show” them in their homes. If that is a sound argument, then Section 26 of the new law would not apply to Tudou or Youku or to other download services. However, this argument fails. Both current regulations and the proposed Section 26 clearly provide that distribution of unlicensed film is also prohibited. Thus, if Tudou and Youku (which are reportedly soon to merge) are not “showing” films, then they are at least certainly distributing films. The fact that they are distributing them over the internet is entirely irrelevant.

We do not know why the Chinese government has chosen not to enforce the existing law with respect to Tudou, Youku and the rest, but we assume the reason is money. Tudou and youku make money and the government presumably benefits from this via tax collection or in some other way. Thus they do not shut Tudou or Youku down. The same is true regarding the illegal production of DVDs. The government knows who most of the illegal DVD producers are and it could shut them down tomorrow. But the government does not do it.

With respect to Tudou and Youku and other download sites, the discussion draft would only make even more bluntly clear what is already the law: it is illegal to distribute, show, broadcast, provide for download or manufacture into a disc any film that is not licensed. All of this illegal activity is a huge and profitable industry in China. Part of the high profit is based on this very illegality.

Foreigners who want to invest in companies like Tudou (NASDAQ: TUDO) or Youku (NYSE: YOKU) should know that they are investing in businesses that make at least a portion of their revenues from illegal content. The risk with Tudou and Youku is not insubstantial as they both show unlicensed film, foreign copyrighted content (which is also illegal under Chinese law) and they both are VIEs.  How much more risk do you want? These risks cannot be eliminated since they are, at least to some extent, built into the system. What will be the result of all of these risks is unknown, but they should at least be factored into any investment decision and our conversations with Wall Street analysts suggest that is not being done.

Comments are always welcome for everyone, of course, but we would particularly like to hear from investors in Tudou and Yokou this time.

  • Shirin

    Interesting topic for the day, as I just met with my friend yesterday whose company buys the right to own and to distribute TV shows and movies from the west and sells them to TV stations and websites in China. Apparently SARFT can be very strict about the content and that the British show SPOOKS fell under the “too political” category to be distributed in China. I haven’t looked in awhile, but at least a couple years ago I clearly remember seeing this show on youku or a similar such sight anyway.
    Also, if everything shown on youku/tudou has to be approved by SARFT, how does that work for all the home-made movies that people post?

  • Twofish

    Harris: We do not know why the Chinese government has chosen not to enforce the
    existing law with respect to Tudou, Youku and the rest, but we assume
    the reason is money.

    No.  The reason is bureaucratic turf.  There is a huge battle between the SARFT and the MIIT over who gets to regulate the internet and the MIIT has tended to win the battles.

    There is a difference in China between “laws” and “regulations”.  A law beats a regulation.  If someone points out that there is a *regulation* that all public displays of film must been approved by SARFT, this gets beat by the Telecommunications *Law* that puts internet regulation in the hands of MIIT. 

    In the end what this boils down to is that SARFT licenses theatres, and MIIT licenses internet websites.  If SARFT rules that something is a “film” and that an internet web site is violating SARFT regulations by showing them, they can do *absolutely nothing* since it’s up to the MIIT to shut down the site, and MIIT isn’t about to take orders from SARFT.

    Also whether something is an agency regulation or a national law makes a *big difference*.  National law trumps agency regulations, and under the current situation, any regulations that SARFT issues that contradict the Telecommunications Law are legally invalid, and if the SARFT tries to shut down a site based on an agency regulation, they are going to end up in court with the judge cancelling that order.

    Now if this gets passed as a National *Law* then you have a different situation, but my guess is that MIIT is going to quash any efforts to get the law passed.  Even if the law gets passed, then there is going to be conflict between the Telecommunications Law and the Film Industry Production Law.  Unless the new law gives SARFT power to shut down websites my guess is that nothing is going to happen.

    Take aways from this about how to read Chinese law.  There are two important things that you need to figure out when looking at a Chinese regulation or law:

    1) Who issues the regulation/law.  There is a *big* difference between an administrative regulation and law.
    2) What happens if the law is violated.  In the last section of the regulation or law, there is usually a section that says what happens when the law is violated.  Often it’s obvious that the consequences are “absolutely nothing.”

  • Twofish

    Also, whoever translated the Article 26 Paragraph 2, missed something really important.  The last clause says


    However, in situations where another law or administrative regulation specifies otherwise, that other law or administrative regulation shall govern. 

    Since internet content providers are subject to MIIT supervision (See Article 3 of the Telecommunications Regulation), this provision is irrelevant to them.

    Harris:  What will be the result of all of these risks is unknown, but they
    should at least be factored into any investment decision and our
    conversations with Wall Street analysts suggest that is not being done.

    I think that people on the buy-side are doing this.  If you look into the prospectus for any stock or IPO for a China related internet company, there are about five pages of stuff that boils down to “the Chinese government can shut this company down whenever it wants.”  If you aren’t comfortable with the Chinese government being able to cause you to lose all of your money, then don’t invest in these sorts of stocks.  For that matter, don’t invest in China at all.

    But….  If you don’t want risk, put all your money in FDIC insured CD’s at which point you are dealing with 0.5% interest minus whatever inflation there is.

    So how do people deal with this?  If you have money that you absolutely cannot afford to lose, then you shouldn’t be putting it into Chinese stocks, and you probably shouldn’t be putting it into *any* stocks.  If you have money that you can put into risky investments, then you likely shouldn’t put it all into one Chinese company.  If you put it in ten companies, or better yet a mutual fund that can invest in hundreds, then when and if the Chinese government shuts down the internet, you are still making money from the stuff that is happening in Brazil.

    But people are adults.  There was one venture capitalist that mentioned that their firm had a 90% failure rate.  Ninety percent of the companies they they invest in fold.  It’s that one in ten when they hit a home run that makes up for all of the failures.

    Now as far as people on the sell-side, that’s a different story.  People sell IPO’s the way that people sell used cars, so if someone is trying to sell you an IPO, you should treat them the way they you treat any salesman.  Listen to what they say, but to realize that they make a commission if you hand over your money.

  • Twofish

    I did some more research (i.e. I went into the SEC filings for the companies involved).  As with many things, SEC filings are extremely educational, and there is this very readable description of Chinese media law.

    I have to very strongly disagree with the legal analysis here. 

    Section 26 states that  “但是,法律、行政法规另有规定的,从其规定” (However, if another law or administrative regulation provides otherwise, the other shall control.)  In the case of internet broadcasters, SARFT and MIIT have jointly issued regulations on licensing internet audiovisual stations, and everyone involved has a license from both the SARFT and MIIT (as well as the half dozen other agencies).  So while it is true to say that internet broadcasters in China could be made illegal at any moment, it’s not true to say that the big content providers are *currently* illegal.  They all have SARFT licenses, and they all appear to be taking orders from SARFT/MIIT as to what content they can publish (i.e. no news or political commentary).  Whatever movies they have online are with SARFT’s blessing.

    There are some very interesting things with Chinese media law.  One is why the Chinese government lets this sites operate.  One thing I think the Chinese government has learned is not to try to police culture in situations where there isn’t an obvious political motivation.  The thing that triggered Charter 77, was when Czechoslovakia started raiding rock bands.  What the Chinese government wants is “bread and circuses” and if people are downloading HK movies or Japanese porn, that keeps them from protesting. 

    It’s also not true that the Chinese government is very relaxed toward copyright violations.  One thing that is interesting is how the Chinese government has cracked down very hard on P2P and file sharing sites.  I think the idea is that if you want bootleg movies, then you can find them at the censored government controlled sites.  If you want the latest teachings of the Dalai Lama, you are out of luck.  By cracking down hard on P2P and treading lightly on licensed sites, the government keeps control over content. 

    There are some other interesting things.  One is that there are regulations against any *new* privately funded media sites.  This pretty much insures that the current sites won’t have any private competition and this obviously makes the stocks more attractive.

    The second interesting thing is why these Chinese internet companies haven’t been sued to death by Western media giants.  These internet companies have substantial overseas assets, but there have been no high profile lawsuits and no evidence from the filings of any lawsuits at all.  Now one thing that I have seen in other industries is that the Chinese government protects local companies.  Which is to say that if you are a Western company that suddenly files a ton of lawsuits against Chinese companies, you’ll suddenly find that your licenses have all been cancelled.  So what ends up happening is that people wind up with quiet agreements.

  • Mike

    I also think that one reason the government hasn’t enforced the law against Youku and Tudou is for stability reasons.  Almost every Chinese person I know uses Tudou or Youku at some point each day or at least each week.  Chinese people love watching foreign shows and movies on these sites, and I cannot imagine what would happen if you suddenly cut people off from that.  The girls in my office discuss Korean, Taiwanese, and HK romance movies and shows all the time.  I cannot imagine the anger that would be unleashed if people could not go watch their TV shows or movies on these sites.  Much like Weibo I think these sites keep people entertained and taking that away and leaving people with state TV and Movies is going to make a lot of people really pissed off.  Not to mention the other reasons commentators have already mentioned.   

  • Twofish

    I’m not an expert on Chinese media law.  I just get annoyed when people make legal arguments that are factually incorrect especially since the internet spreads incorrect information more quickly than before, I’m doing some google searches and it’s sort of amusing how the “virus mutates”.  As people talk about the law, the story gets changed.  This particular blog is sort of important, because there are some critical areas at which a Chinese language rumor becomes an English language one, and this is one of them.

    Now lets look at the law….

    And I believe the arguments here are incorrect, and the more I look into this, the more incorrect they seem.  I’ve already pointed at the Article 26(b) does not apply in situations where someone has issued another regulation.  General regulations on film distribution do not apply to the internet as
    SARFT and MIIT have jointly issued regulations on this issue here they are….

    But there is more, I’ve looked at the copy of the full law and under Article Two, paragraph two, we have


    Film being broadcast through the internet, telecommunications networks, or broadcast television networks, will be governed by the laws and administrative regulations involving the internet, telecommunications networks, and broadcast television networks.

    So the file production law is *completely irrelevant* for internet providers.

    The rules that are relevant are here….

    (Also, if you want to get nit-picky and point out that, under Article 56 of the Legislation Law, the film distribution regulations require that any regulations overriding those film promotion regulations be promulgated by the State Council whereas the referenced regulations are promulgated by the agency heads, I’ll find the initial State Council regulation which established SARFT and gives it regulatory authority over radio, film, and television.)

    And that’s assuming the proposed law goes into effect.  The statement has been made that new law simply codifies current regulations.  I’d like to see someone argue that since I don’t see this.

    Here is current regulation

    It doesn’t mention the internet at all.  The fact that someone felt compelled to add the internet to the draft law, means that someone didn’t think that it applies.

    One other cute thing is that under current regulations, its not illegal to import an unlicensed film.  It’s illegal to import a film that meets the standard “bad” categories, but that’s something different.  In particular much of the online discussion points out that the proposed law would ban several recent popular Taiwanese dramas.  But the point here is that Article 26, doesn’t merely restate current regulation, it adds something new, but ironically that something new has nothing to do with internet broadcasting.  The concern is that the new law would prohibit *non-internet* distributors from distributing foreign films that are outside the “standard banned categories”. 

    And the reason this system needs changing is because of a WTO ruling.  Previously, it was only legally to import films through SARFT approved distributors.  WTO ruled that this system was against trade rules.  China has the legal power under WTO rules to ban films from entering China, but it can’t restrict distribution to preferred companies.  So part of the situation is trying to figure out a new system, and distributors would naturally like to keep as much of its monopoly going so that it makes the most money. 

    It’s also the case the situation major internet operators are operating under licenses from both SARFT and MIIT.  This is not a legal grey area.

    Similarly with the situation in VIE’s.  VIE’s appear to conflict with the “Foreign Investment Catalogue”.  However the FIC is not in and of itself a regulation, and Chinese agencies can and do issue waivers to the FIC.  In the case of the major internet companies, SARFT, MIIT, and everyone else have issued waivers to the general rules which allow them to operate which means that they are fine with the capital structure of those corporations.

    It is true that those agencies have the legal authority to revoke those licenses at a moments notice, but “could be made illegal at a moments notice” is very different from “currently operating illegally.”

    This is not even a legal grey area.

  • Chsu

    For tudou/youku, I understand most of their contents are user generated and uploaded. Is there a similar “safe harbor” protection in China’s copyright law that would reduce liability for these entities if they claim to be ISPs? What about entities like ppstream, pptv, or funshion? It appears they have valid licenses since they show high quality movies, do not have every movie out there, and removed all their Japanese shows after China agreed to recognize Japan’s copyright.