An introduction to the Shanghai Free Trade Zone

So you want to learn about China’s booming economy, and have been given a first class plane ticket to any city in China. Where would you go?

Anyone seeking to understand China’s economic miracle would be well-advised to head to Shanghai. 

Opened to foreign trade after the First Opium War in the 1840s, Shanghai prospered as a centre of commerce between East and West, assuming the role of Asia’s financial centre in the 1930s. Shanghai’s influence waned for several decades thereafter, but in recent years, legal and economic reforms have resulted in a rapid resurgence. Today, Shanghai is China’s largest city (with over 23 million people!) and the “showpiece” of modern China.

On 29 September 2013, a new chapter in Shanghai’s history book was written when China formally inaugurated the China (Shanghai) Pilot Free-Trade Zone (or “FTZ”). The FTZ was conceived as a testing ground for economic and social reforms. The FTZ covers an area of 29 square kilometres when it was initially launched, making it roughly equal in size to the borough of Southwark in London. In December 2014, the area further expanded to 120.72 square kilometres.

The Shanghai FTZ introduced new policies designed to create a more hospitable climate for foreign investment. It removed market entry restrictions and eliminated certain qualification thresholds in 18 service sectors (including legal services, investment management, and ocean freight). 

Moreover, certain business activities that remain prohibited or restricted in other parts of China are now permitted to be undertaken in the Shanghai FTZ.

One example is video game consoles, the sale of which had been banned since 2000 in a purported effort to safeguard the mental health of Chinese children. However, with the new policy, foreign enterprises are now allowed to manufacture and sell gaming and amusement equipment within the FTZ to the domestic Chinese market (much to the delight of Chinese youth, and to the horror of their parents), provided that the content of the games pass the scrutiny of the government regulators.

Another benefit of the Shanghai FTZ is with respect to the incorporation of foreign invested enterprises (FIEs), a fancy term for Chinese companies that have one or more foreign shareholders.

Incorporating an FIE can be a time-consuming and complicated process, requiring approval and registration with various governmental bureaus. However, these procedures were streamlined in the Shanghai FTZ for a three-year trial period beginning on 1 October 2013. The most significant change in the incorporation requirements is that the typical approval procedures to establish an FIE were replaced by a notice/filing system, which means that a foreign investor that wants to set up an FIE that does not fall within the Negative List (as mentioned below) in the Shanghai FTZ merely has to notify (rather than seek express approval from) the government. 

For all of the perceived benefits of the Shanghai FTZ, many market watchers were disappointed by the fact that the supposedly “free” trade zone was not as “free” as people had anticipated. 

Following the announcement of the Shanghai FTZ, the Shanghai Municipal Government introduced the concept of a “Negative List”, which prohibited or restricted companies in the FTZ from engaging in certain businesses set out in in the Negative List. The initial Negative List included 18 sectors (for example, mining, construction, education and real estate) and 190 items (for example, compulsory education, exploration of noble metals and rare earths, internet data centers, and golf courses). 

The Negative List was updated on 30 June 2014. This time, the number of restricted items was reduced to 139, reflecting a relaxation of restrictions on foreign investment. The Shanghai government will likely issue a further revised Negative List in the first half of 2015, which is expected to contain less than 100 items. 

The Shanghai FTZ is an exciting development that may have a substantial impact on China’s foreign investment landscape. For now, however, its full effect remains to be seen. There is no doubt that industry experts are eagerly awaiting the issuance of the new Negative List and will be closely watching the progress of the Shanghai FTZ, as it may serve as a model for free trade zones in other parts of the country. 

Eddie Hsu is counsel in Dentons’ Shanghai office and Monte Lee is an associate at Dentons in Beijing.

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