Easing of Foreign Ownership Limits in China’s Value-Added Telecom Services: What You Need to Know?

On 8 April 2024, the Ministry of Industry and Information Technology of China ("MIIT") issued the "Circular on Pilot Programs for Expanding the Opening-up of Value-added Telecom Business to Foreign Investment" (the “Circular”). This marks China’s renewed effort to enhance foreign investment access and bolster infrastructure development to meet the growing demand for telecoms services.

In the past, China has regulated foreign investment in the telecoms sector, with the extent of restrictions depending on the relevant telecoms service in question. In particular, China has imposed limits on foreign investment in value-added telecommunications ("VAT") services companies that provide internet information services, which are generally subject to a 50% cap, with a few exceptions. Historically these foreign ownership restrictions have led to the widespread adoption of the Variable Interest Entities (VIE) structure in the relevant industries, as well as foreign investors adopting joint ventures with local partners to conduct business in China. However, through the recently issued Circular, the MIIT has announced plans to expand the opening-up of the VAT industry in China. The Circular further eases foreign investment shareholding restrictions in 6 VAT sectors initially across 4 pilot areas, namely Beijing, Shanghai, Hainan Free Trade Port, and Shenzhen, laying the groundwork for broader opening-up in the future as well.

The key points to note from the Circular include the following which we will cover in further detail below:

1. Four Pilot Areas Leading the Way
2. Six Types of VAT Services Now Unrestricted
3. Equal Regulatory Requirements for Both Foreign and Chinese VAT Service Investors
4. Detailed Implementation Plans Yet to be Finalised
5. Potential Termination of the Pilot Program Enabled by the Exit Mechanism

Background: A broader opening-up initiative

The relaxation of restrictions on foreign investment in the VAT sector is part of China's broader strategy to attract foreign capital. Currently, China regulates foreign investment through a system of "pre-establishment national treatment and negative list", which specifies sectors where foreign ownership is restricted or prohibited. In March 2024, the General Office of the State Council issued a plan that outlined 24 measures across five areas to bolster foreign confidence in China's development. Notably, it announced the complete removal of restrictions on foreign investment in the manufacturing sector and affirmed commitments to further opening up in sectors like telecom, healthcare, technology, banking, insurance, and finance.

Key Points

A. 4 Pilot Areas to Lead the Way

According to the Circular, the initial pilot areas to which the relaxing of foreign ownership requirements will apply, are:

1. Beijing's national comprehensive demonstration zone for expanding opening-up in the service sector.
2. Shanghai's Lingang new area of the China Pilot Free Trade Zone and the pioneer area for socialist modernization.
3. Hainan Free Trade Port; and
4. Shenzhen pilot demonstration area of socialism with Chinese characteristics.

The Circular also outlines key conditions that need to be met should other potential local governments apply in the future to be categorised as additional pilot areas. These conditions include institutional advantages to attract foreign investment, a solid foundation of the telecoms industry, and robust regulatory capacity, all of which were shared by the four initial pilot areas despite the variation of their scope and foundation of opening up.

The Circular also outlines key conditions that need to be met should other potential local governments apply in the future to be categorised as additional pilot areas. These conditions include institutional advantages to attract foreign investment, a solid foundation of the telecoms industry, and robust regulatory capacity, all of which were shared by the four initial pilot areas despite the variation of their scope and foundation of opening up.

To enjoy the new opening-up policy in the pilot areas, the VAT business operators must register and have their service facilities, including leased or purchased facilities, within the same pilot area. Acquiring or renting content distribution networks (CDN) and other facilities outside the pilot area for providing acceleration services is prohibited. In addition, the scope of ISP services that are entitled to take advantage of the opening-up policy is limited to the pilot area and must be provided through the internet access equipment of China’s major telecoms companies, while other services can be offered nationwide.

B. 6 Types of VAT Services Unrestricted

In China, telecoms services are categorised into "basic telecommunications services" and "value-added telecommunications services" by Article 8 of the Telecom Regulations. VAT services include telecoms services such as online data processing and information dissemination using public network infrastructure. VAT services are further divided into “B1 services” and “B2 services”.

The previous Regulation on the Administration of Foreign-Invested Telecom Companies set a 50% cap on the proportion of foreign investment in companies operating VAT services. Now the Circular removes the restrictions for the following 6 categories of VAT services in pilot areas, covering both B1 and B2 services. Foreign investors will therefore now be able to wholly own entities providing these VAT services in the pilot areas.

(1) B11: Internet Data Center Services (IDC)

IDC refers to facilities equipped with broadband access offering services such as hosting, maintenance, system configuration, and management for users' servers, networking equipment, and other internet-related devices through outsourcing. It also includes facilities that provide rental services for resources like computing, storage, and software, as well as acting as an agent for leasing communication lines, export bandwidth, and other application services. (E.g., cloud service providers)

(2) B12: Content Distribution Network Services (CDN)

CDN stands for a network platform composed of distributed node servers located in different regions. It provides users with dispersed storage and high-speed caching of content. Based on network dynamics, traffic, and load conditions, CDN distributes content to fast and stable cache servers, enhancing the accessibility and availability of content and services for users by improving response speeds. (E.g., web accelerators)

(3) B14: Internet Service Providers (ISP)

ISP refers to providing various types of users with Internet access services by establishing business nodes with access servers and corresponding software/hardware resources and connecting the nodes to the Internet backbone network via public communication infrastructure. Users can connect to their business nodes using public communication networks or other access methods and access the Internet through these nodes. (E.g., broadband service providers)

(4) B21: Online Data and Transaction Processing Services

Online data processing and transaction processing services refer to providing users with online services, including transaction, electronic data exchange, and network/electronic equipment data processing, through application platforms connected to public communication networks or the Internet. (E.g., e-commerce platforms, IoT platform service providers)

(5) B25: Information Services – Information publishing and delivery services

Information publishing and delivery services refer to establishing information platforms to enable entities or individual users to publish text, images, audio and video, and application software. Platform providers can deliver and distribute this content to the terminals or email addresses designated by the users. The Circular excludes internet news information, online publishing, online audio-visual, and internet cultural operations from the opening-up regime. (E.g., e-commerce platforms, healthcare information platforms)

(6) B25: Information Service – Information protection and processing services

Information protection and processing services refer to providing users with services such as terminal virus scanning and removal, terminal information content protection and processing, and interception of spam messages and unwanted calls through public communication networks or the Internet by establishing public service platforms and the operation of client software running on computers, smart terminals, and other devices. (E.g., data service providers)

C. Equal Regulatory Requirements for Foreign and Chinese VAT Service Investors

Foreign investors are required to obtain approval for their telecoms business operations in pilot areas. They must also comply with the laws and regulations of the approvals and cooperate with the supervision and management of telecoms regulatory authorities. Additionally, in the pilot areas, regulatory authorities will follow the principle of treating domestic and foreign investments equally. It means that while foreign-invested telecoms enterprises in the 6 sectors in pilot areas are no longer subject to shareholding restrictions, they must still comply with China's general regulations for telecoms services, including requirements on capital, premises, personnel, and investors, and obtain the necessary licenses.

D. Detailed Implementation Plans Yet to be Finalised

The local governments of the four pilot areas are responsible for the detailed implementation plans and rules based on the Pilot Programme for Expanding the Opening-up of Value-Added Telecommunications Services (attached to the Circular). These implementation plans are yet to be finalised by the local governments and the MIIT will assess and decide whether to approve the plans. Once finalised, this will provide foreign investors with greater clarity to make more informed decisions around potential investment opportunities.  In addition to the MIIT, local telecoms administrations and local governments of the pilot areas will also have regulatory powers under the pilot implementation plan.

The local telecoms administrations are responsible for supervising pilot enterprises to ensure standardised operations, overseeing service quality management, establishing information-reporting and regular inspection mechanisms, strengthening network and data security supervision, and urging enterprises to fulfil their security responsibilities effectively.

The local governments in the pilot areas will set up mechanisms for sharing information and fostering cooperation among regulatory and enforcement authorities. They will provide support in terms of personnel, funding, and other resources to help the local communications administration enhance its regulatory talent team, upgrade its internet information security management systems, and establish internet regulatory information systems to support the pilot program.

E. Potential Termination of the Pilot Program enabled by the Exit Mechanism

Whilst the Circular outlines an exit mechanism for the pilot areas, the detail of the mechanism is not yet clear. In cases where there are frequent violations of laws and regulations, concentrated risks, or challenges in ensuring adequate safety supervision, MIIT may consider scaling back the scope of the pilot area. If the issues in the pilot areas become severe, the pilot program may be terminated prematurely. The local government would then coordinate with affected companies to uphold consumers' legal rights and interests and manage post-termination affairs.’

Conclusion

The MIIT Circular sends a strong signal of opening up to foreign telecom service providers. Currently, China's cloud computing market is experiencing rapid growth, reaching 602 billion yuan in 2023, with a 32.3% year-on-year increase, surpassing the global growth rate by 12%. The removal of foreign ownership restrictions allows foreign investors to establish VAT facilities independently, simplifying the corporate structure required. This change is expected to attract more foreign investment, particularly in those key hubs for foreign companies in China. As well as boost service quality and, if effective, potentially lead the way for further opening up of foreign investment in the sector.