The Shanghai Free Trade Zone – One year down the line

The China (Shanghai) Pilot Free Trade Zone, which opened on 29 September 2013, is another step toward financial reform and market liberalization and aims to intro-
duce a series of overhauls in finance, shipping, trading, professional services as well as cultural and social services. A notice regarding the General Plan for the SHFTZ (the "Notice") was promulgated by the State Council on 27 September 2013.

The China (Shanghai) Pilot Free Trade Zone (SHFTZ) combines several existing bonded zones: the Waigaoqiao FTZ, Waigaoqiao Free Trade Logistics Park, Yangshan Free Trade Port Area and Pudong Airport Comprehensive FTZ. Unlike traditional bonded zones, the SHFTZ will have even fewer restrictions, such as exemption from customs supervision and unlimited period for storage of goods. While the economic growth is slowing down, the SHFTZ is exploring a new path that will be replicated in other parts of China if it proves successful.

Chinese authorities also hope the SHFTZ will boost China’s competitiveness against the Trans-Pacific Partnership Agreement (TPP), the Trans-Atlantic Trade and Invest-
ment Partnership (TTIP) and the Plurilateral Services Agreement (PSA) recently negotiated among the U.S., European Union, Japan and other countries. At first glance, the market access opportunities appear to be a huge step forward. After all, most of these are currently off-limits to foreign investors outside the SHFTZ and besides, lower hurdles on investor qualifications, investors stand to benefit from more flexible capital requirements and more freedom to conduct business in China.

However, on closer scrutiny, only a limited number of these opportunities have actually gone ‘live’ because en - abling legislation has not been forth - coming and, for the three sectors which are open (i.e.: banking, medical/healthcare and telecommunications), it is still unclear what companies will be permitted to do once they have set up in the SHFTZ. In practice, prospective investors are either being told that they must wait for new rules to be issued before they can incorporate or, like the twelve overseas banks that were among the first to establish beachheads in the SHFTZ, investors are permitted to incorporate. However, they are unable to conduct business as crucial operational guidelines are still pending.

Promised reforms are not in place yet

Supposed significant changes to the Negative List seem to be loosely based on the current nationwide “Catalogue of Industries for Guiding Foreign Investment” resulting in no significant changes in reality. Even though foreign investment projects not listed on the Negative List are only subject to a simple filing instead of requiring approval, the differences be tween the two procedures may not be as significant as anticipated in practice.

Financial reform is one of the key reforms anticipated by investors for the SHFTZ. However, the Notice only mentions generally the free conversion of capital account RMB and liberalization of interest and exchange rates without any details or schedule for implementation.

"So far, SHFTZ has not stood out against other Economic Zones"

The Notice does not mention any reduced enterprise income tax (EIT) rate. Thus, companies in the SHFTZ are still liable for EIT at the standard 25 percent rate, rather than the previously discussed 15 percent reduced rate. In this regard, the SHFTZ is not as competitive as other special economic zones, such as the Qianhai Pilot Economic Zone in Shenzhen. Currently the application procedures are not occurring within five working days. It takes the same amount of time like outside the SHFTZ.

Could the SHFTZ have its main unique selling propositions in the logistics sector?

Logistics companies registered inside the free trade zone may now have a majority share, though they will still need to be joint ventures. Transfer of cargo by shipping companies will now be allowed inside the SHFTZ. Shanghai will become a consolidating point for goods bound for other ports. This will put pressure on ports of other countries that currently handle this transfer traffic. For example, Korea stands to lose considerable volume when goods no longer need to travel to Busan or Incheon to be transferred before going to Northern China.

The same principle will apply to air cargo being transferred at the Pudong airport and even passengers will be able to make international transfers without a visa. Foreign ships will be allowed to ship from the SHFTZ to other domestic ports. Currently, only Chinese-owned vessels can ship between domestic ports. Customs administration will be greatly simplified. Currently, border clearance is performed according to each individual waybill. Inside the SHFTZ, border clearance may be done by monthly or even quarterly clearance of all waybills. Goods can be delivered directly to the warehouses inside the free trade zone without waiting for clearance.

This is especially important for fresh food which can be transferred directly to temperature controlled warehouses. Goods will still need to be cleared before being shipped outside the SHFTZ, but it is expected that clearance time will be reduced by two to three days. Perhaps the biggest impact on the supply chain is that the SHFTZ will now be more attractive as an international hub. Goods can be delivered to the zone and be held in inventory without paying duty.

Only when an item is shipped domestically the duty is paid. Items bound for other countries will not be subject to duty or complicated customs procedures. One speci-
fic application of the last point is worth elaborating: e-commerce fulfillment will be allowed within the zone. Foreign goods can be imported and the duty deferred until the item is ordered. Even international orders could be fulfilled from Shanghai. Currently, Alibaba, Amazon and other Chinese companies are setting up such opera-
tions. It is anticipated that this e-commerce business will eventually be opened up to foreign companies, though it is still in a trial phase with local companies.

Nationwide reforms versus the attractiveness of a free trade zone

The zone was scheduled to benefit from “preferential” policies for financial and investment regulations, but these “preferential” policies have now been implemented on a nationwide basis making the policies less specific for the zone. Many policies which have been rolledout on a nationwide basis have reduced the attractiveness of the FTZ, including cross-border cash pooling and netting for multinational companies. For example, it was planned that foreign companies with bank accounts in the SHFTZ could transfer their excess RMB holdings in and out of China more easily – a few months later this policy was rolled out on a nationwide basis.

According to real estate reports, office space is cheaper in the SHFTZ compared to Shanghai or Beijing downtown. Yet, this comes with some downsides. The Zone is far from the city center which makes it challenging to attract qualified employees, expatriates with kids in school age and last but not least for clients to reach the loca-
tion. The advantage of being able to register a company in five working days has been advertised and attracted numerous companies, but the reality is that the registra-
tion period is then not as fast as once advertised.

"E-Commerce is booming in SHFTZ"

One year down the line

The first year of the SHFTZ is regarded as disappointing by many business executives. With approximately 10,000 companies registered in the SHFTZ, only 6 percent are foreign investors, including financial institutions and multinationals. Service-oriented companies prefer to be located in the central business district of a city and have to maintain a certain image level. The SHFTZ does not provide these requirements fully yet.

Manufacturing and trade oriented companies do find significant advantages in the SHFTZ, particularly if they require bonded warehousing facilities. The key sector which is booming in the SHFTZ is e-commerce, with Amazon, Tmall, etc. opening facilities for easier trade and customs procedures. Overall the SHFTZ is still to meet the initial expectations and will have to prove its advantages particularly for foreign small and medium enterprises.

Kristina Koehler-Coluccia

Kristina Koehler-Coluccia has worked in the Chinese legal and accounting industry since 2003 as Koehler’s China Director. She advises and represents the business interests of Western clients in China, Hong Kong in China, Hong Kong and Singapore.

www.koehlerservices.com