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Shanghai's Free Trade Zone: What It Means to Retailers

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The FTZ is the first of its kind in mainland China and is part of a goal to develop Shanghai into a global financing and shipping center by 2020.

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As investors around the globe are aware, China's state council has recently launched a trial Free Trade Zone (FTZ) in Shanghai. Official guidelines are expected to be released in a few months. The FTZ is the first of its kind in mainland China and is part of a goal to develop Shanghai into a global financing and shipping center by 2020.

The new zone -- which will focus on the finance, logistics, and technology sectors -- will span 28.78 square kilometers in the city's Pudong New Area, including the Waigaoqiao duty-free zone, Yangshan deep-water port, and the international airport area. It's predicted that it will take more than 10 years to build.

For a period of three years, certain laws and restrictions relating to foreign investment will be suspended. For example, the government will allow the following:
  1. the unfettered exchange of the yuan;
  2. the establishment of foreign and joint venture companies;
  3. import quarantine and import/export inspection policies to be relaxed (for example, goods can be imported and re-exported without declaration to customs authorities);
  4. the establishment of privately funded financial institutions;
  5. a tax-free environment for domestic and foreign enterprises;
  6. the establishment of foreign-owned medical institutions and health-care insurance companies;
  7. the sale of video game consoles; and
  8. the use of Facebook (NASDAQ:FB) (this is dubious, see discussion below).
Although the regulations have not been defined, Singapore and Hong Kong will be used as reference points.

Impact of the FTZ: What Can Retailers Expect?

Many international companies have either been unable to bring business to China, or put off by investment barriers and approval procedures. These reforms will remove a number of burdensome regulations and encourage foreign retailers to launch their headquarters in China and thereby spur the growth of cross-border financial businesses. In 2012, cross-border online transactions reached 2 trillion yuan (approx. $326.8 billion) in China.

Two e-retailers have recently obtained licenses to operate in the FTZ. One e-tailer, Shanghai Kuajingtong International Co. Ltd, plans to sell a variety of products and make it easier for consumers to buy from international websites.

In addition to reduced setup costs, the reforms are also likely to reduce financing and logistics costs. For example, a domestic car manufacturer, Shanghai Automotive, estimates that its trade costs will be reduced by 20%.

There is also suggestion that existing retailers will benefit from the changes, as they do not need to operate from the FTZ in order to enjoy the benefits of it.

While it is clear that the FTZ will boost China's economy, it is also likely that the FTZ will have a negative impact on the market in Hong Kong. Chinese consumers are known to browse for goods in China and then go to Hong Kong, where prices are lower, to make purchases. In fact, only 20% of Chinese consumers buy their goods in mainland China. This is no surprise, given that prices in China are approximately 45% higher than in Hong Kong. Although exact numbers are unknown, it is probable that the prices of goods sanctioned within the FTZ will be similar to the prices in Hong Kong.

Interestingly, a contrasting view suggests that commerce will not necessarily shift from Hong Kong to Shanghai. Rather, overall business in both regions will increase. Either way, the FTZ will be benefit consumers by giving them better prices and access to products that have otherwise been unavailable in China.

The FTZ comes at a time when the government is trying to bring about an important shift: It would like to turn China's manufacturing-led economy into to a consumption-led economy. According to governement, the FTZ will "encourage Chinese export companies to expand their production capabilities to cheaper neighboring markets, and invest more on higher value front end and back end manufacturing processes." If successful, the model will be implemented in other regions.

Video Games

China's ban on the sale of video game consoles is set to be lifted within the FTZ. Companies such as Nintendo Co. (OTCMKTS:NTDOY), Microsoft Corporation (NASDAQ:MSFT), and Sony Corporation (ADR) (NYSE:SNE) will be required to register in the zone, and once registered will officially be allowed to promote their gaming products in mainland China, and sell video games in the FTZ. It has been suggested that a pre-condition to allowing the sale may be for the companies to manufacture the video game consoles within the new district.

China's entertainment and media industry is ranked as the world's fourth largest in revenue last year, after the US, Japan, and Germany. In 2012, the Chinese gaming market generated RMB 60 billion in sales (approx. 366 billion yuan), 56.9 billion (approx. 347 billion yuan) of which came from online games. China is ranked as the world's largest online gaming market. It will be interesting to see how this statistic changes as a result of the availability of video game consoles.

Video games were originally banned in China in 2002, as a result of the government's fear of the harmful effects on Chinese youth. Despite the government's newly relaxed approach, it is likely that video games will remain heavily regulated and censored.

However, many local gamers and expatriates alike can obtain consoles from other jurisdictions including Hong Kong. As such, there is already a booming black market of video game consoles in China. Given the new push by Microsoft to expand into the device market, with its acquisition of Nokia's devices business and its plans to open retail stores in China, the new FTZ could become a battleground for these video game companies to capture the enormous (and growing) China market.

Facebook

Like video games, Facebook and other social sites have been restricted within China due to concerns about the impact on social stability. Facebook was allegedly banned in 2009 as a result of its influence on the deadly riots in Xinjiang. However, there has been speculation that, in line with the government's liberalization policies, Facebook will be allowed within the FTZ. In addition, it has also been rumored that the government will lift the ban on other "inappropriate" websites including Twitter and the New York Times.

However, the likelihood of the government breaking down the Great Firewall of China at this point in time is low. Given the perceived risks associated with Facebook and other socially and politically sensitive websites, perhaps the government will wait some time before relaxing its grip completely. The FTZ is a big step forward for Shanghai and China, but it will no doubt take some time before China is truly able to operate on par with the international community.

David Hong is foreign legal counsel with King & Wood Mallesons in Shanghai. He is currently working with CRG, a multi-channel retail services company that assists retailers entering and expanding in China.
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