Entering the trillion dollar Chinese E-commerce market: The Good, the Bad and the Ugly

By José Izquierdo Fernández

Initially, Foreign-Invested Telecommunications Enterprises (FITE) were forbidden from investing more than 50% in Value-Added Telecoms Services (VATS), from which e-commerce businesses are part of. However, during the last decade there has been a progressive liberalization of the Chinese e-commerce sector gradually allowing foreign investors to hold higher stakes in these businesses. The final step in this process was the MIIT Circular 196, released in June 2015, which extended nationwide the Shanghai Free Trade Zone pilot program and allowed for the first time 100% of foreign ownership in certain e-commerce businesses. 

A worker puts imported goods on shelves at the Hangzhou Cross-Border E-Commerce Industrial Park in Hangzhou, capital of east China's Zhejiang Province, Nov. 10, 2015. Over 10 million imported goods have been stored at the Hangzhou Cross-Border E-Commerce Industrial Park by Nov. 9 ahead of the annual online sales campaign Singles Day which falls on Wednesday. [Photo: Xinhua]

However, this set of reforms did not substantially increase the access of foreign investors to the Chinese e-commerce market, as it is proven by the very low number of VATS licenses issued to Foreign Invested Enterprises (FIE). Paradoxically, during the same period of time, massive foreign investments have been directed towards the Chinese telecoms sector through the some-how informal channel of Variable Interest Entity structures (VIE). 

Then, if foreign investors are so interested in getting exposure to Chinese e-commerce businesses, even at the risk of not recovering their investment, why they are not setting up their own e-commerce platforms? Some say that in order to succeed in China’s e-commerce market the key is to sell through established Chinese channels. That would explain why foreign investors are happy to pour money in the –already deep– pockets of national champions (for instance Alibaba and JD), while they seem to be hesitant to invest in setting up brand-new foreign-owned e-commerce platforms. 

And… they might be just right. On December 27, 2016, the National People’s Congress of China released the draft of the forthcoming E-commerce law. The draft addresses a wide variety of issues related to e-commerce, from contract relationships and logistics, to electronic payment and unfair competition. But, most interestingly for foreign companies hoping to do business in China’s huge e-commerce market, the fifth section of the draft set the rules for cross-border e-commerce. 

The Good

After the past November 11 “Single’s Day”, it was clear that the Chinese e-commerce is going through a revolutionary period. Alibaba made USD 25.3 billion in gross merchandise volume just in one day, up 39% from last year. The rapid development of this sector, however, contrasts with the lack of regulation addressing it. The efforts from the public administration and the state to understand and organize this new market are very recent and, therefore, their results are still modest. 

The draft’s provisions fully-address this concern by stipulating that China will increase the digitalization of custom clearance and tax collection, inspection and quarantine procedures. This is good news for those importing foreign goods into China, since it is expected that the reforms will increase the convenience of the reporting mechanisms and speed-up administrative procedures. 

Also, since electronic receipts and certificates will have the same legal force as paper ones, red tape will become increasingly easier to deal with it. Therefore, those importing foreign products into China will be able to focus their fire-power in the much needed online-marketing and partnership-building rather than in keeping track of every receipt collected when dealing with customs administration. 

In addition, the second draft of the forthcoming E-commerce law issued on November 7, 2017, by the Standing Committee of the National People’s Congress focuses its attention on three key issues: privacy, termination of services and real name registration. In contrast with the first draft, the second just refers to the definition of personal information contained in the cybersecurity law. On the other hand, it keeps the same format to regulate termination of services -at least 60 days in advance- and real name registration –obligation to provide the identity and contact information of every person involved in e-commerce activities-. 

Thus, the second draft has undoubtedly simplified the first one by referring certain definitions to other pieces of legislation that already addressed the same concepts. Furthermore, it also provides for a –much needed– higher degree of protection for customers.

The Bad

The draft states that foreign business operators shall be subject to Chinese regulation, making special mention to the protection of personal information. It is not like they were not subject to Chinese laws before, nor that the explicit reference to personal information changes any-how the extensive obligations established in the recently published cybersecurity law. Still, the reference might indicate the intention of the Chinese regulator to start implementing such obligations seriously. So, dear passengers, please keep your seat belts fastened, we are crossing a zone of turbulence! 

The Ugly

The drafts do not dissipate the uncertainty that surrounds the activity of foreign investors. In order to operate a website in China, an Internet Content Provider license (ICP) is required, and for the latter, the company needs to be incorporated in China. Furthermore, ICPs are divided in commercial and non-commercial. The former is required in case the company wants to establish a company to sell its own products through its own website, while the latter is required for setting up a third-party platform (e.g. Alibaba).  

According to different sources, at the current moment “commercial” ICPs are vetoed for foreign-investment enterprises unless they have a majority Chinese partner –and even then, they are extremely hard to get-. On the other hand, after the MIIT Circular 196 referred above, non-commercial ICPs are an option for big-enough companies wanting to sell their products without resorting to third-party platforms. 

The ugly part is that the second draft of the long-time expected Chinese E-commerce law does not seem to suggest that this situation is going to vary. Therefore, it seems that for most foreign companies, the wisest choice will still be to open a (web)shop on a third-party platform such as Tmall, JD.com (B2C), Alibaba or Taobao, and that e-commerce third party platforms will continue to be dominated by the giants that currently run the sector. 

(José Izquierdo Fernández is Robin Li Scholar at the Yenching Academy of Peking University. José is a certified Spanish lawyer specialized in corporate law and cross-border M&A. )