CEPA II

Further trade liberalization between Hong Kong and China

On 27 August 2004, China and the government of Hong Kong Special Administrative Region reached an agreement to further liberalize trade between the two regions under the second phase of the Mainland and Hong Kong Closer Economic Partnership Arrangement ("CEPA II"). This builds on the existing Mainland and Hong Kong Economic Partnership Arrangement which was signed on 29 June 2003 ("CEPA I"). CEPA II covers:

- trade in goods; and

- trade in services.

1. TRADE IN GOODS

1.1 Tariff Elimination

Under CEPA II, the Mainland will allow 713 categories of products of Hong Kong origin to enter China on a Customs duty free basis. The tariff reductions for these products range from 2% to 53%. This is in addition to the 374 categories of Hong Kong products which have been enjoying 0% tariff rates since 1 January 2004 pursuant to CEPA I.

Of the 713 products, 529 products which are currently produced in Hong Kong will enjoy the tariff concessions from 1 January 2005. The remaining 184 products will enjoy the tariff concessions from 1 January 2006 upon confirmation that production of these products has commenced in Hong Kong. A summary of categories of goods which will be granted zero tariff treatment under CEPA II is as follows:

- Aqua - Marine Products

- Chemical Products

- Food and Beverages

- Leather and Fur Products

- Metal Products

- Mechanical, Electrical Products

- Pharmaceutical Products

- Textiles and Clothing

- Other products

1.2 Rules of Origins

To enjoy the Customs duty preferences under CEPA II, the products must satisfy certain rules of origins to qualify them as being of Hong Kong origin. The consultations on the rules of origin for the products covered by CEPA II are to be completed by 1 October 2004.

2. TRADE IN SERVICES

2.1 More Services Liberalized

CEPA II liberalizes 8 new service sectors and expands the scope of some of the 18 services sectors covered in CEPA I. Most commitments under CEPA II will become effective from 1 January 2005 with the exception of the construction sector and part of the commitments made in the distribution sector which are to be implemented with effect from 28 August 2004.

A brief description of some of the CEPA II concessions is as follows:

Service Sectors

CEPA II

WTO / CEPA I / PRC Law

Information Technology

-Permitted to apply for computer information system integration qualifications without establishing an entity in China.

-Limited only to entities established in China, including foreign-invested enterprises.

Job Referral*

-Wholly foreign-owned enterprises ("WFOEs") permitted.

-Minimum registered capital: US$125,000.

-Only Sino-foreign joint ventures ("JVs") permitted.

-Minimum registered capital: US$300,000.

Job Intermediary Service*

-Up to 70% ownership in JVs permitted.

-Minimum registered capital: US$125,000.

-Chinese partner must have been established for over 1 year.

-Up to 49% ownership in JVs permitted.

-Minimum registered capital: US$300,000.

-Chinese partner must have been established for over 3 years.

Airport Services*

-Provide contract management services for small and medium airports for a contractual term not exceeding 20 years permitted through:

- cross-border service arrangements;

- WFOEs; or

- JVs.

-Training and consultation services permitted through:

- cross-border service contracts;

- training and consultation programmes in Hong Kong;

- WFOEs; or

- JVs.

-WFOEs permitted to engage in 7 types of ground services.

-Currently prohibited.

-Currently, only minority ownership in JVs permitted.

-Currently only JVs permitted.

Cultural Entertainment*

-WFOEs and JVs for performing venues in China permitted.

-Permitted to establish branches of Hong Kong performing art agencies in China.

-Performing agency JVs permitted.

-Minority ownership permitted in:

- internet culture enterprise JVs; and

- JVs for setting up internet online service business premises.

-WFOEs and JVs for setting up art galleries, art shops and art work exhibition units permitted.

-Foreign investment currently prohibited.

-Branches currently prohibited.

-Foreign investment currently prohibited.

-Foreign investment currently prohibited.

-Currently only JVs permitted.

Distribution

-With effect from 28 August 2004, WFOE commercial enterprises permitted to:

Retail

- books, newspapers and magazines;

- pharmaceutical products, pesticides, mulching films and processed oil.

Wholesale

- books, newspapers and magazines;

- pharmaceutical products, pesticides and mulching films.

-WFOE commercial enterprises retailing automobiles not to be subject to CEPA I minimum turnover, asset and registered capital requirements.

-Majority foreign ownership in JV commercial enterprises currently permitted; WFOE commercial enterprises permitted from 11 December 2004. (CEPA I: WFOEs permitted from 1 January 2004).

Retail

- books, newspapers and magazines currently permitted;

- pharmaceutical products, pesticides, mulching films and processed oil permitted after 11 December 2004; chemical fertilizers permitted after 11 December 2006.

Wholesale

- books, newspapers and magazines, foreign investment permitted after 1 December 2004.

- pharmaceutical products, pesticides and mulching films permitted after 11 December 2004; processed oil permitted after 11 December 2006.

-WFOE commercial enterprises established pursuant to CEPA I allowed to retail automobiles if the following threshold requirements are satisfied:

- average annual sales value of Hong Kong service supplier in preceding 3 years not less than US$100 million;

- minimum asset of Hong Kong service supplier in previous year is US$10 million; and

- minimum registered capital of WFOE: RMB6 million.

Freight Forwarding Agency

-WFOE international freight forwarding agencies permitted to establish branch office upon full payment of registered capital.

-Branches may only be established when the international freight forwarding agency has been in operation for more than one year and upon full payment of registered capital.

Road Transportation (passenger)*

-WFOEs for public passenger transport in Municipal-level cities permitted.

-WFOEs for hire car services permitted.

-JVs for direct inter-city passenger business services permitted in Guangdong, Guangxi, Hunan, Hainan, Fujian, Jiangxi,Yunnan, Guizhou and Sichuan.

-Currently, only minority ownership in JVs permitted. (CEPA I: WFOEs passenger transport service in the Western China was permitted.)

-Currently, only JVs permitted to operate in certain tourist areas.

-CEPA I: only direct freight business service was permitted.

Maritime Transportation

-WFOEs permitted to provide supplies services (other than fuel and water) for ships owned or managed by their parent company.*

-WFOEs permitted to provide international shipping agency services for vessels owned or operated by their parent company.

-WFOEs permitted to provide cargo handling services.

-WFOEs permitted to provide certain services to feeders that operate between Hong Kong and ports in China that are opened to foreign vessels.*

-Currently JVs and WFOEs only permitted to self-owned or operated vessels.

-Currently only minority ownership in JVs permitted.

-Currently only majority ownership in JVs permitted.

-CEPA I: WFOEs permitted to provide such services for self-owned or operated vessels only.

Audiovisual Services

-WFOEs permitted to construct or renovate cinema theatres for operation of film screening business.

-Motion pictures co-produced by Hong Kong and China are permitted to be processed outside China.*

-WFOEs permitted to engage in distribution of PRC produced motion pictures in pilot areas.*

-Hong Kong and PRC co-produced television programmes permitted to be broadcasted and distributed in the same way as China produced programmes.

-Permitted to provide professional technical services relating to cable television networks in Guangzhou.

-Currently only minority ownership in JVs permitted. (CEPA I: Up to 75% ownership in JVs permitted.)

-Currently such motion pictures are only permitted to be processed in China.

-Currently not permitted.

-Currently no specific PRC laws regulate the broadcast and distribution of Hong Kong and PRC co-produced television programmes.

-Currently not permitted.

Banking

-Branches of Hong Kong banks in China permitted to engage in insurance agency business.*

-Branches of foreign banks in China NOT permitted to engage in insurance agency business.

Securities –Futures*

-Minority ownership in future brokerage JVs permitted.

-Foreign investment prohibited.

Construction and Related Engineering Services

-With effect from 28 August 2004 Hong Kong contractors with certificates of approval for establishing a Taiwan, Hong Kong or Macau-invested enterprise but which have not yet obtained a Construction Enterprise Qualification Certificate (the "Certificate") may apply before 1 December 2004 for a certificate for undertaking a single construction project.

-Previous experience inside and outside Hong Kong can be taken into account when applying for the Certificates.

-Residency requirement waived for Hong Kong permanent residents employed (as engineering technical and financial managerial staff) by foreign-invested construction enterprises ("Construction FIEs") established by Hong Kong contractors.

-No restrictions on the proportion of Hong Kong permanent residents employed as project managers by Construction FIEs established by Hong Kong contractors.

-Required to establish a Construction FIE in China and obtain the Certificate in order to engage in construction work in China. Foreign contractors cannot obtain single project approval for performing construction work in China.

-Only previous experience in China or previous experience outside China in a consortium with Chinese contractors or sub-contracting to Chinese sub-contractors can be taken into account when applying for the Certificate.

-Foreigners employed as engineering technical and financial managerial staff are subject to a 3 months per year PRC residency requirement.

-Number of foreigners that can be employed as PRC approved project managers cannot exceed 1/3 of the total number of required PRC approved project managers.

2.2 Qualifying for CEPA II Concessions

The details to qualify for CEPA II services concessions have not been formalized. However, they are not expected to be very different from the existing "Hong Kong Service Suppliers" requirements as set out in Annex 5 of CEPA I.

3. Conclusions

CEPA II offers additional benefits for Hong Kong services suppliers, companies with manufacturing operations in Hong Kong and multinationals with subsidiaries in Hong Kong in terms of better market access into China. In light of these additional benefits provided to Hong Kong manufactures and services suppliers, companies operating or intending to set up in Hong Kong should consider the following:

- Whether they can take advantage of CEPA I and CEPA II tariff preferences by structuring their manufacturing processes to satisfy the relevant rules of origin;

- Whether their existing Hong Kong entities qualify for CEPA I and CEPA II preferences relating to services liberalization;

- Whether the benefits of CEPA II may be enhanced by including new provisions in future CEPA negotiations, such as the liberalization of other services sectors or the reduction of tariffs on products outside the 1087 specified categories covered by CEPA I and CEPA II, and if so how these concerns can be best raised with the relevant government agencies.