Legal Aspects of Retail and E-Commerce in China

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Legal Aspects of Foreign Investment in the

RETAIL SECTOR AND IN E-COMMERCE

In the Peoples Republic of China

By T.K. Chang*

SYNOPSIS

7.01 Introduction

7.02 Development of Foreign Investment in the Retail Sector

7.03 Summary of Current Law

7.04 Encouraged Wholesaling and Retailing Services

7.05 Foreign Invested Commercial Enterprises

[1] Commercial Sector Measures

[2] Implementation of the Commercial Sector Measures

7.06 Retailing of Certain Specific Products

[1] Publications: Books, Newspapers, Magazines and

Electronic Publications

[2] Audio-visual Products: DVDs, Video Cassettes and

Sound Recordings

[3] Petroleum

[4] Pharmaceuticals

7.07 Favored Treatment of Hong Kong and Macao Investors

7.08 Direct Selling

7.09 E-Commerce

[1] Telecommunications Regulations

[2] Internet Music Services

[3] Variable Interest Entity (VIE) Structure

[4] Electronic Payment Systems

7.10 Conclusion

*T.K. Chang (Ta-kuang) is the managing partner of the New York Office of Zhong Lun Law Firm,a leading private law firm based in China, with offices in six cities in China and London, Tokyo, Hong

Kong and New York. Mr. Chang is a graduate of Harvard University (A.B. 1977, M.B.A. 1983, J.D. 1983)

and Yale University (M.A. 1979). He began doing business in China in 1981, and has been practicing law

for over 30 years in New York, Greenwich, Hong Kong and Beijing. This article is adapted from Chapter

V: (7) inDoing Business in China (2012, Juris Publishing, and is the updated 3rdEdition of the Chapter.

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7.01 IntroductionRetail sales in China in 2010 totaled 13.7 trillion RMB, an increase of 18.5%

from 2009.1

The total value of electronic commercial transactions in China was over 4.5

trillion RMB in 2010, of which the total value of Internet retail transactions was 523.1

billion RMB.

2

As of June 30, 2011, China had 485 million Internet users, of whom 173million used the Internet to make online purchases, and 153 million made payments

online. These figures hint at the enormous untapped potential for foreign investment in

the retail sector and in e-commerce in China.

Today, most of the previous legal restrictions on foreign investment in the retail

sector have been lifted. All of the market-opening concessions made by China in order to

be admitted into the World Trade Organization (WTO) in 2001 have been phased in. In2011, a new Foreign Investment Industrial Guidance Catalogue was promulgated, under

which various additional product or services categories have been removed from the lists

of those that are restricted or prohibited for foreign investment, including the retailing of

autos and franchising.

Importantly, online music services will now be open for foreign investment.

Foreign investment will also be permitted in the importation and master distribution ofbooks, newspapers and periodicals, and the importation of audio-visual products and

electronic publications.

With respect to e-commerce, Internet sales is classified as an industry that

is restricted for foreign investment, rather than prohibited for foreign investment like

many other segments of Chinas Internet market. Yet, surprisingly and perhaps ironically,many major e-commerce companies that are thought of as indigenously Chinese operate

in China under the same legal regime applicable to all foreign invested enterprises. This

is because many of them used foreign companies to list their stock abroad, or becausethey themselves are substantially owned by foreign companies.

Thus, for example, among the major Chinese e-commerce companies,

Alibaba.com and the parent company of Dangdang.com were both incorporated in theCayman Islands, and Joyo.com was incorporated in the British Virgin Islands. Moreover,

Yahoo, Amazon and ebay each held substantial ownership in Alibaba.com, Joyo.com and

Eachnet.com, respectively. These e-commerce companies are therefore subject to thesame legal restrictions on foreign investment in the Internet sector applicable to all other

foreign investors.

The workaround solution to this problem was the so-called variable interest entity

(VIE) structure, in which the required government licenses are held by domestic

Chinese companies, but the actual operations are run by and the economic benefits accrue

1 Blue Book Annual Report on Chinas Commercial Sector (20102011), Chinese Academy of Social

Sciences, Institute of Finance and Trade Economics and the Li & Fung Research Centre, June 2011.2 Guiding Opinion Concerning the Development of Electronic Commerce under the 12 th Five Year Plan,

issued by the Ministry of Commerce, October 19, 2011.

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to the foreign investor. In September 2011, however, the legality of the VIE structure

was thrown into considerable doubt when it was reported that the Chinese government

may crack down on VIE structures that circumvent Chinese law.

Major foreign retailers such as Walmart and Carrefour have in recent years

experienced difficulties in China that often appear to be overtly politicized. Others suchas Best Buy and Home Depot have retreated in the face of fierce local competition. Yet,

despite these setbacks, no global company can afford not to be a player in China, which is

and will continue to be one of the most important retail markets in the world.

7.02 Development of Foreign Investment in the Retail Sector

Walking through the ostentatious splendor of a Shanghai shopping mall, one caneasily forget that the retail sector used to be one of the most restricted sectors for foreign

investment in China. The author can still remember in 1985 being asked by our then

client, the Sheraton Great Wall Hotel in Beijing, whether it would be legal under Chinese

law for a well-known international luxury goods maker to open up a small storefrontwithin the hotel to sell items to foreign tourists. The answer was: although published

Chinese law was silent on the subject, foreign investment in the retail sector was in effect

prohibited, according to unpublished internal government regulations.

But the ambitious executive in charge of the client reached exactly the opposite

conclusion. He decided that the only way to succeed in China was to act according to therule thatwhat is not explicitly prohibited is therefore permitted. The clients attitude

was, lets push the envelope, so that by the time that the government bureaucrats find out

about it, it is already afait accompli that is generating tax revenues.

That, in essence, encapsulates the history of the development of foreign

investment in the retail sector in China. Between Chinas opening in 1978 and 1992,foreign investment in the retail sector was prohibited by the Chinese government.

Chinese-foreign joint ventures were permitted to sell in China limited quantities of the

products that they themselves manufactured in China, and only if they were able to

maintain a balance between their foreign exchange outlays and receipts. But otherwise,foreign invested enterprises were not permitted to engage in any direct retail sales to

Chinese customers.

In 1992, the PRC State Council issued the Provisions on Investment by Foreign

Merchants in Retail Commerce.3

Under these Provisions, six major cities including

Beijing and Shanghai and the five Special Economic Zones were each permitted toestablish on a trial basis one or two Chinese-foreign joint ventures engaged in retailing.

Each trial joint venture store must be individually approved by the central government.

Despite these severe restrictions, hundreds of foreign invested retail stores soonproliferated across China. Foreign retailers, including Carrefour and major Taiwan and

3 Provisions on Investment by Foreign Merchants in Retail Commerce, issued by the State Council,

announced on November 23, 1992.

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Hong Kong chains, just went ahead and opened up stores throughout the country, based

upon the approvals granted by the local governments in which such stores were located.

The State Council tried repeatedly to clamp down on this open defiance of central

government authority.4

For example, it ordered 199 foreign invested stores to be totally

restructured, and it revoked the business licenses of another 36 foreign invested stores,which were ordered to shut down immediately.5

These efforts were only partially

successful, however, as local officials protected the stores under their jurisdiction,

because their career advancement depended upon local tax receipts and gross economic

activity.

The turning point came in 1999, when the U.S. and China, after years of

negotiations, signed the Agreement on Market Access, paving the way for Chinas entryinto the WTO.

6As the price of admission into the WTO, China had to agree to open

many sectors of its economy to foreign investment, including the retail sector. Although

China still had to reach agreement with all the other members of the WTO before it could

be admitted, the agreement between the U.S. and China formed the bulk of Chinasmarket-opening concessions.

China was formally admitted into the WTO in 2001, pursuant to its Protocol ofAccession.

7Attached to the Protocol were detailed schedules and annexes that contained

the specific commitments made by China to remove restrictions on foreign investment in

multiple industry sectors, including on distribution services.

An explanation on terminology is in order here. The Accession Protocol, in line

with WTO parlance, uses the general rubric of distribution services to refer to the fivetypes of services: retailing, wholesaling, direct selling, franchising and commission

agents services. In practice, however, there is significant overlap among all these terms,

and usage in the Protocol and in Chinese regulations is often inconsistent. To avoidneedless confusion, this Chapter will use the term retail sector to refer generally to all

of the above, and will also often combine discussions of retailing and of wholesaling.

China agreed under the Accession Protocol to open up its retail sector to foreigninvestment according to a schedule phased in over the next five years. But by December

2004, three years after WTO entry, most of the previous legal requirements imposed on

4See,Notice Concerning Issues Relating to the Rectification and Restructuring of Non-Trial Project

Foreign Invested Commercial Enterprises, issued by the General Office of the State Council, August 5,1997.5 Notice Regarding the Issuance of the Name Lists of the Rectified and Restructured Non-Trial-Project

Foreign Invested Commercial Enterprises, issued by the Ministry of Foreign Trade and Economic

Cooperation, State Development and Planning Commission and State Administration for Industry and

Commerce, August 10, 1998.6 Agreement on Market Access between the Peoples Republic of China and the United States of America,

signed on November 15, 1999.7Accession of the PRC, Decision of 10 November 2001, Protocol on the Accession of the PRC, World

Trade Organization, 01-5996, November 23, 2001.

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foreign invested retail enterprises had been repealed, including on their geographical

location, number, shareholding structure and form of investment.

In April 2007, the U.S. brought a case before the Dispute Settlement Body of the

WTO with respect to Chinas

measures that restrict market access for or discriminate against foreign

suppliers of distribution services for publications (e.g., books, magazines,

newspapers and electronic publications) and foreign suppliers of audio-

visual services (including distribution services) for audio-visual homeentertainment products.

8

In August 2009, the three-person panel formed by the WTO issued a 499-page decisionin favor of the U.S.,

9which China then appealed. In December2009, the WTO

Appellate Body issued a 195-page report in favor of the U.S.,10

which was officially

adopted on January 19, 2010. Subsequently, China agreed with the U.S. to implement

the WTO ruling within 14 months from the date of adoption of the report.

11

As part of the implementation of the WTO ruling, the Chinese government issued

in December 2011 the latest Foreign Investment Industrial Guidance Catalogue.12

The2011 Catalogue supersedes the previous Foreign Investment Catalogue issued in 2007.

13

In compliance with the WTO ruling, the Chinese government also amended various

regulations concerning the administration of the publications and audio-visual productsindustries.

7.03 Summary of Current Law

To make this Chapter more useful and practical for businesspeople and lawyers,

below is a summary of the current law on foreign investment in the retail sector.

Foreign investment in China is regulated generally under a periodically revised

Foreign Investment Industrial Guidance Catalogue, which classifies industrial sectors into

those that are Encouraged, Restricted or Prohibited for foreign investment. The latest

8 Request for Consultation by the U.S., ChinaMeasures Affecting Trading Rights and Distribution

Services for Certain Publications and Audio-visual Entertainment Products, World Trade Organization

(WT/DS363), 07-1499, April 16, 2007.9 ChinaMeasures Affecting Trading Rights and Distribution Services for Certain Publications and Audio-

visual Entertainment Products, World Trade Organization (WT/DS363), Report of the Panel, 09-3798,August 12, 2009.10

See, Footnote 9, Report of the Appellate Body, 09-6642, December 21, 2009.11See, Footnote 9, Status Report by China Addendum, 11-5707, November 8, 2011.12 Foreign Investment Industrial Guidance Catalogue (Amended 2011), issued by the National

Development and Reform Commission and Ministry of Commerce, issued December 24, 2011, effective

January 30, 2012.13 Foreign Investment Industrial Guidance Catalogue (Revised 2007), issued by the National Development

and Reform Commission and Ministry of Commerce, October 31, 2007, effective December 1, 2007.

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Foreign Investment Catalogue was issued in December 2011, and went into effect

January 30, 2012.

The 2011 Foreign Investment Catalogue classifies as Encouraged for foreign

investment the wholesaling and retailing industries of modern logistics, such as common

delivery of general merchandise and refrigerated delivery of fresh and agriculturalproducts, etc., and related technical services and village chain delivery.

Certain wholesaling and retailing industries remain under the Restricted Class for

foreign investment under the 2011 Foreign Investment Catalogue. Importantly, however,a number of product and services categories under the Restricted Class in the previous

Foreign Investment Catalogue issued in 2007 have been removed. Thus, the previous

restriction on foreign investment has been lifted for the retailing of autos and forcommercial companies involved in franchising operations, entrusted operations or

commercial management.

Significantly, the 2011 Catalogue also removes music from the list of Internetbusinesses Prohibited for foreign investment. Thus, Internet music services, including the

electronic distribution of sound recordings, will now be open for foreign investment.

In accordance with the WTO ruling, the importation and master distribution of

books, newspapers and periodicals are no longer prohibited. Foreign investment is also

permitted in the importation of audio-visual products and electronic publications. Thedistribution of audio-visual products (excluding motion pictures) still must be carried out

in the form of Chinese-foreign cooperative joint ventures, but the Chinese party is no

longer required to be the controlling shareholder.

Foreign investment in the retail sector shall be carried out using an investment

vehicle called the foreign invested commercial enterprise. The foreign investedcommercial enterprise can be in the form of a wholly foreign-owned enterprise, a

Chinese-foreign equity or cooperative joint venture, or a partnership enterprise.

Restrictions remain on foreign investment in direct selling, i.e., selling throughsales representatives by companies such as Avon and Amway. Mail order sales also

remain in the Restricted Class for foreign investment.

The procurement and purchase of grains is in the Restricted Class for foreign

investment. In addition, restrictions will continue on the wholesale, retail and

distribution () of grains, cotton, vegetable oils, sugar, tobacco, crude petroleum,

agricultural chemicals, agricultural films and chemical fertilizers. In these product

categories, the Chinese party must hold the controlling shareholding in chain stores withmore than 30 outlets that sell different types and brands from multiple suppliers.

The construction and operation of large scale agricultural products wholesalemarkets is also restricted for foreign investment. And in the construction and operation

of gas stations, the Chinese party is required to hold the controlling shareholding in any

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gas station chain established by one foreign investor that has more than 30 gas stations

selling refined petroleum of different types and brands from multiple suppliers.

The Chinese party must hold the controlling shareholding in shipping agency, and

foreign investment in ocean shipping tally must be carried out in the form of equity joint

ventures or cooperative joint ventures.

Hong Kong and Macao investors are granted special favorable treatment for their

investments in the retail sector. For example, Hong Kong and Macao investors are

permitted to establish wholly foreign-owned enterprises that engage in the retailing ofpharmaceuticals, agriculture chemicals, agricultural films, chemical fertilizers, vegetable

oil, sugar and cotton, and that have chains with more than 30 shops selling different

brands from different suppliers. They are also permitted to establish wholly foreign-owned enterprises engaged in the distribution of audio-visual products (including post-

motion picture products).

7.04 Encouraged Wholesaling and Retailing Services

The 2011 Foreign Investment Catalogue revises the scope of wholesaling and

retailing services that are Encouraged for foreign investment. According to the previous2007 Foreign Investment Catalogue, the wholesaling and retailing services Encouraged

for foreign investment were:

Article VI. Wholesaling and Retailing Industries

1. Delivery of general merchandise

2. Modern logistics14

Under the 2011 Foreign Investment Catalogue, the industries that are Encouraged for

foreign investment have been revised to:

Article VI. Wholesaling and Retailing Industries

1. Modern logistics, such as common delivery of general

merchandise and refrigerated delivery of fresh and agriculturalproducts, etc., and related technical services

2. Village chain delivery3. Construction and operation of pallet and container unit dual

use systems15

14See, Footnote 13, Foreign Investment Industrial Guidance Catalogue (2007), Encouraged Class, Article

VI: (1) and (2).15See, Footnote 12, Foreign Investment Industrial Guidance Catalogue (2011), Encouraged Class, Article

VI: (1) and (2).

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The scope of Encouraged industries covered by the 2011 Foreign Investment Catalogue

appears to be narrower than the broad categories set forth in the 2007 Foreign Investment

Catalogue.

The more precise focus of the 2011 Foreign Investment Catalogue perhaps

reflects the enormous progress that China has made in recent years in building up a moremodern logistics and distribution, which had been one of the weakest parts of Chinas

retail infrastructure. For reasons of space and coherence, this Chapter will focus on the

retail sector, and will not present a detailed discussion of foreign investment in the

logistics industry, which perhaps belongs more appropriately in the Chapter on thetransportation industry.

7.05 Foreign Invested Commercial Enterprises

[1] Commercial Sector Measures

In 2004, the Ministry of Commerce established a new categorization ofinvestment vehicles for foreign investment called the foreign invested commercial

enterprise. Pursuant to theMeasures for the Administration of Foreign Investment in theCommercial Sector(the Commercial Sector Measures), foreign investment in thecommercial sector shall be carried out by means of the foreign invested commercial

enterprise.16

The foreign invested commercial enterprise can be in the form of either a wholly

foreign-owned enterprise, a Chinese-foreign equity joint venture or a Chinese-foreign

cooperative joint venture. As a limited liability company, the foreign investedcommercial enterprise is subject to the basic requirement for minimum registered capital

under the PRC Company Law of 30,000 RMB. In practice, however, the approval

authorities have generally required much higher amounts in registered capital, dependingupon the locality and types of operations.

In 2010, regulations issued by the State Council went into effect that permitted

foreign companies and foreign individual to establish partnership businesses in China.17

Such partnership enterprises may also engage in the retail business.

The term of operation of foreign invested commercial enterprises may not ingeneral be longer than 30 years, or 40 years for enterprises located in the western and

central regions of China. The foreign investor may be a company, enterprise, other

economic organization or an individual. The Commercial Sector Measures encourageapplication by foreign investors that are strong economically, that have advanced

commercial operation management experience and distribution know-how, and that

possess broad international sales networks.

16 Measures for the Administration of Foreign Investment in the Commercial Sector, issued by the Ministry

of Commerce, April 16, 2004, and effective June 1, 2004.17 Measures for the Administration of Foreign Enterprises or Individuals Establishing Within China

Partnership Enterprises, issued by the State Council, November 25, 2009, effective, March 1, 2010.

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Existing foreign invested enterprises may apply to broaden their approved scope

of business to include retailing and wholesaling.18

Foreign invested commercial

enterprises may also engage in the wholesale business, including the wholesaling ofmerchandise, commission agency (other than auctioneering), import and export and

related ancillary services. Enterprises that engage in auctioneering must comply with

the relevant laws governing auctioneering.

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[2]Implementation of the Commercial Sector Measures

The Commercial Sector Measures outline the procedures for the approval of

foreign invested commercial enterprises by both the central government and localgovernments, perhaps reflecting the previous experience of unauthorized approvals by

local governments. These bureaucratic procedures soon resulted in a backlog of

applications, which led the Chinese government to issue a series of regulations settingforth in detail the application procedures for foreign invested commercial enterprises.

20

These regulations list the documents that must be submitted for the different

forms of foreign investment in the commercial sector, including when a foreign investor

makes an investment in a domestic retail enterprise, or when a non-retail foreign investedenterprise adds distribution to its business scope.

21Provincial authorities shall issue

approval or rejection of such applications within one month, while the Ministry of

Commerce has an approval time limit of three months.22

The Chinese government has continued to simplify such application procedures,

devolving many approval powers to local governments and development zones.23

Provincial governments were eventually given the authority to approve all foreigninvestment commercial enterprises, other than non-store retailing by television,

telephone, mail order, Internet or vending machines, or the wholesaling of audio-visual

products or the sale of books, newspapers and periodicals, which must still be approved

by the Ministry of Commerce.24

7.06 Retailing of Certain Specific Products

18Notice Concerning the Issue of Foreign Invested Non-Commercial Enterprises Adding Sale and

Distribution to Business Scope, issued by the Ministry of Commerce, April 2, 2005.19

See, Auction Law of the PRC, promulgated by the Standing Committee of the National Peoples

Congress, July 5, 1996, effective, July 1, 1997; andLaw of the PRC on the Protection of Cultural Relics,

promulgated by the Standing Committee of the National Peoples Congress, October 28, 2002.20

See, Guide to Application for Foreign Invested Commercial Enterprises, issued by the Ministry of

Commerce, August 5, 2005.21

Application Materials for Foreign Invested Projects in the Commercial Sector, issued by the Ministry

of Commerce, August 5, 2005.22

Time Limits for Review and Approval of Foreign Investment in Commercial Sector Projects, issued by

the Ministry of Commerce, August 5, 2005.23

Notice Concerning Delegating to Local Departments the Review and Approval of Foreign Invested

Commercial Enterprises, issued by the Ministry of Commerce, December 9, 2005; andNotice Concerning

Issues Relating to the Delegation to Central Government Level Economic and Technology Development

Zones of Authority to Review and Approve Foreign Invested Commercial Enterprises and International

Freight Forwarding Agent Enterprises, issued by the Ministry of Commerce, February 9, 2006.24 Notice Concerning Delegation of the Matter of the Approval of Foreign Invested Commercial Enterprises,

issued by the Ministry of Commerce, September 12, 2008

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As discussed above, China is permitted under its WTO Accession Protocol to

continue imposing legal restrictions on the retailing of certain products, including

publications, audio-visual products, petroleum and pharmaceuticals. This Chapter willdiscuss the regulations relating to foreign investment in the retailing of each of these

product categories.

[1] Publications: Books, Newspapers, Magazines and ElectronicPublications

The publishing and distribution of books, newspapers, magazines and electronic

publications are tightly controlled in China, due to their potential political impact. Suchbusiness activities are under the primary jurisdiction of the General Administration of

Press and Publication, but authority is also held by the State Council Information Office,

the Publicity Department of the Communist Party of China, and other ministries, organs

and departments of the Chinese government and the Party.

Under the 2011 Foreign Investment Catalogue, the publishing of books,

newspapers and periodicals is still under the Prohibited Class for foreign investment.But in accordance with the WTO ruling, the importation and master distribution (zong fa

xing)25

of such products have been removed from the Prohibited Class, and would be

permitted for foreign investment in the future.

In order to comply with the WTO ruling, theRegulations for the Administration

of Publications were amended in March 2011, and state:

China permits the establishment of Chinese-foreign equity joint ventures,

Chinese-foreign cooperative joint ventures and wholly foreign-owned

enterprises engaged in the business ofputting on sale (fa xing) books,

newspapers, periodicals andelectronic publications. [Emphasis added]

There are two changes in this provision, as compared to the previous version of theseRegulations issued in 2002.

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First, under the 2002 Regulations, such foreign invested enterprises were onlypermitted to engage in the sub-distribution (fen xiao) of such publications, whereas

under the 2011 Regulations, they are permitted to engage in the putting on sale (fa xing)

of such publications. The U.S. and China disagree on the definition of these legal terms,

as well as the definition of other legal terms for which it is difficult to find English andChinese equivalents.

27For the sake of clarity, the term fen xiao is generally translated

25 The term, zong fa xing, which the U.S. translated as master distribution, is a term that China argued

is one of those unique terms that can find no English word matching its exact meaning. See, Footnote 9,

WTO Report of the Panel, Annex A-1, Translation Differences in the Report, 09-3798, August 12, 2009.26 Amendments to the Regulations for the Administration of Publications, Article 19, issued by the State

Council, March 19, 2011, amending Article 39 of the previous Regulations for the Administration of

Publications, issued by the State Council, December 25, 2001, effective February 1, 2002.27See, Footnote 25. The term, fa xing, which the U.S. translated as distribution, is another term that

China argued is one of the unique terms that can find no English word matching its exact meaning, The

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as distribution in this Chapter, unless context requires the more specific translation of

sub-distribution.

The second change in the above provision was to add electronic publications to

the list of products in which such foreign investment was permitted. Furthermore, the

2011 Foreign Investment Catalogue removes the importation of electronic publicationsfrom the list of businesses Prohibited for foreign investment.

In further compliance with the WTO ruling, theRegulations for theAdministration of the Publications Marketwere amended and restated in March 2011.

28

Under these Regulations, the foreign investor may not be the controlling shareholder in

foreign invested chain stores with more than 30 outlets that are engaged in distribution (faxing) of books, newspapers and magazines. Hong Kong and Macao investors arepermitted, however, to own up to 65% equity in such enterprises.

The previous regulation governing foreign invested enterprises for the distribution

of books, newspapers and periodicals, as well as the three supplementary provisions tosuch regulation, have also been repealed.29

[2]Audio-visual Products: DVDs, Video Cassettes and Sound Recordings

The production and distribution of audio-visual products, including DVDs,

video cassettes and sound recordings, are strictly controlled by the Chinese government.Such business activities are under the primary jurisdiction of the State Administration for

Radio, Film and Television, but authority is also held by the Publicity Department of the

Communist Party of China, the Ministry of Culture and other ministries, organs anddepartments of the Chinese government and the Party.

Under the 2011 Foreign Investment Catalogue, the publishing and production ofaudio-visual products are still under the Prohibited Class for foreign investment. But in

accordance with the WTO ruling, the importation of such products has been removed

from the Prohibited Class, and would be permitted for foreign investment in the future.

TheMeasures for the Administration of the Importation of Audio-visual Products wereamended accordingly in April 2011.

30

term fen xiao was also translated as distribution by the U.S., but China translated it as sub-

distribution. WTO Report of the Panel, Annex A-1, Translation Differences in the Report.28

Regulations for the Administration of the Publications Market, issued by the General Administration ofPress and Publications and the Ministry of Commerce, March 25, 2011.29See, Measures for the Administration of Foreign Invested Distribution Enterprises for Books,

Newspapers and Periodicals, issued by the General Administration of Press and Publication and the

Ministry of Foreign Trade and Economic Relations, March 17, 2003, effective December 1, 2004; and

Supplementary Provisions, April 2, 2007, effective May 1, 2007; andSupplementary Provisions II, August

2, 2009, effective October 1, 2009; andSupplementary Provisions III, December 27, 2010, effective

January 1, 2011.30 Measures for the Administration of the Importation of Audio-visual Products, issued by the General

Administration of Press and Publications and General Administration of Customs, April 6, 2011.

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Under the 2011 Foreign Investment Catalogue, the distribution of audio-visual

products (excluding motion pictures) is still required to be carried out in the form of

Chinese-foreign cooperative joint ventures, but the Chinese party is no longer required tobe the controlling shareholder.

In March 2011, the Chinese government amended theRegulations for the

Administration of Audio-visual Products to state that China permits the establishment ofChinese-foreign cooperative joint ventures engaged in putting on sale (fa xing) audio-visual products. Under the previous 2002 Regulations, such joint ventures were only

permitted to engage in the sub-distribution (fen xiao) of audio-visual products.31

As mentioned above, the Chinese government also amended theRegulations for

the Administration of the Publications Market, which repeal the two previous regulations

governing the wholesaling, retailing and rental of audio-visual products, and governing

Chinese-foreign cooperative enterprises for the distribution of audio-visual products (andits two supplementary provisions).

32Thus, Hong Kong and Macao investors are now

permitted to establish wholly foreign-owned enterprises or equity joint ventures engaged

in the distribution of audio-visual products (including post-motion picture products).

[3] Petroleum

The Chinese government continues to impose restrictions on foreign investment

in the sale of crude petroleum and refined petroleum. The Chinese party is required to

hold the controlling interest in chain stores with more than 30 outlets that sell different

types and brands from multiple suppliers that are engaged in the wholesaling, retailing orlogistics distribution of crude petroleum.

The Ministry of Commerce has issued the Measures for the Administration of

the Crude Petroleum Market, which impose strict requirements on enterprises selling

crude petroleum, including minimum registered capital of 100 million RMB, crude

petroleum storage facility with a capacity of at least 200,000 cubic meters, etc.33

Similarly, theMeasures for the Administration of the Refined Petroleum Market

require that an enterprise engaged in the wholesaling of refined petroleum have

minimum registered capital of 30 million RMB, have refined petroleum storage facilitywith a capacity of at least 10,000 cubic meters and fulfill other strict conditions.

34

31 Regulations for the Administration of Audio-visual Products, issued by the State Council, March 19,

2011. amending and restating the previous Regulations, issued by the State Council, December 25, 2001,

effective, February 1, 2002. See, discussion of the terms fa xing and fen xiao in Footnote 27 and

associated text.32See, Footnote 28, Regulations for the Administration of the Publications Market, repealing Measures for

the Administration of the Wholesaling, Retailing and Rental of Audio-visual Products, issued by theMinistry of Culture, November 3, 2006, effective December 1, 2006; andMeasures for the Administration

of Chinese-Foreign Cooperative Enterprises in the Distribution of Audio-visual Products, issued by the

Ministry of Culture and Ministry of Commerce, February 9, 2004, effective January 1, 2004; and

Supplementary Provisions, August 20, 2009, effective October 1, 2009; andSupplementary Provisions II,

December 27, 2010, effective January 1, 2011.33

Measures for the Administration of the Crude Petroleum Market, issued by the Ministry of Commerce,

December 4, 2006, effective January 1, 2007.34

Measures for the Administration of the Refined Petroleum Market, issued by the Ministry of Commerce,

December 4, 2006, effective January 1, 2007.

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With respect to the wholesaling of refined petroleum and the construction and

operation of gas stations, the Chinese party is required to hold the controlling interest in a

gas station chain established by one foreign investor that has more than 30 gas stationsselling refined petroleum of different types and brands from multiple suppliers. The

international oil majors, such as BP, Exxon Mobile, Shell and Total, have all been

approved to enter the retail market for refined petroleum, and plan to build thousands ofgas stations across China.

[4] Pharmaceuticals

Pharmaceuticals had been one of the sectors restricted for foreign investment

under the 2007 Foreign Investment Catalogue, as well as the draft version of the 2011

Foreign Investment Catalogue that had been published in April 2011 for public comment.In the final promulgated version of the 2011 Foreign Investment Catalogue, however, the

pharmaceuticals sector has been removed from the list of industries that are restricted for

foreign investment.

Nevertheless, the pharmaceuticals sector remains highly regulated under

regulations that are applicable to both Chinese companies and foreign companies andtherefore in compliance with the WTO rules on the non-discriminatory treatment of

foreign companies. The State Food and Drug Administration has issued theMeasures for

the Administration of Drug Business Licenses, which establish the regulatory framework

for the issuance of licenses for the distribution of pharmaceuticals.35

The Ministry of

Commerce, which shares responsibility for regulating the sales of pharmaceuticals, has

issuedits national pharmaceuticals distribution policy for the 20112015 Five-Yearperiod.

36

7.07 Favored Treatment of Hong Kong and Macao Investors

Investors from Hong Kong and Macao are granted favourable treatment with

respect to their investments in the retail sector, in accordance with the Closer EconomicPartnership Arrangements (CEPA) signed by China with Hong Kong and with Macao.37

In order to prevent foreign investors from simply forming a company in Hong

Kong and taking advantage of such favorable treatment, the CEPA agreement defines the

criteria for a service supplier from Hong Kong that would enjoy such treatment. Theservice supplier must be a company organized under Hong Kong law, be engaged in

substantive business operations in Hong Kong for 3 years or more, have paid profits tax

in Hong Kong and own or rent premises in Hong Kong, and in addition, more than half of

its staff must be permanent Hong Kong residents.38

35 Measures for the Administration of Drug Business Licenses, issued by the State Food and Drug

Administration, February 4, 2004, effective April 1, 200436 National Pharmaceuticals Circulation Development Plan Outline, issued by the Ministry of Commerce,

May 6, 2011.37 Mainland and Hong Kong Closer Economic Partnership Arrangement, signed on June 29, 2003; and

Mainland and Macao Closer Economic Partnership Arrangement, signed on October 17, 2003.38See, Footnote 37, Mainland and Hong Kong Closer Economic Partnership Arrangement, Annex 5,

Definition of Service Supplier and Related Requirements.

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Hong Kong and Macao investors are permitted to establish wholly-owned

enterprises that have more than 30 shops selling different brands from different suppliers

and engaged in the sale of pharmaceuticals, agriculture chemicals, agricultural films,chemical fertilizers, vegetable oils, sugar and cotton. They are granted this favorable

treatment pursuant to the Supplementary Provisions to the Measures for the

Administration of Foreign Investment in the Commercial Sector.

39

The SupplementaryProvisions supersede the and Supplementary Provisions, which had established equity

thresholds of 51% and 65%, respectively. But it is unclear whether the Supplementary

Provisions would override the Supplementary Provisions, which permit Hong Kong and

Macao investors to own up to 65% equity in chains with more than 50 shops (as opposedto 30 shops).

40

As discussed above, Hong Kong and Macao investors are permitted to establishwholly foreign-owned enterprises or equity joint ventures engaged in the distribution of

audio-visual products (including post-motion picture products). In addition, they are

permitted to own up to 65% equity in chain stores distributing books, newspapers and

periodicals.

7.08 Direct Selling

Direct selling, i.e., selling through sales representatives, was one of the first types

of retailing carried out by foreign investors to flourish in China. Companies such as

Avon, Mary Kay Cosmetics and Amway found a ready market of eager customers and

ambitious sales representatives.

At the same time, direct selling has been one most strictly regulated industries in

China, in part due to prevalence of pyramid schemes and other abuses among Chinese

direct selling companies. In 1998, the State Council imposed an outright ban on the

direct selling operations of all foreign and domestic companies,41

and ordered them to

convert their businesses into fixed-location store operations.42

Multinationals that had made major investments in their direct selling business in

China in reliance upon previous government approvals were blindsided by the ban, but

had no choice but to comply with the new regulatory regime. Avon, for example, wasforced to establish many thousands of retail stores and department store counters

throughout China.

39 Supplementary Provisions to the Measures for the Administration of Foreign Investment in the

Commercial Sector (IV), issued by the Ministry of Commerce, February 5, 2009.40 Supplementary Provisions to the Measures for the Administration of Foreign Investment in the

Commercial Sector, issued by the Ministry of Commerce: (I) issued January 9, 2006; (II) issued

November 3, 2006 and effective December 1, 2006; and (III) issued November 5, 2007.41Notice Concerning the Prohibition of Direct Selling Economic Activities, issued by the State Council, April 18,

1998.42 Notice Concerning Relevant Issues Concerning the Conversion of the Sales Methods Used by Foreign Invested

Direct Selling Enterprises, issued by the Ministry of Foreign Trade and Economic Cooperation, State Administration ofIndustry and Commerce and Bureau of Internal Trade, June 18, 1998.

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The ban on direct selling was finally lifted in 2005, when the State Council issued

theRegulations for the Administration of Direct Selling.43

But the State Council also

issued regulations concerning pyramid selling that prohibited multi-level marketing(which was the way international direct selling companies conducted business in the rest

of the world), and permitted only single-level selling.44

According to these regulations, foreign companies investing in a direct sellingenterprise must have at least 3 years of overseas direct selling experience. Such directselling enterprise must have minimum registered capital of 80 million RMB. The

enterprise must put up a security deposit of 30 million RMB, which will be adjusted

monthly to 15% of the enterprises sales revenues in the previous month, with aminimum of 20 million RMB and a maximum of 100 million RMB. The security deposit

will be used by the government to pay for returns of merchandise by consumers,

compensation to sales representatives and indemnity to consumers due to product liability.

The direct selling enterprise is jointly liable for the selling activities of its salesrepresentatives. Such representatives compensation must be based on their sales to

end-users only, and their commission cannot exceed 30% of sales revenues, including

any non-cash compensation. The direct selling enterprise must sign service contracts

with its sales representatives, which may be terminated by the sales representativesduring the first 60 days after signing, or by giving 15 days notice at any time thereafter.

The sales representative may not enter a consumers residence without

permission, and if so requested by the consumer, must stop all selling activity and leave

the consumers residence. The consumer is provided with a 30-day cooling off period,during which the consumer can demand replacement or return of the product, so long as

the product has not been unpacked. In the event of dispute with the consumer, the

burden of proof is on the seller.

The regulations also require that local governments conduct an inspection of

direct selling enterprises.45 The Ministry of Commerce will then post on its direct sellingadministration website the names of the inspected direct selling enterprises and their

service territories and locations.46

By the end of 2009, 24 enterprises had obtained direct selling licenses from theMinistry of Commerce, including 13 foreign invested enterprises.

47Avon had received

the first national license for direct selling in February 2006,48

but the complex hybrid

business model of fixed locations and direct selling that Avon operated in China was

43Regulations for the Administration of Direct Selling, issued by the State Council, August 23, 2005,

effective December 1, 2005.44

Regulations on the Prohibition of Pyramid Selling, issued by the State Council, August 23, 2005,effective November 1, 2005.45

Notice Concerning Issues Relating to Clarifying the Inspection Work of Direct Selling Enterprise Service

Networks, issued by the Ministry of Commerce, March 21, 2007.46

Measures for the Administration of the Establishment of Direct Selling Service Networks, issued by the

Ministry of Commerce, September 20, 2006.47 Lu, Sheng, Understanding Chinas Retail Market, China Business Review, online version only, May-

June, 2010.48

Avon Corporation, Report on Form 10-K for period ended December 31, 2007, filed with the U.S. Securities and

Exchange Commission, February 21, 2008.

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difficult to manage. In 2010, Avons revenues from China decreased by 35%, and its

profits decreased by negative 154% to become a heavy loss, and the number of its active

sales representatives decreased by 39%.49

The initial advantage that the foreign direct selling companies enjoyed inpenetrating the Chinese retail market, which was mostly closed to foreign investment at

the time, has lessened in importance over the years, as the rest of the Chinese retailmarket became more open to foreign investment.

7.09 E-Commerce

[1] Telecommunications Regulations

The Chinese government has actively promoted and guided the development ofe-commerce in China,

50and encourages and supports the development of Internet goods

transactions and related services, and will implement even more active policies to

promote the development of Internet commerce.51

The Ministry of Commerce has evenpublished a list of the 83 model e-commerce enterprises.

52

The State Internet Information Office under the State Council and the Ministry ofIndustry and Information Technology have primary responsibility for regulating the

Internet sector in China. As for e-commerce, authority is also shared with the Ministry ofCommerce, the State Administration for Industry and Commerce and each of the

government departments having jurisdiction over the particular types of goods being sold

over the Internet, such as books and publications, audio-visual products, pharmaceuticals

or petroleum products, as discussed in greater detail elsewhere in this Chapter.

Internet enterprises are required generally to hold a value-added

telecommunications business license. The term value-added telecommunications

business is defined under the PRC Telecommunications Regulations, which divides the

telecommunications business into basic and value-added.

53

Basictelecommunications business refers to the business of public Internet infrastructure

facilities and public data delivery and basic voice communications.

Value-added telecommunications business refers to telecommunications and

information services that utilize the public Internet infrastructure, and encompasses mostInternet services, including e-mail, online information storage and the focus of this

Chapter, e-commerce. The telecommunications services included under these two terms

49 Avon Corporation, Report on Form 10-K for period ended December 31, 2010, filed with the U.S.Securities and Exchange Commission, February 24, 2011.50See, Third-Party Electronic Commerce Platform Services Guidelines, issued by the Ministry of

Commerce, April 12, 2011; andSeveral Opinions Concerning Acceleration of the Development of ElectronicCommerce, issued by the State Council, January 8, 2005; andGuideline Opinions Concerning Online Commerce(Temporary), issued by the Ministry of Commerce, March 6, 2007.51 Provisional Measures for the Administration of Internet Goods Transactions and Related Services, issued

by State Administration for Industry and Commerce, May 31, 2010.52 Electronic Commerce Model Enterprises List, issued by the Ministry of Commerce, August 10, 2011.53 PRC Telecommunications Regulations, issued by the State Council, September 25, 2000.

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have been revised pursuant to theNotice Concerning the Revision of the Catalogue of

Telecommunications Services.54

Enterprises that provide value-added telecommunications services nationwide or

across provinces are required to have a minimum registered capital of 10 million RMB,whereas enterprises engaged in such business within only one province need a registered

capital of only 1 million RMB. Other requirements and procedures are set forth in theMeasures for the Administration of Telecommunications Business Operating Licenses.55

In addition, local governments, including those of Beijing and Shanghai, have also issued

additional regulations governing the issuance of licenses to local telecommunications

enterprises.

E-commerce, or Internet sales, has been classified under the Restrict Class forforeign investment under successive Foreign Investment Catalogues. The principal

regulation governing foreign investment in Internet and e-commerce enterprises is theProvisions for the Administration of Foreign Invested Telecommunications Enterprises,issued by the State Council in 2001, and amended and restated in 2008.

56

The foreign investors in a foreign invested telecommunications enterprise cannotin the end hold more than 50% of the equity in such enterprise. The words in the end

imply that temporary varying equity proportions may be permitted, so long as the finalresult is that the foreign investors cannot hold more than 50%.

The principal foreign investor in a value-added telecommunications enterprise

must have good past results and operating experience in valued-added

telecommunications services. The statutory language implies that the principal foreigninvestor cannot be a new entrant into the telecommunications business. The term

principal foreign investor is defined as the foreign investor that holds the largest

proportion (and more than 30%) of the total investment by all the foreign investors.

If the e-commerce enterprise is engaged in the sale of books, newspapers orperiodicals, or pharmaceuticals or petroleum products, then it must hold the additional

respective licenses required for operating such businesses. Such licenses must be

disclosedon its website in the form of either clear photographs of, or hyperlinks to, such

licenses.57

Internet enterprises may also be required to hold a telecommunications and

information services business operating license. This license is usually referred to in

China by its name in English, as an ICP license, or internet content provider license,

54

Notice Concerning the Revision of the Catalogue of Telecommunications Services, issued by theMinistry of Information Industry, February 21, 2003.55 Measures for the Administration of Telecommunications Business Operating Licenses, issued by the

Ministry of Industry and Information Technology, March 5, 2009, effective April 10, 2009.56 Provisions for the Administration of Foreign Invested Telecommunications Enterprises, issued by the

State Council, December 12, 2001, effective January 1, 2002, and amended and restated, September 10,

2008.57See,Notice Concerning Relevant Problems Relating to the Approval and Administration of Foreign

Investment in Projects Involving Sales By Means of the Internet or Vending Machines, issued by the

Ministry of Commerce General office, August 19, 2010.

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and the license is regulated pursuant to the Measures for the Administration of Internet

Information Services.58

In response to recent online protests and scandals involving prominent e-

commerce companies such as Alibaba, the Chinese government was, as of late 2011,drafting new regulations on e-commerce that will reportedly clarify the rights and

responsibilities of the different parties involved in e-commerce.59 In addition, drafts of acomprehensive PRC Telecommunications Law have been debated for many years; whenpromulgated, it will further clarify the regulatory regime governing the Internet and e-

commerce in China.

[2] Internet Music Services

The 2011 Foreign Investment Catalogue lifts the previous restriction on foreign

investment in Internet music services, in order to comply with the 2010 WTO ruling.According to the 2011 Foreign Investment Catalogue, the parenthetical, except for

music, is added to the list of Internet services that are Prohibited for foreign investment:

Article X: (7)

News websites, Internet audio-visual program services, Internet cafes and

services locations, Internet culture operations (except for music)60

[Emphasis added]

It is unclear from the statutory language whether the exception, except for music,modifies only the preceding phrase, Internet culture operations (which could

conceivably mean that only informational websites about music would be permitted), or

whether it would be interpreted to modify the other enumerated items, in particular,

Internet audio-visual program services.

But regardless of the statutory language, the Foreign Investment Catalogue was

revised in 2011 in part to comply with the 2010 WTO ruling. The WTO ruling clearlydealt with electronic distribution of sound recordings. According to the Report of the

Panel in the WTO case:

Section 8.2.3 (b) Electronic Distribution of Sound Recordings

(i) Article X:7 of the Catalogue of Prohibited Foreign

Investment Industries of the Catalogueis alsoinconsistent with Article XVII of the GATS.

61

58 Measures for the Administration of Internet Information Services, issued by the State Council, September

25, 2000.59 Lee, Melanie, China to Draft New Regulations for E-Commerce, Reuters, October 19, 2011.60See, Footnote 12, Foreign Investment Industrial Guidance Catalogue (2011), Prohibited Class, Article X:

(7). Multinational companies have already begun to provide Internet music services in China. See,exempli

gratia,http://rdio-china.com/61See, Footnote 9, Report of the Panel, Paragraph 8.2.3(b)(i), Page 467.

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This particular holding in the Report of the Panel is affirmed by the Appellate Body:

Paragraph 413

In the light of the above, we upholdthe Panels conclusion, in paragraph

8.2.3(b)(i) of the Panel Report, that, as regards the electronic distributionof sound recordings Article X:7 of the [List] of Prohibited Foreign

Investment Industries of the Catalogueis also inconsistent with Article

XVII of the GATS.62

The language of the WTO original decision and appellate decision militate for the

conclusion that foreign investment in online music audio services would be permitted in

the future.

The question then becomes, would the WTO ruling compel the Chinese

government to liberalize its restrictions on foreign investment in online music video

services, such as music videos and video streaming? The texts of the WTO originaldecision and appellate decision are not clear on this issue. The Appellate Panel did state

that:

The Panel observed that the entry "Videos, (...) distribution services"extended to the distribution of both physical and non-physical products

and reasoned that "the concept of 'distribution services' in China's entries

relating to videos and to sound recording must have similar meaning", that

is, they both include physical and non-physical products.

We agree with this reasoning of the Panel.63

The answers to the above questions of legal construction, and the extent of liberalization

of restrictions on foreign investment in Internet music services, will have to awaitelucidation in future Chinese regulations.

[3] Variable Interest Entity (VIE) Structure

As discussed previously, many major Chinese Internet and e-commercecompanies are subject to the same regulatory regime applicable to all foreign invested

enterprises, because they operate through foreign companies incorporated abroad, or are

themselves substantially owned by foreign companies. In order to comply with Chinese

law, such companies must conduct their Internet operations in China through acomplicated structure of holding companies and interlocking agreements called the

variable interest entity (VIE) structure.

In a typical simplified VIE structure, a domestic Chinese company will be

established, and it is the eponymous variable interest entity, which is a technical termderived from U.S. financial accounting standards. This domestic Chinese company will

62See, Footnote 10, Report of the Appellate Body, Paragraph 413, Page 166.63See, Footnote 10, Report of the Appellate Body, Paragraphs 368-369, Pages 152-153.

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hold the necessary licenses, domain names, trademarks and other licenses required for the

companys Internet businesses in China.

The foreign company will then establish one or more foreign invested enterprises,

which will sign a series of agreements with the domestic Chinese company. Suchagreements will commonly include a technical service or consultancy agreement, an

equity pledge agreement, a loan agreement, a proxy or power of attorney and otherrelated agreements. Under these agreements, the foreign invested enterprises will carryout the Internet operations and receive the economic benefits of such operations, but will

have only limited ownership rights.

Internet businesses in politically sensitive areas, such as providing news, videos

or cultural services, are generally prohibited for foreign investment under the ForeignInvestment Catalogue. Companies engaged in such businesses, such as Tudou.com,

Sina.com and Baidu.com, must use the VIE structure in order to comply with Chinese

law.64

In contrast, e-commerce is not in the Prohibited Class of Internet businesses forforeign investment, but is merely in the Restricted Class under successive Foreign

Investment Catalogues.

Nevertheless, major Chinese e-commerce companies have also used the VIE

structure for a variety of reasons, including facilitation of their stock listing abroad, theinherent problems of the required joint venture structure and the sheer difficulty of

obtaining approval for foreign invested telecommunications enterprises.

Thus, for example, the e-commerce company Dangdang.com used a Cayman

Islands company to list its stock in Hong Kong and New York. The Cayman Islandscompany then established a wholly foreign owned enterprise in China that in turn was a

partner in a Chinese-foreign joint venture. These foreign invested enterprises then entered

into a series of agreements with Beijing Dangdang Kewen E-Commerce Co. Ltd., a

domestic Chinese company owned by the companys founders, which held the licenses,

domain names and trademarks required for operating the companys Internet businessesin China.

65

In 2006, the Ministry of Industry and Information Technology issued theNoticeConcerning Strengthening the Administration of Foreign Investment in Operating Value-

Added Telecommunications Business.66

This Notice decreed that:

Telecommunications companies within China shall not lease, transfer or

sell in any form or through any transformative means their

telecommunications business operating license to any foreign investor, orprovide in any form resources, venues, facilities or other conditions for the

illegal telecommunications operations in China of any foreign investor.

64See, e.g., Prospectus for Tudou.com, Page 6, filed with the U.S. Securities and Exchange Commission,

August 17, 2011. Sina.com reportedly held 11 different government licenses in order to be able to conduct

its various Internet businesses.65 Prospectus for Dangdang.com, Page 4, filed with the U.S. Securities and Exchange Commission,

December 8, 2010.66 Notice Concerning Strengthening the Administration of Foreign Investment in Operating Value-Added

Telecommunications Business, issued by Ministry of Industry and Information Technology, July 13, 2006.

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The Notice required a telecommunications enterprise to own its domain names and

trademarks under its own name or that of its shareholder. The enterprise must also have

premises and facilities to conduct the businesses specified in its license.

Subsequently, in September 2011, it was reported that the China SecuritiesRegulatory Commission had submitted an internal report to the State Council in which it

requested that the State Council take actions to halt the use of abusive VIE structures.67

It is uncertain whether the Chinese government will enforce the 2006 Notice more

strictly in the future, and the ramifications of the 2011 CSRC report to the State Councilare also unclear. In 1999, the Chinese government forced foreign companies that had

used the so-called Chinese-Chinese-foreign arrangement in order to circumvent

restrictions on foreign investment in Chinese telecommunications carriers to unwind theirinvestments, in many cases at a substantial economic loss.

It is perhaps less likely that the Chinese government would force existing Internet

companies that are already listed on foreign stock exchanges to unwind their VIE

structures. Nevertheless, there can be little doubt that VIE structures and other similar

financial engineering designed to sidestep Chinese legal restrictions will face increasedscrutiny and regulation in the future.

[4] Electronic Payment Systems

The most profitable aspect of e-commerce, as demonstrated by the experience of

Paypal in the U.S., and Alipay in China, is often the secure payment system used for

paying for merchandise online. The allegedly unauthorized transfer of Alipay out of theAlibaba group in 2011 was the subject of a major dispute between Alibaba and its foreign

majority owners, Yahoo and Softbank. Yahoos stock price plummeted when it was

discovered that Alibaba, in which Yahoo held a major stake, had transferred its entire

interest in Alipay to a company personally owned by Alibabas founder.

According to theMeasures for the Administration of Non-Financial InstitutionsPayment Services, issued by the Peoples Bank of China, non-financial institutions mustobtain a payment business license in order to provide online payment services and

other currency funds transfer services.68

The detailed procedures concerning the

application and qualifications for the payment business license are set forth in theImplementing Provisions to theMeasures for the Administration of Non-Financial

Institutions Payment Services.69

In May and September 2011, the Peoples Bank of China announced that it had

issued the first two batches of payment business licenses to 40 online payment companies,

including Alipay, Tenpay, 99bill and ChinaPay, but not to the online payment services of

67 Popular China Company Structure Under Threat, Reuters, September 18, 2011.68 Measures for the Administration of Non-Financial Institutions Payment Services, issued by the Peoples

Bank of China, effective September 1, 2010.69 Implementing Provisions to the Measures for the Administration of Non-Financial Institutions Payment

Services, issued by the Peoples Bank of China, effective December 3, 2010.

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Baidu and Netease.70

The Chinese government was, as of late 2011, in the process of

drafting new regulations governing foreign invested online payment processors, which

reportedly will limit foreign ownership to 49%.71

7.10 Conclusion

The mirage of a billion Chinese customers has bedazzled foreign traders and

investors since the days of the proverbial 19th century Lancashire cotton mill owner whohoped to lengthen the shirt-tail of every Chinese person. For many years since then and

after Chinas opening in 1978, that vision has been more chimera than reality. But in the

first decade of the 21st century, with the lifting of most of the restrictions on foreigninvestment in the retail sector following Chinas WTO entry, the dream of a billion

customers is finally coming true.

Restrictions remain on foreign investment in the retail sector, including on direct

selling, mail order and Internet sales, and on foreign investment in the retailing of

publications and audio-visual products and crude and refined petroleum, as well as grains,

cotton, vegetable oils, sugar, tobacco, agricultural chemicals, agricultural film andchemical fertilizers.

Foreign investment in e-commerce and online payment systems also continue to

be restricted, and are subject to the extensive parallel systems of regulations governingvalue-added telecommunications services and banking services. Regulation of the

Internet is a core interest of the Chinese government, which must balance important

political, economic and commercial considerations in this key aspect of the Chineseeconomy and society.

Despite these continuing restrictions and a fiercely competitive environment,

China remains an indispensable part of any international companys global retail strategy,

and one in which, as Apple, Ikea, Zara, Uniqlo and others have demonstrated, it ispossible for foreign companies to prosper and succeed.

70 China Issues Third-Party Payment Licenses to Regulate, Spur Online Businesses, English

Xihuanet.com, May 28, 2011; and Chinas Central Bank Issues 13 Additional Online Payment Licenses:

Baidu and Netease Still Missing, iChinaStock.com, September 1, 2011. 71 Mann, Joseph, Ebay Plans Paypal Partnership in China, Financial Times, October 18, 2011.

Documents

Legal Aspects of Retail and E-Commerce in China