CEPA III - HKGCC WISH LIST

Introduction This submission describes the wish list of the Hong Kong General Chamber of Commerce on the next phase of CEPA (Closer Economic Partnership Arrangement). We shall term this next phase of CEPA "CEPA III", following the implementation of CEPA on 1 January 2004 ("CEPA I"), and the signing of the "Supplementary Agreement to the Mainland and Hong Kong Closer Economic Partnership Arrangement" on 27 October 2004 (commonly known as "CEPA II"). This CEPA III submission is gathered from Chamber members' input, supplemented by the Chamber's own research. It is thus based principally on the experience of the business sector. Implementation of CEPA Thus far the biggest concern about CEPA is its implementation in the mainland. In the case of trade in services, around 700 Hong Kong companies have applied and obtained Hong Kong Service Supplier Certificates, but less than 200 of them have actually started operations in the mainland. Problems such as local protectionism, complicated application procedures, different interpretation of different department, etc., have all become barriers to CEPA's effective implementation. In this submission, the Chamber puts forward recommendations to improve the effective implementation of CEPA through strengthening the third part of CEPA - trade and investment facilitation. The Chamber has always held that trade and investment facilitation is a very important aspect of CEPA. As it was not covered in CEPA II, we recommend that a bigger effort be made to achieve further progress on trade and investment facilitation under CEPA III. We have made suggestions covering: - addressing local protectionism - transparency in laws and regulations - cooperation of small and medium enterprises - intellectual property - product inspection and certification - customs clearance and control point issues - e-business Furthermore, CEPA III provides the opportunity to strengthen the institutional structure to support the ongoing consultation and implementation of CEPA. The Chamber advocates the establishment of standing committees, a dispute resolution mechanism, and a business advisory committee to allow a greater and more transparent degree of participation by the private sector. The Hong Kong-Mainland Joint Businesses Liaison Committee, which the Chamber founded along with The Chinese General Chamber of Commerce, The Chinese Manufacturer's Association of Hong Kong and Federation of Hong Kong Industry can be tasked to collect CEPA related inquiries, to monitor CEPA's implementation by local governments, and to help the Steering Committee handle CEPA-related disputes. If this committee is officially appointed by both the SARG and the Ministry of Commerce, then it could be a very visible way for Hong Kong businesses to seek help and provide input on CEPA matters. Trade in goods Good progress has been made in CEPA I and CEPA II in implementing zero-tariff trade between the Mainland and the HKSAR. In this submission, we propose that the zero-tariff arrangement be broadened by introducing further liberalisation in Rules of origin. Trade in services The Chamber submitted various papers at different stages of the consultation on CEPA I and CEPA II relating to liberalisation of trade in services. While many of them have been reflected in the CEPA I and CEPA II texts, a number of recommendations have not so far been taken up in CEPA. Therefore, while the bulk of this submission contains new suggestions, we have retained some of the more important views from our previous papers in the current submission. This submission thus covers the following service sectors:

http://www.chamber.org.hk/memberarea/chamber_view/dec01.jpg

I. Implementation of CEPA CEPA is widely acknowledged as a good agreement. However, after one year, CEPA's impact has not been as much as originally expected. In the case of trade in services, for example, around 700 Hong Kong companies have applied and obtained Hong Kong Service Supplier Certificates, but less than 200 of them have actually started operations in the mainland. Problems such as local protectionism, complicated application procedures, different interpretation of different department, etc., have all become additional barriers. How to ensure CEPA is effectively implemented is thus the biggest practical concern. This should be addressed at two levels, namely, trade and investment facilitation, and strengthening CEPA's institutional arrangement. Trade and investment facilitation The Chamber has long held the view that in a practical day-to-day sense, Trade and Investment Facilitation is the most important part of CEPA. The new measures to facilitate Trade and investment are suggested as below. Addressing local protectionism Since China's accession to the WTO, remarkable progress has been made in market access and trade liberalisation. However, at the local level, protectionism on the mainland is still very strong. It has become an additional layer of barriers for foreign investors seeking entry into the Mainland. It should be added that local protectionism is a problem not only for Hong Kong investors, but also for Mainland companies themselves. It is not uncommon for a company which has obtained a business license in a city to find itself unable to run the same business in another city, without getting another license from the latter. For SMEs, it is not practical to establish many branches in different cities. As a result, the potential benefit of CEPA cannot be achieved. Local protectionism is manifest in many forms - local taxes, additional documentary requirements, lengthy licensing procedure, etc. It is not a matter of any single practice. To tackle local protectionism, therefore, an overall policy is required, and CEPA, as an all-embracing arrangement, would be a useful vehicle. Through CEPA the Central Government can give the mandate to address various protectionist practices that are happening at the everyday level. This will surely help improve the investment environment and facilitate the implementation of CEPA and WTO. Transparency in laws and regulations All new regulations relating to CEPA's implementation should be published as soon as possible. For example, in the case of direct bonded trucking services between Hong Kong and other provinces, Hong Kong companies are allowed to operate the service under CEPA, yet the procedure and requirement of license application is still not clear. The Mainland authorities should be uniform in their interpretation of the fine points of the policies and establish a mechanism to address specific implementation problems. Cooperation of small and medium enterprises The Mainland authorities should set up a dedicated department to furnish information, and render assistance, to Hong Kong businessmen in the Mainland and answer their enquiries, in addition to a special counter which accords priority to the processing of applications from Hong Kong businessmen. Intellectual property Despite a full range of laws on intellectual property rights (IPR) protection, their enforcement is haphazard and often ineffective. In practice, the IPR law does not generally have a great deterrent effect. The problem is sometimes exacerbated by the complicated and sometimes inconsistent application of court procedures on IPR cases, e.g. related to expert witness or evidence taking, with the result that IPR infringement is still rampant. CEPA III should provide an opportunity to launch a dedicated effort to boost IPR enforcement. Product inspection and certification The product standards in Hong Kong and the Mainland should be harmonised. Internationally recognized standards for product inspection and certification should be made use of, to simplify procedures and improve efficiency. One way to expedite harmonisation of standards is to entrust the inspection and certification to established certification bodies – the HKGCC being one. These bodies can be designated as authorised agencies to assist in the inspection and certification of products that cross the two jurisdictions. Custom clearance and control point issues Every control point in the Mainland involves a number of departments such as customs, immigration, health, quarantine, traffic, etc. If communication among these departments can be strengthened, the border clearance process can be much more efficiently run. For instance, if information provided by consignors and traders can be shared among various departments, much duplication could be avoided and time and cost saved. Mainland quarantine procedures are not business friendly. For instance, the Mainland mandates dis-infection of empty containers, which is not required in Hong Kong or other neighboring territories. A specific suggestion relates to the daily working hours of the cargo loading areas (i.e. operated by the factories) and the Shenzhen/Dongguan Customs. These should be extended to allow time for cross-boundary cargo trucks to make an additional round trip per day. Electronic business Application of e-commerce and Internet in the cargo trade between Hong Kong and the Mainland should be promoted. Sound infrastructure for e-commerce should be put in place and aligned with that of Hong Kong to enable speedy computerised processing for export-oriented enterprises. Institutional Arrangement The institutional structure provided under CEPA has shown to be simple and effective. As implementation issues begin to surface, the ongoing administration of CEPA-related matters will become more complicated, especially in the areas of trade in services and trade and investment facilitation. The Chamber believes it is time, under CEPA III, to strengthen the institutional structure of CEPA. Our suggestions include the following. Establishment of standing committees CEPA Article 19 provides for the establishment of working groups under the Steering Committee. As CEPA is an ongoing process, it would be appropriate for the bodies under CEPA to be of the nature of "standing committee" rather than ad hoc groups. Consideration should therefore be given to establishing standard committees in the following areas: - Trade in goods and Rules of Origin - Trade in services - Trade and investment facilitation Monitoring implementation Despite the many problems encountered in implementation, CEPA has not so far given rise to major disputes. This is no doubt a reflection that CEPA has truly lived up to the spirit of cooperation. The best way to ensure that such spirit of cooperation lives on is to institutionalise it. We recommend that the Hong Kong-Mainland Joint Businesses Liaison Committee, which the Chamber founded along with The Chinese General Chamber of Commerce, The Chinese Manufacturer's Association of Hong Kong and Federation of Hong Kong Industry can be tasked to collect CEPA related inquiries, to monitor CEPA's implementation by local governments, and to help the Steering Committee handle CEPA-related disputes. If this committee is officially appointed by both the SARG and the Ministry of Commerce, then it could be a very visible way for Hong Kong businesses to seek help and provide input on CEPA matters. For the longer term, to strengthen the institutional structure, it would be desirable to begin examining the details of a system of enforcement, appeal, and dispute resolution. II. Trade in Goods The Chamber considers that very good progress has been made in CEPA I and CEPA II in implementing zero-tariff trade between the Mainland and the HKSAR. Together, a total of 1087 items under the Mainland's tariff codes are now eligible for zero tariff treatment (374 from CEPA I and 713 from CEPA II). From the experience of CEPA I and CEPA II, we have the following observations. First, in terms of tariff saving, the effect of CEPA has not been as much as originally estimated by the government or the Chamber. As of the end of November 2004, a total of 2711 CEPA-Certificates of Origin have been issued, representing an export volume of $1billion. While this is a sizeable amount, it is minor in comparison to Hong Kong's total domestic exports. However, this does not mean CEPA's zero-tariff provision is not attractive to industry, as demonstrated by the huge jump in the number of zero-tariff items under CEPA II - 713 as compared to 374 under CEPA I. What is more, the CEPA I list had been drawn up mostly by the government, while all products under CEPA II were nominated by industry itself. This is a good reflection of how useful and substantive CEPA is to industry. We would add that the enlarged list of zero-tariff products under CEPA II is, strictly speaking, not a further liberalisation, but an implementation of the provisions of CEPA I. Under the current arrangement for zero-tariff application and verification, the range of products for zero-tariff treatment should continue to be broadened. To move forward in liberalising trade in goods, we recommend that the HKSAR government take advantage of the CEPA III Consultation to seek further liberalisation in Rules of Origin. There are two aspects of liberalisation in Rules of Origin which should be pursued. Firstly, for products for which ROO are determined by "principal processes", we suggest that a new application procedure be opened up to enable manufacturers to apply for a change to the ROO. Such application procedure should enable possible relaxation to be considered in determining the principal processes under the ROO. Secondly, for products where ROO are based on percentage value-added, we recommend that the percentage value-added be revised from the current 30% to 25%. From the experience of CEPA I, it is clear to us that there will be no massive surge in export from Hong Kong to the Mainland, however liberalised the zero-tariff regime is. The purpose of the above measures is thus to help enhance Hong Kong industry's ability to produce exports of higher value and greater relevance to the Mainland market. It will not affect Mainland industry in any adverse way. III. Trade in Services FINANCIAL SERVICES Insurance Main request: capital requirement for market access High capital requirement is a deterrent to investors. Already, the return on capital tends to be constrained by joint venture requirements. A big capital requirement will further lower the return on capital. This is especially unfavourable to smaller players like those from Hong Kong, which have comparative advantage in service quality and expertise rather than in asset size. Registered capital requirements for insurers in China are rooted in a law that pre-dates China's accession to the WTO. It mandates initial requirements of RMB 200 million to RMB 500 million. Further, depending on the number of branch locations, these requirements could go as high as RMB 1.5 billion. These regulations were established in 1995, when the Chinese insurance market was relatively closed. Since then, great change has taken place in the Chinese insurance market, with many more Chinese and foreign firms launching operations. Eventually, China will have to be regulating global insurers with global assets, not just domestic insurers with domestic assets. This means that its prudential regulation needs to reflect international standards and place a greater emphasis on insurer solvency than on registered capital. Thus it is time to relax the registered capital requirements, starting with Hong Kong operators through CEPA. The Mainland's concern for small domestic players can be alleviated through a gradual programme of reform towards a risk-based solvency regulatory regime, thus enabling it to maintain market soundness and lower capital requirement at the same time. This could begin with a tiered structure of capital requirements relating to the scale of business of large and small providers and calibrated to risks being covered, thus making it possible for lower capital requirement to be applied to Hong Kong providers. Capital requirement: national treatment In non-life services, there is an unequal treatment in terms of branch office capital requirement, in that for the same level of capital required (RMB200 million), foreign providers obtain a single city license whereas a local company gets a license for a whole region. A gradual way to liberalise this would be to offer Hong Kong providers national treatment through CEPA. Repatriation and capital replenishment According to a new requirement under the Foreign Exchange regulations effective since November 2002, any remittance of reinsurance premiums in hard currency is taken as eroding the capital base of an insurer, which therefore has to be replenished. Insurers are thus required to create a fund of US$10 million as a base before doing foreign currency business, and the parent company has to constantly replenish this fund. In relation to branches, the funding required is US$5 million if working capital is above RMB500 million, or US$2 million if below. It is hoped that through CEPA Hong Kong providers can be exempt from this requirement. Banking The main request is about earlier liberalization of RMB business for Mainland local residents. According to China's WTO Protocol of Accession, foreign banks would only be allowed to conduct Renminbi business with local residents by the end of 2006 or in early 2007. For CEPA III, Hong Kong banks would like to be able to conduct Renminbi business with local residents as early as possible after 1st January, 2005. The current working capital requirement for a branch conducting a full range of RMB and foreign-currency business with all customers (including local enterprises and residents) in the Mainland is RMB500 million. This is in excess of what is required to effectively run such businesses, which should about RMB300. In order to improve the efficiency of cash flow, the working capital requirement for a branch of Hong Kong banks should be lowered from RMB500 million to RMB300 million. In order to expand the business scope in the Mainland, Hong Kong banks would like to conduct intermediate businesses such as selling bonds and funds in the Mainland. Credit card is one of the major businesses of the banks in Hong Kong. Hong Kong banks would thus like to issue dual currency (Renminbi and US Dollar) credit cards in the Mainland to all customers including local corporations and residents. In Hong Kong, there is no interest tax for individuals when they deposit RMB in Hong Kong banks, but there is an interest tax in the Mainland. This difference means Hong Kong banks in the Mainland cannot attract RMB deposit from Hong Kong residents. It is suggested that interest tax should be waived for Hong Kong residents who have deposits with China branches of Hong Kong banks. Currently, each branch of a Hong Kong bank in the Mainland should be qualified individually under the statutory required ratios (e.g. liquidity ratio, capital adequacy ratio etc.). This does not help the management of multi-branches. Hong Kong banks should be allowed to calculate the statutory required ratios based on the consolidated account of all Mainland branches, instead of individual branches separately. Besides licensed banks and restricted licensed banks, deposit-taking companies are authorized institutions under the Hong Kong Monetary Authority in Hong Kong. Currently, Hong Kong deposit-taking companies cannot set up business operations in the Mainland. It is recommended that under CEPA III, Hong Kong deposit-taking companies will be allowed to set up operations in the Mainland and to provide the multifunctional deposit card services. Securities Asset management: lowering capital requirement The final rules on the Establishment of Fund Management Companies with Foreign Investment Participation require a foreign institution seeking to enter into a joint venture with a domestic Chinese firm to have no less than RMB 300 million. The requirement is excessively high for Hong Kong-based asset management firms. There may be asset management firms in other jurisdictions which belong to large banks or broker dealers, and those firms will not find it difficult to meet high capital requirements. For Hong Kong, however, the industry is expertise-based and practitioners may be highly successful without being big companies. In contrast to the business of a bank or broker-dealer, the business of managing assets does not require large amounts of capital to protect investors. The business of asset management is not capital intensive, and client assets typically are not in the custody of the asset manager and are not at risk if the asset manager experiences financial reverses. Such level of capital requirement on asset managers is not typical in other jurisdictions. The main request for the asset management industry is, therefore, to reduce the level of capital requirement for fund managers. Market expansion measures Under CEPA II, Hong Kong intermediary agencies can set up joint venture future brokerage companies in the Mainland with less than 49% ownership, with same business scope and capital requirements as those for Mainland enterprises. With that provision already in place, we would seek through CEPA III to extend it to other securities service providers besides brokerage. Furthermore, qualified Hong Kong firms with substantial operating history (say ten years) should be allowed to have the ability to do more in China, to provide services direct rather than through a joint venture. They should be allowed wider scope of activities, e.g. to include underwriting, secondary trading of government and corporate debt and equity, hybrid mortgage products, derivative trading and asset management. In terms of Mainland access to Hong Kong, although there is no barrier in Hong Kong, there is much room for expansion in the Hong Kong market for Mainland securities firms. In the same way as Article 13 encourages Mainland banks to expand their business in Hong Kong, it will be a welcome move for Hong Kong if the Mainland can encourage its own securities industries to expand their presence in the SAR, e.g. more Mainland securities companies to establish and list in Hong Kong. Moreover, a two-way market expansion between Hong Kong and the Mainland can be achieved through liberalisation of the conditions for QFII and QDII (qualified foreign institutional investor and qualified domestic institutional investor). The long term goal would be to see the full participation of Hong Kong investors, including individual investors, to participate in the A share market using RMB, but in the meantime, an in-principle encouragement through a provision similar to CEPA Article 13 would be useful. IT AND TELECOM SERVICES Computer and IT Services Market access into the IT services sector is restricted in the Mainland. The exception is "consultancy service related to hardware installation", for which there is no restriction. Under CEPA II, Hong Kong service suppliers are allowed to apply for computer information system integration qualification certification, but the business scope and ownership of computer and IT services are still not defined. In terms of services, Hong Kong firms are more interested in software and data-related businesses to which a lot of restrictions apply. Software services According to China's WTO commitment, only joint venture is allowed for "software implementation". This is too restrictive for Hong Kong software industry, which has an abundance of expertise in a wide range of software services. Hong Kong firms would therefore like to seek to be able to establish wholly-owned subsidiaries in software services through CEPA, especially including: - development of business software - digital entertainment - computer-aided design and manufacturing services - computer-aided planning and engineering design - software implementation and consultancy Data services In terms of data services, there is no commitment under the WTO accession protocol except for input preparation, for which joint venture is allowed. As data base service is one of the strengths of the Hong Kong computer services sector, CEPA now provides an opportunity for market access to be granted for these services to Hong Kong providers. Specifically, for data base development and management, Hong Kong firms would benefit from the opening of the market to allow them to establish commercial presence. Recognising that data base services is regarded as a comparatively sensitive sector, we would first seek to have joint-venture arrangement, with majority ownership by Hong Kong companies. This should apply to the broad range of data base services, but if there is a need, the services can be more specifically described as covering: - business-sector oriented data base development and management - business application of geographical information system For Hong Kong companies providing data processing (as opposed to "development") services, as the subject matter is less sensitive, wholly-owned businesses should be allowed. Telecommunications CEPA I only provides a narrow three-month time advantage of WTO commitments for value-added telecommunications services. CEPA III now offers an opportunity to broaden Hong Kong operators' contribution and participation in the Mainland market. Currently, the PRC's WTO commitments provide for the progressive liberalization of three baskets of services. These baskets are Value Added Services (VAS), Basic Telecommunications Services (i.e., network and fixed line services) and Mobile Services (including both voice and data). Each basket has its own liberalization schedule/time frame. In addition, each basket has a geographic liberalization schedule (3 cities, 17 cities, nationwide) and a foreign ownership liberalization schedule (% of foreign ownership allowed). This can be shown in the following table:

http://www.chamber.org.hk/memberarea/chamber_view/dec02.jpg

As shown above China's commitment with respect to value-added services (VAS) has been fully rolled out. The WTO VAS commitment are for specified services provided over the network of a fixed or mobile licensee. China's WTO commitments indicate that VAS includes email, voice mail, on-line information and database retrieval, EDI, store and forward fax, code and protocol conversion, and on-line information and data processing. Overall, the WTO list of VAS is relatively limited and has been narrowly construed by the Ministry of Information Industry (MII). Services not included in the list are generally viewed by the MII as not being liberalized as VAS under the WTO commitments. In addition, even within the categories of VAS that are open to foreign investment (such as on-line information retrieval and processing), foreign invested joint ventures are not eligible to apply for permits to provide certain specific types of content and services (such as online games) that domestic firms are eligible to apply for and routinely obtain. In terms of fixed network and mobile services, the WTO fixed network commitment covers networks as well as a list of domestic and international voice and data services whether provided on a network or resale basis. It also includes IP telephony. Mobile is characterized by terminal mobility, cell switching and roaming; it includes voice, data and video images. Fixed network and mobile sectors will not see the WTO commitments met for several years. In these sectors, there are market access (geographical coverage, foreign ownership) and timeframe issues to contend with. For VAS, foreign ownership remains an issue as does the definition of VAS and the limits on VAS businesses open to foreign investment. In addition, CEPA also provides an opportunity for interconnection issues to be addressed. Geographical coverage and timelines Geographical coverage is of particular importance to the telecom industry, in terms of user expectations/requirements, costs and competitiveness. Unfortunately, under China's WTO commitments, geographical restrictions will apply until the end of 2006 (for mobile voice and data) and the end of 2007 (for fixed network services in both domestic and international telecom, including voice, packet switch data, circuit switch data, fax and private leased circuit), although VAS is no longer subject to geographic restrictions. The aim for Hong Kong telecom operators would thus be to negotiate for complete elimination of geographical restrictions immediately. If this could be achieved and become effective soon after January 2005, it would give Hong Kong firms a time advantage of two to three years. Ownership and timelines Under China's WTO commitments, foreign service providers will be allowed: (a) 49% maximum ownership in the fixed network sector by 11 December 2007; and (b) 49% maximum ownership in the mobile sector by 11 December 2006. This contrasts with the treatment for VAS where foreign service providers have been allowed 50% maximum foreign ownership from December 2003. There is thus room for Hong Kong operators to seek a time advantage of up to three years, if these percentage provisions for fixed and mobile can apply immediately instead of by the December 2006 and December 2007. Equally valuable would be an increase in foreign ownership allowed, especially of the "extra 1%" - the relaxation of ownership from 49% to 50% for basic fixed and mobile service providers. This will enable Hong Kong operators be equal partners with their Mainland joint venture counterparts. In terms of VAS, as resale services, the maximum foreign ownership should be raised to 100% to reflect global best practices. If this cannot be achieved immediately, as a start, it should be raised to 51%. We do not underestimate the difficulty in getting the "extra 1%" or more for basic fixed and mobile services. If it were deemed too difficult and the ownership level must remain at 49%, Hong Kong entities could still negotiate for a more effective level of management participation. Definition issues Value-added services enjoy a higher level of liberalization than basic services. What constitutes VAS is thus an important definitional issue. In this regard, the negotiating objective for CEPA III should be to move services from the more restrictive basic/fixed category to the less restrictive VAS category (or to have basic services regulated as VAS, as is the case with paging). Indeed, the services covered by the VAS commitment are rather limited. The fixed network category includes not only networks/facilities but also a large number of other services provided on a resale basis. Regulating these basic services as VAS means, among other things, that the Mainland partner in a joint venture that provided these services would not have to be a state-owned enterprise; the required investment would be at the level required for VAS and not at the much higher levels required for basic services; the maximum percentage foreign ownership would be 50% instead of 49%; and such ownership would be permitted now on a nationwide basis instead of several years in the future. Specifically, we suggest that the full range of Internet Protocol (IP) based services and resale-based services should be classified (i.e., regulated) as value-added services when they are offered by Hong Kong telecom service providers. The latter should be permitted to operate the full range of VAS businesses that domestic VAS companies are permitted to operate. To the extent poss