Southern Perspective Shenzhen

There is a tangible feeling of a shift in the view of the role of foreign investment into the Chinese economy, foreign investment is not welcomed with open arms anymore.

Foreign investment has deeply penetrated most sectors of the economy that are open, each of the top 5 enterprises are co-owned or controlled by foreign companies.

These strong nationalistic sentiments are thought to have put pressure on government officials at the time they were considering Coca-Cola’s proposed acquisition of Huiyuan Juice Company.

As the Chinese economy and large Chinese companies begin to be more self sufficient and look towards the domestic market for growth and development foreign companies will increasingly find themselves encountering barriers to market access, many US companies are feeling the squeeze already.

Foreign companies looking to invest in China will need to be aware of the specific particulars of the security review system that will most likely affect their attempted investments.

Under the new regulations, the National Economic Security Review (NES) requires approvals for certain categories of acquisitions; “important industries, elements that may affect national economic security and famous trademarks, time-honored brand companies”.

Acquisitions of companies that fall into any of these categories must first apply to MOFCOM for approval first, which you can bet will not come quickly or easily if at all.

The problem with the categories that China sets as those that require review is that they are not well defined.

This leads to high risk for any company that is considering an acquisition of a Chinese company as the guidelines are too broad and there is no explanation as to what companies fall into which categories.

This lack of clear edges in the definition will give rise to confusion in China as many other national governments give clear explanations as to what they deem sensitive areas.

In April 2008, the Organization for Economic Co-operation and Development released a paper discussing the “Protection of ‘Critical Infrastructure’ and the role of investment Policies Relating to National Security”.

This paper details the manner in which countries will view foreign investment in many specific categories including banking, land development, aviation and media.

Many other developed nations have clearly expressed how they define their critical infrastructure.

These types of clear cut explanations as to which areas are open and which are not are key to companies being able to understand the policies of the countries they are operating in and how those policies will affect their business.

Clear policies and consistent enforcement of logical decisions that follow the plan laid out in both the AML and the NES review are the best security to protect harmonious growth and development for the global economy.

The rise of new economic powers has shifted views regarding market access for foreign companies.

Since the US began to scrutinize foreign direct investment more closely after 9/11, many other nations took notice and followed with their own Merger and Acquisition (M&A) regulations and economic security reviews.

While there are legitimate security concerns (both physically and economically) that nations must protect themselves from, this type of regulation is ripe for abuse.

Nations will become increasingly hostile in dealing with many types of foreign direct investment and proposed M&A activity.

Government regulators around the world are lowering thresholds for intervention, increasing the aggressiveness with which they investigate these cases and increasing penalties for violations.

This will lead to increased government involvement with their leading companies and has the potential to lead to serious conflict as world powers compete for growth and development.

M&A is quickly becoming the preferred method of international investment for companies looking for a quick and low risk method of entering a market.

This practice can be mutually beneficial, as the acquired or merged company receives an infusion of financing and potentially some expertise or advanced technology from the acquiring company.

The acquisition or merger of some companies can trigger an emotional response from citizens.

Examples include the California based oil company Unocal attempted acquisition by a Chinese State Owned Enterprise and the disapproved acquisition of the Huiyuan Juice Company by Coca-Cola as well as the withdrawn acquisition of Rio Tinto, an Australian mining company, by Chinalco.

While none of these deals appeared to be in direct conflict with anti-monopoly laws of the respective nations, they were all controversial.

What does China’s National Economic Security mean for big business worldwide?

China’s National Security Review

The Chinese government will “accelerate the establishment of the National Security Review Mechanism of foreign investment” stated Chinese Premier Wen Jiabao in March of 2010.

China’s National Economic Security (NES) review was initially proscribed by Article 31 of the Anti-monopoly law (AML).

Critics state that the security-review system will simply place additional burdens on foreign companies investing in China.

Supporters point out that these types of reviews have become standard practice internationally and that China is simply following the international norm.

Peter Wang, of the law firm Jones Day in Shanghai summed up the situation, “The definition of national security is bound to be somewhat broader than what people think of as national security in the U.S. – it’s going to be economic security and economic development and stability,”. The national security review system is “not unexpected, and it’s not necessarily unreasonable, but it’s certainly not making things any easier.”

The best example of Chinese NES Review is the failed attempted acquisition of Xuzhou Machinery by the Carlyle Group.

The Chinese government did not approve this acquisition and cited national security concerns.

Speculation as to what the security review will specifically entail is rife.

From the indications so far, it is likely to be a combination of current observed international practice that will require time, practice and revision before becoming the efficient tool that it aspires to be.

There is a tangible feeling of a shift in the view of the role of foreign investment into the Chinese economy.

Foreign investment has deeply penetrated most sectors of the economy that are open, each of the top 5 enterprises are co-owned or controlled by foreign companies.

These strong nationalistic sentiments are thought to have put pressure on government officials at the time they were considering Coca-Cola’s proposed acquisition of Huiyuan Juice Company.

As the Chinese economy and large Chinese companies begin to be more self sufficient and look towards the domestic market for growth and development foreign companies will increasingly find themselves encountering barriers to market access.

Foreign companies looking to invest in China will need to be aware of the specific particulars of the security review system that will most likely affect their attempted investments.

Under the new regulations, the NES requires approvals for certain categories of acquisitions; “important industries, elements that may affect national economic security and famous trademarks, time-honored brand companies”.

Acquisitions of companies that fall into any of these categories must first apply to MOFCOM for approval first.

What problems will this cause for international companies looking to increase access to the Chinese domestic market?

Is China slowly closing its doors to FDI and sealing off the path to the largest domestic market on the planet?

Our last posts have been about mediation and the benefits it brings. Unfortunately, mediation is not always going to solve your problems.

Now what?

Another option is arbitration.  To understand where you stand in reference to mediation and litigation, please see the  picture below:

What Arbitration can do for you

Arbitration is method you can employ to reach settlement quicker. Litigation can drag on for years, arbitration can have things done in months or possibly even weeks. It is highly structured and at the end of the day, the arbitrator will make a legally binding decision on the parties. You can choice where you would like to arbitrate and who will be the arbitrator.

Another advantage of arbitration is it is confidential.  Like mediation, this forum will keep your business, your business.

How will I set up Arbitration?

When setting up your contracts, an arbitration clause will be necessary.  But these can be tricky.  Locality and business scope can all play a factor on how you structure your arbitration clause in your contract. You need investigate these items before drafting your arbitration clause .

Learn a little more here.

Hong Kong is no stranger to Alternative Dispute Resolution (ADR). The Hong Kong International Arbitration Centre handled 280 cases in 2004 up to 602 cases in 2008. When foreign investors in Asia have disputes, they prefer to have a neutral “third place” for them to be settled. Hong Kong has been claimed as one of the preferred places for foreign dispute settlement, due to its developed law system and geographical location.

Practice Direction 31 (from here on referenced as PD31) for mediation, which is one method of  ADR, came into effect on 12 February 2010. PD31 is a practice direction that only pertains to the ADR method of mediation and encourages people to mediate before or during litigation procedures.

A detailed look at PD31

PD31’s main task is to encourage people to settle their disputes by making it compulsorily to consider mediation before or during litigation. While it is not “mandatory”, PD31 instructs legal representatives to inform the parties the court could issue adverse costs if they “unreasonably fail” to mediate. Unless the party has a good reason not to mediate, then they will not take on these adverse costs. Outlined by Herbert Smith LLP, we will touch on the five essential points that are particularly important when considering the new PD31 on mediation in Hong Kong.

1. Active exploration of ADR

The court has a “duty as part of active case management” to encourage other methods, such as ADR, to settle disputes. In other words, the court’s duty is to help the parties to settle matters but it is also the party’s responsibility to help facilitate these methods when ever possible.

2. Costs of unreasonably failing to mediate

When a party unreasonably fails to mediate, the court may include “adverse” costs to them. There is a minimum requirement one can participate to avoid the adverse cost, as well as having an acceptable reason why one can not mediate.  The term “unreasonable” is not clearly defined.  The best method is to go through the motions and up one mediation session. IF it does not work out, you have made you attempt. You might also resolve some issues as well.

3. Mediation procedure

Mediation certificate

The Mediation Certificate is important because it states whether the parties agree to mediate, more importantly if they do not agree to mediate, what is the explanation. The second function of this certificate is to verify if the legal representatives have explained that mediation is an option available to them, the cost of mediation compared to litigation and explaining PD31 contents.

Mediation notice

In the event one party would like to mediate, they must draft a Mediation Notice after sending the Mediation certificate. The Mediation Notice should include the party’s willingness to mediate and how to suggest how to carry out the mediation.

Mediation Response

Once the notice is received, a mediation response must be sent to the court in 14 days. In the response, it should be noted whether they agree to mediate the dispute and if not, why not.  The respondent also has the right to suggest ways of carrying out mediation.

Mediation Minute

Once an agreement is reached, it should be reduce into writing with the signatures from the parties or legal representatives. In the event the parties can not come to an agreement about mediation, for example choosing a mediator or location, they may look to the court for guidance to help solve those differences.

4. Stay of legal proceedings

At any time during litigation, the parties may opt for mediation in order to try to resolve their differences. Providing they do not conflict with any “milestone dates”, the court will allow a short break to start mediation. Milestone dates such as, case management conferences, pre trial review and trail date, stay of legal procedures will not be granted in attempt to reduce delays in court proceedings. If the parties come to agreement during the time of mediation, they will have to inform the court and formally close the proceedings. If an agreement is not reached with in that time, the previous proceedings will continue.

5. Without prejudice communication and confidentiality

One of the advantages of mediation is confidentiality. It can be a private forum between the parties, legal parties and mediator. PD31 claims the court can not compel one of these parties to divulge information to the court for evidence.

What now?

Even though mediation was available before, people might not have had the opportunity to learn about the other alternatives available to them. PD31 dictates legal counsels are to make sure their clients are aware of the advantages and cost benefits of mediation. Whether mediation is more enjoyable than litigation is not the point to be debated, but rather, PD31 requires a second option that may yield a better out come. PD31 brings awareness to this second option of mediation; an option that has always been available.

When I tell people that I studied Chinese Business Law, I usually get the same response just about every time, “They have laws here?”

Ha ha ha, we chuckle each and every time but that is the pervasive perception of many people who do business in China.

And these comments come mostly from people who have been on the ground in China trading punches with suppliers for years.

This reaction is common when coming from the US, where people have sued the golden arches for making them fat or that their hot beverage was too hot.

The simple fact of reality is that China does not enjoy the direct confrontation that we do in the West when problems arise and must be dealt with.

While the courts in China are changing, it will take time for the structure of the legal system to develop, just as it did everywhere else.

In the meantime, you do have several options for dealing with disputes IF you PREPARE correctly.

Mediation is a great choice and is quickly becoming a preferred method of settling disputes in Hong Kong, if fact as of January 10^th, 2010 solicitors are required by law to inform and explain the availability and differences between mediation and litigation.

This is the direction that dispute resolution will take in Asia, and those that do business in Asia will need to understand the manner in which to handle disputes with a minimum of disruption to business.

Mediation is not a one-size-fits all solution to disputes in China, there are situations when it is a good idea and situations when it is a bad idea.

Mediation is a good idea when;

• You have a solid history of cooperation with the other party
• There are many different parties involved or individual parties where there is a clear distinction about who is responsible for your relationship
  • Mediation works best between two parties that will attempt to be fairly open about their relationship
• There are no hugely overwhelming issues between the parties
  • Mediation works well for smoothing over small bumps in the relationship road, not for overly complex and involved issues
• You have an ongoing relationship with the other party
  • Mediation is not a good option for resolving disputes with a wham-bam-thank you ma’am relationship with a supplier that you are using for a single project.
• The parties BOTH want to reach an agreement
  • If one side is going to be a stick in the mud, they will have a pretty easy time stopping the mediation process

There are also times when mediation will probably be ineffective;

• If the parties have a history of adversarial relations or there is hostility between the two parties.
  • If both parties come to the table looking for a fight, they’re going to find one and nothing will be resolved.
• If the issues in dispute are overly complex or involve many different parties
  • Remember the goal of mediation is for the parties to resolve the disputes themselves, the mediator can only facilitate the parties and act as an independent third party
• If the issues are purely legal issues or one party is forced by requirement to mediate.
  • This is the inherent issue I have with judges requiring parties to mediate, when someone is forced into a situation where they must amicably reach an agreement they will often fail to do so if forced.
• If continuing the dispute is beneficial to one of the parties
  • In a situation where one party would benefit from a long a drawn out mediation, it is possible to entice the opposing party by acting as if you are serious about resolving the problem when in fact they are simply wasting time.
• If there is a significant power imbalance between the two parties.

A well trained mediator should be able to help you work through some small problems.

Their job is the help parties look forward and not dwell on the past.

They should also be able to separate the people involved in the dispute from the problem that is the core of the dispute.

Most importantly they need to be able to help the parties find common points of interest and remember why they are doing business in the first place.

Keep your eyes open and your head on a swivel, its good advice in sports and its good advice for China.

Anyone that has looked into buying real estate in China knows that the pricing can fluctuate wildly.

In my Chinese home town of Shenzhen, this is true like no other city.

Prices for real estate in Shenzhen have risen steadily since I arrived here over five years ago.

While prices for flats in Shenzhen are still not so close to the astronomical prices that flats in Hong Kong command, prices here do rival that of those in Beijing and Shanghai.

Shenzhen is an interesting area because of the proximity to Hong Kong and there is reason to believe that there is a significant flow on so called “hot money” from Hong Kong into China via Shenzhen.

China has taken significant steps to try to avoid the inflow of speculative money by placing tight regulations on the RMB and newer restrictions on the flow of investment capital into the country.

China’s central bank recently stated that they would begin to increase the monitoring of suspected speculative money into and out of the country.

The State administration of Foreign Exchange also announced that they would tighten the regulations on individual persons and the transferring of yuan and foreign currencies between bank accounts.

Some experts have expressed doubt that these new measures would have the desired effect on the inflow of hot money.

Because of China’s relatively low priced real estate, speculative capital will follow the old mantra, where there’s a will, there’s a way.

The problem comes into the picture when inflation begins to pressure China’s central bank and it is forced into making a decision about whether to appreciate the yuan or raise interest rates, neither of which is appealing to the Chinese central government.

The central government would be smart to encourage Chinese investors to begin to acquire more investments internationally in order to avoid the continuing growth of a potential asset bubble in some of the major Chinese cities.

While many cities in China still appear to be interesting places for speculative investment, the question of whether or not the assets are still a good value and at what point the asset bubble may burst and how Chinese investors can protect themselves.

Remember the good ol’ days when you could smoke in the hospital? Well, they are gone. Maybe not as progressive as New York, but a considerable one.  Smoking in China is considered a second sport.

South China’s Shenzhen City plans to fully prohibit the premises of all medical institutions in the city in 2011.

All medical institutions above city and district levels, including military hospitals, will ban smoking from June next year, while community health centers, clinics and private hospitals will impose the ban from December 2010, Yang Guoan, vice director of the city’s health education research institute, said at the meeting.

Anyone caught smoking at these institutions will be fined starting Jan. 1, 2011.

Policies for smoking controls inside the Special Economic Zone are still being studied and the levels of fines to be imposed have yet to be determined.

In addition, all doctors will be expected to record patients’ smoking histories when they visit hospitals for the first time, after the ban is imposed.

I am sure it won’t be missed.

Six months ago Shenzhen removed their once mayor, Xu Zongheng, for “serious disciplinary violations”(China Daily)

Corruption is not uncommon in the ranks of officials but day by day work is being done. A new policy has come about recently:

“Officials whose spouse and children have all emigrated to foreign countries should not take top positions in the Party and government,” said a regulation issued by the Communist Party of China (CPC) Shenzhen committee and the Shenzhen government on Wednesday.

The reasoning behind all this is not to discourage people from moving out of China, but to discourage absconding to those places to in order make off with the big government pay checks.

The Ministry of Commerce has estimated, “About 4,000 corrupt officials fled the country with at least $50 billion between 1978 and 2003.”

How effective will this new policy be? It is hard to say now, but steps are being taken even if they are small ones.

I just moved into a new office in Shenzhen and happened across this little gem.  I have driven past this place a couple times. I never realized what this place was  or rather wasn’t.

It is called St. Mars, but quite similar to the more famous coffee shop Starbucks.  The resemblance is rather close. Same colors, script, umbrellas and even the glass awning over the doors.

My opinion on this is clearly ” hitchhiking” on the Starbucks brand.

Instead of me commenting on this further, I thought I would like to let a friend over at IP Dragon get a hold of this. He is very knowledgeable about IP and Trademark. I believe he could offer a better view on this than i could.

Check him out.

Regulating a stock market is not a simple task, as we discussed in the last post, “The Chinese Stock Market, I’m all in and I make all the rules”. 

There is a fundamental difference between the way in which China regulates its securities market and the way many Western markets are regulated. 

This difference is most observable in the basic functions of the Chinese Securities Regulatory Commission (CSRC) and the Securities and Exchange Commission (SEC). 

The SEC is focused on ensuring compliance to regulations, the CSRC “balances” two responsibilities, ensuring compliance and encouraging growth/development. 

Is this arraignment a classic case of the wolf guarding the chicken coop?

The CSRC is the door keeper to the market, they issue licenses to different types of financial service firms. 

Usually, these are short term, for a year, and the CSRC can control market access and, in effect, regulate the market by controlling these licenses. 

The question that comes into play is how does the CSRC monitor itself internally to ensure that these licenses are issued in way to encourages growth of the overall market and that opportunities for self enrichment are controlled? 

Next week we will discuss some of the recent history in regards to State Owned Enterprises (SOE) and the trouble they have had in reform.